Editor: Marcy Lantz, CPA
In light of the new rules enacted by the law known as the Tax Cuts and Jobs Act, P.L. 115-97, and recent final regulations issued on charitable gift substantiation (Regs. Secs. 1.170A-15 through 17), taxpayers may discover their donations to charity may not qualify for an income tax deduction. With these new stringent regulations, it is very possible that it will be more common to see deductions disallowed upon exam. However, just because a charitable contribution fails to qualify for an individual income tax deduction, a deduction is not precluded for purposes of trust and estate income taxes or for lifetime gifts or bequests to charity.
Charitable deduction rules for trust and estate income taxes and transfer taxes are found in different Code sections from the rules for individual income taxes. A recap of the applicable law for deduction of the charitable contribution under individual income tax, trust and estate income tax, gift tax, and estate tax law is noted in the table "Recap of Charitable Deduction Rules for US Citizens/Residents" (below) by applicable form number for reporting purposes.
As tax preparers, CPAs must proactively inform clients before the clients make substantial donations, to ensure they will be entitled to the deduction as intended. One important and easy thing to check is whether the organization is a qualified charity. The IRS has an online research tool (available at apps.irs.gov/app/eos) to determine if certain entities are qualified tax-exempt organizations, along with a list of automatically revoked organizations.
If the charity appears on this database, a taxpayer can quickly determine whether contributions to the organization are deductible. Religious and governmental organizations may not be listed in this database; however, all other organizations qualified to receive a charitable contribution should be listed.
Gift and estate transfer tax implications
What happens if a client contributed more than $15,000 (the limit on nontaxable gifts for 2019) in 2019 to an organization that does not appear to be a qualified tax-exempt organization? Other than the obvious failure to obtain the income tax benefit, that client may have made an inadvertent taxable gift reportable on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
Charitable contributions to qualified tax-exempt organizations do not need to be disclosed on a gift tax return unless the taxpayer otherwise has a reporting requirement for other taxable gifts. For 2019 the annual exclusion for a gift of a present interest is $15,000.
Sec. 2503 defines taxable gifts to mean the total amount of gifts made during the calendar year less the deductions provided in Sec. 2522 and with certain defined exclusions from reportable gifts. The charitable deduction components in Sec. 2522 (and Sec. 2055 for an estate tax charitable deduction) are quite different from the income tax deduction rules under Sec. 170.
For a U.S. citizen or resident, Sec. 2522 allows an unlimited gift tax deduction for a gratuitous transfer of money or property to, or for the use of, certain charitable entities and for specified purposes. Four categories of permissible donees are included in Sec. 2522 similar to the rules under Sec. 170. However, the Sec. 2522 rules do not require the entity to be domiciled in the United States, nor do they require the funds or property to be used in the United States. Therefore, if a client has made a substantial donation to a charity located outside the United States, as long as the charity meets the purpose test, the donation qualifies for the gift tax deduction. (For nonresidents who are not U.S. citizens, the donation must be made to a U.S. entity and the funds or property transferred for charitable use in the United States, similar to the rules for a deduction under Sec. 170.)
Further, if the recipient organization fails to qualify as a tax-exempt organization, the donation may still meet the purpose test and the donation may qualify for the gift tax deduction.
Example: A small not-for-profit formed to provide breast cancer patients funds for reconstructive surgery failed to file a Form 990 series return for several years and had its tax-exempt status automatically revoked.
This organization does not qualify for the income tax deduction, but it does qualify for the gift tax deduction, because there is no requirement under Sec. 2522 to be a tax-exempt entity and the charity meets the purpose test.
A note of caution: If the charity lost its tax-exempt status because it was disqualified for attempting to influence legislation or intervene in any political campaign, then it will fail the permissible-donee rules. If the donation is made to a political organization under Sec. 527(e)(1), there is no need to report the gift on Form 709.
Adequate disclosure of a charitable gift vs. individual income tax charitable deduction substantiation rules
If the donation deduction qualifies under Sec. 2522 or Sec. 2055 and there are no other taxable gifts to report, there is no requirement to report the donation on a gift tax return.
