To qualify for an income tax deduction on a charitable gift, a taxpayer must itemize deductions on his or her income tax return, meet substantiation requirements and make the gift to a qualified charitable organization. It is particularly beneficial to make a charitable gift of appreciated property held for more than one year that, if sold, would qualify for long-term capital gains tax treatment (e.g., stock). If such property is contributed to charity in kind, the appreciation is not subject to capital gains taxes assuming that the contribution complies with all of the applicable rules.
Example: Jill purchased a stock for $10,000 more than 1 year ago and the stock is now worth $50,000. If she sold the stock today and gave the charity the $50,000 sale proceeds, she would have to report the $40,000 capital gain and pay tax thereon. Alternatively, if Jill gifted the $50,000 of stock directly to a public charity, she would qualify for a charitable tax deduction (subject to annual deduction limits) equal to the fair market value of the stock ($50,000), and avoid paying the capital gains taxes on the $40,000 of appreciation—a much better result.
Frequently Asked Questions
What is a qualified charity?
Only contributions to a "qualified organization" are potentially tax deductible. Churches, synagogues, mosques and governmental entities are automatically given charitable organization status. Other organizations must apply to the IRS and a list is updated quarterly. To ensure that the organization is "qualified", a donor should ask for the organization's tax exemption certificate or request the IRS list.
Certain charitable organizations qualify as 50% charities, allowing the annual deduction of cash gifts to equal up to 50% of the taxpayer's adjusted gross income (AGI). These include, but are not limited to:
- Religious organizations
- Non-profit schools
- Hospitals and medical research related organizations
- Organizations such as the Red Cross, Boy Scouts, Girl Scouts and Goodwill
Common organizations that qualify as 30% organizations are:
- War veterans' organizations
- Fraternal orders and associations
- Certain non-profit cemetery companies or corporations, so long as one's contributions are not used for the care of a specific lot or crypt
What are the income tax deduction limits applicable to gifts to charity?
Gifts to, or for the use of, qualified charitable deductions are deductible. The actual amount deductible in any given year is limited to a percentage of AGI dependent upon the type of organization (see above) and type of property given (see below) and is subject to a 5 year carry–forward of any excess. The charitable income tax deduction is taken on Schedule A (Form 1040) with the tax benefit realized measured by the taxpayer's marginal (highest) income tax bracket.
Ordinary income property is property where you would have recognized ordinary income or short–term gain had you sold it at fair market value on the date it was contributed (e.g., inventory, works of art created by the donor, and short–term capital gain property such as stocks). Short–term capital gain property is capital gain property that has been held for 1 year or less. The deduction for contributions of ordinary income property, especially short-term capital gain property is not the fair market value of the asset. The deduction is the lesser of the cost basis of the asset or its fair market value.
Annual deductions for contributions of cash, ordinary income property, and capital gain property held short–term (1 year or less) are limited to 50% of one's AGI for the year if made to a "50%" charity. Similar contributions to a "30%" charity would be limited to 30% of AGI. In either case, the unused contribution is subject to a 5 year carry–forward.
Contributions of property that would have resulted in a long–term capital gain are deductible at their fair market value. Annual deductions are limited to 30% of AGI if given to a "50%" organization or 20% if given to a "30%" organization.
Example: Jill's AGI is equal to $200,000. She donates a stock that she has held for many years with a market value of $100,000 and a cost basis of $10,000 to a 50% organization—her only charitable contribution for the year. She would be able to deduct only $60,000 of the contribution amount this year (30% of $200,000 AGI) and carry forward the remaining $40,000 for up to 5 years.
Does it make sense to gift a capital asset with a loss?
It is much better to sell a capital asset first, give the sale proceeds to charity, and utilize the loss to offset gains in the rest of the portfolio and reduce current income tax liability from the loss and income tax deduction.
What substantiation requirements must be met to realize the income tax benefits of a charitable gift?
To take an income tax deduction, all charitable gifts must be substantiated. No deduction can be taken for a monetary gift unless the taxpayer has a bank record or acknowledgement from the charity showing its name, date and the amount of the contribution. This means that charitable gifts made with cash without a corresponding acknowledgement from the charity are not deductible. For contributions of non-cash property, the taxpayer must have a receipt from the charity and a record showing his or her name and describing the gift. There are also additional substantiation requirements applicable for contributions of $250 or more, non-cash contributions exceeding $500 and contributions of cars, boats and planes.
What options are available to utilize retirement accounts to fund a sizable lifetime charitable gift?
The passing of the American Tax Relief Act of 2015 made permanent the provision allowing tax-free distributions from individual retirement accounts (IRAs) to public charities (Qualified Charitable Distribution [QCD]). This provision is only available to taxpayer's age 70½ or older and is limited to $100,000 per taxpayer per year. Thus, a married couple both over age 70½ and having substantial IRAs could transfer up to $200,000 this year.
A QCD may satisfy all or part of a taxpayer's required minimum distribution (RMD) from a traditional IRA and has the added bonus of being excluded from income on their tax return. This makes this election a very powerful income tax planning tool for charitably inclined taxpayers.
What other tools are available to realize an income tax benefit from a charitable gift?
There are several options that a taxpayer can utilize to benefit from a charitable transfer. These include, but are not limited to:
- Bargain sales
- Charitable gift annuities
- Charitable lead trusts
- Charitable remainder trusts
- Community foundations
- Donor-advised funds
- Gifts of life insurance
- Pooled income funds
- Private foundations
Charitable contributions are deductible in the year they are made. For checks mailed, this means when the envelope is post marked. For charitable gifts that are charged to a credit card, the deduction is taken when the charge is made. For gifts of stock held in street name, the gift is completed when the stock is transferred on the books of the corporation.