As the year-end approaches, it‘s a good time for you, or each client’s tax professional, to review the client’s tax planning strategy to see if there is any advantage to making a charitable contribution that will included on this year’s return.
Congress is debating major changes to the Internal Revenue Code (IRC), and any changes that make it into law could affect charitable giving strategies. For now, however, the current laws still apply, and financial professionals will likely need to understand the current laws, thoroughly, to understand the changes.
Generally, today, a charitable deduction is taken in the year that the contribution was made. There are, however, exceptions for certain types of property interests described below. Consideration should also be given to the possibility of making a charitable distribution from an individual retirement arrangement (IRA) to cover RMD requirements if the income is not needed and the IRA holder wishes to avoid additional tax liability.
1. What general rules apply to charitable deductions?
An individual may deduct certain amounts for charitable contributions. The amount of a contribution of property other than money is generally equal to the fair market value of the property. However, under certain circumstances, the deduction for a gift of property must be reduced. For guidelines concerning the determination of fair market value.
The amount that may be deducted in any one year is subject to certain income percentage limits that depend on the type of property, the type of charitable organization to which the gift is made, and whether the contribution is made directly “to” the charity or “for the use of” the charity. An individual who does not itemize deductions may not take a charitable deduction.
As a general rule, a gift of less than an individual’s entire interest in property is not deductible, but certain exceptions are provided.
For a charitable contribution to be deductible, the charity must receive some benefit from the donated property. In addition, the donor cannot expect to receive some economic benefit (aside from the tax deduction) from the charity in return for the donation. For instance, if a taxpayer contributes substantially appreciated property, and later reacquires it from the charity under a prearrangement, or if the charity sells the appreciated property and uses the proceeds to purchase other property from the taxpayer under a similar arrangement, the taxpayer recognizes gain on the contribution. However, where there is no arrangement, and no duty on the part of the charity to return the property to the donor, the taxpayer is entitled to a deduction. In addition, if the charity does return the property, the taxpayer receives a new basis in the property (i.e., the price he paid to reacquire it).
In determining whether a payment that is partly in consideration for goods or services (i.e., a quid pro quo contribution) qualifies as a charitable deduction, the IRS has adopted the two-part test set forth in United States v. American Bar Endowment. In order for a charitable contribution to be deductible, a taxpayer must (1) intend to make a payment in excess of the fair market value of the goods or services received, and (2) actually make a payment in an amount that exceeds the fair market value of the goods or services. The deduction amount may not exceed the excess of (1) the amount of any cash paid and the fair market value of the goods or services; over (2) the fair market value of the goods or services provided in return.
2. When is the deduction for charitable donations taken?
Generally, the deduction for a contribution is taken in the year the gift is made. However, if the contribution is a future interest in tangible personal property (such as stamps, artwork, etc.), the contribution is considered made (and the deduction allowable) only “when all intervening interests in, and rights to the actual possession or enjoyment of, the property have expired” or are held by parties unrelated to the donor.
Example: If a donor creates a charitable remainder trust and funds it with a piece of artwork, the donor may not take a charitable income tax deduction for the contribution to the charitable remainder trust until the year the trustee sells the artwork.
This rule does not apply to gifts of undivided present interests, or to gifts of future interests in real property or in intangible personal property. A grant of stock options by a company to a charitable trust resulted in a deduction in the year in which the options were exercised. Where real estate was transferred to a charity and subject to an option to repurchase, the IRS determined that fair market value under IRC Section 170 was equal to the value of the property upon the expiration of the option. A fixture that is to be severed from real property is treated as tangible personal property. The deduction for a charitable contribution made by an accrual basis S corporation is properly passed through to shareholders and taken in the year that the contribution is actually paid.
3. What is a charitable IRA rollover or qualified charitable distribution?
A taxpayer age 70½ or older is permitted to make a qualified charitable distribution (QCD) from a traditional IRA or Roth IRA that was not includable in the gross income of the taxpayer. The exclusion for qualified charitable distributions generally is available for distributions from any type of IRA (including a Roth IRA, which is described in Section 408A, and a deemed IRA, which is described in Section 408(q)), that is neither an ongoing Simplified Employee Pension (SEP) IRA nor an ongoing Savings Incentive Match Plan for Employees (SIMPLE) IRA. (A SEP IRA is described in Section 408(k), and a SIMPE IRA is described in Section 408(p).)
The provision permitting a QCD to be excluded from gross income was allowed to expire at the end of 2011, but the American Taxpayer Relief Act of 2012 (“ATRA 2012”) retroactively revived the provision for 2012 and extended it for the 2013 tax year. The Tax Increase Prevention Act of 2014 extended the provision retroactively for 2014, and the Protecting Americans Against Tax Hikes (PATH) Act of 2015 made the provision permanent.
A QCD is any distribution:
not exceeding $100,000 in the aggregate during the taxable year;
made directly, in a trustee-to-charity transfer (including a check from an IRA made payable to a charity and delivered by the IRA owner to the charity);
from a traditional or Roth IRA (although distributions from ongoing SEPs and SIMPLE IRAs do not qualify);
to a public charity (but not a donor-advised fund or supporting organization);
that would otherwise qualify as a deductible charitable contribution (not including the percentage of income limits in IRC Section 170(b) (Q 707)); and
to the extent the distribution would otherwise be includable in gross income.
No charitable income tax deduction is allowed for a qualified charitable distribution.
4. What are some other important points to keep in mind when planning charitable gifts?
Only distributions from a taxpayer’s own IRA are includable to determine whether a taxpayer has met the $100,000 limit. Therefore, although married taxpayers can make qualified distributions totaling $200,000, each spouse can only make distributions of up to $100,000 from his or her own IRA.
A participant in a qualified plan, an IRC Section 403(b) tax sheltered annuity, or an eligible IRC Section 457 governmental plan is first required to perform a rollover to a traditional IRA before taking advantage of a charitable IRA rollover.
Transfers to donor-advised funds, supporting organizations, private foundations, charitable remainder trusts, charitable gift annuities, and pooled income funds are not qualified charitable distributions.
Rollovers to charities by taxpayers who reside in states that tax IRA distributions and do not have a charitable deduction cannot escape tax at the state level.
If a qualified charitable distribution is made from any IRA funded with nondeductible contributions, the distribution is treated as coming first from deductible contributions and earnings. This is contrary to the general rule that distributions from a traditional IRA with both deductible and nondeductible contributions are deemed made on a pro-rata basis.
Qualified charitable distributions count toward a taxpayer’s required minimum distributions.
The prohibition on making a qualified charitable distribution from a SEP IRA or a SIMPLE IRA only applies to “ongoing” SEP IRAs or SIMPLE IRAs. These kinds of IRAs are ongoing if a contribution is made for the taxable year of the charitable distribution.
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