Updated: Jun 3, 2020
While we would like to believe most people give from the kindness of their heart, the reality is, many strategically give to lower their tax liability. In fact, wealthy people often give to avoid estate tax, income taxes, and capital gains tax. When giving is part of your tax strategy, you want to make sure each charitable gift is eligible for a tax deduction. Gifts to public charities, private foundations, businesses, politicians, donor-advised funds, individuals and trusts will each have a different impact on your taxable income. A few key differences are highlighted below.
Giving to Public Charities
Under the 2020 CARES Act, cash donations to qualified organizations are deductible on up to 100% of your adjusted gross income.
What is adjusted gross income
Your Adjusted Gross Income (AGI) is the sum of your earned income, passive income, business and investment income, and a few other items. Your AGI is used to determine how much of your income is taxable before taking itemized deductions and other deductions. Let’s say a single adult has earned income and business income that add up to an AGI of $100,000. If he meets the threshold to itemize his deductions, he should be able to itemize a maximum of $60,000 (60%) of charitable deductions to a qualified organization.
What is a qualified organization?
My Brother’s Keeper, Boys and Girls Club, and most churches are qualified organizations. You may deduct a charitable contribution made to, or for the use of, organizations that otherwise are qualified under section 170(c) of the Internal Revenue Code. You can search for a qualified organization via the IRS Tax Exemption Search.
It is important to note that, your gifts are only deductible if you do not receive anything from the public charity in return. If you receive a benefit as a result of making a contribution to a qualified organization, you can deduct only the amount of your contribution that is more than the value of the benefit you receive. IRS Publication 526 provides the following example:
You pay $65 for a ticket to a dinner dance at a church. Your entire $65 payment goes to the church. The ticket to the dinner dance has a fair market value of $25. When you buy your ticket, you know its value is less than your payment. To figure the amount of your charitable contribution, subtract the value of the benefit you receive ($25) from your total payment ($65). You can deduct $40 as a charitable contribution to the church.
Although most cash gifts to qualified organizations are deductible, noncash gifts have certain limits. For instance, you cannot deduct the value of accounting services, legal services, or other services given to a qualified organization, but you may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be:
Directly connected with the services;
Expenses you had only because of the services you gave; and
Not personal, living, or family expenses.
Also, if you give property to a qualified organization, you generally can deduct the fair market value (FMV) of the property at the time of the contribution. If your total deduction for all noncash contributions for the year is over $500, you must complete Form 8283 and attach it to your Form 1040. Noncash contributions to public charities are limited to 50% of your adjusted gross income minus your cash contributions subject to the 60% limit.
One of the most common types of noncash contributions is appreciated stocks. Let's say your friend Joshua purchased 100 shares of Disney stock ten years ago. Today, the value of his shares has doubled. If Joshua decides to sell the stock, he will receive a large gain subject to capital gains tax. If Joshua decides to donate the stock, he will receive a tax deduction equal to the fair market value of the stock (as long as the value does not surpass 50% of his AGI). Joshua will have to do a cost-benefit analysis to determine which option provides him the most value.
Giving to Private Foundations
Private Foundations are different from public charities. To learn the difference, checkout my previous blog Private Foundations vs Public Charities. If you make cash contributions or noncash contributions (other than capital gain property) during the year to a private foundation, your deduction for those contributions is limited to the lessor of:
30% of your adjusted gross income, or
50% of your adjusted gross income minus all your contributions to 50% limit organizations (other than contributions subject to a 100% limit or qualified conservation contributions).
Giving to Businesses and Non-qualified Organizations
You cannot deduct contributions to an LLC, S-Corporation, C-Corporation, or any other type of businesses. Similarly, contributions to non-qualified tax-exempt organizations should not be itemized on your tax return. These types of non-qualified tax-exempt organizations include:
Certain state bar associations
Chambers of commerce and other business leagues or organizations.
Civic leagues and associations.
Country clubs and other social clubs.
Foreign organizations other than certain Canadian, Israeli, or Mexican charitable organizations.
Political organizations and candidates
Giving to Political Organizations
Most donations to political organizations are not tax-deductible. PAC Funds, political parties, candidate campaigns and other political organizations are not qualified public charities eligible for tax-exempt donations.
