Tax planning is very different than tax return preparation. The goal of tax preparation is to minimize your tax owed this year. The goal of tax planning is to maximize your after-tax net worth by minimizing your taxes owed over your lifetime.
We focus on tax planning. These strategies may increase this year’s tax burden but with the goal of ultimately increasing your future after-tax net worth.
We also often focus our attention on federal tax planning because it affects the most people, has very large marginal tax rates, and most plans that create federal tax savings also create state tax savings.
However, this article is about tax preparation and about state taxes.
When it comes to Qualified Charitable Distributions, there are two ways you can report them on your federal return and which one you pick can create either additional savings or additional cost on your Virginia state return.
The Virginia state tax return instructions read:
If you claimed the standard deduction on your federal income tax return, you must also claim the standard deduction on your Virginia return. The Virginia standard deduction amounts are:
Filing Status Description Standard Deduction 1 All Returns – Single $3,000 2 All Returns – Married, Filing Jointly $6,000 3 Form 760 (resident) – Married, filing separate returns $3,000
…If you claim itemized deductions on your federal income tax return, you must also itemize your deductions on your Virginia return. This requirement applies even if using the standard deduction would result in a greater tax benefit on your Virginia return.
You can generally claim the same deductions for Virginia purposes that you claimed on your federal Schedule A, except for the deduction for state and local income taxes. The computation is provided in the appropriate line instructions for each Virginia income tax return. You do not need to file a copy of your federal Schedule A.
This means that if you itemize on your federal return, you must itemize on your Virginia state return. If most of your itemized deductions are State and Local Taxes, then you may find that your state itemized deductions are worth less than the standard deduction.
On the other hand, if you take the standard deduction on your federal return, you must take the standard deduction on your Virginia state return. While the federal standard deductions increased from $12,600 for married filing jointly to $24,000 in 2018, the state standard deduction remained at $6,000. Before the tax cuts update, $6,000 was was 47.6% of the value of the federal deduction. Now, it is only 25% of the federal deduction.
This means that while many federal filers may benefit from switching to the federal standard deduction, when it comes time to file their Virginia state taxes, they will be forced to take the state standard deduction as well. This might produce a lower deduction than itemizing on their state taxes would have been worth to them.
For the most people, this won’t have a lot of effect. In 2018, the tax law changed substantially and itemized deductions in particular took a hit. The State and Local Taxes deduction is now capped at $10,000 for joint filers, the Mortgage Interest deduction is limited for new purchases to $750,000 in mortgage debt, and the Misc Expenses is repealed which means you can no longer deduct investment management fees.
This means that for healthy and wealthy individuals, the only itemized deductions left might be $10,000 of state taxes (which is excluded from state itemizing anyway), a bit of mortgage interest, and their charitable intentions. For state tax purposes, that bit of mortgage interest and charitable intentions are the part that might be able to jump the hurdle of $3,000 or $6,000, making state itemizing valuable, but might not jump the federal $24,000 (now $24,400 in 2019) with the addition of state taxes.
This strange effect of state tax law makes Qualified Charitable Distributions (QCDs) an even more important feature of your tax return. If you are over age 70 1/2, then you can give out of your IRA distribution, such as your Required Minimum Distribution (RMD), and directly to charity without it counting as taxable income in the first place. This lowers your AGI potentially increasing the amount of your Medical Expenses deduction and lowering your Medicare IRMAA surcharge, among other factors.
However, if it turns out that you need the itemized charitable deduction in order to benefit from itemizing on state taxes and there isn’t much cost in a higher AGI, then you can always switch to reporting your QCD the “normal” way: by reporting the IRA distribution as taxable income and then pairing it with an itemized charitable deduction.
This flexibility of QCDs – to either lower your AGI directly without care to your deductions or to be reported as a charitable deduction to help you itemize – makes them a very useful tool when it comes to managing your state taxes.
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