Giving to Charity: The Basics

November 7, 2012

Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

While it may be better to give than to receive, with proper planning it's possible to do both at the same time. Consider the strategies below to help you make the greatest impact with your charitable giving while receiving some tax savings for yourself, too.

Ground rules for giving

The tax aspects of charitable giving can be complex, so it's a good idea to consult a tax professional about your personal giving strategy. That said, here are a few ground rules:

• Itemize deductions on your tax return if you plan to deduct charitable contributions.
• Request a receipt receipt if you make a donation of $250 or more to a single charity. Also, you'll need a receipt or a corroborating bank record for all cash donations, regardless of amount.
• Get an independent appraisal for gifts of property in excess of $5,000 ($10,000 for closely held stock). Exception: You won't need an appraisal for exchange-traded stocks, bonds or mutual funds.
• Subtract the value of any benefits you received for your charitable contribution (e.g., books, tapes, meals, entertainment and so on) before you deduct it.

Keep in mind, you can deduct up to 50% of your adjusted gross income (the "bottom line" on page 1 of IRS Form 1040) for most donations to qualifying public charities each year (or 30% of AGI for gifts of long-term property). If that's not enough to cover your charitable gifts in any given year, unused deductions may be carried forward for five years.

Tax treatments by type of gift

Generally speaking, the tax advantages of a charitable contribution depend on three factors: the recipient (only donations to qualified charities are deductible); how you structure the gift; and its form. Different types of charitable donations—cash, stock or personal property—offer different tax advantages and drawbacks. Let's look at some of the options.

Good old cash

Cash donations are simple and usually fully deductible. As previously mentioned, you will need a receipt from the charity or a bank record (such as a canceled check or statement) to substantiate your cash gift, no matter how small.

Tangible personal property

You can donate almost any item, including old clothing, household goods, or vehicles.

If the property doesn't relate to the charity's mission, you may deduct the amount you paid for it or the property's current reasonable value, whichever is less.

If property is related to the mission of the charity—old clothes donated to the Salvation Army, for example—it's usually fully deductible based on its current reasonable value. Many charities will provide some guidance on "thrift value," but it's ultimately up to you to determine the value of your donation for tax purposes.

Keep in mind that gifts of used clothing and household items must be in "good used condition or better." Most charities won't accept a gift unless it's in satisfactory condition to begin with, but you can always take digital pictures of donated household items and used clothing if you're worried about proving their condition in the event of a tax audit.

Ordinary income property

You can donate property created by or used in a trade or business. This includes inventory held for sale—or, if you're an artist or craftsperson, items you created for sale. This category also covers property that, if sold, would generate ordinary income instead of long-term capital gains, such as investments held for one year or less.

Long-term capital gain property

You can usually deduct the full fair market value of appreciated long-term assets such as stocks, bonds or mutual funds you've held for more than one year. For example, the full fair market value of publicly traded securities is the average of the high-low price on the date of transfer. What's more, there's no capital gains tax.

A wrinkle here is that the deduction is limited to 30% of your adjusted gross income instead of the usual 50% limit for donations of cash and short-term property made to public charities—though you can still carry forward unused deductions for five years.

If you choose to deduct your cost basis only, you can raise the limit to 50% of your adjusted gross income. But if you're holding securities with a loss, it's better to sell first, take the capital loss for tax purposes, and then donate the cash. Keep in mind, in most cases, donating appreciated securities can be a cost-effective way to benefit the charities of your choice.

Hypothetical Example: Donating Cash vs. Donating Stock

You can sell your stock and then donate what's left over after you pay capital gains tax, or you can donate securities directly – either way, in the example below, your $100,000 in stock is gone. But with the second option, you get a bigger deduction and the charity gets a bigger donation.

1. Assumes cost basis of $5,000, that the investment has been held for more than a year, and that all realized gains are subject to a 15% long-term capital gains tax rate. Does not take into account any state or local taxes.

2. Assumes donor is in the 28% federal income tax bracket, and does not take into account any state or local taxes. Certain federal income tax deductions, including the charitable contribution, are available only to taxpayers who itemize deductions, and may be subject to reduction for taxpayers with adjusted gross income (AGI) above certain levels. In addition, deductions for charitable contributions may be limited based on the type of property donated, the type of charity, and the donor's AGI. For example, deductions for contributions of appreciated property to public charities generally are limited to 30% of the donor's AGI. Excess contributions may be carried forward for up to five years.

Volunteering

You can deduct transportation costs and other expenses related to volunteering. However, keep in mind, the value of volunteer time isn't deductible.

More sophisticated giving options

If you want to make a longer-term commitment to giving, charitable remainder trusts (CRTs), pooled income funds, private foundations, and donor-advised funds all offer different benefits in terms of flexibility, taxes, administrative costs, and account minimums.