Deductibility of Charitable Contributions
A charitable contribution is a gift made to religious, charitable, educational, or other philanthropic organizations. Charitable contributions can be deducted from income tax or from estate tax. There are AGI limits to deducting charitable contributions from income tax, but not from estate tax. To be deductible, the charitable organization must be recognized as such by the IRS; donations to other organizations or to individuals are not deductible. Deductible charitable contributions can be made by individuals, estates, and corporations. The taxpayer can make gifts by writing a check, transferring life insurance policies, assigning stock, signing over a deed to real estate, or conveying other property to the charity. Charitable contributions by individuals and corporations can be deducted against income, thus lowering income taxes; estate tax charitable deductions reduce the value of an estate subject to the estate tax. Contributions to some types of charity trusts can also reduce income taxes, and gift and estate taxes, depending on the type of charitable trust. Gifts of a future interest in property can also be deducted in the tax year of the gift, but only if the gift is irrevocable, and if it is a contingent gift, only if there is no possibility that the gift will go to a noncharitable recipient. In other words, the contingency would have to specify another charitable organization where contributions would be deductible.
The charitable deduction reduces the out-of-pocket cost of the contribution by the amount contributed multiplied by the donor’s tax bracket:
Out-Of-Pocket Costs of a Charitable Contribution = Amount Contributed – (Amount Contributed × Tax Bracket)
So, if you give property worth $1000 to a qualified charity and you are in the 25% tax bracket, then your out-of-pocket cost of the contributed property is $750 (= $1000 × 25%)
If the contributions are to a qualified domestic organization, then they are deductible. Unless a tax treaty provides otherwise, 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. Charitable remainder trusts and charitable lead trusts can also be used to lower taxes on income and gratuitous transfers.
However, charitable contributions by a decedent may be deductible from estate tax whether the charity is domestic or foreign, and there are no limits to the deduction. In any case, it must be certified by the IRS that it is a charitable organization. If it is uncertain that an organization will qualify, the taxpayer can obtain a determination letter from the IRS that will specify whether the charity qualifies. Charitable contributions are only deductible from estate tax if made by the decedent, either as a gift or as a bequest. Gifts made by the estate or the beneficiaries are not deductible. Post-life charitable gifts can be made by will, assigning charitable beneficiaries to employee benefit contracts or life insurance contracts, or by trust.
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 deductible. Additionally, allowing the deduction of charitable contributions spurs greater giving, since the actual cost of the charitable contribution to the donor is lowered by the marginal percentage of his tax bracket. For instance, if you are in the 35% tax bracket and you give $1000 to your church, then your actual cost will be $650, since you will be able to save $350 from your taxes. In essence, the government is paying the 35% it would have gotten from you to the charity, thus indirectly supporting the charity through your contribution.
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, IRC §170(l) provides an exception for the purchase of athletic tickets from colleges or universities, allowing 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 deductible portion is limited to 80% of the amount donated minus the value of the tickets.
If the donor receives only a token benefit, then the charitable gift is fully deductible if the following 3 conditions are true:
- the value of the gift is insubstantial,
- the qualified organization receiving the gift correctly determines that the benefit has little value, and
- the donee informs the taxpayer that the charitable contribution is fully deductible in spite of the benefit received.
Certain items 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.
Some community property states stipulate that any gift of community property to a charity by one spouse must be with the consent of the other spouse; otherwise it is invalid. In this case, the IRS may disallow the deduction since the contribution was not considered valid by the state.
Securities can only be deducted for 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 sent.
Contributions of services are generally not deductible, since it gives the taxpayer too much discretion in valuing the provided service. However, incidental expenses in providing the services are deductible, including out-of-pocket expenses incurred in providing volunteer services to charitable organizations, including actual vehicle expenses or the mileage rate, cost of public transportation incurred for the service, or the cost and upkeep of uniforms, supplies, and equipment to perform the service. 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.
Attending a convention of a qualified organization may be deductible if the organization wants the volunteer to attend. Deductible expenses include lodging, food, and any other unreimbursed expenses incurred while performing the volunteer services. To prevent abuse, volunteer travel expenses are only deductible if there is no substantial recreational, pleasurable, or vacation value that is unrelated to the volunteer service itself.
Tax Tip — Tax-Free Distributions to Charitable Organizations
IRA owners who have reached 70½ are permitted to donate up to $100,000 from their IRAs to charitable organizations, thereby eliminating the tax on the distribution, but which, nonetheless, still counts toward the required minimum distribution. Other changes created by the American Taxpayer Relief Act include:
- recharacterizing a distribution paid in January as having been paid on December of the previous year;
- treating a December distribution to the taxpayer as a charitable contribution for that year if the proceeds are donated to a charity by February 1.
As of January, 2016, this provision has been made permanent, after having been extended several times.
