Give generously, but understand tax implications first
Basic knowledge of rules can help donors develop clear philanthropic strategyOctober 24th, 2013
There are many options when it comes to charitable giving. With some advance planning, you can make a difference for a cause that's important to you.
But before you dive in, make sure you have a clear strategy and understand the basic rules for tax-deductible contributions. Planning ahead can be extremely helpful—and in some cases crucial—to maximizing the effectiveness of your donation as well as your generosity. While reducing taxes isn't the main reason many of us give, a charitable donation can indeed offer some benefits.
If you don't yet have a clear strategy, start by examining your priorities. Which causes are important to you? How much can you donate in terms of time and money? Do you prefer to disclose your identity or remain anonymous?
You'll need to identify qualified charitable organizations that are tax-exempt so your contributions are deductible. Most operate as a 501(c)3. If you'd like to donate assets other than money, consider what forms they'll take; gifting doesn't always have to mean cash.
Next you'll want to do some homework to make sure you're giving your money to an organization that's well-managed and has a solid future. To identify qualified charitable organizations, you can use the IRS's online search tool or visit Charity Navigator, a website that examines financial documents to help users assess lesser-known charities.
Cash donations require either bank records or written acknowledgment from the charity documenting the amount and date of contribution. Cash donations of $250 or more given to only one organization on one day require written substantiation from the organization.
Noncash donations have specific documentation requirements. These become more stringent as the value of your gift increases. In some cases, you might need to get an appraisal.
When you donate stock or property held for more than one year, the deduction is generally equal to the fair market value of the property. This effectively allows you to remove appreciated property from your estate and avoid capital gains taxes by receiving a current tax deduction. With a few exceptions, when you donate ordinary income property—inventory or stock held one year or less—your deduction is limited to your basis in the property.
If you receive a benefit, such as merchandise or services, from the charity as a result of your contribution, you can deduct only the amount by which your donation exceeds the fair market value of the benefit you received. You can't deduct the value of any services you provide, but you can deduct expenses related to any volunteer work, such as transportation. Meals and lodging are deductible as long as there isn't a significant element of personal pleasure resulting from the travel. Mileage is deductible at a rate of $0.14 per mile.
Beginning in 2013, higher-income taxpayers again will be subject to the phaseout of some itemized deductions. Charitable donations, among other currently deductible items, will be subject to the phaseout, making them less advantageous for tax purposes.
In addition, a cap on the total amount of itemized deductions also is being debated. If such a rule were implemented, taxpayers wouldn't be able to deduct amounts in excess of the cap. While a cap is still only being discussed, possible amounts suggested have been $25,000 and $50,000. In this scenario, taxpayers would see no tax benefit on itemized deductions in excess of these amounts.
Another possibility being discussed would force higher-income taxpayers to take a deduction for charitable donations as if they were in the 28 percent bracket rather than a higher tax bracket. This would diminish the tax benefit for wealthier individuals.
You may have heard about using trusts for making charitable contributions. Two relatively common types are charitable remainder trusts and charitable lead trusts.
With a charitable remainder trust, a portion of trust income is first dispersed to the beneficiaries of the trust, and after a specified term, the remainder of the trust is donated to a designated charity. In contrast, with a charitable lead trust, a portion of trust income is first donated to a designated charity, and after a specified term, the remainder of the trust is transferred to individual beneficiaries. Trusts can be extremely complex, so be sure to consult with an accountant or tax attorney for guidance.
Tips for businesses
Consider including charitable giving within your business strategy. Understanding tax limitations on charitable deductions can help your company make the most of the amounts you gift. While your company can make contributions in any amount, the IRS limits deductions at 10 percent of net taxable income. Contributions above 10 percent can be carried over into future years. For flow-through businesses, such as S corporations, partnerships, or LLCs, the limitation is determined on the owner's tax return and could be up to 30 percent or 50 percent of income.
Also consider your long-term business plans. If you plan to sell your company eventually or transition ownership interests, you'll have a major opportunity to increase your charitable activities. Business ownership interests fuel your personal net worth, and a change in ownership status can present new opportunities to reduce your income and estate tax liabilities while increasing your charitable contributions. Popular gifting strategies during a liquidity event (such as selling one's business) include donor-advised funds, private foundations, and charitable trusts.
Make sure to document the value of your donations and activities. Charitable activities can help distinguish your company in the business community as well as among the competition, and they can help your company stand out as a potential employer. Reporting on charitable activities to employees and other stakeholders also demonstrates your commitment and appreciation.
S corporations can deduct the fair market value of appreciated assets contributed to charity, while only reducing the shareholders' basis in the company by the assets' basis. This provision is available through the end of 2013.
C corporations can take an enhanced deduction for contributions of certain food inventory. As part of the Katrina Relief Act of 2005, an enhanced deduction also is available for wholesome food inventory donated for the care of the ill, needy, or infants. This deduction is available through 2013 to all business taxpayers but cannot exceed 10 percent of the taxpayer's aggregate net income for the year.
The bottom line
Charitable giving isn't all about the tax deductions. But the deductions do have a way of boosting the incentive for people to give more than they might do otherwise. This makes tax deductions a valuable tool not just for donors but for recipients as well.
As you evaluate your charitable giving plans, keep tax deductibility in mind. And be sure to consult with your accountant or tax attorney to help you arrive at the best decision for you, your family, your business, and your legacy.