Remember the adage “It’s better to give than to receive”? With proper planning, it’s possible to do both at the same time. Your financial goals may include giving to the causes that are most important to you. As you plan, these strategies can help you make the greatest impact while potentially receiving tax savings too.
Ground rules for giving
The tax aspects of charitable giving can be complex. It’s always a good idea to consult a tax professional about your giving strategy. That said, here are a few ground rules for charitable giving:
- Request a receipt if you donate $250 or more to a single charity. If the donation is in cash, you'll need a receipt or supporting bank records, regardless of amount.
- Get an independent appraisal for gifts of property in excess of $5,000 ($10,000 for closely held stock). 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 (for example books, tapes, meals, entertainment and so on) before you deduct it.
- Normally, you must itemize your deductions on your tax return if you want to receive a tax benefit for your charitable donations. If your standard deduction exceeds your total itemized deductions, then you likely won’t itemize. You’ll help your favorite charity—which is a good reason on its own to give—but won’t reduce your tax bill.
Note: For 2021, you may be able to take a small charitable deduction even if you do not itemize your deductions on your tax return. For 2021 an individual can deduct up to $300 or a married couple can deduct up to $600 if the donations are made to an operating charity in the form of cash.1
- There are annual limits on the deductible donation. Under the CARES Act and the Consolidated Appropriations Act, you can elect to take an increased donations deduction to certain charities, however, its only for cash donations in 2020 and 2021. Under this temporary rule, individuals may deduct 100% of AGI on cash donations to qualifying operating charities (donations to private foundations and donor advised funds are excluded from this rule).
If you don’t elect to use the 100% AGI limit, your donations to qualified charities will fall under the normal AGI limits. In generally your donation deduction will be limited to 50% of your adjusted gross income (AGI) —unless you only give cash, in which case the limit increases to 60% of AGI. Whereas, the limit on donating appreciated assets to a qualified charities is 30% of your AGI. These limits are reduced for donations to certain organizations, such as private foundations.
Tax treatments by type of gift
The tax advantages of a charitable contribution generally depend on three factors: the recipient (only donations to qualified charities are deductible), how you structure the gift, and the type of property you choose to give. Different types of property donations—whether its cash, business assets, or investments—offer different tax advantages and drawbacks:
Cash donations are simple, but as previously mentioned, make sure you keep 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.
You can deduct transportation costs and other expenses related to volunteering. However, the value of volunteer time isn’t deductible.
Tangible personal property
You can donate almost any item, including old clothing, household goods or vehicles. Gifts of used clothing and household items must be in “good” used condition or better, under IRS tax rules. If the property doesn't relate to the charity's mission, you may deduct the amount you paid for the property or the property's current reasonable value, whichever is less. If property is related to the charity's mission—old clothes donated to the Salvation Army, for example—it's usually fully deductible based on its current reasonable value. Some charities will provide guidance on the value, but it's ultimately up to you to determine the value for tax purposes.
Ordinary income property and short-term capital property
Ordinary income property normally includes assets such as inventory held for sale by a business, artwork created by the donor, or manufactured items you produced. In addition, any short-term capital assets, such as investments like stock, held for less than a year are also considered to be ordinary income property.
If the assets you are donating would have generated ordinary income if it was sold on the day of the donation, then the IRS limits how much you can deduct to the fair market value fair market value reduced by the amount of ordinary income or short-term capital gain that would have been realized. Or to put it another way, your deduction will generally be limited to the cost basis of the asset.
There are some notable exemptions to this rule. You may be able to take the full deduction for the FMV of the property if you include the appreciated value of the asset in your gross income on your tax return. Also, if the property you want to donate has decreased in value, your deduction could be further limited (see “Property that has decreased in value” below to learn more).
Appreciated long-term capital-gain property
You can usually deduct the full fair market value of appreciated long-term assets. These are assets or investments that you've held for more than one year and a day, and can include stocks, bonds, mutual funds, or other personal assets like real estate that has appreciated in value. An additional benefit of donating long-term capital assets is you don’t have recognize the capital gain associated with that donation, which means you pay no capital gains tax on that asset.
Donating long term assets—especially highly appreciated securities—instead of cash can be a very effective and tax-efficient way to support a charity. Generally, if your assets have appreciated in value, it’s best not to sell securities to generate the cash you need for a donation. Contributing the securities directly to the charity increases the amount of your gift as well as your potential deduction.
One rule to remember here is that the deduction is limited to 30% of your adjusted gross income (AGI). If you’re not able to use the entire donation deduction this year, you can still carry forward unused deductions for five years. However, if you’re planning a large donation that’s close to or exceeds your AGI limit, consider talking to a tax professional before making your donation.
Here's an example of how donating appreciated investments can increase the amount of a donation. Let’s say Sarah and Steve are married, file a joint tax return, and want to donate $100,000 worth of stock to their local animal shelter. They are in the 35% federal ordinary income tax bracket and are subject to the 20% long term capital gains tax rate, plus the 3.8% net investment income tax. They have two options: they could sell the stock and donate the cash, or they could just donate the stock directly to the charity. The chart below shows that donating the stock would result in a much larger tax savings in this situation.
The example is hypothetical and provided for illustrative purposes only.
2Assumes a 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 20% long-term capital gains tax rate and the 3.8% net investment income tax. The analysis does not take into account any state or local taxes.
3Assumes donor is in the 37% 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 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.
Property that has decreased in value
For property that has decreased in value below its cost basis, the IRS has a special rule that says you can only take a donation deduction for the fair market value of that asset. In some situations, such as when you have shares of stock that have decreased in value to the point where you have losses, it may be better to sell that asset first and then donate the cash proceeds. By doing so, you may be able to take a capital loss deduction against your other capital gains, and then donate the remaining cash and get a deduction for the donations fair market value.
Giving through specialized charitable vehicles
While gifts of cash or appreciated investments can be given directly to a charity, it often makes sense to consider specialized charitable vehicles to make giving easier and to manage the tax benefits. If you give regularly, certain giving vehicles such as donor-advised funds or private foundations can make sense.
Donor-advised funds, for example, allow you to make a donation of appreciated stock held long-term and receive a current-year tax deduction. You can then grant those assets out over time and have the remaining assets invested so they can grow for future grants to worthwhile charities.
If you prefer to leave assets to charity but also earn income for a period of time, a charitable remainder trust (CRT) or pooled income fund is worth exploring.
Another donation option to consider if your over age 70 1/2 years is a qualified charitable distribution (QCD) from your tax-deferred retirement account, such as a traditional IRA. A QCD is a tax-free distribution from a retirement account that can be donated directly to a qualified charity and does not have to be taken into your income for tax purposes. In addition, a QCD can also be used to meet up to $100,000 of the required minimum distribution for your IRA. It should be noted that there is no tax deduction for a QCD; however, you don’t have to include that distribution into your taxable income.
The bottom line
Each of these donation strategies and vehicles offers different benefits, but in the end, what really matters is helping an organization that matters to you. The tax benefits from a donation are just icing on the cake. So, compare your options and talk with a financial planner, tax adviser, and/or a philanthropic adviser (such as those at Schwab Charitable) to help determine the best way to give for your particular situation.
1 An operating charity does not include private foundations or donor advised funds.