Tax Insight: For Tax Year 2014 and Beyond, 3rd ed. Edition (2015)
Part VI. Personal Expenses, Deductions, and Credits
Chapter 29. Charitable Contributions
It Pays to Be Kind
Congress wants to encourage charitable giving because it benefits the country in so many ways. To that end, the tax code allows contributions to qualified charities to be deducted from your tax return as an itemized deduction. In fact, the tax code is so encouraging of charitable giving that it provides a rare “double-dip” opportunity in which you can get two tax reductions for the price of one.
There are many ways to support and donate to charitable organizations: You can give money directly to the organization; you can volunteer your time; or you can give items of value in order to further an organization’s work. With nearly every type of gift there is also a way to deduct the value of that gift from your tax return.
As is the case with all tax deductions, no one should give to charity for the sole purpose of getting a deduction—it doesn’t make financial sense. However, you probably contribute to charitable organizations more often than you realize. Each time you take items to Good Will, give money in church collections, or drive a group of kids on a Boy Scout trip, you are making a deductible charitable contribution. The key to capturing the tax benefits of these everyday events is to recognize them as such and then to record them.
It is important to know, however, that not every charitable act is deductible. There are many good things that you can do for people and organizations that don’t fall within the guidelines of the tax code. For example, if you help an individual in need by giving him/her money for food, clothing, or shelter, you cannot deduct those gifts. To be deductible, the contributions must be given to a charitable organization recognized by the IRS, not to an individual or non-recognized organization. (In fact, the organization should be able to show proof that it is recognized by the IRS.) This is probably because there would not be a viable way for the IRS to verify the gifts that you claim if they were given directly to people. Charitable organizations, on the other hand, are registered with the IRS and have an incentive to report your gifts accurately (so that they don’t lose their status as a non-taxable entity). This helps ensure that people aren’t just giving each other money and claiming large deductions for “donations” of charitable gifts.
In this chapter I cover five key areas related to the charitable giving deduction:
· Gifts of money
· Non-money gifts
· Gifts of service
· Gifts of appreciated assets—the best way to give
· Maximizing the tax benefit of your gifts
Gifts of Money
Contributions of money are deductible on a dollar-for-dollar basis. You should avoid using cash for your contributions. Instead, use checks so that you have a verifiable record of payment. When you claim charitable contributions as a deduction on your tax return, you must keep good records of each donation, the organization it was given to, and the date and value of the donation. If you donate more than $250 to any organization during the year, be sure to get a receipt or letter from the organization. Without this proof of your donation, the deductions will not be allowed.
If you receive anything in return for your donation, you must subtract the value of that item from your deduction. For example, if you buy a ticket to a fundraising dinner for $200 and the value of the dinner is $50, your deduction for the charitable contribution would be only $150. Most charitable organizations make the value of any gift or service you receive very clear on the receipt they give you so that you can claim the appropriate amount for your deduction. Also be sure to note that contributions to political organizations or campaigns are not deductible.
The maximum deduction allowed to be taken in one year is limited to 50% of your Adjustable Gross Income (AGI). Anything more than that can be carried forward for future use for up to five years. Contributions to certain organizations are limited to 30% of AGI.
Example Collin is retired. He doesn’t require a very significant income to live on. In fact, he is very comfortable with an income of $40,000 per year (with an AGI of $30,000). Collin has a favorite charity that he has donated to for decades. The charity recently approached him for a substantial donation to help build a new facility that they need to expand their work. Collin agreed to donate $50,000 to the building of the facility.
Collin will reap a benefit on his tax return for the donation. In fact, that benefit will come over a span of four years. Collin’s AGI is $30,000, so the maximum charitable contribution deduction that he can claim per year is $15,000 ($30,000 AGI × 50% of AGI limitation = $15,000). The remaining charitable contribution that he cannot deduct in the first year will roll forward each year until it is used up completely, or for five years, whichever comes first. He will be able to claim $15,000 each year for the first three years (totaling $45,000) and then use the remaining $5,000 in the fourth year.
In addition to the contributions you make in money, you probably also make contributions “in kind.” When you clean out your garage or attic and donate things to a local charitable thrift store, you can take a deduction for those non-cash donations. The value of the deduction you can claim is the fair-market value of the item you donated. This value is usually determined by the price a thrift store could sell the item for (and is almost never close to what you paid for it). The donated item must also be in good condition. There are a few special rules that come into play regarding in-kind donations:
· If you donate a single non-cash item worth more than $5,000, you must get an independent appraisal of its value.
· Art, jewelry, or collectables must be appraised before you can deduct them, even if they are worth less than $5,000.
· Donations of food are not deductible.
· Vehicle donations have additional rules that you should be familiar with before making such a donation.
Note If you claim a significant amount of non-cash contributions, your records should include, first and foremost, a detailed list of what you donated and of the thrift-store value of each item. It is also advisable to take pictures of the things you will donate. Finally, be sure to get receipts from the charitable organization for the items you donated.
Tip Many thrift stores offer a list that shows the value of items that are commonly contributed. In addition, software programs are available that give you national averages of the thrift store value for thousands of items. The key is to be generous in your giving, but not overly generous in the value that you place on those gifts on your tax return.
