By: Robert Gordon MBA, CFP®, AIFA®
Paying Uncle Milty’s rent for the last 3 months buys you lots of points in the family, but you don’t get any recognition or benefit from the Internal Revenue Service (IRS). When figuring your deductions, it’s important to know what constitutes a charitable deduction, otherwise you might draw the unwanted eye of the IRS.
The IRS defines a charity as a nonprofit organization with a charitable purpose that is exempt under IRS Code 501(c)(3). IRS Publication 78 provides a list of approved charities and Publication 526 provides the rules and regulations on charitable contributions.
The higher your marginal tax bracket, the more valuable the charitable contribution in terms of tax savings. If you are in the 15% tax bracket, the cost of a $1,000 donation is $850. In other words, give $1,000 and reduce your taxes by $150. If you are in the 33% tax bracket, that same gift costs you $670 – give $1,000 and reduce your taxes by $330.
While giving to a qualified charity is a simple concept, there are limitations on the benefits. The limiting factors involved are shaped by your adjusted gross income, the type of organization that you are giving the asset to and the type of property you are giving. In general, the deduction for charitable contributions is limited to 50% of your adjusted gross income (AGI), but under certain circumstances a 20% or 30% limit may apply.
One of the first things an individual should screen is the type of organization they are giving to, as this could have the biggest impact on your deduction. Organizations that are classified as public charities include the following:
- churches, hospitals, qualified medical research organizations affiliated with hospitals, schools, colleges and universities
- organizations which have an active program of fundraising and receive contributions from many sources, including the general public
- governmental agencies, corporations, private foundations or other public charities
- organizations which receive income from the conduct of activities in furtherance of the organization’s exempt purposes or
- organizations which actively function in a supporting relationship to one or more existing public charities1
Contributions of cash to these types of organizations qualify for the 50% limit. If an organization does not fit the classification of any of the above, it would fall under the 30% limit. Private foundations are one prominent example. Private foundations typically have a single major source of funding (usually gifts from one family or corporation rather than funding from many sources) and their primary activity is generally making grants to other charitable organizations or individuals. A great example of a private foundation would be the Bill & Melinda Gates Foundation.
The other factor limiting your charitable deduction revolves around the type of property that you are giving to the charity, as not all donations are cash. Donors that contribute appreciated property have additional items that they need to consider. Gifts of capital gain property to 50% organizations (public charities and foundations) have a 30% of AGI limit and gifts of capital gain property to 30% organizations have a 20% of AGI limit. These caps do not apply if the donor chooses to reduce the fair market value of the property by the amount that would have been long-term capital gain if they had sold the property. The chart below attempts to clarify this:
|Deduction Limits for Public Charities||Deduction Limits for Private Charities|
|Cash||Up to 50% of AGI||Up to 30% of AGI|
|*Capital Gain Property at FMV||Up to 30% of AGI||Up to 20% of AGI|
* Please note that capital gain property may receive a deduction of up to 50% of AGI under special circumstances.
Charitable contributions in excess of the percentage limitations can be carried over and deducted for up to five succeeding years to the extent the limit is not used up in those years. Carryovers retain their character (i.e. 50% limit contributions continue to be 50% contributions in the carryover years and the same applies to 20% or 30% contributions.) Charitable contribution carry-forwards can be deducted only after the current year’s charitable contributions have been taken. I’m sure the legislators had a great time making up these rules!
Let’s imagine that a husband and wife with a combined AGI of $100,000 in 2009 decided to help their church in an extensive rebuilding project. They decided to use a combination of cash and appreciated securities to provide $60,000 for the project. The church is a 50% charity. Of the $60,000 they plan to contribute, only $10,000 is cash. The remainder is appreciated securities. According to the limits set by the IRS, they will receive full credit for their cash gift of $10,000. However, because the appreciated stock contribution is limited to 30% of the fair market value (they already decided against using the cost basis approach) they are limited to taking a deduction for $30,000 of the $50,000 giving them a total charitable deduction of $40,000 instead of their $50,000 maximum for 2009. The remainder of the fair market value of the appreciated securities at time of donation can be carried over to the following year. Assuming they have no other charitable contributions of appreciated securities and that their AGI remains the same, they should be able to claim the remaining $20,000 of charitable contributions on their 2010 taxes.
Well, after reading about the rules and regulations, you are probably happy that you can’t claim a charitable deduction for Uncle Milty! The rules are complex and our best recommendation is that you consult with an advisor who can help you navigate through the maze. You already know that giving to charity makes you feel good emotionally; with a little thought and professional guidance you can make your gifting more tax efficient as well.
Are you ready to realize the benefits of charitable giving? Contact Investor Solutions at 1-800-508-8500. We can help you determine the appropriate strategy for making your charitable dreams a reality.
1 IRS Publication 526