Michael Kitces is a partner and the director of wealth management for Pinnacle Advisory Group, co-founder of the XY Planning Network, and publisher of the continuing education blog for financial planners, Nerd's Eye View. You can follow him on Twitter at @MichaelKitces.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The recently enacted tax legislation makes it much less likely that many taxpayers will itemize their deductions. Joining me to discuss what's going on with deductions as well as some strategies for taxpayers to consider is Michael Kitces; he's joining me via Skype.
Michael, thank you so much for being here.
Michael Kitces: My pleasure. Thanks for having me.
Benz: Many of these tweaks mean that for many taxpayers the standard deduction will be larger than their itemized deductions, but when you talk to clients and kind of think about strategizing, do you believe that there are some opportunities to potentially cluster your itemized deductions together in certain years and potentially get more bang for those itemized deductions and actually find some years where your itemized deductions exceed the standard deductions? Can you talk a little bit more about that strategy?
Kitces: I think we're going to see a lot more focus on this; lower SALT caps, lower mortgage deductions, the giant category of miscellaneous itemized deductions subject to 2% floor are all gone--that had everything from tax preparer fees, investment advisory fees, unreimbursed employee business expenses--most of these have gone away. Because of that a lot of people may not be over the standard deduction every year, but they might get there if they bunch some of their expenses together. We call this a deduction lumping and charitable clumping. Trying to take various deductions we have and mash them all together in single years to see if at least in one year we can jump over the line.
Now unfortunately because we lost miscellaneous itemized deductions and the other categories are more curtailed, it will be hard for us to do this because we are going to keep bumping into some of these caps. But for anybody that is not all ready at the $10,000 cap for SALT deductions this means you are going to just focus more on the timing of your state estimated tax payments. The timing of your property tax payments if you are in a county that actually allows you to prepay your property taxes. You might, say, prepay your 2019 property taxes and pay your 2020 property taxes all in 2019, so that you can try to get over the line in that particular year or at least make sure you are using all of the $10,000 cap.
For a lot of folks the primary way they'll do this actually is with what we call charitable clumping. So taking charitable contributions, if you give regularly to a charity, saying, instead of giving our regular annual gift we're actually going to do several years worth of gifting upfront into a donor advised fund, where we can get the deduction all at once in one year try to get over the standard deduction line. Then if we only want to gift certain dollars out every year, we will give the money out incrementally over time from the donor advised fund to the charity we're trying to give it to. And so it gives us an opportunity to bunch the deductions together but then still spread out the charitable giving over whatever timing we otherwise want to do it.
Benz: You mentioned donor advised funds Michael, let's just quickly recap what those are for people who aren’t familiar with them and how they can be such a nice fit for people who want to do this charitable clumping that you are talking about.
Kitces: The basic idea of a donor advised fund is, you can think of it like a holding tank for your charitable contributions. When you put money into the funds, you get a charitable deduction as though you were giving to charity, but the money doesn't actually leave the fund and go to a charity until you direct the funds to make the distribution. It gives me a way to put lots of money in now if I want to get all my deductions at once, but then have the donor advised fund dole the money out to my actual end charities--my church, my synagogue, my arts organization, whatever it is--over time. If you know you make regular gifting anyway and you have plans to keep doing it, rather than giving $500 a year or $1,000 a year or $10,000 a year or whatever you are giving number is, try to do more of it all at once in a single year so you can get over the line and get more of a deduction, and then make the distributions out of the donor advised funds whenever you actually want the charity to get the money.
Benz: In the meantime as long as the money stays within the donor advised fund it can earn at least some return that will not be taxable to you because it doesn't belong to you anymore nor will it be taxable to the charity.
Kitces: Right. If you have some money that you are setting aside and earmarking toward charity anyway as long as it's yours it's taxable. When it grows inside of a donor advised fund, it actually grows tax-free because it is all earmarked for charity at this point. You can get a little bit more leverage out of the dollars as well as you are building them up to donate in the future.
Obviously with the caveat for any of these strategies, you have to have the cash available to do it in the first place. We see people taking more of a focus on just timing of cash flows, can they afford to do things like prepay taxes and even when we are looking at strategies like charitable clumping--well maybe I don’t have the cash flow to do several years of charitable giving upfront, but I could donate an appreciated stock into my donor advised fund, get a tax deduction, and then repurchase the stock with the money I would have given to charity over the next few years. Eventually I end up at the same place, but I lump the deduction into one year in order to get the deduction through.
Benz: Lots of moving parts, obviously, Michael. Thank you so much for being here to provide some guidance on these issues. It sounds like this is also a spot where a financial advisor or a tax advisor could probably give you a lot of good insights about your next steps.
Kitces: Absolutely. I think we're going to see a lot more effort in looking at multiyear tax planning going forward as we try to plan out, when are the cash flows coming and which years can we get over the standard deduction line and which years can we not, particularly for married couples. Because that lower SALT cap is a pretty big gap to where married couple standard deductions are, especially married couples that don't own a home.
Benz: Great point. Thank you so much for being here, Michael.
Kitces: Absolutely, my pleasure.
Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.