This week, The Atlantic reported, to the surprise of no one, that charitable donations increase as the year draws to a close and spike on the last day. Why is this? Last minute tax planning. People want to make sure that they lower their tax bill for the year by making a charitable contribution, which is then deductible. The last day to make such a gift for the tax year 2013 is, naturally, December 31, 2013.
Two questions arise. First, to whom do you make such gifts, and second, is it worth it?
Who Gets the Gifts?
In order to receive the charitable donation deduction, the organization receiving the donation must be a qualified organization. Generally, a qualified organization will be classified as a 501(c)(3) not-for-profit organization. Such an organization generally be organized and operated only for charitable, religious, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals. It may also include veterans’ groups (e.g.: the VFW), fraternal societies, or government subdivisions that perform government functions (think: police department).
Remember, however: organizations such as a 501(c)(4) will not be qualified organizations. Notably, many 501(c)(3) entities will have lobbying or advocacy arms which are established as 501(c)(4)s; strictly speaking, they are formally separate entities. The IRS maintains a list of qualified entities; to see if the organization to which you wish to make a donation is on this list, go to: http://www.irs.gov/Charities &NonProfits/ExemptOrganizationsSelectCheck.
Worth It?
To figure out if it’s worth it, you have to do two calculations – 1) how much can you deduct? and 2) what would your tax liability be otherwise? As a general rule, these contributions are going to reduce your tax liability. So as a general greater than/less than proposition, it makes sense to do so – without considering other external factors, like how much time/energy/money it will take you to realize the deductions. But keep in mine – it is a bit of an asymmetrical exchange. More on that later.
Putting that aside, how much you can deduct is subject to several limits. Those limits hinge on what kind of donation is being made (i.e.: money vs. property, appreciated vs. depreciated property, etc.), the adjusted gross income of the donor, and the type of organization that is receiving the property.
Contributions of property are subject to many rules; however, chief among them is that the amount of the deduction is limited to the fair market value of the property at the time it is donated.
The fair market value of contributed property that is subject to a debt must be reduced by any allowable deduction for interest paid or expected to be paid that is attributable to any period after the contribution. Moreover, it must be reduced by the amount of debt assumed by the charitable organization or by any other third party when you surrender control of the property to the charitable organization.
Special rules also apply if the property you are donating has changed in value – either up or down. If contributed property has decreased in value, your deduction is limited to its fair market value. If it has increased in value, however, you may have to reduce the fair market value (and, therefore, the deduction you take) by the amount of appreciation of the property if it is ordinary income property – property that would result in ordinary income to you if you sold it. If it is capital gains property, the deduction you take should be the fair market value of the property. And, yes, there are always exceptions.
Now that you know how to value the property you donate for the deduction, it’s important to know at what point those deductions max out – at what point you can no longer increase your deduction because you’ve reached the limit for deductions for this year.
As a baseline rule, your deduction for charitable contributions cannot exceed 50% of your adjusted gross income. The 50% rule applies when you donate to qualified organizations that…well, qualify. These will include churches, educational organizations, other organizations that support such, and various private foundations that meet certain requirements. However, that limit is lowered to 30% when you make contributions to – and you have to love this language – “all qualified organizations other than 50% limit organizations.” As examples, the IRS cites veterans’ organizations (think VFW), fraternal societies, and some private nonoperating foundations.
There are other restrictions which can cap your deduction at either 30% or 20%. For instance, if you donate capital gain property to an organization that qualifies for a 50% deduction, and you do not account for the appreciation, your deduction will be capped at 30%.
The 20% limit isn’t a free standing limit; instead, it does to 30% limit organizations what the 30% limit does for 50% limit organizations. It simply applies to capital gain property that is contributed and for which appreciation is not accounted.
Despite the limitations, there is good news. Like certain losses, deductions that you cannot take in a given tax year because you hit the limit (50% or 30%, depending) can be carried over to the following year for up to five years, until it is used up, or until the five years expires.
Two more points about deductions. First, you cannot take a deduction for your time donated to charitable organizations – say, volunteering. Second, charitable giving is a bit asymmetrical. When you donate money, say $10,000, you are lowering your adjusted gross income (AGI), and therefore, the amount on which your tax is calculated. You receive a reduction in tax that is equal to the amount you donate (say, $10,000) multiplied by your highest marginal tax rate that year. If your marginal tax rate is 25%, you realize a tax savings of $2,500 (if your rate is 28%, you realize a savings of $2,800, and so on). You can realize greater savings, however, if you are on the cusp, and you not only reduce your AGI, but lower your AGI into a lower top marginal tax rate. The asymmetry comes from the fact that while you receive only a quarter of the $10,000 as a benefit, or so, the organization to which you donate receives the full $10,000. With that said, ’tis better to give than to receive, and despite any asymmetry, you will still receive a tax break – it’s just best to know how it works.
Good luck, and happy giving.
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