By: Allen E.F. Rozansky, JD/MBA
As our devoted blog readers know, Estate ProtectionTM is not just estate planning but also includes keeping an eye on, and planning to reduce, your income tax exposure through income and capital gains tax planning.
There has been (and, surely will continue to be) much debate about whether the changes to the U.S income tax system by Congress and President Trump late last year (the “2017 Tax Act”) will be beneficial and if so, to whom. But one thing is for sure – as a result of a couple of different changes, the 2017 Tax Act may benefit those taxpayers who are (1) 70-years old or older, (2) desire to make charitable contributions, and (3) are required to take minimum distributions from their individual retirement accounts (“IRAs”).
Standard vs. Itemized Deductions?
Under the United States tax system, taxpayers have the choice of reducing their taxable income by either itemizing certain deductions or by using the “standardized deduction”. Under the 2017 Tax Act, the number of expenses that a taxpayer may take as an itemized deduction has been reduced. In addition, the personal exemption deduction ($4,050 per person) has been eliminated. However, the amount of the standard deduction was almost doubled in the 2017 Tax Act to $24,000 for a married couple filing jointly and to $12,000 for individual taxpayers. Thus, those taxpayers whose itemized deductions (under the new 2017 Tax Act rules) total less than that $24,000 or $12,000 level will most likely take the standard deduction, resulting in a lower taxable income and a lower federal tax bill.
It should be noted that charitable contributions can still be included in a taxpayer’s itemized deductions under the 2017 Tax Act. However, the amount of charitable contributions that a person can take as an itemized deduction is limited. In general, the amount you can include in your itemized deductions each year for charitable contributions can’t be more than 50% of your adjusted gross income. In addition, the amount that may be included in your itemized deductions may be further limited to 30% or 20% of your adjusted gross income, depending on the type of property you donate and the type of organization to which you are giving. For those with smaller income levels, this may substantially limit the portion of charitable contributions that may be used to reduce the amount of federal income tax owed.
Taxation of IRAs
As most owners of an IRA understand, starting after the age of 70, an IRA owner must take a required minimum distribution (RMD) from the IRA each year. The amount of that RMD is determined by how much is in the IRA and the owner’s age. If the RMD is made from a traditional IRA (as opposed to a Roth IRA) the amount of the distribution will be included in the owner’s taxable income. These rules did not change under the 2017 Tax Act.
Also, it is important to remember that, if you pass away with funds remaining in your IRA, those funds will be included in your taxable estate and could be subject to the 40% federal estate tax. Most Americans will not be as concerned with how much is in their taxable estate, given that the federal estate tax exemption (known as the “Basic Exclusion Amount”) was increased under the 2017 Tax Act from $5,490,000 per person (or approximately $11,000,000 per couple) to $11,180,000 per person or $22,360,000 per couple (which numbers are scheduled to increase to $11,400,000 and $22,800,000 in 2019 and continue to increase with inflation through 2025). However, the estate taxes should not be completely ignored. For starters, the increase in the Basic Exclusion Amount under the 2017 Tax Act only goes through 2025. In 2026, the amount will return to $5,490,000 per person and $10,980,000 per couple (but still increased with inflation), unless Congress takes some action in the meantime to make the increase permanent (the House of Representatives recently passed a bill making the increase permanent but the Senate has not, yet, considered that bill) or otherwise change the amount (at least one Democratic Senator has proposed reducing the Basic Exclusion Amount to the amount it was in 2009 - $3,500,000 per person – at the 2009 estate tax rate – 45%). If an IRA owner ignores the federal estate tax and the amount is reduced, either because of Congressional inaction or by a new Congress with a different view of the estate tax, the IRA funds could be needlessly taxed at the 40% estate tax rate (or higher)
Qualified Charitable Deductions
One income tax advantage that was not eliminated by the 2017 Tax Act, however, is the Qualified Charitable Deduction (“QCD”). Under the QCD rules, a taxpayer who is 70-years old or older may direct the trustee of his or her IRA to make a transfer to one or more charities directly from the IRA (as opposed to a distribution from the IRA to the taxpayer and then from the taxpayer to the charity). Under the QCD rules, the amount of the distribution will not be included in the taxpayer’s taxable income. In addition, even though the taxpayer did not receive the distribution, it will count against the taxpayer’s RMD.
It is important to note that, to offset this exclusion from income, the QCD rule provides that the amount of the charitable distribution will not be deductible by the taxpayer against his or her income. However, this may not be a disadvantage under the new 2017 Tax Act rules. It may be that the amount of the charitable distribution is not enough to cause the taxpayer’s itemized deductions to exceed his or her standard deduction. Thus the charitable deduction may not be needed.
As a result, the taxpayer taking advantage of the QCD rules will be able to make a charitable donation, using money that would otherwise cause his or her taxable income to increase, meeting his or her required minimum distribution, reducing the size of his or her taxable estate, and still get to take advantage of the new, higher standard deduction. If instead, the taxpayer had received the distribution him or herself and then donated the cash to charity, his or her income would increase upon receipt of the distribution and the charitable deduction would be lost, since it did not increase his or her itemized deductions enough to exceed the standard deduction amount. If you, or a parent or grandparent, are 70-years old or older, have an IRA, and are considering making one or more charitable gifts, a Qualified Charitable Distribution should definitely be considered.
Mallon Lonnquist Morris & Watrous, LLC is a strategic business law firm located in Denver, Colorado, with practice focused in all major aspects of business, real estate, financial transactions, estate planning, tax, and related litigation. Allen E.F. Rozansky, JD/MBA is Senior Estate & Tax Counsel to the firm. Allen regularly represents clients in Estate ProtectionTM matters, including estate, income and capital gains, and asset protection planning, as well as business entity formations and operations, probate and estate administration, and probate and trust litigation. Allen can be reached by e-mail at email@example.com or by phone at (303) 722-8305.