EXECUTIVE SUMMARY
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In analyzing a charitable contribution, a taxpayer must determine if the contribution is to a qualifying charity, the amount of the contribution for deduction purposes, and how much of the contribution can be deducted in the current year.
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The IRS provides a list of qualifying charities in Publication 78.
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When a contribution of property is made, the amount of the contribution depends on the type of property and the type of charity to which the property is donated.
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If the full amount of a donation is not deductible in the tax year it is made, the taxpayer may carry forward the excess amount for up to five years.
New laws passed in recent years have added complexity to the rules regarding the deduction for charitable contributions for individual taxpayers. This article discusses the issues involved in determining whether a charitable contribution is deductible, what the amount of a contribution is, and when and how much of a contribution is deductible.
The determination of the charitable contribution deduction can be surprisingly complex for some taxpayers. This is especially true when taxpayers donate to relatively unknown organizations, donate property, and/or bump into the various percentage limits that may apply to their contributions. Recent tax legislation has also increased the complexity of even seemingly simple cash and property contributions of clothing, household appliances, cars, and taxidermy property. This article addresses three issues that must be resolved in order to determine the amount a taxpayer is allowed to deduct on the tax return: (1) Is the entity a qualifying charity? (2) How much was donated? (3) How much is currently deductible? The article focuses only on individuals.
Is the Entity a Qualified Charity?
The first question a taxpayer must answer in claiming a charitable deduction is whether the organization is a qualifying charity. Sec. 170(c) basically lists generic qualifying organizations. Many organizations are widely recognized as bona fide charities falling within these general listings, such as the American Red Cross and the American Cancer Society. But what if a taxpayer has made a contribution to the Green Guerillas, the Blue Jeans Center, Inc., or the Fabulous Leopard Percussionists Inc.? Are these organizations bona fide charities? Practitioners and taxpayers can consult IRS Publication 78, Cumulative List of Organizations Described in Section 170(c) of the Internal Revenue Code of 1986 (available at http://apps.irs.gov/app/pub78), to see if a relatively unknown specific organization is listed as a qualifying charity.
This publication also indicates whether the charity is a public charity (50% limit) or a private charity (30% limit). For instance, each of the above organizations is identified as “a public charity with a 50% deductibility limitation.”1 The Bill and Melinda Gates Foundation is identified as “a private foundation, generally with a 30% deductibility limitation.” Although this publication is useful, practitioners and taxpayers need to be aware that it does not list all qualifying organizations.
How Much Was Donated?
If an organization is a qualified charity, the taxpayer must next determine the amount that was donated for charitable contribution deduction purposes. For purposes of determining the amount donated, different rules apply to contributions of cash and contributions of property.
Cash Contributions
Cash contributions generally present few problems. However, if a taxpayer receives goods or services from the organization in return for a contribution, there may or may not be a donation. For example, purchasing cookies from the Girl Scouts (a bona fide charity) is not a charitable contribution absent evidence showing that the purchase price exceeded the product’s fair market value (FMV).2 Similarly, amounts paid for chances to participate in raffles, lotteries, similar drawings, or other contests for valuable prizes are not charitable contributions.3 In these situations, taxpayers have a chance to win a valuable prize and thus get full consideration for their payments. However, the receipt in the past of goods or services from a donee does not necessarily preclude a taxpayer from taking a deduction for a donation. For example, a taxpayer making a contribution to the American National Red Cross in gratitude for food and temporary shelter given to the taxpayer when her home was destroyed by a tornado has made a charitable contribution.4
A new complicating factor for cash or other monetary gift donations made after August 17, 2006, is that no deduction is allowed unless the taxpayer has a bank record of the contribution or a written communication from the donee showing the name of the charity, the date of the contribution, and the amount of the contribution.5 Thus, cash deposited into a Salvation Army kettle is no longer deductible without a receipt from the organization.
Property Contributions
Donations of property are more complex. Exhibit 1 provides a graphical overview of the following discussion. Property donations are based on the property’s FMV at the time of the contribution less certain required reductions.6 This rule basically splits property donations into “depreciated” and “appreciated” categories. Property counts as depreciated when the property’s FMV is less than its adjusted basis at the time of donation. Many taxpayers donate property that falls into this category, such as used clothing and household goods. Because there is no required reduction for depreciated property, the amount deemed donated to charity is the property’s FMV. However, in a recent law change, effective after August 17, 2006, donations of clothing and other household items must be in “good used condition” in order to get a deduction.7
Furthermore, the IRS may by regulation deny a deduction for clothing and household items that have minimal monetary value.8 However, these new rules do not apply to any contribution of a single item of clothing or a household item for which a deduction of more than $500 is claimed if taxpayers include a qualified appraisal for the property in their tax returns.9 Household items in-clude furniture, furnishings, electronics, appliances, linens, and other similar items. Food, paintings, antiques, and other objects of art, jewelry, gems, or collections are not household items.10 Other special rules apply to contributions of cars, boats, and airplanes with a claimed value exceeding $500.11 In the event that the charity sells these items, the deduction is limited to the gross proceeds received by the charity.
