Blog post

How to make the most of tax deductibility in the US

6 min read
Sep 23, 2014
Giving What We Can is not only about donating to the most effective causes, but also donating in a way that maximizes the impact of a donation. One of the ways of doing this is by using tax deducibility. The aim of the article is to explain to US taxpayers the key rules that govern charitable contribution deductions for the purposes of the US Federal Income Tax, as well as of the other alternatives, which enable you to make the most out of the donated money.

First of all, when deciding whether you would like to itemize your deductions, you need to remember that you will be giving up the standard deduction, which amounts to $6,200 in the 2014 tax year if your filing status is single. Therefore, for the charitable contribution deductions to be beneficial for the purposes of reducing the taxable income they should exceed that sum, otherwise you will end up paying more income tax. However, there is a long list of other itemized deductions that count towards the total, which can be used alongside your charitable contributions.

If you want to claim the deductions, you must file your income taxes using Form 1040 and list your itemized deductions on Schedule A (in the same document).

The total of your deductions may be limited if your adjusted gross income (AGI) is more than:

  • $150,000 if married filing separately,
  • $250,000 if single,
  • $275.000 if head of household, or
  • $300,000 if married filing jointly or qualifying widow(er)

See the instructions for Schedule A (Form 1040 above) for more information about this limit.

In order for a taxpayer to be able to deduct the charitable donations from their pre-tax income, there are certain criteria that the donor, and the charity, has to meet.

1. The donation must be made to an organization which is qualified to receive deductible contributions.

The examples of qualified organisations include:

  • Churches, synagogues, mosques and other religious organisations.
  • Nonprofit charitable organisations.
  • Nonprofit educational organisations.
  • Nonprofit hospital and medical research organisations.

The status of a tax-exempt non-profit charitable organization benefits the donor by allowing him to deduct the contributions from his income for the federal tax purposes. The exceptions to this rule include the situations when the organization uses any of its net earnings to benefit a private shareholder or if it attempts to influence political campaigns or legislation.

The detailed criteria for the organisation to qualify can be found here.

The easiest way to find out whether the status of an organisation enables you to deduct your contributions is to either ask the organisation itself or use the online data base, provided by the IRS.

Deworm The World Initiative, Against Malaria Foundations and Project Healthy Children, charities which have been recommended by Giving What We can as some of the most-effective giving opportunities, are all exempt from federal income tax and exempt under section 501(c)(3) of the Internal Revenue Code, allowing you to rely on charitable contribution deductions.

2. The type of contribution will determine whether it is deductible.

The contributions which are not deductible for the tax purposes include:

  • A contribution to a specific individual,
  • A contribution to a non-qualified organization,
  • The part of a contribution from which you received or expect to receive a benefit,
  • The value of your time or services,
  • Your personal expenses.

You can find the detailed outlines here.

In case you benefit from a charitable contribution, you can still deduct it from your income; however what you can deduct will be limited to the amount of contribution that is more than the value of the benefit you receive.

Cash

The rule of thumb is that you can deduct monetary contributions you make to, or for the use of, a qualified organisation.

Generally, your deduction for charitable contributions cannot be more than 50% of your AGI. Any charitable donation can also be carried forward and taken the next year for the period of up to 5 years.

Property

If you donate an appreciated property, you are entitled to deduct the value of that property on the tax return for that year. The similar limit of no more than 50% of your AGI applies to the donations in the form of property.

The amount of your charitable contribution is based on the fair market value of the property at the time of the donation.

There are some limitations on claiming the deductions from donations in the form of capital gain property.

Long-Term Capital Gain Property

If you are contributing property that would have yielded a long-term capital gain in a sale, then the deduction for the contribution is limited to 30% of your adjusted gross income in the year of donation if the donee is a public charity, and limited to 20% if the donee is a private foundation.

Short-Term Capital Gain Property

If the property which you decided to donate would have produced an ordinary gain or a short-term capital gain (one year or less) had you sold it, then you are eligible to deduct only the adjusted basis in the property. This means that the amount of deduction is the property’s basic value, and not the amount of its appreciated market value.

Limitations

The special lower 30% limit on what you can deduct applies for capital gain property if and only if you chose not to reduce the fair market value of the property by the amount that would have been long-term capital gain if you had sold the property.

Estate tax

Every dollar donated to a qualifying charity can be deducted from your estate tax. If you donate $1 million, then $1 million can be deducted from your estate tax. Additionally, there’s no limit to how much you can deduct.

As a result, by leaving testamentary gifts to charitable organisations, individuals can often increase the amount of inheritance available for heirs through tax deductions. A donation not only reduces the amount of the tax owed dollar for dollar, it also reduces the size of the estate to be taxed.

For example, an estate worth $11 million, with $1 million exempt from taxes will owe $5.5 million in estate taxes (55% tax rate on $10 million), leaving $5.5 million for the beneficiaries.

However, if the owner of the estate leaves testamentary gift amounting to $1 million, the taxable income is reduced, and results in a $4.95 million tax total. The estate is also able to rely on a dollar-for-dollar tax deduction for the donations, reducing the tax bill to $3.95, thus increasing inheritance by $550.000.

3. You need to present the evidence.

If you want to deduct a cash contribution, from you income, for the tax purposes, you need to provide evidence that the donation was made.

You must maintain a bank record, payroll deduction records or a written communication from the organization containing its name, the date of the contribution and amount of the contribution. For text message donations, a telephone bill will meet the record-keeping requirement if it shows the information mentioned above.

If your contribution is $250 or more, you need to have an acknowledgement of your contribution from the qualified organisation.

Bear in mind that, when figuring out the amount of contribution, you should not combine the contributions you made over the course of the year; each donation is separate for the tax purposes.

Conclusion

Charitable contributions can significantly affect the amount of estate tax that you need to pay. Even though charitable contributions are not as beneficial for the taxpayer with regard to the amount of payable US Federal Income Tax, tax deductions can still give benefits to the taxpayer - this is addition to the great benefits donations bring to the causes supported. When filling in taxes, it is often well worth looking into what you can deduct and what is the best way of doing so.