As you all probably know, a new tax law was enacted toward the end of December 2017 and took effect in 2018. There are some fundamental changes that will change how we see taxes, and they will affect the economy and decisions we make. We have all been talking about the ability to save money with 529 accounts. There is another part of the law, however, that has a far bigger effect on the frum community – and that is the ability to deduct charity. I’m not sure why we are not hearing more talk in the community regarding this one.
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What is income tax? What are tax deductions? How does it all work? Let’s review the basics of the old law. Step one: You add up your income. Step two: You deduct either a standard amount or your itemized list. Step three: You deduct (approximately) $4,000 for each person in the family. The result was your “taxable income.” You then paid a percentage of your taxable income in tax.
What changed: In the new law, you do not get to claim dependents. Kids are history – well, not exactly. In lieu of deductions for dependents, you get a child tax credit of $2,000 per child under 17 and $500 for other dependents.
Now let’s look at itemized deductions. The itemized deductions are: 1) medical expenses over 7.5% of your income, 2) real estate taxes, 3) state income taxes, 4) mortgage interest, and 5) charity. If the sum of these totals more than the standard deduction, you would claim the total instead of the standard deduction. That is called “itemizing.” Bottom line is that when people owned a house they generally itemized. Even a few non-home owners itemized if they had high state taxes and high charity.
You do not get to claim both the standard and the itemized deduction. It is one or the other. Obviously, you should itemize if it is higher. But if your itemized list is lower than the standard deduction, then you claim that. Now, here’s the important part: In the past, it was not hard to exceed the $12,600 standard deduction. The new law, however, is a whole different ballgame. The new law increased the standard deduction to $24,000. And, although the items included in your itemized deductions generally stay the same, state income taxes and real estate taxes combined cannot be more then $10,000. Ouch!
With this increased standard deduction, fewer people will itemize. Those whose itemized deductions amount to less than $24,000 will simply take the standard. Here’s the catch: By claiming the standard deduction, you are getting no tax benefit from deductions, such as mortgage or charity. Your tax liability is the same whether or not you give charity.
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Let’s consider an example. I am assuming that you own a house. (If you don’t, you will almost certainly not itemize.) Your real estate taxes and state income taxes (hereafter SALT: state and local taxes) will be capped at $10,000. You still need to come up with an additional $14,000 in deductions to even start to see a benefit! If your house is paid off, you will have a challenge. Let’s assume you have a mortgage of $300,000 at 4%. That means that your interest deduction is $12,000 per year. Okay, we are up to $22,000. You give charity of $7,000 per year. Your itemized deductions therefore come to $29,000 (SALT, $10,000; interest, $12,000; and charity, $7,000.). Since $29,000 is higher than $24,000, you will naturally claim the higher amount. However, your benefit is only on the last $5,000 spent. That is because you would get a deduction of $24,000 even if you did nothing. The benefit of those itemized deductions, therefore, is only your tax rate times $5,000. In the past, we told people that they would save federal income taxes by buying houses and giving charity. Under the new law, you will save nothing (if you take the standard deduction) or less than you assumed (if you itemize). Remember that many wealthy people do not have mortgages at all, so they will need to spend at least $14,000 on charity to even begin to save a dime from charity.
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Some new strategies will allow you to still save taxes by giving charity. The first among them is bunching deductions – that is, giving charity every other year. I did an article on this last year, but it is now in the front-and-center of tax planning.
Here’s an example: A couple has $10,000 in SALT, $10,000 in mortgage, and $10,000 in charity. This adds up to $30,000, so they will itemize. But they would save more taxes if – instead of giving $10,000 charity each year – they gave $20,000 every other year. They are claiming a total deduction of $30,000, but they automatically get to claim $24,000, so they are only benefiting from the last $6,000 year that takes them over the standard.
The only deduction that we can “play” with is charity. If this couple gave $20,000 every other year, they would benefit from an extra $4,000 of lower taxable income. If this couple had a lower mortgage – or no mortgage at all – then the savings from bunching might be even more pronounced!
