Situation: Financial representatives who first start to work in the charitable market often have trouble understanding “How much can be deducted?” The confusion is understandable. While our income tax law encourages charitable giving by allowing charitable contributions to offset an individual’s taxable income, it also imposes annual limitations on the amounts that can be deducted. This Counselor’s Corner is dedicated to a discussion of the income tax rules that limit the amount an individual can deduct.
Solution: Before we begin let’s be clear that these limits apply only for income tax purposes. There is no limit on the estate and gift tax charitable deduction as long as the transfer is made in a qualified manner to a qualified charity. When money or property is given to a qualified charity, the donor can generally deduct the fair market value of the property for estate and gift tax purposes at the time of the contribution. However, the income tax rules limit the amount an individual can deduct each year to specific percentages of his or her “contribution base.” An individual’s contribution base in most cases is simply the individual’s adjusted gross income (AGI). The extent to which these limitations apply depends on the types of charities to which the gifts are made, the types of property contributed, and how the property is contributed.
It’s also important to remember that the charitable deduction for individuals is an itemized deduction that, like all itemized deductions, is not available if a taxpayer chooses to take the standard deduction. With the increase of the standard deduction and the elimination/ limitation of many itemized deductions as a result of the 2017 tax legislation many taxpayers will not receive an income tax benefit for their charitable contributions.
Limits on Deductions – Preliminary Questions
The income tax rules limit the amount an individual can deduct to a specific percentage of an individual’s adjusted gross income (AGI), and the following three factors determine the percentage limit:
• Type of charity to which the gift is made: Public charity vs. private foundation
• Type of asset contributed to the charity: Cash, ordinary income, capital gain
• How the property is contributed to the charity: “To” or “for the use of” the charity
Types of Charities. Generally, there are two types of charities – public and private foundations. The rules governing each are involved and beyond the scope of this article. A public charity receives its support from many sources which can include private foundations. Also, a public charity must continue to seek money from diverse sources to retain its public status.
Type of Asset. Another preliminary issue that must be considered in determining the amount of the tax deduction is the value of the property contributed. The property value is based on the type of asset. For cash contributions, the value is simply the amount of cash contributed. For a contribution made in property, the amount of the income tax deduction is generally based on the fair market value (FMV) of the property contributed. However, as indicated below, in certain circumstances, the value of a noncash property contribution is subject to reduction in value.
How the Property is Contributed to the Charity.
The deduction limitations discussed below focus on contributions made “to” a charity rather than “for the use of” a charity. If the IRS characterizes a gift as one “for the use of” the charity, the deductibility limitations will be lower. While the difference between gifts “to” and “for the use of” is not always clear, in general, most contributions that are given to a charity and used for the charity’s general intended purpose will qualify as deductions “to” the charity.
AGI Limitation on Charitable Income Tax Deduction
In general, taxpayers may take a charitable deduction for contributions of up to a certain percentage of their annual adjusted gross income. The chart below indicates the maximum amount that can be deducted.
How the Various Limitations Interact. If, in a particular year, a taxpayer makes contributions subject to the various limitations discussed above, determining the amount that is currently deductible may be somewhat complicated. It involves placing each contribution in the right limitation “bucket” and stepping through each category limitation from high to low. IRS Publication 526, Charitable Contributions contains a deduction limitation worksheet that is helpful, but clients should seek the help of their tax advisors in these more complex situations.
Carryovers. Contributions that exceed the various percentage limitations can be carried forward for up to five succeeding tax years. Contributions carried forward are subject to the same percentage limits in the year to which they are carried over as those that applied when they were made.
Example of donating an existing life insurance policy. The following illustrates how the income tax deduction works for a gift of a policy to a public charity where the individual making the transfer has AGI of $120,000.
From the discussion above, it is easy to see that the question “How much can I deduct?” is not always easily answered. In complex situations where many techniques are layered together for tax efficiency, it is important that clients seek expert guidance on the applicability of these limitations before they assume that a planning scenario ensures a current or future charitable deduction.
How DBS Can Help
This year your business clients will be trying to sort out the details of the tax reform legislation and how it impacts their business. This will give you the opportunity to make them aware of how they can utilize the changes to help achieve their planning needs. Questions about the recent legislation can be directed to DBS advanced case design resource, Terri Getman JD, CLU, ChFC, RICP, AEP (Distinguished) at extension 230.