The government views those with income of $200,000 or more as “high-income taxpayers,” and charitable contributions are a popular write-off for this group of individuals. For 2015 (the most recent year for which statistics are available), the average charitable contribution deduction for those with adjusted gross income (AGI) of $200,000 to under $250,000 was $11,370. For those with AGI of $250,000 or more, the average deduction was $16,580. In this period of tax uncertainty resulting from Congressional goals of tax reform, what can high-income taxpayers do to maximize their tax-advantaged giving opportunities?
Tax Rules for Charitable Contributions
High-income taxpayers should understand the basic charitable contribution rules for federal income tax purposes, which are fairly straightforward (Code Sec. 170):
• A taxpayer must itemize deductions. No above-the-line deduction for non-itemizers is allowed.
• Donations must go to an IRS-recognized charity, which can be found in Publication 78 online (https://www.irs.gov/charities-non-profits/organizations-eligible-to-receive-tax-deductible-charitable-contributions).
• A taxpayer must follow substantiation rules, with may include obtaining written acknowledgments from the charity and qualified appraisals from outside appraisers.
• Cash donations are limited to 50% of adjusted gross income. Donations of appreciated property usually are limited to 30% of AGI (with the exception of donations of conservation easements explained later). Deductions in excess of these limits can be carried forward for up to five years.
• The deduction for charitable contributions is subject to the phase-out of itemized deductions for high-income taxpayers. This means that the tax write-off for contributions can be reduced by as much as 80%.
Conservation easements are a type of special arrangement to let taxpayers have their cake and eat it too. Property owners can give away interests, take a tax deduction, and continue to enjoy the property.
To be deductible, the donation must be a contribution of a qualified real property interest (i.e., a restriction granted in perpetuity on the use which may be made of the real property) to a qualified organization exclusively for conservation purposes (Code Sec. 170(h) and Reg. §1.170A-14). The types of conservation contributions include:
• Preservation of land areas for outdoor recreation by, or the education of, the general public.
• Protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem.
• Preservation of open space (including farmland and forest land).
• Preservation of a historically important land area or a certified historic structure (such as a building façade).
Donations of conservation easements are limited to 50%of AGI minus the deduction for other charitable contributions. Any excess amount can be carried forward for up to 15 years. For donations by farmers and ranchers, the AGI limit is 100%, rather than the usual 50%, with the same 15-year carryover.
However, the IRS has made syndicated conservation easements a reportable transaction that must be disclosed on a taxpayer’s return and may invite IRS scrutiny (Notice 2017-10, IRB 2017-4, 544). For more details about conservation easements in general, see the IRS’s Conservation Easement Audit Technique Guide (https://www.irs.gov/pub/irs-utl/conservation_easement.pdf).
Qualified Charitable Distributions
An IRA owner who is at least age 70½ has an additional way to give to charity. They can make a qualified charitable distribution (QCD) of up to $100,000 annually from the IRA (Code Sec. 408(d)(8)). The distribution is not taxed, and can be counted toward a required minimum distribution (RMD). But no charitable contribution deduction can be taken; no double tax break is allowed.
QCDs are restricted to regular IRAs. They cannot be made from IRA-type accounts, such as SEP-IRAs or SIMPLE-IRAs.
A donor-advised fund is a fund or account in which a donor can advise but not dictate how to distribute or invest amounts held in the fund (Code Sec. 170(f)(18)). Usually, a taxpayer giving cash or property to a donor-advised fund can take an immediate tax deduction even though the funds have not yet been disbursed to a charity.
Donor-advised funds from some major brokerage firms and mutual funds have minimum contribution amounts and fees.
High-income taxpayers may own businesses that can make donations.
• For C corporations, donations are limited to 10% of taxable income.
• For owners of pass-through entities, their share of the businesses’ donations is reported on their personal returns.
Usually, donations of inventory are deductible to the extent of the lesser of the fair market value on the date of the contribution or its basis (typically cost). If the cost of donated inventory is not included in your opening inventory, the inventory's basis is zero so no deduction can be claimed. However, businesses that donate inventory for the care of the ill, the needy, or infants, an enhanced deduction is allowed (Code Sec. 170(e)(3)).
Leave-based donation programs. Companies may have programs that enable employees to donate their unused personal, sick, or vacation days, with this time used by other employees in medical emergencies or disasters. Donated leave time is taxable compensation to the donors, subject to payroll taxes. Employees cannot take any charitable contribution for their donations.
A special rule applies for donations to benefit victims of Hurricane Harvey. The IRS has guidance (https://www.irs.gov/pub/irs-drop/n-17-48.pdf) on the tax treatment of these leave-based donation programs. Employees are not taxed on their donations for this purpose, and no employment taxes are owed on employee contributions for this purpose. Employer can then donate the amount of these donations to a charity providing relief to victims of Hurricane Harvey and claim a tax deduction for this action. Employer donations to tax-exempt organizations must be made before January 1, 2019.
There are many variations on charitable giving, each with special tax ramifications. Some examples:
• Donations of appreciated property held more than one year are deductible at the property’s fair market value on the date of the contribution. Potential capital gain is never recognized.
• Donations can be arranged through special trusts, such as charitable remainder trusts. The donor (and spouse) can enjoy the property for life (or a term of years), with the remainder passed to a named charity. The donor can take a current deduction for the present value of the remainder interest. Another trust option is the charitable lead trust.
• Wealthy individuals can set up their own private foundations to further their philanthropic goals. Special tax rules apply to these foundations.
Year-End Tax Planning
At present, it is uncertain whether there will be any changes in the rules for charitable contributions and, if so, when they will become effective. Likely, the charitable contribution rules for 2017 will be unchanged. However, a decline in tax rates would mean that tax value of donations would be reduced. For example, a $1,000 donation for someone in the 39.6% tax bracket saves nearly $400 in federal income taxes. If the rate for the same taxpayer declines to 25%, the savings would be only $250.
While high-income taxpayers may continue to be generous donors, regardless of tax breaks for giving, thought should be given now to making donations before the end of the year. Review charitable giving to year-to-date and project the tax savings for additional gifts that can be made by December 31, 2017. Allow sufficient time when making donations that require qualified appraisals and legal documentation.