By Kenneth H. Bridges, CPA, PFS March 2011
Many of our clients are quite philanthropic. Fortunately, the tax law greatly rewards philanthropy. Here is a brief synopsis of the general rules and suggested strategies.
Cash donations – The most common and straightforward type of charitable gift is a gift of cash to a public charity (e.g. your church, alma mater, Red Cross, etc.). A cash donation can offset up to 50% of your income for the year, with any excess carrying forward for up to 5 years.
Noncash donations – You can also claim a tax deduction for the fair market value of property other than cash which you donate to charity. This can include for example clothing and furniture. However, the greatest tax benefit typically comes from donating appreciated property like stocks or real estate. Let’s assume that you have some highly appreciated stock which you are about to sell. If instead you make a donation of the stock to charity, you avoid paying tax on the gain and you get a tax deduction for the value of the property; a double benefit. The potential tax savings in this case can be up to 60% of the value of the property. In other words, your favorite charity can get a dollar at an after-tax cost to you of 40 cents. In order to get a tax deduction for the full value of the property, you must have held the property for at least one year and the nature of the property must be of the sort that if you sold it you would have a long-term capital gain. Also, unless the property is publicly-traded stock, you will have to get a qualified appraisal. The amount of your deduction for a donation of appreciated property is limited to 30% of your income, with any excess carrying forward for up to 5 years.
Conservation easements – Let’s assume you have a tract of land which could potentially be developed into a residential subdivision, but you don’t want to ever see the land developed, desiring for it to forever remain in its beautiful natural state. If you are willing to grant a perpetual conservation easement to a qualified organization (effectively giving up your rights to develop the property), then the tax law will reward you with a tax deduction. The amount of the deduction is the difference between the appraised value of the land assuming its highest and best use value before the granting of the conservation easement and its value after granting the conservation easement. Be careful here, however. The IRS perceives that there has been a lot of abuse in this area and is now carefully scrutinizing deductions for conservation easements.
Strategies where carryforwards may expire unused – As noted above, the deduction for cash donations is limited to 50% of your income and the deduction for appreciated property is limited to 30% of your income. In each case, these amounts carry forward for up to 5 years, subject each year to these same percentage limitations. Tax rules provide that you must utilize current year donations before dipping into your carryforwards. Accordingly, for taxpayers who regularly make donations that are very significant compared to their taxable income, there can be a risk of carryforwards expiring unused. In these situations, we sometimes suggest that a client consider bunching significant donations into one tax year, then skip a year in order to be able to dip back into the carryforwards (on a FIFO basis) before they expire. In other cases, it may make sense to accelerate income into the final year of a carryforward. In situations where there is concern that the IRS might challenge the value placed on a gift (e.g. a conservation easement), having a carryforward can actually be comforting as it can provide some potential cushion against such a challenge.
Private foundations – For those who wish to get a tax deduction today (e.g. potentially matching the deduction against a large gain), but wish to effectively control the money for a long period of time (perhaps even leaving a legacy for future generations to manage), a private foundation can work well. With a private foundation, you get a tax deduction when the money goes into the foundation, but are typically only required to gift 5% of the value of the foundation’s assets to charities each year.
Donor-advised funds – Private foundations are subject to a number of limitations and require some upfront set-up cost and on-going administrative effort. For those who want to get their tax deduction now and have some time to decide which charities will benefit, but don’t want the cost, hassle or limitations of a private foundation, a “donor-advised fund” can be the answer. These organizations are technically public charities, and with a gift to them you are relinquishing control over the funds. However, these organizations have a long history of following the advisement of their donors. When you make a gift to a donor-advised fund, they set up an account in your name with the assets. Whenever you want to make a gift to charity, you provide them with the name of the organization and amount and they send a gift of that amount to the charity with a letter indicating that the gift is from you. You can continue this process so long as a balance remains in your account.
Charitable remainder trust – Plan to leave assets to charity at your death, but need an income stream from such during your life? A “charitable remainder trust” (CRT) can be the answer for you; particularly if you have highly appreciated property you are about to sell. Instead of selling the property yourself, you gift it to your CRT and the CRT sells it and avoids paying tax on the capital gain. Also, you get a tax deduction for the net present value that will go to charity at your death. The CRT makes distribution to you each year, which are generally subject to tax (often at capital gains rates, depending on the income of the CRT).
Estate tax benefits – The Federal estate tax can potentially consume a substantial percentage of your estate. However, any amounts gifted to charity during your lifetime or at your death escape the estate tax.
Substantiation requirements – Under present law, you must have in hand at the time you file your income tax return a “donee acknowledgement statement” for any gift of $250 or more. Your cancelled check alone is insufficient documentation.
Charitable gifts from IRA – Legislation first enacted in August 2006 (which later expired, but was extended by late 2010 legislation) permits those age 70 ½ and older to have distributions made from their IRA to a charitable organization, without such amount being included in their income. The advantages of such donations (versus taking a distribution from your IRA then making the charitable gift) include: (a) you avoid increasing your adjusted gross income, which can cause social security benefits to become taxable and also result in limitations on your personal exemptions and itemized deductions; (b) you avoid the percentage limitations on charitable donation deductions; and (c) if you do not otherwise have sufficient deductions to itemize you avoid wasting your standard deduction. The amount is limited to $100,000 per year and the IRA distribution cannot be to a private foundation or donor-advised fund.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.