Deductibility of Charitable Contributions

A charitable contribution is a gift made to religious, charitable, educational, or other philanthropic organizations. Charitable contributions can be made by both individuals and corporations. If the contributions are to a qualified domestic organization, then they are deductible. Direct contributions to foreign charities are not deductible, but contributions to domestic organizations that disperse the contributions to foreign organizations are deductible. However, direct contributions to certain charities in Canada, Mexico, or Israel are deductible to a certain extent.

The tax objective of allowing charitable contributions is to support various services that are socially desirable, allowing taxpayers to provide greater support for these services than the government is providing, such as helping the poor or supporting religious organizations. Because the United States Constitution's requirement for the separation of church and state, governments of the United States cannot provide direct support to religions, so they provide indirect support by allowing contributions to religious organizations to be deducted from taxes.

A gift is characterized by the intention of giving the gift by the donor, acceptance by the donee, and the absence of consideration for the gift. The charitable contribution is only deductible if the gift was made through disinterested generosity as the courts have defined it over the years. A donor who receives a tangible benefit from the gift can only deduct the excess value of the contribution over the benefit.

Example: you pay $25 to see a movie in which the proceeds are paid to a charitable organization. Since movies typically cost $10, you can only deduct $25 – $10 = $15.

However, if the donor receives only a token benefit, then the charitable gift is fully deductible if the following 3 conditions are true:

1. the value of the gift is insubstantial,
2. the qualified organization receiving the gift correctly determines that the benefit has little value, and
3. the donee informs the taxpayer that the charitable contribution is fully deductible in spite of the benefit received.

However, IRC §170(l) provides an exception for the purchase of athletic tickets from colleges or universities, which allows 80% of the amount paid to be deductible as a charitable contribution. However, if the donor receives tickets in exchange for the donation, then the portion that is deductible is limited to 80% of the amount donated minus the value of the tickets.

Contributions of services are generally not deductible. However, incidental expenses in providing the services are deductible. If travel is involved, then the donor can deduct the standard mileage rate of $.14 per mile. Additionally, out-of-pocket costs for transportation, lodging, and the cost of meals while away from home to perform the services are deductible, unless the travel involves a significant amount of recreation or pleasure.

There are certain items that are not deductible, including the following:

• rental value of property usage used by the charity;
• the cost of raffle, bingo, or lottery tickets;
• dues and fees paid to such organizations as country clubs, fraternal orders, and lodges;
• blood given to a blood bank;
• donations to homeowners associations;
• cost of tuition for education, especially if provided by religious organizations.

To be deductible, the charitable contribution must be made to a qualified organization, which includes the following:

• a State or possession of the United States or any of its subdivisions;
• veterans' organizations;
• fraternal organization operating under the lodge system;
• cemetery companies;
• corporation, trust, or community chest fund or foundation located in the United States and organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes or for the prevention of cruelty to children or animals;
• other organizations listed in IRC §501(c).

An organization must apply for and receive the tax-exempt status under IRC §501, and this list is published periodically as IRS Publication 78. However, not every qualified organization is listed in this document. The IRS also provides the Exempt Organization Select Check, which is a search tool to find or verify qualified charities. Because charitable contributions can only be deducted if made to a qualified organization, contributions to individuals are not deductible. Qualified charitable organizations must file Form 990, Return of Organization Exempt From Income Tax annually.

Charitable contributions can only be deducted in the tax year of the payment of the contribution, both for cash and accrual basis taxpayers, and only as itemized deductions on Schedule A of Form 1040. The contribution is deemed to have been made when the donee receives the property, or if the gift is sent by mail or other delivery, then on the date that the gift was sent. So a check for a charitable contribution that was mailed on December 31 will be deductible for that calendar year.

The deductibility of securities can only made be made in the tax year when the securities are transferred to the charity's name, unless the securities are unconditionally endorsed and mailed to the donee or its agent, in which case the gift is deductible in the year that it was sent.

Substantiation and Reporting Requirements

Naturally, deductible charitable contributions must be substantiated. All cash payments must be substantiated, regardless of the amount. If the value of a property contribution is more than $250, then the taxpayer must obtain written substantiation of the contribution from the charitable organization, specifying the amount donated and a description of the property, and a statement that no consideration in the form of either goods or services was received for the gift. The taxpayer must receive the substantiation before the earlier of the date that the taxpayer's tax return is filed or the due date including extensions of the return for the year of the contribution. If the donated property value is over $500 but not over $5000, then the taxpayer must file Section A of Form 8283, Non-Cash Charitable Contributions. When the claimed value of the property exceeds $5000, or $10,000 for non-publicly traded stock, then the taxpayer must get a qualified appraisal, then file Section B of Form 8283. A summary of the appraisal must be sent along with the tax return. Failure to document the contribution will result in a disallowance of the deduction. Furthermore, there are hefty penalties for the overvaluation of donated property.

When property is donated, then the deductible amount is equal to its fair market value. The taxpayer must provide the following information about the donation, if required:

• how the value of the fair market value of the property was determined;
• the terms of any agreement with the organization about how the property will be used or for its potential sale or other disposition;
• a signed copy of the appraisal if the property value was determined by appraisal. If the donated item was a work of art with an aggregate value of greater than $20,000, then the appraisal must be attached to the taxpayer's return.

Appraisal fees for donated real estate or art cannot be deducted as a charitable contribution but only as a miscellaneous itemized deduction s subject to the 2% AGI floor.

