Philanthropy is one of the strongest bonds among Americans and is encouraged by tax laws that allow deductions for gifts to charity. As simple as that may seem, the rules for tax deductions can be as convoluted as a Rube Goldberg machine for pouring liquids, depending on factors including:
- Nature of the property given (cash, appreciated securities, artwork, automobiles, real estate, artwork, collectibles and other tangibles, etc.)
- Value and cost basis of the property donated
- Source of the property given (your IRA or otherwise)
- Type of the charity to which the property is donated
- Whether you itemize deductions or take the Optional Standard Deduction
For the sake of simplicity, the following discussion focuses on tax deductibility of the most widespread type of gifts to charity:
outright gifts of cash and marketable securities to qualified 501(c)3 organizations such as your church or alma mater, the Girls and Boy Scouts, the YMCA, the Red Cross and United Way, etc.
Gifts of Cash and Appreciated Marketable Securities
Taxpayers who itemize deductions on their tax returns are generally allowed to include the amount of cash or the value of marketable securities donated to qualified 501(c)3 organizations. The amount of the deduction allowed depends on whether the gifts are in the form of cash or marketable securities.
The tax deduction is taken “below the line” on the taxpayer’s income tax return, after determining Adjusted Gross Income (“AGI”). The deduction is allowed not only for outright gifts to qualified 501(c)3 organizations, but also for gifts to such vehicles as charitable gift annuities, donor-advised funds and private foundations.
Despite the lower amount of the maximum deduction allowed for gifts of marketable securities, there can be a significant advantage of such gifts: the avoidance of capital gains taxes.
Appreciated publicly traded stock that you’ve held more than one year is considered long-term capital gains property. If you donate it to a qualified charity, you may be able to enjoy two tax benefits:
- If you itemize deductions, you can claim a charitable deduction equal to the stock’s fair market value, and
- You can avoid the capital gains tax you’d pay if you sold the stock.
Donating appreciated stock can be especially beneficial to taxpayers facing the 3.8% net investment income tax (NIIT) or the top 20% long-term capital gains rate this year.
Stock vs. Cash
Let’s say you donate $10,000 of stock that you originally paid $3,000 for, your ordinary-income tax rate is 37%, and your long-term capital gains rate is 20%. And let's say that you itemize deductions.
- If you sold the stock, you’d pay $1,400 in tax on the $7,000 gain. If you were also subject to the 3.8% NIIT, you’d pay another $266 in NIIT.
- But if you donate the stock to charity instead, you would save $5,366 in federal tax ($1,666 in capital gains tax and NIIT plus $3,700 from the $10,000 income tax deduction). If you donated $10,000 in cash, your federal tax savings would be only $3,700.
What happens when the total amount of gifts for any one year exceeds the maximum deduction allowed? The excess can be carried forward and used as deductions against future income for up to five years.
A Tax Break for Those Who Do Not Itemize Deductions
As recently as 2006, charitable donations could be deducted only by taxpayers who itemized deductions on their returns, and the threshold to itemize was relatively low. Since then, numerous events and legislative actions have changed that.
- The 2017 Tax Cuts and Jobs Act (TCJA) reduced the amount of itemized deductions allowable on tax returns, but nearly doubled the optional standard deduction.
- As a result, the IRS estimates that 87% of taxpayers found it preferable to elect the new, higher standard deduction than to itemize deductions on their returns.
- At the same time, many feared that this could create a disincentive for making tax-deductible charitable contributions unless their aggregate amount exceeded the new standard deduction.
Beginning in 2020, however, taxpayers who claim the standard deduction also have a chance to deduct charitable donations.
- The Coronavirus Aid, Relief and Economic Security (CARES) Act gave taxpayers who take the standard deduction the ability to take an additional “above the line” $300 federal income tax deduction for qualified charitable contributions made in cash.
- "Above the line” means that the deduction is above line 15 on the 2019 1040 tax form, and will reduce both your adjusted gross income and your taxable income which, in turn, reduces the amount of federal income tax you owe.
For the 2021 tax year, the charitable deduction is even better, at least for those who file a joint return. For 2020 the charitable limit was $300 per “tax unit", meaning that those who are married and filing jointly can only get a $300 deduction.
