U.S. charities receive a significant portion of donor dollars from individual donors. It is important for individual donors to understand the different types of charitable donations and factors affecting the deductibility of those donations.
In 1917, Congress passed the first major beneficial legislation for individual charitable contributions—a federal income tax deduction. Charitable donation deduction requirements are outlined in Internal Revenue Code Section 170, Charitable, etc., Contributions and Gifts, which states the charitable donation deduction for individual donors in any given year is limited to either 20 percent, 30 percent or 50 percent of their contribution base, depending on the type of property donated and recipient’s public charity status. There is a five-year carryforward for charitable donation deductions in excess of the deduction amount allowed (contribution base). When computing the contribution base, one must understand the various types of donations.
Cash remains the simplest donation type, currently providing a maximum deduction limitation of 50 percent of the donor’s adjusted gross income (AGI) for donations to a public charity. Public charities—often called 50 percent charities—include churches, schools, hospitals, government entities, private operating foundations and other not-for-profit agencies organized for charitable, religious, educational, scientific or literary purposes. If cash is given to a private non-operating foundation, the maximum deduction limitation is reduced to 30 percent of AGI. Amounts in excess of the 50 percent or 30 percent limitation may be carried forward for five years.
Long-term capital gain property, such as marketable securities held in excess of 12 months, is another popular charitable donation type for individual donors. When donating long-term capital gain property, the charitable donation deduction is determined using either the regular or elective method.
- Regular method – The charitable contribution amount is equal to the property’s fair market value (FMV) with the charitable donation deduction limited to 30 percent of the donor’s AGI.
- Elective method – The charitable contribution amount is computed by reducing the forgone long-term capital gain from the property’s FMV. If elected, this method increases the deduction limit to 50 percent of AGI.
The five-year carryforward is available with both methods. The percentage limitations of the methods described above assume the long-term capital gain property is donated to a 50 percent charity, e.g., donations of long-term capital gain property to private non-operating foundations and veteran’s organizations are limited to 30 percent and 20 percent as opposed to 50 percent and 30 percent.
Ordinary income property is another popular type of charitable donation. The deduction allowed for ordinary income property is generally equal to the lesser of the property’s FMV or its adjusted basis and limited to 50 percent—30 percent if given to a private non-operating foundation—of a donor’s AGI with any excess carried forward five years. Ordinary income property is defined as any asset that, if sold, would generate ordinary income or short-term capital gain. Inventory is a common example of an ordinary income property donation. The Protecting Americans from Tax Hikes Act of 2015 extended the Apparently Wholesome Food Donation Credit; the IRS defines this as food intended for human consumption. For these donations, the deduction is equal to the lesser of the inventory’s basis plus 50 percent of the lost gain (FMV less basis) or twice the inventory’s basis. The deduction is limited to 15 percent of the donor’s net income from any trade or business with the excess carried forward five years.
Charitable deductions also are allowed for out-of-pocket expenses incurred while providing volunteer services to a charitable organization, including meal costs, lodging, vehicle expenses (gasoline and oil), parking fees and tolls. These deductions are treated as cash donations and limited to 50 percent of the donor’s AGI.
Bargain sale is another donation vehicle between an individual and a charitable organization. A bargain sale occurs when the donor sells appreciated property to the charity for less than FMV and receives a deduction equal to the property’s appreciation. A bargain sale results in a transaction that is part sale and part charitable donation for the donor. In some cases, it may be more advantageous to donate property directly to the charity when the property has appreciated in value as opposed to selling the property first and donating the appreciated property’s sale proceeds. Conversely, since losses from the donation of a property that has declined in value are not recognized, it is generally more advantageous to first sell the property to realize the loss and then donate the cash proceeds to the charity. When contemplating a property donation to a charity, donors should consult their tax advisors to understand the donation’s tax implications.
Some donors contribute tangible personal property, e.g., vehicles and art. When donating tangible personal property, donors must consider additional limitations of the charitable deduction. If the charity will not use the property in furtherance of its tax-exempt function, the deductible amount is limited to the donor’s basis in the property, as opposed to the FMV. These donations require special reporting from the charity to the IRS to help the donor determine the appropriate deduction amount.
Quid pro quo contributions are gifts to a charity that are treated partly as a contribution and partly as payment for goods and services by the donor. This type of contribution also may be limited. The most common quid pro quo donation is the purchase of a table at a charity event. In this case, the deduction is limited to the amount paid to purchase the table less the value of the benefit (meal and entertainment) received in return. Silent auctions are another quid pro quo contribution where only the amount paid in excess of the item’s value is allowed as a charitable deduction. The donor’s charitable deduction for quid pro quo contributions is limited to the excess of the cash and the value of any property contributed more than the value of goods and services received. A properly prepared donor acknowledgement letter will provide the value of goods and services received in exchange for the donation. Many times, raffles are included in charity functions along with a silent auction—as a reminder, raffles are considered games of chance and do not give rise to a charitable deduction, regardless of the ticket amount or the outcome.
A relatively new donation type is the tax-free distribution from an individual retirement account (IRA). These donations provide opportunities for individuals who must take required minimum distributions from their IRA. A distribution directly from the IRA to an appropriate charity—private foundations and donor-advised funds are excluded—is a qualified charitable distribution (QCD) and limited to $100,000 per tax year. A QCD is a 100 percent above-the-line deduction, which reduces the overall tax burden by not including the otherwise taxable IRA distribution in the AGI. Because the QCD is not an itemized deduction, AGI limitations of 50 percent, 30 percent or 20 percent are not applicable.
Charitable donations provide valuable tax benefits. In addition to obtaining proper substantiation for the donation, donors must be aware of the charitable donation types, how to value the donation amount and each donation’s percentage limitation. In addition to the donation percentage limitations, there is an overall limitation; ordering the limitations becomes a key factor in tax planning. Contact your BKD advisor if you have questions regarding your specific charitable giving and the available tax deductions.