Property counts as appreciated when the property’s FMV exceeds its adjusted basis at the time of donation. Appre-ciated property is split between ordinary income property and capital gain property. Ordinary income property refers to property that if sold would generate either ordinary income or short-term capital gain.12 Capital gain property refers to property that if sold would generate long-term capital gain or Sec. 1231 gain.13
Ordinary income property: The amount deemed donated for ordinary income property is its FMV less the amount that would have been taxed as either ordinary income or short-term capital gain had it been sold rather than donated.14 Thus, the donated amount is generally equal to the property’s basis.
Capital gain property: For capital gain property, the amount donated partly depends on the charity to which the property was donated and sometimes on what the charity does with the donated property. There are three rules to be followed with this property.
Rule 1 involves gifts of tangible personal property (i.e., nonrealty) that are put to an unrelated use by the recipient charity. An unrelated use is one in which the charity does not use the property for the purpose or function constituting the basis for the charity’s exemption from tax.15 In this case, the amount donated is equal to the property’s FMV less any ordinary income or capital gain that the taxpayer would have recognized if the taxpayer had sold the property at the time of contribution.16 This rule limits the donation amount to the property’s basis. Securities are not subject to this rule because they are considered intangible property.
Rule 2 involves gifts of property to certain private foundations, including private nonoperating foundations, those not distributing contributions within 2½ months of the close of their tax year, and those not maintaining a common pooled fund.17 The determination of the amount donated to these private foundations follows the same procedures applicable to property under Rule 1.18 Thus, the amount donated is generally equal to the basis of the property. However, gifts of qualifying stock to these foundations are not reduced by the long-term capital gain potential. Stock is qualified if market quotations are readily available on an established securities market, if the stock has been held long term, and if the donor has not contributed stock exceeding 10% (in value) of all the corporation’s outstanding stock.19
Rule 3 involves all other capital gain property. The amount donated is the property’s FMV less any ordinary income potential such as depreciation recapture.20 Exceptions apply to this rule. For example, although musical compositions and musical copyrights may now be treated as capital assets, these items are not considered capital gain property for charitable contributions.21 Donations of any taxidermy property are subject to reduction for the capital gain potential inherent in the property.22 In addition, the taxpayer’s basis in taxidermy property is limited to the direct costs paid or incurred for preparing, stuffing, or mounting the property.23 This limitation precludes indirect costs incurred in obtaining the property such as transportation, equipment, hunting costs, etc., from being included in the basis.
How Much Is Currently Deductible?
Various percentage limits apply to determine how much of the charitable contributions are currently deductible. The appropriate limits depend on the nature of the charity and the type of property donated. Properties must also be “sequenced” in order to determine the amounts currently allowed. Initially, general limits for public and private charities are determined; sublimits are then calculated for capital gain property as discussed below.
Contributions to public charities (50% limit organizations) are taken first. The allowable deduction for amounts donated to these organizations is limited to 50% of the taxpayer’s contribution base for the tax year.24 The contribution base is adjusted gross income (AGI) computed without regard to any net operating loss carryback to the tax year.25 For simplicity, AGI will be used as the contribution base for the remainder of this article. Contributions subject to the 30% sublimit on capital gain property (discussed below) are taken after contributions that are not subject to the sublimit.