A bargain sale can minimize the out-of-pocket cost of a charitable gift. In years past, appreciated property could be sold to a charity for the donor’s cost basis of the property, thereby allowing the donor to recoup his investment and allowing the charity to receive the appreciated value of the property. At the same time, the donor could deduct the entire appreciated value of the property. So a donor could give a charity $10,000 worth of stock that cost $3000, by selling the stock to the charity for the $3000, thereby reimbursing his cost, while still allowing the donor to deduct the $7000 of appreciation donated to the charity. This is still true for capital gain property, but not for income-producing property.
For capital gain property, the charitable deduction is equal to the fair market value (FMR) of the contribution minus the sales price:
Charitable Deduction for Capital Gain Property = Fair Market Value of Contribution = Property’s FMR – Sale Price
For ordinary income property, the appreciation of the property is not deductible. Only a portion of the adjusted basis of the contribution is deductible, equal to the proportion of the contributed part over the fair market value of the property:
Charitable Deduction for Ordinary Income Property = Portion of Adjusted Basis of Contribution = Adjusted Basis of Property × FMV of Contribution/FMV of Entire Property
Example: You sell property with an FMR of $10,000 to a qualified charity for $2000, for which you have a $4000 tax basis. Thus, your donating $8000 of value to the charity. If the property was capital gain property, then you can deduct your contribution, equal to $8000 (= $10,000 – $2000). If the property was ordinary income property, then your deduction is limited to $3200 (= $4000 × $8000/$10,000).
Substantiation and Reporting Requirements
Naturally, deductible charitable contributions must be substantiated. All cash payments must be substantiated, regardless of the amount. Clothing and household items, such as furniture, can only be deducted if they are in reasonably good condition. However, some items in less than good condition, such as antiques, can be deducted if the value is greater than $500 and a written qualified appraisal is attached to the tax return to substantiate that value.
If the claimed deduction is less than $250, then only a receipt is needed to record the transaction. 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
- 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 a contemporaneous written acknowledgment — the acknowledgment must be received before the earlier of the date that the taxpayer's tax return is filed or by the due date including extensions of the return for the year of the contribution. Except where noted, records for substantiating contributions are not filed with the tax return but should be kept by the taxpayer.
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, the deductible amount equals its fair market value. The taxpayer must provide the following information about the donation, if required:
- contribution date;
- description of the property;
- if the claimed deduction exceeds $500, then written evidence must provide:
- donor acquisition date;
- how the donor acquired the property;
- the donor's adjusted basis, which is usually its cost;
- whether the donor received goods or services in exchange for the contribution and a good faith estimate of the value of what is received;
- fair market value and how it was determined;
- additionally, if the claimed property value exceeds $5000, or $10,000 for nonpublicly traded stock, then the following additional information must be substantiated:
- 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 art was donated, with an aggregate value exceeding $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 subject to the 2% AGI floor. Publicly traded securities do not need an appraisal, since their value is easily ascertained by the financial markets.
For donations of cars or other vehicles, boats, or airplanes, the deduction is limited to the gross sales proceeds received by the charity from the sale of the donated property. Additionally, if the claimed value exceeds $500, then Copy B of Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes must be attached to the donor's tax return.
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 tax due to the overvaluation. However, no penalties apply unless the underpayment exceeds $5000. For donated property with a claimed value exceeding $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 a 40% penalty applies.
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 taxpayer's total contribution is 20% or less of the taxpayer's adjusted gross income (AGI), then they are fully deductible;
- if the total contribution exceeds 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 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 equals its FMV.
Example — Tax Advantage of Donating Appreciated Property
You have an AGI of $100,000 before donating to charity. You have stock with a FMV of $17,000 that was held for more than 1 year and your adjusted basis in the stock is $10,000.
Case 1: You sell the stock, increasing your taxable income to $100,000 + ($17,000 – $10,000) = $107,000. You donate the $17,000 sales proceeds to charity, reducing your taxable income to $90,000.
Case 2: You donate the appreciated stock to charity. Your taxable income is reduced to $100,000 – $17,000 = $83,000.
As you can see, by donating the appreciated stock, you save the long-term capital gains tax on $7,000. Note, however, that if your adjusted basis in the property exceeds FMV, then you should sell the property to claim the loss, then donate the property to the charity.
However, 2 exceptions prevent 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 worth $10,000 when donated 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 donor's basis of $5000, since art is unrelated to the charitable objective of the Kiwanis Club.
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 private non-operating 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 private non-operating 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% organization), such as:
- 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.
The Tax Cuts and Jobs Act has increased the 50% AGI limit to 60% for cash contributions paid to public charities or some private foundations, starting in 2018.
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% × $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.
Charitable contributions exceeding deductibility limits 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.
Qualified Charitable Distributions
Taxpayers who will be at least 70½ by the end of the calendar year may donate up to $100,000 in cash directly from their IRAs to qualified charities. These qualified charitable distributions (QCDs) are tax-free to the taxpayer and are counted for RMDs. Moreover, the $100,000 limit is separate for each spouse, so a married couple can contribute up to $200,000 from their IRA if they both satisfy the age requirements.