If the taxpayer donates a car or other vehicle, with a value of over $500, then Copy B of Form 1098-C must be attached to the taxpayer's return and the deduction is limited to the gross sales proceeds received by the charity from the sale of the vehicle.

20% and 40% Overvaluation Penalties for Donated Property

If the value of donated property is substantially overstated, then the IRS may assess either a 20% or 40% penalty on the underpayment of the tax because of the overvaluation. However, no penalties apply unless the underpayment exceeds $5000. For donated property with a claimed value that exceeds $5000, if the IRS determines that the claimed value of the donated property is 150% or more of what the IRS deems to be the correct value, then a 20% penalty will be assessed on the underpayment of the tax. If the excess is 200% or more, then the penalty is 40% of the tax underpayment resulting from the overvaluation.

The 20% penalty can be avoided if the taxpayer relied on a qualified appraisal and made a good-faith effort to investigate the value of property. However, there are no exceptions for the 40% penalty.

Charitable Contribution Deduction Limits

Generally, there is a deductibility ceiling of 50% for cash contributions and 30% for contributions of appreciated property held long-term.

The deductibility of charitable contributions is limited by the following:

• if the total contribution of the taxpayer is 20% or less of the taxpayer's adjusted gross income (AGI), then they are fully deductible;
• if the total contribution is greater than 20%, then the deduction may be limited to either 20%, 30%, or 50% of AGI depending on the type of organization receiving the property and the type of property;
• no more than 50% of AGI is deductible for any given tax year. Any amounts over that can be carried forward for 5 years.

The tax rules for charitable contributions make a distinction between ordinary income property and capital gain property. Ordinary income property is property that results in the recognition of ordinary income when sold, which includes inventory from the taxpayer's trade or business, or manuscripts or art that was created by the donor, and also capital assets that were held by the donor for 1 year or less. It also includes property that is subject to the recapture of depreciation. The deduction of ordinary income property is limited to the lesser of:

• the fair market value (FMV) of the property when it was donated or
• the donor's adjusted basis in the property.

Capital gain property is any capital asset held by the taxpayer for more than 1 year or §1231 property that was used in a trade or business. Generally, the deduction of capital gain property is equal to its FMV.

However, there are 2 exceptions that prevent the taxpayer from deducting appreciation on capital gain property. The 1st exception applies to tangible personalty, which is all tangible property that is not realty. If the donee uses the property that is unrelated to its purpose as a charity, then the deduction is limited to the donor's adjusted basis in the property. The taxpayer must determine that the property is being used in a related use by the donee. If the taxpayer has a reasonable expectation that the donated property will be used in a way that is related to the charitable organization, then the FMV of the property is deductible, even if the donee later sells the property. So if a donor contributes a historical painting that was worth $10,000 at the time of the donation to an art museum and in which the taxpayer had an adjusted basis of $5000, and the art museum displays a painting for a certain amount of time, then the donor can deduct $10,000, even if the art museum later sells the painting. If the painting had been donated to the Kiwanis Club, then the deduction would be limited to $5000.

The other exception limiting the deductibility of the capital gain on donated property is when the donee is a non-operating private foundation. A private operating foundation spends most of its income in the active conduct of the charity for which it was established. A non-operating private foundation is one that does not. The full contribution to a private operating foundation is generally deductible, but the capital gain on property donated to a non-operating private foundation is not deductible — the deduction is limited to the taxpayer's adjusted basis. However, the capital gain appreciation may be fully deductible if the private non-operating foundation distributes the contribution to public charities or private operating foundations within 2½ months after the year of the donation. Donors can also deduct the full amount of qualified appreciated stock, which is stock with a listed market value on a securities exchange, to private non-operating foundations.

AGI Limits on Deductibility

The deductibility of charitable contributions is limited to 50% of the donor's AGI without regard to net operating loss carrybacks if the donee is a certain type of organization (hereafter: 50% organizations), such as:

• churches,
• most educational organizations,
• hospitals or medical schools, governments,
• any organization that receives a substantial part of its support from the public or from the government,
• any organization supported by the government that manages property or investments for a college or university,
• private operating foundations and private non-operating foundations that qualify for the private operating foundation treatment, or for private non-operating foundations for which the contributions are pooled into a common fund used to support public charities.

A 30% ceiling applies for contributions of cash and ordinary income property to private non-operating foundations that are not 50% organizations or for contributions of appreciated capital gain property to 50% organizations unless the donor makes a special election, called the reduced deduction election, in which the donor forgoes the deduction on the appreciation of the property.

For instance, if a taxpayer with an AGI of $100,000 donates land with an adjusted basis of $35,000 and a fair market value of $40,000 to a medical school and the taxpayer held the property for more than 1 year, then the deduction is limited to 30% x $100,000 = $30,000. However, if the taxpayer makes the reduced deduction election, then the taxpayer's adjusted basis of $35,000 is deductible.

There is also a 20% ceiling that limits the deductibility of contributions of long-term capital gain property to private non-operating foundations that are not 50% organizations.

Contribution Carryovers

Charitable contributions that exceed the limits of the deductibility for the tax year can be carried forward for up to 5 years. However, the carryovers retain the character of the original contribution and are also subject to the same percentage limitations that apply to the original contribution. So 30% property that is carried over remains 30% property.

Furthermore, current charitable contributions must be claimed before any carryovers and if the carryovers are from more than 1 year, then they must be used up on a first-in, first-out (FIFO) order.