Contributions to private charities (30% limit organizations) are then ad-dressed. For amounts donated to these organizations, the deduction is limited to the lesser of (1) 30% of AGI or (2) the excess of 50% of the taxpayer’s AGI over the allowable amounts to the public charities.26
The third item in sequencing involves capital gain property that is donated to public charities where no reduction for the inherent capital gain in the property was required. A sublimit of 30% of AGI is imposed on this property.27 Thus, amounts previously allowed under the general 50%-of-AGI rule for public charities may be reduced by this new sublimit. For sequencing purposes, these contributions are claimed after all 50% contributions that are not subject to this sublimit as noted above. A taxpayer may avoid this sublimit by making an election to reduce the amount donated by the amount of the potential capital gain in the property. If the election is made, it applies to all donations of such property made during the year.28
This election could be advantageous when the taxpayer cannot claim excess contributions in the future because of anticipated losses or impending death. For example, if a taxpayer with $50,000 AGI donated land with a $60,000 FMV and a $25,000 basis to a public charity, the 30% sublimit would allow a current deduction of only $15,000, resulting in a $45,000 carryforward. If the carryforward is likely to expire unused because future AGI may be lacking due to anticipated losses or death, the taxpayer would be better off making the reduced election, resulting in a current deduction of $25,000 with no carryforward.
The final step is to use the sublimit that applies to capital gain property donated to private charities. This sublimit is equal to the lesser of (1) 20% of AGI or (2) the excess of 30% of AGI over the amount of capital gain allowed in the third step above.29 Property subject to this sublimit is taken after all other donations to 30% charities.
Any contributions exceeding these limits may be carried forward by the taxpayer and claimed in the succeeding five years.30 Contribution carryforwards remain subject to the same percentage limitations they had in the year of origination. Contributions made in any of the succeeding years are taken before any carryforward contributions. Allowable carryforward contributions are claimed in the order made.
Other Considerations
Holding periods are critical when donations consist of capital gain property. A one-day difference could determine whether the deduction is equal to the property’s basis or its FMV. Property must be held more than one year to be eligible for the potential FMV deduction. In this regard, “tacked on” holding periods that may result from the way the property was acquired should not be overlooked. The tacked-on holding period may result in long-term classification even though the taxpayer may not have actually held the property more than one year. Two common situations in which a tacked-on holding period may arise are property received by gift or property acquired through a nontaxable exchange. Appreciated gift property may have a low carryover basis from the donor, so meeting the long-term holding period could be especially important.
Business or investment property that has an FMV below its basis should be sold rather than donated directly to charity. Selling the property will result in deductible loss. The taxpayer could then donate the sale proceeds to a charity and take a deduction for the cash contribution. If the property is simply donated to the charity, the loss deduction vanishes because the deduction is based on the property’s FMV. This rule would not apply to “personal use” property because any loss on sale would not be deductible.
Taxpayers must be especially careful when dealing with contributions of appreciated property where depreciation, amortization, or depletion have been claimed. These deductions would generally result in ordinary income recognition if the property were sold rather than donated to charity because of various recapture provisions in the Code. Consequently, a donation of such property to a charity is likely to result in a deduction that is less than the property’s FMV.
Finally, taxpayers should make sure they have the proper documentation required for charitable contributions. This may be fairly simple, such as a receipt from the charity or a bank record. In other instances, documentation may be more complex, such as when appraisals are required.
Example: To illustrate the previously discussed rules, assume that J, anticipating a good year in his business, made contributions to charities during 2007 as detailed in Exhibit 2. The car will be used by Meals on Wheels to make deliveries to its clients. The painting given to the Denver Art Museum will be displayed by the museum. The sculpture given to the Boise State University Foundation will be sold to raise cash. Because of an uninsured flood loss to J’s business late in the year, his adjusted gross income was only $70,000.
To determine the amount of charitable deduction, J would first make sure the recipient organizations were qualifying charities. A check of IRS Publication 78 reveals that these organizations are 50% public charities, with the exception of the 5 Star Health Foundation Inc., the 100 Miler Club, and the A. H. Bean Foundation, which are 30% private charities.
J would next determine the “amounts” donated to charity. The cash donations are straightforward. The car is depreciated property so the amount donated is the FMV of $1,000. The donations of inventory are appreciated ordinary income property. The amounts donated are thus limited to J’s basis in the inventory. The stock donations are both appreciated capital gain property. Assuming that the stock given to the 100 Miler Club is qualified stock, both stock donations are taken at FMV and both contributions will be subject to sublimits: 30% in the case of the Girl Scouts and 20% in the case of the 100 Miler Club.
Because the painting (appreciated capital gain property) will be displayed by the museum, it is put to a related use and J’s donated amount will be the painting’s FMV. The painting will also be subject to the 30% sublimit. J could avoid the 30% sublimit on the stock given to the Girl Scouts and on the painting by making a reduced contribution election. This example assumes that the election was not made. The sculpture donation is being put to an unrelated use, so J’s donation is deemed to be the basis of $3,000.
