Maximize Your Charitable Contributions to Minimize Your Tax LiabilityBy Jennifer Leelaviwatana | February 11, 2020
Since the enactment of the Tax Cuts and Jobs Act of 2017, taxpayers are limited to a deduction of up to $10,000 of state and local income taxes. Without the ability to deduct the full amount of their state and local income taxes, most taxpayers do not have enough deductions to itemize. In addition, under the Appropriations Act of 2020, medical expenses are only deductible when they exceed 7.5% of taxpayers’ Adjusted Gross Income (AGI). However, charitable contributions can still have a powerful effect on minimizing taxpayers’ tax liability.
CASH IS KING
Taxpayers can receive deductions up to 60% of their AGI when donating cash to charity and can receive deductions up to 50% of their AGI when donating certain noncash contributions such as clothes, household items, capital property (stock), artwork, etc.
For taxpayers who contribute cash and capital property together, the overall limitation is 50% of their AGI. Charitable contributions that exceed the AGI limitation will carry forward for the following five years. For example, John and Jane, a married couple filing jointly, have a total of $1,000,000 in AGI for the 2020 tax year. John made a pledge to a local charity in the amount of $100,000 to be paid out over five years. John has an option to start his pledge in 2020 or 2021. Jane inherits money and stock in early 2020 and contributes cash of $100,000 to a local charity. Jane also donates stock worth $200,000 to a local charity and $200,000 in cash to her private foundation. John decides to postpone his pledge until next year since Jane is making a large gift in 2020.
In general, a capital property that is donated to a qualified charity is limited to 30% of taxpayers’ AGI. However, a capital property donated to a personal private foundation is limited to 20% of taxpayers’ AGI. As Jane donated stock to her personal private foundation, the deductions are limited to 20% of her AGI. Therefore, John and Jane can deduct $400,000 of the total $500,000 on their 2020 tax returns and carry forward $100,000, or 20%, of their charitable contributions to the 2021 tax year.
The first limitation (limited to 60% of AGI) is cash to a 50% qualified charity, the second limitation (limited to 30% of AGI) is stock (capital property) to a 50% qualified charity and the last limitation (limited to 20% of AGI) is stock (capital property) to a second category qualified charity. In this case, the last $200,000 donated to Jane’s private foundation will be limited to $100,000, as the combination of the stock donation to the 50% qualified charity and the second category qualified charities cannot exceed the $300,000 limitation. The carryforward amount of $100,000 of the 20% deduction can be used for the following five years.
WHAT ARE THE QUALIFIED CHARITIES?
IRS Publication 526 explains how to claim a deduction for charitable contributions and provides a list of qualified charities, which are also sometimes referred to as 50% limit organizations.
- Churches and conventions or associations
- Educational organizations with a regular faculty and curriculum that normally have a regularly enrolled student body attending classes on-site.
- Hospitals and certain medical research organizations associated with these hospitals.
- Organizations that are operated only to receive, hold, invest and administer property and to make expenditures to or for the benefit of state and municipal colleges and universities and that normally receive substantial support from the United States or any state or their political subdivisions, or from the general public.
- The United States or any state, the District of Columbia, a U.S. possession (including Puerto Rico), a political subdivision of a state or U.S. possession, or an Indian tribal government or any of its subdivisions that perform substantial government functions.
- Publicly supported charities
- Organizations that may not qualify as “publicly supported” but that meet other tests showing they respond to the needs of the general public, not a limited number of donors or other persons. They must normally receive more than one-third of their support either from organizations described in (1) through (6), or from persons other than “disqualified persons.”
- Most organizations operated or controlled by, and operated for the benefit of, those organizations described in (1) through (7).
- Private operating foundations.
- Private nonoperating foundations that make qualifying distributions of 100% of contributions within 21⁄2 months following the year they receive the contribution. A deduction for charitable contributions to any of these private nonoperating foundations must be supported by evidence from the foundation confirming it made the qualifying distributions timely. A copy of this supporting data should be attached to your tax return.
- A private foundation whose contributions are pooled into a common fund, if the foundation would be described in (8) but for the right of substantial contributors to name the public charities that receive contributions from the fund. The foundation must distribute the common fund’s income within 21⁄2 months following the tax year in which it was realized and must distribute the corpus not later than one year after the donor’s death (or after the death of the donor’s surviving spouse if the spouse can name the recipients of the corpus).
HOW IS GIFTING CAPITAL GAINS PROPERTY TO A PERSONAL PRIVATE FOUNDATION TREATED?
Since a personal private foundation is not listed as a 50% limit organization, it falls under a “second category of qualified organizations.” When taxpayers make noncash contributions of capital gain property during the year (1) to an organization under this category or (2) “for the use of” any qualified organization, their deductions for those contributions are limited to 20% of their adjusted gross income. Note the “for the use of” contribution exception. A 20% or 30% limit applies to noncash contributions that are “for the use of” the qualified organization instead of “to” the qualified organization. A contribution is “for the use of” a qualified organization when it is held in a legally enforceable trust for the qualified organization or in a similar legal arrangement.
In the example above, if John changes his mind and starts contributing toward his pledge in 2020, since Jane has already met the 30% and 20% limit, he would benefit most from a tax standpoint by contributing $20,000 in cash. As a result, John and Jane can deduct $420,000 on their 2020 tax returns.
If John prefers to donate the first installment of his pledge ($20,000) to a 50% qualified charity using his stock, the limitation will be as follows:
Since John and Jane’s stock donation to a 50% qualified charity is $220,000, they are only allowed to deduct $80,000 of capital gains property to the second category qualified charities (limited to 20% of their AGI). Their 20% charitable contribution carry forward to 2021 will be $120,000.
The crucial question is how much tax liability does $420,000 of charitable contributions save? It depends on John and Jane’s tax rate. Let’s assume their marginal tax rate is 37%. $420,000 of charitable contributions will decrease John and Jane’s tax liability in 2020 by $155,400 ($420,000 x 37%). Keep in mind one other incentive to use a long-term capital property as a currency to donate – taxpayers receive a fair market value at the time of the donation and do not pay taxes on any unrealized gains. Thus, most taxpayers choose to donate stock with large unrealized gains.
Most taxpayers are able to use 100% of their charitable contributions up front. Depending on the size and character of the donation and the amount of AGI for that year, taxpayers may incur carryovers that can be used over a number of years (but not exceeding the five-year carryover limitation). Thus, it is imperative to understand how carryovers are being applied on your tax returns and to work closely with tax advisors to ensure that tax benefits are maximized for a large gift given to charity.
About Jennifer Leelaviwatana
Jennifer Leelaviwatana, CPA, is a Partner in the Private Client Services Group at Marks Paneth LLP. In this role, she provides a broad range of tax planning and consulting services to high-net-worth individuals, closely-held businesses, estates and trusts and clients in the real estate and professional services industries. Ms. Leelaviwatana’s specialty areas include strategic tax planning, preparation and compliance for partnerships, S-Corporations, private foundations and trusts. Prior to joining Marks Paneth, Ms. Leelaviwatana worked at... READ MORE +