- For the 2021 tax year, however, those who are married and filing jointly can each take a $300 deduction, for a total of $600. One drawback, however, is that the 2021 deduction is “below the line.”
NOTE:
- If you itemize deductions on your tax return, you cannot take the CARES Act deduction.
- The CARES Act deduction applies only to gifts made to qualified charities. This does not include charitable gift annuities, donor-advised fund sponsors, private foundations and supporting organizations.
Qualified Charitable Distributions (“QCD”)
The Pension Protection Act of 2006 created a new avenue for making charitable contributions known as a Qualified Charitable Distributions (“QCD”). This enables the owner of an IRA to reduce his/her taxable income by the amount of money donated directly from his/her IRA to a “qualified charity.”
Significantly, this does not require the donor to itemize deductions.
There are four basic requirements for a QCD:
| 1. |
You must be at least 70 ½ years age of when making the QCD. NOTE: You must actually be age 70 ½ or older on the date of distribution, not merely turning 70 ½ sometime that year. Even a beneficiary of an inherited IRA can be eligible for a QCD, as long as the beneficiary is at least age 70 ½ on the date of the distribution. |
| 2. |
The QCD must come from a Traditional or Inherited IRA. Distributions from SEP or Simple IRAs do not qualify. |
| 3. |
The distribution must go directly from your IRA to a qualified 501(c)3 organization as described in IRC Section 170(b)(1)(A). Currently, QCDs cannot be made to charitable gift annuities, donor-advised fund sponsors, private foundations and supporting organizations. |
| 4. |
You must receive a letter from the charity stating that no goods or services were received in exchange for the contribution. |
One of the biggest advantages of QCD is that the deduction is taken “above the line”, meaning that it is taken as a reduction in adjusted gross income. The benefits of the “above the line” deduction are two-fold:”
- The “above the line” deduction is available to you in addition to itemized deductions and/or the optional standard deduction taken “below the line.”
- Because AGI is used for many tax calculations, having a lower number can allow the donor to stay in a lower tax bracket, reduce or eliminate the taxation of Social Security or other income, and remain eligible for deductions and credits that might be lost if the taxpayer had to declare the RMD amount as income.
The maximum dollar amount of a QCD for any individual from his/her IRAs is limited to $100,000 per year. This annual limitation is allowed on a “per taxpayer” basis across any/all of the individual’s IRAs, regardless of how many accounts are used to generate the charitable distribution. That means a married couple can
each donate up to $100,000 as long as each taxpayer’s QCDs come from his/her respective IRA.
You can make a qualified charitable distribution that exceeds your required minimum distribution for a given year. However, that extra distribution cannot be carried over and used to meet the minimum required distributions for future years. This contrasts with other strategies, such as a donation of cash and appreciated securities, where a large donation can be made in one year and the tax benefits can be carried forward.
Should you make your 2021 Qualified Charitable Distribution (QCD) right now in case Congress ends the tax breaks for QCDs later this year?
The original Pension Protection Act that created QCDs was only in effect for two years – 2006 and 2007 – after which the QCD rules lapsed. Over the next decade, the rules were reinstated before lapsing and being reinstated several times. Finally, the PATH Act of 2015 made QCDs permanent. As a result, QCDs no longer face the ongoing threat of lapse, or the challenge of trying to figure out whether they should be done early in the year in anticipation of retroactive reinstatement later.
Instead, QCDs are now a permanent element of the tax law, and likely to remain in place for the foreseeable future, which allows for proactive tax planning opportunities assuming all the requirements are met.
Comparison of Tax Impact on Ways to Contribute
The following tables summarize the tax deductibility in 2020 and 2021 for charitable contributions made in either cash or appreciated marketable securities – or through Qualified Charitable Distributions (QDCs).
Which Type of Charitable Contribution is Most Tax Efficient for You?
As always, that depends.
- For taxpayers who itemize their deductions, care has to be taken to determine whether the contributions should be in the form of cash (100% deductible against their AGI), or in the form of appreciated securities (avoiding any capital gains tax that might be incurred by selling the securities but only 60% of the value is deductible against that year’s AGI).
- In either event, a Qualified Charitable Distribution could be used in addition to the other gift(s).
Charitable giving is a noble endeavor that is subjected to complicated tax laws. It is therefore a good idea to consult your wealth advisor about how most efficiently you can fulfill your philanthropic goals.