The holidays are fast approaching and so is the end of the 2014 tax year. In less than a month, 2015 will be here and that means that there is only a limited time left to reduce your 2014 tax bill. One of the simplest ways to do this is to donate to a charitable organization qualified under section 501(c)(3) of the Internal Revenue Code. The benefit of donating to charity is two-fold; you are able to help those in need and obtain a tax deduction for your efforts.
Who Can I Donate To?
In order to qualify for the charitable donation deduction, you must donate to an organization, not an individual, and the organization must be qualified by the Internal Revenue Service under section 501(c)(3) of the Internal Revenue Code. The easiest way to determine whether a charity is a qualified 501(c)(3) tax-exempt organization is to visit the organization’s website. Most qualified organizations will have a sentence or two on their website stating that they are qualified under 501(c)(3) and that any donations to them are tax deductible. If the organization does not have any information on the website or does not have a website, the IRS also has a search tool on their website that you can use to verify the organization’s tax-exempt status.
What Can Be Donated?
Charities will generally inform you as to the types of donations that they accept. The majority of organizations will accept cash donations (checks and credit cards). Some organizations may also accept different types of personal property such as clothing, food, furniture, and automobiles to name a few. In some cases, certain expenses can even be considered donations. Unreimbursed foster care expenses incurred by a taxpayer in connection with fostering an animal for a qualified 501(c)(3) organization are an example of expenses that can be deducted as charitable contributions.
When making any kind of contribution, cash or non-cash, it is important to get a receipt or acknowledgement from the organization. Receipts are important because they prove your deduction claim and also help establish the fair market value of non-cash items. For all cash contributions and for non-cash contributions with a fair market value in excess of $250, the IRS requires you to keep receipts to substantiate your deduction. For donations of property with a fair market value in excess of $5,000, you will need to get a qualified appraisal. If you claim a deduction without a receipt and your return is later audited, the IRS may disallow your deduction which could result in additional tax owed as well as interest and penalties.
How Does the Deduction Work?
The charitable contribution deduction is reported on Schedule A of your individual tax return as an itemized deduction. Itemized deductions reduce your taxable income dollar for dollar. The value of the deduction is the fair market value of cash and property that you donated to qualified 501(c)(3) organizations during the tax year. The total value of the deduction that you claim is limited to 50% of your adjusted gross income, which is line 38 on your Form 1040. Donations of capital gain property, or any property that you would have reported a gain on if you had sold it, are limited to 30% of your adjusted gross income. Any contributions that you make in excess of these limitations may be carried forward and used during the next five tax years. If your adjusted gross income is over $150,000 for the tax year, the amount of certain itemized deductions, including charitable contributions, will also be limited.
Despite the 30% adjusted gross income limitation, it is still very beneficial to donate capital gains property such as appreciated stocks. By donating appreciated capital gain property to charity, you avoid the need to pay tax on the capital gain while simultaneously getting a tax deduction for the property’s fair market value. In essence, you are being given a tax deduction for something that you never paid tax on.
There are also types of trusts that you can set up to receive a charitable deduction. The most common type of trust is known as a charitable remainder trust. Charitable remainder trusts allow you to transfer property into them and then receive the income from the property. At the end of a specified number of years, or at the end of your life, the property in the trust will be given to the qualified charity named in the trust documents. With this type of trust, the value of your tax deduction will be the fair market value of the property less the value of income you expect to receive from it. In addition, if you donate appreciated capital gains property, you will not need to pay tax on the gains. Setting up a charitable remainder trust is also an excellent estate planning tool as it allows you to receive a tax deduction and also reduce your taxable estate.
If charitable contributions are made by a business and not an individual, the type of business entity will dictate where the deduction is claimed. C-corporations are the only organization type that may claim charitable contributions as a deduction. They are deducted on Line 19 of the corporation’s Form 1120. For all other organizations, charitable contributions are reported on the partners’ or shareholders’ Form K-1s, which are in turn reported on the individuals’ tax returns as if they had made the contributions personally.
Please be aware that there may be additional limitations and nuances in the tax code that may apply to your charitable contribution. The advice provided herein is merely a general summation of the Internal Revenue Code. We highly recommend seeking the advice of a tax professional before making a large contribution so that he/she can assess your tax situation and assist you in determining the most beneficial course of action.
Jacob Lutz, CPA
Jacob joined Cerini & Associates in January of 2013 and has been actively providing tax, compliance, and business advisory services to a wide variety of both for-profit and non-profit clients.