To apply the general percentage limits, J could construct a worksheet as illustrated in Exhibit 3. In the “Amount Donated” column J would first list amounts donated to public charities, making sure that contributions subject to the 30% sublimit follow contributions not subject to this sublimit. He would then list donated amounts to private charities, again making sure that contributions subject to the 20% sublimit follow those contributions not subject to the sublimit.
Next, J would extend the public charity donated amounts into column A of the worksheet until he reached the 50% AGI limit of $35,000. J would then extend the private charity donated amounts into column C until he reached the column C limit of $7,000 (the lesser of (1) 30% of AGI or (2) 50% of AGI less the total of column A).
The 30% sublimit for certain capital gain property given to public charities would then be applied. Donated amounts that are subject to the sublimit would be entered in column B until the column limit of $21,000 (30% of AGI) was reached. For amounts appearing in both column A and column B, the deductible amount is the smaller of the two numbers. Finally, J would similarly extend sublimited private charity amounts into column D until he reached the column D limit of $0 (the lesser of (1) 20% of AGI or (2) 30% of AGI less the total of column B).
Exhibit 3 reveals that J may currently deduct a total of $32,000 as an itemized deduction. He has a $2,000 carryforward from the painting given to the art museum and a $12,000 carryforward from the stock given to the 100 Miler Club. These carryforward amounts will be subject to the same percentage limits in the subsequent years.
Conclusion
Taxpayers must examine three things to determine their charitable contribution deduction for any particular year:
- The status of the recipient organization as a qualifying charity;
- The amount considered donated; and
- The amount deductible in the current year.
Fortunately, most taxpayers do not face all the complexities that may surround the charitable donation deduction. However, all taxpayers should be aware of recent law changes denying deductions for contributions where the taxpayer lacks substantiating bank records or written communication from the charities. In addition, taxpayers should be aware that household goods must now be in “good used condition” in order to get a deduction, and the IRS may by regulation deny a deduction for clothing and household items that have minimal monetary value.
When taxpayers donate property to charities, the determination of the allowable deduction becomes more complex. The amount donated will depend on a number of factors, such as the type of property donated, the holding period of the property, and what the charity intends to do with the donation. For taxpayers hitting the percentage limitations, the computation becomes even more complex. Donations denied in the current year may be carried forward for only five years, so taxpayers should plan ahead to make sure that the carryforward amounts do not expire.
As the large amounts of money and property contributed to charitable organizations each year show, Americans continue to be a most generous people. It is unfortunate that they sometimes must face the complex computations to take advantage of a reward for their generosity.
For more information about this article, contact Prof. Boes at boesrich@isu.edu or Prof. Wells at wellgary@isu.edu.
Notes
1 The Fabulous Leopard Percussionists was qualified only until December 2007.
2 Werbianskyj, TC Memo 1975-93.
3 Goldman, 388 F2d 476 (6th Cir. 1967), aff’g 46 TC 136 (1966); see also Rev. Rul. 67-246, 1967-2 CB 104.
4 Rev. Rul. 80-77, 1980-1 CB 56.
5 Sec. 170(f)(17).
6 Regs. Sec. 1.170A-1(c).
7 Sec. 170(f)(16)(A).
8 Sec. 170(f)(16)(B).
9 Sec. 170(f)(16)(C).
10 Sec. 170(f)(16)(D).
11 Sec. 170(f)(12).
12 Regs. Sec. 1.170A-4(b)(1).
13 Regs. Sec. 1.170A-4(b)(2) and Sec. 170(b)(1)(C)(iv).
14 Sec. 170(e)(1)(A).
15 Sec. 170(e)(1)(B)(i)(I) and Regs. Sec. 1.170A-4(b)(3).
16 Secs. 170(e)(1)(A) and 170(e)(1)(B)(i).
17 Sec. 170(b)(1)(F).
18 Secs. 170(e)(1)(A) and 170(e)(1)(B)(ii).
19 Sec. 170(e)(5).
20 Sec. 170(e)(1)(A).
21 Id.
22 Sec. 170(e)(1)(B)(iv).
23 Sec. 170(f)(15)(A).
24 Sec. 170(b)(1)(A).
25 Sec. 170(b)(1)(G).
26 Sec. 170(b)(1)(B).
27 Sec. 170(b)(1)(C).
28 Sec. 170(b)(1)(C)(iii).
29 Sec. 170(b)(1)(D).
30 Secs. 170(d)(1), 170(b)(1)(B), 170(b)(1)(C)(ii), and 170(b)(1)(D)(ii).
