by Robert F. Sharpe, Jr.
A look at how four couples may be impacted by the Tax Cuts and Jobs Act of 2017.
Now that the dust is settling from December’s major tax overhaul, it’s time to start getting a better fix on who was negatively impacted, who was relatively unaffected and who benefits from the combination of higher standard deductions, lower tax brackets, expanded amounts of charitable gifts that can be deducted and repeal of limitations on charitable and other deductions.
Those who feel the pinch
Kathy and Alan are both over age 65 and comfortably retired. They enjoy an income of over $200,000 per year. Their home is paid for, so they have no mortgage interest deduction. Their state income tax is $12,000 and property taxes are $8,000 per year. They make charitable gifts of $5,000 per year.
Last year their total deductions of $25,000 substantially exceeded their standard deduction of $15,200, and their charitable gifts were thus fully deductible against a 28% marginal tax rate, saving $1,400 in taxes.
This year their deductions, now totaling $15,000, will be less than their new standard deduction of $26,600,* and they will no longer be able to deduct their charitable gifts.
In their new 24% tax bracket, it will now require nearly $6,600 in pretax income to make the same gifts that required pretax income of just $5,000 last year. Keep in mind, however, they will have $11,400 less income subject to tax on account of their higher standard deduction and they will enjoy additional savings due to their lower tax rate.
Despite the increased cost of their gifts, they plan to continue making gifts of the same amount as before, as they have lifelong relationships with the charities they support. They doubt, however, that they will start any more significant philanthropic relationships in the near future.
Note the situation would be different if Kathy and Alan were single. That is because the standard deduction is only $13,600 for single taxpayers over 65, and the $10,000 cap on state taxes applies to both single and married taxpayers. As a result, many more single donors will be able to clear the standard deduction “hurdle” and will continue to itemize all or a portion of their charitable gifts.
Relatively neutral impact for others
Let’s look at another example. Cindy is a nurse supervisor and makes $83,000 per year. Jim is a police captain earning $81,000. They pay state income tax of $7,900 per year. They pay mortgage interest of $14,964. Their property taxes are $6,300. Their property and income taxes exceed the aggregate limit of $10,000, so they are “capped” at that amount.
Their itemized deductions without making charitable gifts amount to $24,964.
Under this example, they would be better off itemizing their deductions as their deductions slightly exceed their standard deduction amount
Note the $24,974 figure does not include their charitable gifts. They make total gifts to a number of charitable interests totaling $7,500 per year. Because their “fixed” deductions already exceed their standard deduction, they are able to fully deduct their charitable gifts, the same as under prior law.
The difference is that in 2017 they would have deducted their gifts against a 28% rate, saving them $2,100 in taxes. In 2018 their marginal tax rate will be 24%. Their tax savings would decrease by $300 to $1,800. They do not plan to significantly alter their charitable giving plans due to this change.
Let’s look at the impact on a higher-income couple. Consider the case of John, a corporate executive making $750,000 per year, and Sara, an architect making the same amount.
They have a $1.5 million mortgage on their home and pay $67,000 in interest, $44,000 of which is deductible given the $1 million mortgage limit for interest deductibility. (The maximum mortgage for which interest can be deducted is reduced to $750,000 for mortgages incurred after 2017.) Their state income taxes are $75,000 per year, and their property taxes are $25,000. They also make annual charitable gifts totaling $25,000.
Under prior law their total deductions were $169,000. They were not, however, allowed to deduct this entire amount in 2017 because the Pease Limitation required them to reduce their total itemized deductions by 3% of the amount their income exceeded $313,800, or $35,586.
Under the new law, their deductions will be reduced to $10,000 worth of state and local taxes and their mortgage interest deduction of $44,000. Along with their $25,000 in charitable gifts, they will still have total deductions of $79,000. Because the Pease Limitation is repealed, they will not have to reduce this amount.
Their new standard deduction is $24,000. Even without their charitable gifts, the $54,000 in other deductions places them well above the $24,000 standard deduction.
Under prior law they would have deducted their gifts against the highest tax rate of 39.6%, saving them $9,900 in taxes.
Under the new law, the maximum tax rate is 37% and their gifts will save them $9,250 in taxes. They have no plans to alter their giving patterns as it requires no additional income to make the same gifts; furthermore, the after-tax cost of giving $25,000 increases by only $650.
The principal winners
Some higher-income individuals making larger gifts will actually see the cost of their gifts decline under the new law.
Take the case of Lewis and Melissa. Their AGI is $2 million. They have an outstanding capital gift pledge of $300,000 to a campaign where Lewis is on the steering committee.
In 2009 they decided to “take a flyer” and invested $200,000 in Ford Motor Company stock. It is now worth $1 million. Their state and federal capital gains tax liability would be over $250,000 if they sold the stock.
The couple decides instead to use $300,000 worth of the stock to satisfy their pledge. Their mortgage interest and state income taxes are sufficient for them to itemize their deductions. Their $300,000 gift is thus fully deductible as it does not exceed the 30% of AGI limit for gifts of appreciated assets.
They were surprised to learn that their tax savings from this gift will actually be greater in 2018 than in the past. How is that possible?
Had they made their gift last year, the Pease Limitation would have required them to reduce their itemized deductions by $50,586 (3% of the amount their income exceeds the Pease threshold of $313,800).
Their net deduction of $249,414 would have been deducted against the 2017 maximum tax rate of 39.6%, saving them some $98,768 in federal taxes.
Because the Pease Limitation was repealed by the 2017 tax legislation, they will be able to take the full $300,000 deduction in 2018. This will be deducted against the 2018 maximum tax rate of 37%, and yield tax savings of $111,000, which is $12,232 (or 12%) more than what their 2017 savings would have been.
These examples illustrate that nonprofits will experience the impact of recent tax legislation differently depending on the demographics of their constituency. Next month we will explore a number of ways donors who are negatively impacted can make changes in the way they give to restore prior tax benefits. ■
Robert Sharpe is Chairman of Sharpe Group.