Gifts must be of a present interest for the annual exclusion to apply, meaning it must be a full transfer with no retained interest in the asset transferred. If the donor retains an interest in the asset transferred, a deduction is allowed only if (1) in the case of a remainder interest, the interest is in a trust that is a charitable split interest trust (described in Sec. 664) or a pooled income fund (Sec 642(c)(5)); or (2) in the case of any other interest, the interest is in the form of a guaranteed annuity or is a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly).
Though Sec. 2522 does not specifically provide substantiation rules, the adequate-disclosure rules under Regs. Sec. 301.6501(c)-1 outline required documentation and disclosures. For the transfer to be adequately disclosed on the return, certain details outlined in Regs. Sec. 301.6501(c)-1(f)(2) must be provided, including a description of the property and any consideration received, and a detailed description of the method for determining the value of the property or an appraisal that meets the requirements of Regs. Sec. 301.6501(c)-1(f)(3). For gift tax purposes, the language defining qualified appraisers and appraisals is similar to Sec. 170(f)(11); however, it imposes additional restrictions that the appraiser cannot be the donor or donee or be related directly or through employment.
Income tax charitable deduction for estates and trusts
When should a client make charitable contributions from a trust instead of personally?
The first place to look when considering a charitable contribution out of a trust or estate is to the trust document or will; charitable deductions are only allowed for trusts and estates that contain provisions to allow for charitable contributions. Under Sec. 642(c)(2), a deduction is allowed to estates and certain trusts for amounts that are paid for purposes of a charitable contribution. In the case of trusts, a deduction for amounts set aside for charitable contributions will only be allowed to trusts that are pooled income funds (and only with respect to income attributable to gain from the sale of a capital asset held for more than one year), trusts created on or before Oct. 9, 1969, and certain trusts established by wills executed on or before Oct. 9, 1969.
Generally speaking, to qualify as an income tax deduction for an estate or trust, the charitable donation must qualify as an individual income tax deduction under the stringent guidelines of Sec. 170; however, for amounts paid for purposes of charitable contributions, a deduction is allowed for contributions made to foreign charities. For both trusts and estates, the charitable contribution is deductible only to the extent that the amount donated was paid or set aside from income. Charitable gifts of principal are not deductible. No adjusted-gross-income limitation is applied to these gifts, however, so trusts and estates can claim a deduction for up to 100% of their taxable income.
More differences to consider
As trust and estate charitable deductions fall under an entirely different Code section than for individual returns, there are a slew of other differences:
Sec. 642(c) allows a deduction for amounts paid for purposes of charitable contributions to foreign charities and omits the requirement for the charity to be a tax-exempt organization for both amounts paid and set aside for charitable contributions. This means that clients can make deductible charitable contributions to a broader set of organizations than they would be allowed to on a personal return.
In addition, trusts and estates may make a special election under Regs. Sec. 1.642(c)-1(b) to treat contributions as paid in the preceding tax year. This allows for flexible tax planning around the timing of a charitable tax deduction. A trust can elect to set aside a charitable contribution and deduct it for a tax year so long as the charitable contribution is paid before the close of the following tax year.
Trusts and estates, unfortunately, are not allowed to carry over unused charitable deductions to future years. It is therefore very important to plan if a significant donation is expected to be made from gross income.
Perhaps the most important takeaway from this discussion is to remember the charitable deduction rules are quite different depending on the type of engagement. There are various planning opportunities for nonstandard donations and potentially unintended consequences if the donation is not made following the rules governing the specific area of tax. Although the post-TCJA tax climate has created additional challenges for charitable planning, tax advisers must also respond to high-wealth individuals' desire to impact their favorite charitable causes and be ready with innovative solutions.
Marcy Lantz, CPA, CSEP, is a partner with Aldrich Group in Lake Oswego, Ore.
For additional information about these items, contact Ms. Lantz at 503-620-4489 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with CPAmerica Inc.