Charitable giving has been negatively impacted in recent years. First, 2017’s Tax Cuts and Jobs Act (TCJA) increased the standard deduction, which resulted in fewer taxpayers itemizing deductions. Then COVID-19 hit. Unfortunately, the pandemic has left many charitable organizations facing the same hardships as for-profit businesses. In-person fundraisers have been cancelled, annual events have been postponed, and program services have been significantly impacted or changed. Projects and programs will return to normal eventually, but it may take some time.
Congress has responded to these pandemic-related challenges by making changes to incentivize charitable giving for 2020 and 2021. We will explore these changes as well as the more common traditional ways to make charitable contributions.
CARES Act Charitable Giving Incentives
Two key provisions included in last year’s CARES Act could impact your charitable giving in 2021:
- Increased AGI Limitations. Individual donors have an annual cap on deductible charitable contributions based on their Adjusted Gross Income (AGI). Different types of donations see varying limitations, but in general, the most an individual taxpayer can take is 60 percent of AGI.
For 2020 and 2021 only, charitable deduction limitations for cash donations to certain organizations have increased to 100 percent of AGI. This applies – at the taxpayer's election – to donations to all charitable organizations except donor-advised funds, supporting organizations, or private foundations. The intent of these restrictions is to get cash in the hands of charities that will use the funds now, rather than pool or defer giving.
- New Above-the-line Deduction. Normally, taxpayers must itemize deductions (versus taking the standard deduction) to see a tax benefit from their charitable contributions. As discussed earlier, the significant increase in the standard deduction due to the Tax Cuts and Jobs Act resulted in a decrease in the use of itemized deductions.
Thanks to the CARES Act, taxpayers who do not itemize can see the benefit of their donations on their tax returns. For 2020 and 2021, an above-the-line deduction of up to $300 per taxpayer is allowed for cash donations to public charities.
Traditional Charitable Giving Tax Strategies
In addition to the CARES Act incentives, traditional charitable giving tax strategies still exist. Here are five ways charitable donations are still beneficial tax-wise.
- Qualified Charitable Distribution (QCD) from an IRA. For individuals age 70.5 and over, an otherwise taxable distribution of up to $100,000 from an IRA can be paid directly to a charity. This is a win-win for the donor and the qualified charity. Not only does the charitable organization get a donation, but the donor does not need to include this amount in income or pay tax on the distribution. So, while no charitable deduction will be taken for this amount, utilizing a QCD can lower your tax bill by keeping AGI down. This can benefit the taxation of Social Security income, decrease Medicare premiums, and help avoid the Alternative Minimum Tax (AMT) and Net Investment Income Tax (NIIT).
Another advantage is a QCD can count towards the annual Required Minimum Distribution (RMD) from an IRA that individuals ages 72 and over must satisfy. Wealthier individuals can arrange to simply donate amounts they would otherwise be required to receive (and pay tax on) under the RMD rules. To take advantage of the QCD for RMDs, funds must come out of the IRA by December 31.
Note: The CARES Act did not change the QCD rules, but using the increased 2020 AGI limitations plus a QCD could prove an excellent tax strategy if making a large gift is a goal.
- Appreciated Property Donations. Gifting appreciated assets is beneficial for taxpayers because a current-year itemized deduction for the fair market value of the asset is allowed (subject to the applicable AGI limitation for noncash donations) and there is no tax liability for the increase in value from the original cost. Be sure to hold property such as stock for at least one year before donating. Otherwise, the deduction will be limited to the basis in the property, which is generally original cost.
Make sure to obtain an independent written appraisal to attach to the tax return if the property is valued at more than $5,000. Also, complete Form 8283 (Noncash Charitable Contributions) or the entire deduction could potentially be disallowed. There are exceptions to the appraisal requirement, including donations of publicly-traded stock. Donating property to charity has its quirks, so it's best to review all factors and consult your tax advisor before making any large property donations.
- Donor-Advised Funds. Donor-Advised Funds (DAFs) have become increasingly popular since the TCJA was enacted. A DAF is somewhat similar to a private foundation, but it is something the average taxpayer can easily do without a lot of administrative burden. An account is created with a sponsoring not-for-profit organization, a contribution is made, and the organization will take control of the funds by investing and managing the assets.
The donor receives a tax deduction in the year a contribution is made to the DAF, but the contribution does not have to be distributed in that year. Rather, the donor advises the sponsoring organization as to which charitable organizations should receive the donation and when. This allows the money to grow tax-free while invested and gives the donor time to determine which charities should receive the donation.
The philanthropic community does not typically prefer DAFs because donors can wait as long as they’d like to decide where to give the funds. Naturally, organizations would rather have the money to benefit their cause sooner than later. The ability to easily contribute noncash assets to DAFs is attractive, though, as smaller organizations aren't always able to handle complex transactions. Ideally, DAFs open a door to bring donors and charities together.
- Deduction Bunching. Although not a new strategy, bunching itemized deductions has become popular in the post-TCJA era. Instead of giving smaller amounts year over year, lump two or more years' worth of donations into one year to get over the standard deduction threshold when it may otherwise not have been surpassed. This allows a tax benefit for the donation year. Remember, though, that states have their own rules and thresholds. Even in years where there is no proactive donation bunching for federal tax planning, make sure to track the amount given because it may in fact help exceed the state standard deduction (if there is one).
- Charitable Trusts. Generally used by high-net-worth individuals, charitable trusts can be a great tax planning tool. However, they can also be very complex. Contributions to a charitable trust give a partial charitable donation deduction for the donor, provide an income stream from donated assets, and help avoid future potential estate taxes. Donating appreciated property to a charitable trust can often be a smart move.
A charitable remainder trust is a commonly-used charitable trust. Assets are transferred into the trust, and the trust's terms will determine the annual income to the donor. At the end of the specified time period, assets will then transfer to the charity.
Hopefully, the use of tax strategies and CARES Act incentives will keep charitable giving strong and offer tax advantages to those who thought they no longer were eligible. Make sure to consider current and future income levels, tax rates, and other deductions and plan accordingly to get the most bang for your charitable buck. Looking at these factors holistically before giving is likely to be beneficial.