DAFS, QCDS, ROTHS AND 2019 TAX PLANNING-2020 IS COMING

Hope everyone had a great Halloween. Now, it’s time to finish your 2019 Tax Planning. You know the drill. You can’t extend December 31st– it’s the last day to get major tax planning resolved and implemented. This year we will focus on three key areas; Donor Advised Funds, Qualified Charitable Distributions and Roth accounts. And, then finish with some overall points to remember.

Donor Advised Funds (“DAFs”). For charitable gifts, this simple, tax-smart investment solution has become a real favorite, particularly starting in 2018. The concept of DAFs is that taxpayers can contribute to an investment account now and get a current deduction yet determine in the future where and when the money will go.

The Tax Cuts and Jobs Act of 2017 increased the standard deduction (up to $24,400 in 2019 for married couples). Couples with itemized deductions less than the standard deduction receive no tax benefit from their contributions. However, they could get a benefit by “bunching” their contributions using a DAF.   For example, if a couple made annual charitable contributions of $10,000 per year, they could contribute $40,000 to the DAF in 2019, e.g., and certainly, in that case, their itemized deductions would exceed the standard. The $40,000 would be used as their charity funding source over the next four years. In this manner, they would receive the full $40,000 tax deduction in 2019 for the contribution to the account, though they will not receive a deduction in the years after for the donations made from this account.

Now, what’s really great about a DAF is that if long-term appreciated securities are contributed to the DAF, you won’t have to pay capital gains taxes on them and the full fair market value (not cost) qualifies as an itemized deduction, up to 30% of your AGI. Why use after tax dollars for charity, when you can use appreciated securities?

Within the DAF, your fund grows tax-free. You or your wealth manager can manage the funds. The funds are not part of your estate. However, you advise your custodian, such as Schwab, the timing and amounts of the charitable donations. In general, your recommendations as donor will be accepted unless the payment is being made to fulfill an existing pledge or in a circumstance where you would receive benefit or value from the charity, such as a dinner, greens fees, etc.

Many taxpayers are using the DAF as part of their long-term charitable giving and estate planning strategy. They annually transfer long-term appreciated securities to a DAF, get a nice tax deduction, allow the funds to grow (unlike Foundations which have a 5% minimum distribution, there are no minimum distributions for DAFs) and then before or after their passing, the charities they support receive the benefits.

Qualified Charitable Distributions (“QCDs”). A QCD is a direct transfer of funds from your IRA to a qualified charity. These payments count towards satisfying your required minimum distribution (“RMD”) for the year. You must be 70 ½ years or older, you can give up to $100,000 (regardless of the RMD required) and the funds must come out of your IRA by December 31. You don’t get a tax deduction, but you make charitable contributions with pre-tax dollars. Each dollar in QCDs reduces the taxable portion of your RMD, up to your full RMD amount.

For taxpayers 70 ½ or older, their annual charitable contributions generally should be QCDs and if their gifting exceeds their RMDs, they can either do QCDs up to $100,000 annually or, instead of QCDs,fund a DAF with long-term appreciated securities and bunch the contributions to maximize the tax deduction.

Roth Accounts. A Roth IRA is a tax-advantaged, retirement savings account that allows you to withdraw your savings tax-free. Roth IRAs are funded with after-tax dollars. They grow tax-free and distributions of both principal and interest are tax-free. Roth IRAs do not have RMD requirements that traditional pre-tax IRAs have. They can be stretched by spouses and beneficiaries without tax. They are the best type of account that a beneficiary could receive upon your passing.

A taxpayer can convert an IRA to a Roth account anytime, regardless of age or income level- the IRS is happy to get your money. A Roth conversion is especially appealing if you expect to be in a higher marginal tax bracket in retirement. Conversions make sense when taxable income is low or negative. In addition, some couples interested in Roth conversions make DAFs in the same year to keep their taxes where they would have been without the conversion or the DAF.

2020 is coming. You still have almost two months to resolve your 2019 tax planning and get it implemented. Make sure you and your CPA review your situation before year-end to make sure you understand your likely tax status and review possible strategies that could help you. At DWM, we don’t prepare tax returns. However, we do prepare projections for our clients based on our experience and knowledge to help them identify key elements and potential strategies to reduce surprises and save taxes. Time is running out on 2019. Don’t forget to do your year-end tax planning. And, of course, contact us if you have any questions.

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Obamacare Court Decision May Impact Roth Conversion

Roth Conversions and ObamacareOn June 28, the Supreme Court affirmed Obamacare. Numerous tax changes were included in the law. Some have already gone into effect and others are scheduled to kick in over the next several years. A new 3.8% surtax on investment income will start on January 1, 2013. Capital gains rates will increase from 15% to 18.8%. And, if Congress allows the Bush tax cuts to expire, the top rate would be 23.8% on capital gains and 43.4% on dividends.

Advisers and investors are now looking at ways to accelerate income into 2012 and considering other long-term strategies, such as converting a regular IRA into a Roth IRA.

Regular IRAs have been characterized as “deals with the devil” that taxpayers make with the IRS. Money invested is not taxed when contributed but later, after the amounts have grown over the years, and then the tax is based on the full amount of the IRA, including earnings, at the then current tax rates. 

With a conversion to a Roth, a taxpayer ends the “arrangement.” Taxes are paid on amounts not previously taxed. The taxpayer can continue to grow the Roth account from that point without tax and pay no tax at the time of distribution(s). Furthermore, the taxpayer and their spouse are not required to take regular minimum distributions starting at age 70 ½ as are required for traditional IRAs. Hence, a Roth account could grow tax free for decades without tax and could continue to grow tax-free during the beneficiaries’ lifetimes as well, though annual distributions are required once mom and dad die.

So, the question is, does it make sense to convert now, based on new taxes going into effect in 2013 and the likelihood that income taxes will increase in coming years? And, if so, when should the conversion be done? Here are a few rules of thumb:

  1. If you are likely to leave money to your heirs, then a Roth account is the best possible asset you could leave them. Investments within a Roth account grow tax-free. Hence, inheriting a Roth account is better than cash. Consider converting.
  2. If you are likely to spend your IRA(s) in your lifetime, conversion is probably not the best idea. In this case, your earnings in retirement will likely be less than your working years. Hence, even though tax rates are higher overall, your individual tax rate may be the same or lower.
  3. If you are not sure, then you should have your fee-only, independent Registered Investment Advisor run some scenarios for you of conversion or not, using hypothetical tax rates during working and retirement years. Taxpayers can get a real “bang for their buck” when using non-IRA funds to pay the income taxes on conversion to a Roth.

Check with your CPA before you make your final decision. If you do decide to convert, you may want to convert over time, perhaps 5-10 years, so that the income produced by the conversion doesn’t push you into a higher tax bracket. The special conversion election in 2010 to split the income and report it in 2011 and 2012 no longer applies. However, conversion still is available regardless of the income of the taxpayer(s).