Gifts of Service
One type of charitable contribution that is not deductible, even when given to recognized organizations, is the giving of your time. Many people assume that they can deduct their time given to a charity at the rate that they would otherwise charge in their profession. For example, an attorney may give free advice to the local Good Will when he would have charged another person or business $500 for that advice. He may not deduct the $500 as a contribution. The reason for this seems to come down to verifiability, as well as the risk of arbitrary values being applied to a person’s time in order to juice the deductible amount.
Though time and personal service are not deductible, travel expenses incurred in order to give that service may be, if no significant element of personal pleasure, recreation, or vacation is involved. The most common deduction for charitable travel is for the mileage put on your vehicle while traveling to, from, and during the service for the charity. Charitable mileage can be deducted at the standard rate of $0.14 per mile, plus parking and tolls. Incidentally, the $0.14 per mile rate is not indexed for inflation and would literally take an act of Congress to be changed. You may also deduct actual travel expenses instead of the standard mileage rate, as well as any other actual costs incurred in giving the service.
Caution If you are going to claim a mileage deduction, keep accurate records of starting and ending odometer readings, reasons for the travel, and dates. Also get a third-party record of your vehicle’s mileage at the beginning of each year (such as the receipt from an oil change).
I have heard about a lot of organizations lately that bring people to exotic locations in order to perform a service, such as helping a local orphanage. If you pay for travel to such a location in order to perform service for a recognized charity, your out-of-pocket costs are deductible only if there is no substantial “pleasure” involved in the trip. If you go sightseeing for a few days and stay at a resort, there is a really good chance that your deduction will be denied.
Gifts of Appreciated Assets—the Best Way to Give (from a Tax Perspective)
The charitable contribution deduction has one of my favorite opportunities for “double-dipping” in the tax code. That opportunity comes when you contribute appreciated assets, such as investments, to a recognized charitable organization. When you make a contribution of an appreciated asset, you can take a deduction in the same way you would if you had written a check to the organization at the asset’s current market value. The bonus for contributing an appreciated asset, though, is that you will not have to pay capital gains taxes on that asset. You get a deduction for the full market value without ever recognizing (and paying taxes on) the gain. That’s two benefits for the price of one—a very rare treat in the tax code.
Example Nicole purchased 10 shares of stock in August of Year 1 for $100 per share (for a total cost of $1,000). In September of Year 2 she sold the stock at a price of $300 per share, or $3,000. This transaction resulted in a long-term gain of $2,000. Her tax bracket for long-term capital gains was 15%, so she had to pay $300 in tax on the gain.
In Year 2 Nicole also donated $3,000 to the Red Cross, her favorite charity. She did so by writing a check. This donation gave her a $3,000 deduction, resulting in a tax savings of $840 (she’s in the 28% marginal income tax bracket).
As an alternative, Nicole could have donated the $3,000 to the American Red Cross in the form of her shares of Google stock, instead of selling the shares and writing a check to the Red Cross. If she had done so, she would not have had to pay the $300 capital gains tax and would still have received the $840 in tax savings from the deduction. This would have brought a combined $1,140 tax savings, or 38% of the value of the contribution.
This special tax treatment is available only for assets that have long-term gain. Donations of assets that have been held for a year or less (short-term gains), or of an asset that would bring ordinary income when sold (such as inventory) are not given this special tax treatment.
The total value (of deductions) that comes from donations of appreciated assets cannot exceed 30% of your AGI for the year. Any deductions of appreciated assets that are more than 30% of AGI can be carried forward for up to five years for future deductions. After five years the carry-forward disappears.
Tip Do not use this strategy for assets that would sell at a loss. In that case it would be more beneficial to sell the position, capture the loss so that you can use it on your tax return, and then donate the cash to charity for the deduction. It is exactly opposite to the strategy for donating positions with capital gains.
Maximizing the Tax Benefit of Your Gifts
Careful planning can help you make the most of your charitable deductions, especially in certain situations. One of those is when your taxable income is very close to the threshold between tax brackets. Another is when your total itemized deductions are close to the same value as the standard deduction. In both of these situations, you may benefit by carefully planning the timing of a contribution.
Example Sarah is a sales manager for a phone book company. She gives 10% of her income to her church each year as a tithing contribution. She knows that she will receive an especially large bonus in January for the success the company has had this year. As she plans her taxes, she realizes the bonus will bump her from her usual 15% tax bracket up to the 25% tax bracket next year. She decides to hold off on making this year’s contribution to her church until January 1, so that she can have two years’ worth of charitable contribution deductions next year, when they will save her 25% in taxes instead of 15%.
To get the greatest charitable contribution deduction possible for you, you’ll need to have a method to properly record what you give. If you already track your expenses, just add the “Charity” category to your system. If you don’t normally track your expenses . . . start! At least do so for tax-deductible items. Keep a list of your contributions in the place where you pay your bills. If you do a fair amount of driving for charitable organizations, keep a mileage log book in your car. In short, find a way to capture and record each occasion in which you give charitably in your everyday life.