Some political organizations, however, have a separate public charity to which donations are tax-deductible. The Sierra Club, for example, is a 501(c)(4) tax-exempt organization that is not eligible for tax-deductible donations. On the other hand, the Sierra Club Foundation carries out the charitable activities of The Sierra Club and is legally allowed to accept tax deductible contributions.
Giving to a Donor-Advised Fund
Donor-advised funds are key philanthropic and tax planning tools. Cash, stocks or non-publicly traded assets such as real estate, private business interests and private company stock can be donated into a donor-advised fund for an immediate charitable tax deduction. The donated assets can then be distributed to the intended charity at a later date.
Before the 2020 CARES Act, tax deductibility limits of contributions to donor-advised funds were the same as other 501(c)(3) public charities. For 2020, cash donations to donor-advised funds are not subject to the 100% AGI limit. They are subject to the 60% limit. There are, however, circumstances in which you can't deduct your contribution to a donor-advised fund. Some of those circumstances include:
The qualified organization that sponsors the fund is a war veterans' organization, a fraternal society, or a nonprofit cemetery company; or
You don't have an acknowledgment from that sponsoring organization that it has exclusive legal control over the assets contributed.
It is important to note that, donor-advised funds have become increasingly popular over the past several years due to changes in the tax law. The IRS has issued requirements and proposed regulations in efforts to minimize the use of donor-advised funds for tax loopholes. For more information on Donor-Advised Funds, see Donor-Advised Funds vs. Private Foundations.
Giving to a Trust
Giving to a trust is complicated. While most gifts to a trust are not deductible on an income tax return, wealthy people often move assets into certain types of trusts to reduce or eliminate the estate tax. Specific types of trusts, such as charitable remainder trusts and charitable lead trusts, allow taxpayers to move assets out of their estate and split the trust assets between a charity and another beneficiary.
One alternative to a charitable trust is the Charitable Gift Annuity (CGA). With a CGA, the donor transfers assets to a charity. With this transfer, the donor enters into an unsecured contract with the charity that requires fixed payments to the donor over a specified number of years. This giving vehicle allows the donor to receive cash flow while also receiving a tax deduction for the charitable portion of the gift.
Giving to Individuals
Gifts to your children, your best friend, your Uncle, your co-worker’s new baby or any other individual are usually not tax deductible. Gifts are only deductible when made to qualified organizations. While this may seem straightforward, there are instances where the gift recipient might be unclear.
For example, let’s say your niece set up a Go Fund Me account to raise money for lodging during an international trip with her Gospel Choir. Any funds donated to this fundraiser are not tax deductible because the end recipient of the gift is your niece, an individual.
Or, let’s say your cousin needs $5,000 for college tuition. You decide to pay the tuition directly to the college. While the college is a qualified organization, the payment is made on behalf of an individual, and is thus not tax deductible. Charitable contributions set aside for use by a specific person are not deductible. (Side note, in this situation it might be smarter to donate to the child’s 529 plan. Paying tuition on behalf of a student could decrease their financial aid eligibility in future years).
Your total deduction of charitable contributions cannot exceed your adjusted gross income. If your contributions are subject to more than one of the limits, you include all or part of each contribution in a certain order, carrying over any excess to a subsequent year (if allowed).
It is also important to note that, if you gave gifts to someone in 2020 totaling more than $15,000 (other than to your spouse), you probably must file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. Form 709 tracks your "taxable" gifts over your lifetime to inform the IRS how much of your basic exclusion will be available against the estate tax. The reality is, most of us will never have to worry about the estate tax as the basic exclusion for 2020 is $11,580,000 ($23,160,000 for married couples). Despite that reality, all taxpayers are required to report gifts over $15,000 to the IRS.
Gifts from Your IRA
For the seasoned folk over age 70 1/2, giving directly from your IRA lowers your taxable income and provides you with a charitable tax deduction. Donors that meet the age requirement can give up to $100.000 from their IRA to a qualified charity.
Whew. As you can see, there are plenty of ways to give, but only a limited amount of tax-friendly ways to give. Although incorporating a tax strategy into your giving is financially efficient, let us not forget 2 Corinthians 9:6-7:
Now this I say, he who sows sparingly will also reap sparingly, and he who sows bountifully will also reap bountifully. Each one must do just as he has purposed in his heart, not grudgingly or under compulsion, for God loves a cheerful giver.
For more information on the Tax Side of Giving, contact The Little CPA.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.