The charitable contribution deduction has been a part of the U.S. tax code for over 100 years and has remained a valuable resource for taxpayers to reduce their taxable income. Charitable contributions are reported on Schedule A (Itemized Deductions) of an individual’s Form 1040 (Individual Income Tax Return). Tax laws are constantly changing, but the charitable contribution deduction has remained consistent over the years. The majority of changes to the charitable contribution deduction have involved the total amount that a taxpayer can deduct, but there have recently been additional changes due to COVID-19. It is important to stay aware of these modifications in order to maximize the deduction on an income tax return.
Before taking a look at maximizing the charitable contribution deduction, it is important to review what is deductible according to the IRS. First and foremost, in order to take a charitable deduction, the taxpayer must have made the donation to a “qualified charitable organization.” Organizations organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational, or other specified purposes and that meet certain other requirements are “qualified charitable organizations,” tax exempt under Internal Revenue Code Section 501©(3). It is common to hear tax accountants mention “501(c)(3) charities” when discussing charitable contributions. As mentioned, 501(c)(3) charitable organizations are exempt from paying federal income taxes; however, the organization’s net earnings must be used solely for the advancement of its charitable purpose. Examples of donations that would not be tax deductible include donations to political/lobbying organizations, foreign charities, and individuals. It is also important to note that when a charity provides something of value to a donor in exchange for the donation, only the amount of the donation in excess of the goods or services provided is deductible. For example, if Matt buys a ticket to a charity dinner for $150 and the value of the dinner is $25, Matt can only take a charitable deduction of $125. Donations of $250 or more must be recognized with a receipt from the charitable organization, and if a good or service is provided, the receipt should have information to determine the amount of the tax-deductible gift.
One advantageous method for maximizing the charitable contribution deduction involves a tax-planning method called “bundling.” In short, “bundling” is timing charitable giving to produce maximum benefit for the taxpayer. With the TCJA (2017), the standard deduction nearly doubled to $24,000 (married couple) and $12,000 (single person) resulting in more taxpayers claiming the standard deduction. One of the implications of claiming the standard deduction is the taxpayer does not benefit by itemizing deductions for his or her charitable giving. Through “bundling,” individuals can condense two or more years’ worth of charitable giving into a single tax year and itemize to gain the maximum tax benefit, then take the standard deduction during other years. If “bundling” sounds like a beneficial planning technique, you might want to consider setting up a Donor Advised Fund (DAF). Utilizing a DAF, donors can contribute assets into their named account, get an immediate tax deduction, invest, and grow DAF assets tax-free, then suggest grants out of the fund to support the charities of their choosing over time. “Bundling” and DAFs require additional tax planning with a tax professional but can be very useful tools for maximizing the charitable contribution deduction.
Another useful tool for satisfying charitable giving involves Qualified Charitable Distributions (QCD). A QCD is a direct transfer of funds from your IRA custodian, payable to a qualified charity. QCDs can be counted toward satisfying required minimum distributions (RMDs) for the tax year, while excluding the amount donated from the taxpayer’s taxable income.. Since the income is excluded from taxable income, taxpayers may not also deduct the charitable donation, but the direct donation still has the effect of reducing taxable income and the tax impact of RMDs.
While there are numerous options available to help utilize the charitable contribution deduction every tax year, there are a couple that are specific to the 2021 tax year. Ordinarily, individuals who elect to take the standard deduction cannot claim a deduction for their charitable contributions; however, for the 2021 tax year, taxpayers can deduct $300 ($600 if married filing jointly) directly against their taxable income without itemizing deductions. Therefore, for the 2021 tax year, everyone can benefit from up to $300 ($600 if married filing jointly) of charitable giving. Another key change specific to the 2021 tax year permits electing individuals to apply an increased limit, up to 100% of their Adjusted Gross Income (AGI), for qualified contributions made during calendar-year 2021. Qualified contributions are contributions made in cash to qualifying charitable organizations. The limit has traditionally been capped at 60% of AGI for cash donations. However, be aware that there are exemptions to the 100% AGI rule. Non-cash donations and donations made to Donor Advised Funds, Private Foundations, and Charitable Trusts do not qualify for the increased limit. It is also worth noting that excess contributions not allowed under the AGI limitations can be carried forward up to five years.
The charitable contribution deduction is a vital part of the U.S. tax code benefiting both individuals and charitable organizations for decades. If you have questions regarding the charitable contribution deduction and maximizing its benefit, please reach out to LBMC.