Tax Law is About Incentivizing Behavior

The tax law is written to incentive certain behaviors and penalize other behaviors. This is the primary reason for the complexity. Just think about the recent Paycheck Protection Program. Congress could have just given money to small businesses like they did with stimulus checks to individuals but by doing so they would lose control over how that money was spent. They wanted to incentivize employers to retain and pay employees through the pandemic. The result, 23 different rulings from the Small Business Administration, numerous rule changes, and five different versions of FAQs totaling 56 FAQs in all.

Charitable giving is a behavior our government is interested in incentivizing to the point where the government will subsidize the donor’s gift if structured well.

How to Deduct Charitable Giving

First, how does the government subsidize charitable giving? An income tax deduction is allowed for charitable contributions to qualified charities as an itemized deduction. However, itemized deductions are only beneficial when they exceed the standard deduction. The standard deduction is the “freebie” deduction the government gives you if it is larger than the sum of your state and local taxes (currently limited to $10,000), your mortgage interest expense, and your charitable contributions. There is also the possibility of adding medical expenses to itemized deductions if they exceed the high hurdle of 7.5% of AGI, which is uncommon year over year. Since the state and local tax deduction is now limited to $10,000 and mortgage interest is generally paid monthly with little flexibility, charitable contributions become the focal point when trying to receive any incremental tax benefit from your itemized deductions.

Itemized Deductions vs. Standard Deduction

$10,000 State and Local Tax Ded.OR$25,100 Standard Deduction
$15,000 Charitable Ded.
$25,000 Itemized Ded.

John and Jane have paid off their mortgage and incur $10,000 in state and local taxes. The married couple would also like to make $15,000 in charitable contributions during the year. John and Jane’s itemized deductions total $25,000. Since the government allows John and Jane the greater of itemized deductions or a $25,100 standard deduction, the property taxes and charitable contributions would generate zero tax savings. In other words, John and Jane could have given $0 to charity and their income tax would have been the exact same, no impact whatsoever! Savvy taxpayers can use this standard deduction to their advantage via lump sum giving discussed below. But first, what are some of the new charitable giving rules for 2020 and 2021.

New Charitable Giving Rules

The standard deduction was effectively doubled under the Tax Cuts and Jobs Act beginning in 2018. This is a good thing for individuals (a higher free deduction) but it also raised the hurdle for being able to take advantage of any charitable gifting. In March, the CARES Act created a new ability to deduct up to $300 of cash donations to qualified public charities without having to be tested against the standard deduction. This $300 deduction was initially only allowed for 2020 however, the recent law signed by the President December 27th, 2020 extended this to 2021 as well and for 2021 the cap for married individuals is $600 while the cap for single filers remains $300. What this means for you is that if you gave $300 to charity in 2020 but will not itemize you should still provide the $300 of charitable receipts to your CPA to take this deduction. In 2021, even if you normally would not make any donations, you might consider supporting a charity you believe in, as the government is willing to subsidize that gift up to $600 for a married couple.

Congress was not only thinking of the small donors in the CARES Act. The existing law pre-March 2020 stated that the charitable contribution deduction was only allowed up to 60% of adjusted gross income. The excess could be carried over for five years and potentially deducted on future income tax returns. For 2020 and 2021 Congress removed the 60% limit at the election of the donor for cash gifts to qualifying charities. For those mega donors wishing to give away more than 60% of their income, be thoughtful in your election to remove the 60% threshold as it might be better tax planning to have the 60% threshold remain in place. The election to carry forward the excess deduction over 60% of income to future years could produce a higher overall tax savings since the carryover would likely result in a deduction at higher tax rates rates. It is important to note that to qualify to offset 100% of AGI the donation must be made in cash to qualifying charities, not donor advised funds or supporting organizations.

To summarize, for those who will not donate enough for their itemized deductions to exceed $12,550 single or $25,100 married, the $300 charitable deduction is available for 2020 and the $300 (single) and $600 (married) deduction is available for 2021. For those who wish to donate more than 60% of their income, the election to use 60% or 100% is available for 2020 and 2021 tax returns. For those somewhere in the middle, maximizing the available government subsidy of charitable giving comes down to timing and selection on what to give.

Donating Appreciated Securities

Individuals looking to donate at least $10,000 a year can significantly impact their charitable giving deduction through proper planning. The most common planning tools to achieve this optimization are the donor advised fund and donating appreciated property instead of cash. When a donation is made with appreciated property that has been held for over a year, the donor receives a deduction at the fair market value of the property and simultaneously does not have to recognize the appreciation as capital gain income.

For example, Steven invested $20,000 in Tesla a few years ago. It is now worth $50,000. Steven can donate the entire $50,000 of shares of Tesla, receive a $50,000 income tax deduction, and never recognize the growth from $20,000 to $50,000 as income.

Steven might really like this idea except he wishes to contribute to the charities he supports monthly not in large lump sums every few years. Steven can open a donor advised fund, transfer his Tesla stock to his donor advised fund, take the $50,000 income tax deduction, sell the Tesla shares inside the donor advised fund income tax free, and then grant that $50,000 to the charities of his choosing at the time of his choosing. This ability enables Steven to take advantage of the tax benefits of “lump sum giving” while being able to support charitable organizations for the months and years to come.

There are Many More Ways

As we covered in the opening sentence, there is no shortage of complexity. In addition to all the various choices and options described above, there are limitations on the amount of income you can offset with the deduction of long-term appreciated property. The rules are different for short-term appreciated property. There are special rules for those over 70½ who wish to donate to charity out of their IRA via a Qualified Charitable Distribution. For those with larger giving objectives, individuals can set up private foundations, charitable lead trusts, charitable remainder trusts, conservation easements, and the list goes on and on. The takeaway is not to memorize all the rules and options but to be aware of what is available so you can take full advantage of the government subsidy offered to you while accomplishing your giving goals.