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Some of you might be asking, how does one practically give charity every other year? There are a couple of ways. Of course, you need to have cash available for this to work. Living hand to mouth is a problem. Here are some strategies:
1) The simple way: Just give charity every other year. The shuls and schools will be happy to accept your money and apply it to whatever pledge you want. No big deal.
2) The complicated way: There is something called a donor advised fund. It works like this: You give charity to a fund managed, say, by the Associated Jewish Charities. The money stays with them, and they will disburse to charities in future years according to your wishes. If you are donating a lot of money, this makes sense. These funds are usually used by the very wealthy who donate very large sums – potentially millions. In my humble opinion, however, if you are just donating an extra $5,000 or $10,000, a donor advised fund seems like overkill. And they do involve some paperwork.
3) The Agudah scrip way: Agudah scrip is coupons that you buy and that can be given to charities in town just like real money. The concept behind scrip is that a portion of your charity to meshulachim and others is given to the schools. How does scrip help you? Let’s say that, at the end of 2018, you donate $2,000 to the Agudah. You will get the donation for 2018, and you can disburse those coupons whenever you want. All local organizations, schools, shuls, and meshulachim accept them. I imagine you could say to the Agudah that you will donate $6,000 at the end of 2018 and request delivery of $500 in scrip each month for the next 12 months. By the way, everything is handled by volunteers, and the Agudah does not take any of the money.
4) For those over age 70-and-a-half, there is an important loophole. You can give money directly from an IRA to a charity. This allows you the benefit of a tax deduction even if you do not itemize. This is really important and critical to tax planning for those in this age bracket. Now, for those with a 401k, it is not allowed – but there is a workaround. You can indirectly give money from a 401k to a charity. First you must “roll” the money to an IRA and then give it to a charity. You still have to take the RMD, the required minimum distribution, from the 401k, so, as you can see, this is getting complex.
This same bunching trick used to work for real estate taxes, where you would prepay your real estate taxes during some years. But the IRS announced (at the end of December 2017) that you generally cannot prepay real estate taxes! Many have asked whether the IRS is authorized to say this and whether it is a binding rule. The IRS ruling makes reference to a real estate bill “assessed,” and it has particular significance for Marylanders whose houses are “assessed” every three years.
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The question arises about whether it is good to have a mortgage to help you top the standard deduction and itemize instead. The answer is too complicated to summarize, but I would generally advise you to have a 30-year mortgage and not pay it off early. Any other approach would require a careful analysis.
That said, living mortgage-free has great benefits and is the cornerstone of the advice given out by the radio financial guru, Dave Ramsey. A caveat: Ramsey’s advice is sometimes too simplified and, arguably, objectively wrong. However, the goal of being debt-free has great merit. The mortgage issue therefore requires serious number crunching and, indeed, soul searching. Oh – one more thing – if Dave Ramsey had to advise frum families on finance, he would have a nervous breakdown.
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Miscellaneous points:
- People still need to know who their tax dependents are in order to claim day care, college, and medical expenses associated with those dependents.
- How the state of Maryland income taxes will connect with all this is beyond the scope of this article, but the state government has committed to not raising Maryland taxes as a result of the tax law change. In general if you cannot itemize on the federal, you cannot itemize on the state. Therefore, you default to the Maryland standard deduction, which is pretty low. I will try and do an article just covering Maryland taxes.
- Some people might want to gift their charity dollars to a friend or relative who is itemizing so at least someone gets a tax break. That person will officially give the money to the charity and get the deduction.
- The Agudah makes no claim as to the tax deductibility of the scrip program. Talk to a tax advisor.
- The timing of marriages can have great importance. Make it “O’taxes” before you make it “O’fishel.”
As you can see, the future is complicated, but clearly, we need to pursue every avenue to benefit from the tax laws that now exist. What I state here is a quick synopsis of the current approach and not a substitute for talking with a tax advisor.
Eli Pollock CPA can be reached at elipollock2@yahoo.com. Agudah scrip can be purchased from many members of the community as well as at shuls and many schools. For more information, call Simcha Kossman: 410-358-8687.
