Charitable giving and taxes were married, for better or worse, long ago in Washington. Their progeny are today’s tax deductible donations and the rules and regulations surrounding them.
Here’s a recap of the courtship. The 16th amendment to the Constitution opened the doors to the modern-era federal income tax in 1913. Four years later, the War Revenue Act of 1917 raised taxes and created the charitable deduction. The nation needed to pay for the vast expense of joining World War I, but some people worried that raising taxes on the nation’s wealthiest people would cause them to give less to charity. Concern about the charities mingled with fear that the government might have to spend more to address problems if those charities could no longer deal with them. Tax deductible donations would, in theory, encourage philanthropy even though the nation’s leading citizens had less of the surplus wealth that made up their largesse.
Debate still rages over the fairness of the deductions. The real action, however, comes from accountants and financial advisors helping people to support worthy causes while protecting their assets. Here’s a look at tax deductible donations: who can receive them, what can be given, and how deductions can be applied.
Although it’s often used as a noun for a generic nonprofit organization, 501(c)(3) is a section of the Internal Revenue Code that defines and lists groups that are exempt from paying taxes. Gifts to 501(c)(3) groups can qualify for tax deductions. That does not hold for all 501(c)(3) groups, however, such as those engaged heavily in politics. And there are some groups that are not 501(c)(3) but can receive tax deductible gifts. The Internal Revenue Service provides a Tax Exempt Organization Search Tool to help people determine whether gifts to a particular group might qualify for a tax deduction.
The charitable groups include churches, museums, the Boy Scouts and Girl Scouts, war veterans organizations, fraternal societies, nonprofit cemetery organizations and volunteer fire departments.
Assets also can be placed into trusts and foundations that will channel them to qualified nonprofit organizations. However, the rules involving charitable donations, taxes, and trusts and foundations are complex. This article is not meant to provide tax advice, but to present ideas for taxpayers to consider. Readers should consult fiduciary advisors before acting on any information presented here, especially if it involves trusts and foundations.
A taxpayer can take deductions for gifts of cash, property and investments. The type of gift one gives, as well as the amount and the way the gift is structured, affects the tax benefits. Also, the IRS has different rules for individual, business, and corporate donors. The inherent complications are multiplied for 2021 by special provisions in tax law made in response to the coronavirus pandemic.
Normally, tax filers must itemize deductions to gain the benefit of charitable deductions. For 2021, even filers who do not itemize can deduct for cash contributions – up to $300 for single or married filing separately, and up to $600 for married couples filing jointly. Also, those who use itemized deductions can deduct qualifying charitable cash contributions of up to 100% of their adjusted gross income (AGI). Some taxpayers will be able to use this to bring their taxable income to zero. Any unused amount can be carried over for up to five years.
The IRS requires taxpayers to obtain a written acknowledgement from a charity before claiming cash or property donations worth more than $250. The letter must state the amount of cash or the value of the goods or services, and whether the charity gave anything of value for the donation.
Keep a receipt or bank record, like a cancelled check, for any donation.
Let’s look at a few strategies that help people fulfill the twin purposes of supporting charities while protecting their assets.
An IRA Charitable Rollover, or, to use the current term, a Qualified Charitable Distribution (QCD), is not deductible, but it still has tax benefits. A person who is 70 1/2 years old or more can give up to $100,000 to a qualifying group directly from an IRA, without the donation counting as taxable income when it is withdrawn. The contributions must be made from a traditional IRA or Roth IRA directly to the charitable group. The distribution counts toward the individual’s required minimum distribution amount (RMD), which otherwise might have been taxable income.
This principle is similar to the charitable rollover in that an asset is transferred directly to the qualified organization. In this case, however, it’s stock rather than an IRA. If a taxpayer donates stock instead of selling it and donating the proceeds, neither he nor the qualifying group pays capital gains taxes on it. The donor can deduct the full fair-market value of the stock.
An investor can make this part of portfolio rebalancing, which often involves shedding stock that has made sizeable gains. Donating such stock means not paying capital gains taxes on it. Money preserved in this way can be invested as part of the rebalancing.
A donor-advised fund (DAF) is a private fund that an individual can create to manage charitable donations. This versatile tool can accommodate donations of cash, stock, and other assets, including cryptocurrency, art and collectibles, real estate, and privately held business interests. Thus, a DAF can help the many charities that are not equipped to accept anything beyond cash, checks and credit cards.
The donor or donors retain control over the distribution of money to charities while enjoying tax benefits. The value of these assets can grow tax free while they remain in the DAF. The tax benefits include federal income tax deductions of up to 60% of adjusted gross income for cash contributions and up to 30% of AGI for appreciating securities, while also avoiding capital gains taxes.
A DAF can provide extra value to someone nearing retirement. Consider someone in a high tax bracket who expects to be in lower bracket when she retires. She can pour a great deal of money into a DAF and write off the donations off while taxes are hitting the hardest. In retirement, when donations to a DAF would have fewer tax benefits, she can continue to support favored causes from her well-stocked DAF for years.
Taxpayers also can combine DAFs with charitable trusts to great advantage. Between charitable lead trusts (CLT) and charitable remainder trusts (CRT), the options are as varied as the goals of any taxpayer/philanthropist/legator.
Even without using a DAF, a taxpayer can load up on charitable donations in one year to maximize the tax benefit. This strategy is particularly useful in a year when someone has an unusual amount of income, such as from a big work bonus. That means the tax obligation would be bigger than usual, so a large deduction for charitable giving would come in handy.
The 2017 Tax Cuts and Jobs Act nearly doubled the standard deduction. That made it pointless for many tax filers to use itemized deductions, and thus write off donations. Bunching up donations in one year can make it possible to itemize deductions that year and take the standard deductions in “off” years.
A fiduciary wealth advisor like Cope Corrales can direct a client on how to optimize a bunching strategy across all possible deductions over time. That kind of advice can be crucial to successfully maximizing the tax benefits of charitable donations.
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