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Millions of Americans give to charity every year – whether to their church, their university, or their local soup kitchen. Yet many of us fail to take full advantage of the significant income tax savings that can be generated from our charitable donations, leaving hundreds, or even thousands, of dollars in unclaimed tax deductions. While charitable giving is personally rewarding in and of itself, why not make it financially rewarding as well? By keeping records of your charitable donations and strategically planning your charitable giving, you can increase your tax savings and boost the amount of money going to your favorite cause.
In order to qualify for the charitable deduction, the donation must be made to a “qualified organization,” as defined under the tax code. You can ask the organization whether it is a qualified organization or check with the IRS, which has an online tool that allows the public to search its database of qualified organizations, found at www.irs.gov/charities. You can also call the IRS directly at 1 (877) 829-5500.
Limitations on the Deduction
The deduction may be limited if you make a large donation relative to your income. For example, the deduction is generally limited to 50% of your AGI for the taxable year. Different rules may apply for gifts of appreciated property or donations to private foundations.
In case you are audited, you must obtain a record of your donation, such as a bank statement or a receipt from the organization. You should keep these records at least three years from the year in which you file the tax return claiming the deduction.
While you can claim a deduction for a simple cash gift to a charity, there are ways to maximize the tax benefits of your donation by using certain gifting strategies.
Because the income tax deduction becomes more valuable as you make more money and shift into higher tax brackets, you can maximize your tax benefits by making substantial donations in years where you have higher income. For example, suppose you are considering making a $10,000 donation to your favorite charity, but you’re not sure if you want to make the donation this year or next year. This year, you have an adjusted gross income of $250,000, resulting in an income tax rate of 36%. A donation of $10,000 will therefore generate tax savings of $3,600. Suppose you expect to retire the following year, causing your adjusted gross income to fall to $50,000, lowering your income tax rate to 25%. Because you are in a lower tax bracket in the second year, the same $10,000 donation will generate only $2,500 in tax savings. By thinking ahead and making the donation in the first year, you save over $1,000 by simply shifting the timing of the gift.
Donations of Appreciated Property
Donating appreciated property can leverage your tax benefits by not only generating an income tax deduction, but also eliminating capital gains tax on the donated property. To illustrate, if you bought stock for $1,000 5 years ago, and the stock is now worth $9,000, you can donate the stock to charity and claim a $9,000 charitable deduction. The charity would sell the stock and receive $9,000 to use in its work. However, if you sell the stock, and then donate the proceeds to charity, you could pay $1,900 in capital gains tax and the charity would receive only $7,100. Meanwhile, your deduction is limited to the $7,100 that was ultimately received by the charity. By simply altering the form of the donation, the charity receives an additional $1,900, your deduction increases by $1,900, and you avoid $1,900 in tax payments – a win-win for both parties.
Charitable Remainder Trusts
Charitable remainder trusts are more-sophisticated vehicles for charitable giving and require the counsel of an experienced tax lawyer. Charitable remainder trusts allow the donor to transfer property into a trust in exchange for a stream of income payments, which can be a helpful tool for retirement planning. Charitable remainder trusts can both delay and minimize capital gains tax on appreciated property transferred to the trust. This structure is particularly useful in the wake of recent tax increases on high-income earners pursuant to the American Taxpayer Relief Act of 2012. Because the trust spreads the income payments to the donor over a number of years, it can lower the donor’s income tax rate and prevent the donor from being subject to the 20% tax rate on capital gains and the 3.8% tax on investment income, both of which apply only to those with income over a certain threshold.
About the Author
Shannon McNulty is a Philadelphia income tax attorney. She is a frequent author and speaker on personal and corporate tax issues.