By PJ Manchanda and Alexander Alzate
The Tax Cuts and Jobs Act eliminated many individual income tax deductions. One that was not eliminated, and was actually somewhat enhanced, is the deduction for charitable contributions. Consequently, it’s important to understand some of the basic rules and limitations affecting different types of charitable contributions.
Limitations and Ordering Rules
The amount of charitable contributions an individual taxpayer can deduct in any tax year is limited depending on the types of organizations to which the contributions were made, the kinds of property contributed and the value of the donated property. The adjusted gross income percentage limitations involved in calculating taxpayers’ allowable charitable contribution deduction are: 50 percent, 30 percent and 20 percent. There is also a 60 percent limitation for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026.
The 50 percent limitation applies to all charitable contributions made in the aggregate during the year (including those subject to the separate 20 percent or 30 percent limitations, discussed below), meaning that a taxpayer’s total charitable contribution deduction cannot exceed 50 percent of the taxpayer’s AGI in any one year. The 50 percent limitation also applies to donations made to organizations the IRS has designated as “50 percent charities.” The most common 50 percent charities include: churches, schools, hospitals, governmental entities and other nonprofit entities organized for charitable, religious, educational, scientific or literary purposes.
Donations to qualified organizations that are “non-50 percent charities” are subject to a 30 percent of AGI limitation. Examples of these are: veterans organizations, fraternal societies and nonprofit cemeteries. Deductible amounts spent on behalf of a student living with the taxpayer are also subject to the 30 percent limit.
The other 30 percent limit applies to contributions of capital gain property to 50 percent charities. It’s important to note that the 30 percent limit applies when the taxpayer deducts the fair market value of capital gain property contributed. If the taxpayer elects to reduce the FMV by the long-term capital gain the taxpayer would have recognized had they sold the capital asset (thus reducing to cost basis), then the contribution would be subject to the 50 percent limitation instead.
The 20 percent AGI limitation applies to capital gain property contributed to 30 percent charities.
The Tax Cuts and Jobs Act increased the AGI limitation for cash contributions to public and charities and certain private foundations to 60 percent from 50 percent. No changes were made to the 30 percent and 20 percent limitations. The 60 percent AGI limitation is effective for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026.
The AGI limitations for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2016 are applied in the following order:
- The taxpayer would calculate cash contributions made to public charities and certain private foundations, not to exceed 60 percent of their AGI.
- The taxpayer would calculate contributions made to 50 percent charities, not to exceed 50 percent of their AGI. Cash contributions taken into account in the first step are not taken into account for purposes of applying the 50 percent limit. However, that limit is reduced by the aggregate cash contributions allowed under the 60 percent limit.
- Contributions made to non-50 percent charities to the extent of the lesser of: (1) 30 percent of AGI or (2) 50 percent of AGI reduced by all contributions to 50 percent charities and cash contributions allowed under the 60 percent limit.
- Contributions of capital gain property to 50 percent charities, up to the lesser of: (1) 30 percent of AGI or (2) 50 percent of AGI, less other contributions to 50 percent charities and cash contributions allowed under the 60 percent limit.
- Contributions of capital gain property to non-50 percent charities, to the extent of the lesser of: (1) 20 percent of AGI or (2) 30 percent of AGI, less contributions subject to the 30 percent limit.
Charitable contributions that are not deductible in the current year because they exceed the taxpayer’s AGI limitation can be carried forward for 5 years. The ordering rules require the taxpayer to first deduct all current year contributions before using any carryover contributions. If the taxpayer has carryovers from 2 or more prior years, the taxpayer must use the carryover from the earlier year first. A carryover of a contribution to a 50 percent limit organization must be used before contributions in the current year to organizations other than 50 percent limit organizations. The taxpayer should consider any charitable contribution carryovers that are at risk of expiring in a given year before making any charitable contributions in the current year to avoid losing tax benefits from the carryovers.
Assume Jim’s AGI for tax year 2018 is $100,000 and that he donated the following:
- Cash of $4,000 donated to a 50 percent charity, which is fully deductible since it’s below 60 percent AGI limitation ($60,000). This contribution is not taken into account in determining the 50 percent limitation since it has already been taken into account in determining the 60 percent limitation.
- Stock (FMV is $60,000, Basis is $44,000) donated to a 50 percent charity, which is deductible up to the lesser of: (1) 30 percent of AGI ($30,000) or (2) 50 percent of AGI, minus contributions to 50 percent limit charities and cash contributions subject to the 60 percent limitation. $50,000 minus $4,000 [from Step 1] is $46,000. Since we have to choose the lesser of the two options, this gift is deductible up to $30,000.
- Car (personal use) donated to a non-50 percent charity for $10,000, which is deductible up to the lesser of: (1) 20 percent of AGI ($20,000) or (2) 30 percent of AGI, minus contributions to 30 percent limit charities. $30,000 minus $30,000 [from Step 2] equals $0.
In this example, the total charitable contributions allowed as a deduction for 2017 is $34,000.
Total carryover is $40,000. The $30,000 stock donation, subject to the 30 percent limitation, and the $10,000 car donation, subject to the 20 percent limitation.
When contributing property, the taxpayer can generally deduct the FMV of the property as of the date of contribution. If the property has appreciated in value, however, some adjustments may have to be made, depending on whether the property is considered ordinary income property or capital gain property.
Ordinary Income Property. Property is ordinary income property if the taxpayer would have recognized ordinary income or short-term capital gain had the taxpayer sold it at FMV on the date it was contributed. Examples of ordinary income property are inventory, works of art created by the donor, and capital assets held one year or less (short-term capital gain property). The amount of the deduction for a contribution of ordinary income property is its FMV, minus the amount that would be ordinary income or short-term capital gain if the property is sold for its FMV, which is usually the cost basis.
Capital Gain Property. Property is capital gain property if the taxpayer would have recognized long-term capital gain had the taxpayer sold it at FMV on the date of contribution. Capital assets include most of the items a taxpayer owns and uses for personal purposes or investment, such as stocks, bonds, jewelry, cars and furniture. The amount of the deduction for capital assets is generally the FMV, but in certain situations, the taxpayer must reduce the deduction by any amount that would have been long-term capital gain if the taxpayer had sold the property.
Tax Planning Tips
Taxpayers that are 70½ or older can transfer their required minimum distributions directly from their IRA to a charity in a tax-free transaction. If the taxpayer withdraws the RMD from the IRA and then donates the amount received to a charity, the taxpayer may still get a deduction for the charitable contribution, but the withdrawal will be included in their AGI and may affect other items such as medical deductions.
A donor- advised fund is a fund or account in which a donor can advise the fund on how to distribute or invest assets held in the fund. This is a useful strategy when the taxpayer desires to get a current tax deduction without having to decide which charities to donate to until later.
It is important to note that C corporations making gifts of food inventory to the ill, needy or infants qualify for an enhanced deduction. The deduction is the lesser of twice the basis, or basis plus one-half of the appreciation.
Lastly, if the taxpayer has an option to donate either stock or cash, they may want to consider donating appreciated stock that has been owned for more than one year. This provides the following tax benefits: The taxpayer avoids having to pay capital gains tax on the appreciated value and the taxpayer secures a deduction at the higher current FMV.
PJ Manchanda is a CPA and Tax Manager who specializes in tax returns for high-net-worth individuals and Alexander Alzate is a senior tax associate, both at Mazars USA.