Charitable Contributions: Potential Impact on Section 199A
Posted on 06.07.18
By Mark Hodges, CPA | Family, Executive & Entrepreneur Advisory Services Team
The Tax Cuts & Jobs Act (TCJA) passed in December 2017 provides for a new…highly beneficial…tax deduction pursuant to Section 199A which is generally 20 percent of the individual’s domestic qualified business income. There are some exceptions, however, and one of main exceptions relates to an exclusion for income from a specified service trade or business, which may trap many taxpayers. Many taxpayers are questioning whether their business activities will fall under the broad definition of a specified service trade or business for purposes of calculating the new Section 199A pass-through deduction. The TCJA currently defines a specified service trade or business as those in the field of law, accounting, financial services, and several other enumerated fields, or where the business’s principal asset is the reputation or skill of one or more owners or employees. If a business falls under this definition, there may be limited or no deduction provided by Section 199A. Good news, however, there may be several planning opportunities if you find your business activity falling under the category of a specified service trade or business which will allow you to still take advantage of the new Section 199A and the related tax savings. This article will briefly discuss strategies focused on charitable contributions. Keep in mind that the value of these strategies will depend on your individual tax situation.
Traditionally, charitable contributions reduce taxable income and save tax by providing taxpayers with an itemized deduction. With the new tax law in effect, charitable contributions may provide additional benefits related to the Section 199A deduction. The phase-out for the Section 199A deduction is based on taxable income versus Adjusted Gross Income (AGI). As a result, charitable contributions can be utilized to decrease your taxable income and potentially allow taxpayers to qualify for part, or potentially all, of the 20 percent deduction. In certain situations, the combined cash outlay for charitable contributions and calculated tax will be less than the tax due had there been no charitable contribution. In other words, you can pay less (tax plus charitable contributions) when contributions pull you back into that phase-out range.
Since the Section 199A deduction is calculated at the individual level, an opportunity arises for certain individuals owning pass-through entities with Qualified Business Income (QBI) to qualify for the 20 percent deduction when individual taxable income would normally reduce or eliminate the deduction. For 2018, the 20 percent deduction will be limited or phased out when taxable income falls between 315,000 and 415,000 dollars for Married Filing Jointly taxpayers (157,500 and 207,500 dollars for Single taxpayers). If the taxpayer’s taxable income falls between the ranges above, then a percentage of the total phase-out range will apply when calculating the components of the 20 percent deduction.
Strategies to reduce taxable income and/or increase charitable contributions
- Taxpayers who are required to withdraw from their Investment Retirement Accounts (IRAs) due to Required Minimum Distribution (RMD) rules stand to benefit if they receive qualified business income from a pass-through entity. Taxpayers can use a Qualified Charitable Distribution, up to 100,000 dollars, as their RMD to prevent inclusion of this amount in taxable income. Keep in mind that the contribution is not additionally reported on Schedule A as a charitable contribution, but it is permanently removed from taxable income. This planning strategy has the added benefit of reducing AGI and may also help to minimize Net Investment Income tax.
- A donor advised fund (DAF) may be utilized to provide a large charitable deduction in a single year without actually directing funds to specific charities in the year of contribution. This gives the donor discretion in directing the funds to various charities in the future while claiming the tax deduction in the year of contribution. This can be especially helpful to taxpayers who want to make larger contributions during their working years and can then make the donations out of the DAF on a more regular basis, even into retirement. Reducing income through increased charitable contributions while working may help taxpayers to qualify for the Section 199A deduction. This strategy may become more widely used as taxpayers group multiple years of charitable deductions into a single year in order to surpass the increased standard deduction threshold for certain tax years.
With a DAF, taxpayers may consider contributing marketable securities that have appreciated substantially in addition to cash contributions. The charitable contribution will be for the current fair market value of the contribution, not the original cost basis. This will permanently prevent inclusion of the capital gain in taxable income. Additional details on this strategy.
- For taxpayers who will already surpass the maximum allowed itemized deduction of 10,000 dollars for state and local taxes, the Neighborhood Assistance Program (NAP) provides multiple tax benefits. In addition to generating a charitable donation deduction, Virginia allows a state tax credit in an amount equal to 65 percent of the value donated to an approved organization. Taxpayers utilizing this strategy decrease their income through increased charitable contributions while also receiving an additional state benefit, the tax credits. This effectively shifts the state income tax deduction (which is limited to 10,000 dollars) to the unlimited charitable contribution deduction. Read more on NAP credits.
Keep in mind that there are still limitations on allowable charitable deductions under the new tax law. See below for detail on the types of contributions and the respective limitation percentages. Charitable contributions can be carried forward for five years if limited in the year of contribution due to Adjusted Gross Income.
|Type of Contribution||Public Charity||Private Foundations/Non-Operating Foundations|
|Cash||Limited to 60% of AGI*||Limited to 30% of AGI|
Capital Gain Property
(Marketable securities held for more than a year)
|Limited to 30% of AGI||Limited to 20% of AGI|
|*Cash contributions to public charities were previously limited to 50% of AGI, the Tax Cuts & Jobs Act increased this to 60% AGI.|
When looking at opportunities to decrease taxable income, Congress has greatly limited options available prior to the TCJA. With the new law limiting state and local tax deductions to $10,000 and placing limitations on deductible mortgage interest expense, charitable contributions are one option available to taxpayers to decrease their taxable income while accomplishing their charitable intentions. When looking closely at specified service or trade business owners, these contributions can be significantly more valuable to help keep taxable income below the thresholds and maintain the Section 199A deduction which is generally 20% of the individual’s domestic qualified business income.
Although the strategies mentioned above will not be effective for all individuals, there could be significant tax savings available by making additional charitable contributions in the coming years. Questions regarding planning opportunities? Please reach out to your Keiter representative or 804.747.0000 | Email.
Charitable Contributions: Changes with New Tax Law
Understanding the New Section 199A Pass-through Deduction
Individual Tax Planning: Neighborhood Assistance Program (NAP) Credit Benefits
Tax Cuts and Jobs Act Overview
Tax Cuts and Jobs Act Resource Guide