Gifts to charity may produce an immediate income tax deduction and result in reducing the amount of gift and estate taxes payable. Moreover, it is possible to obtain these results and at the same time retain the income produced by the asset being contributed to a charity. This article will discuss the tax effect of gifts to charity.
Gifts to a qualified charity of property that has appreciated in value (e.g. appreciated securities and undeveloped real estate) make it necessary that you be aware of the major issues that might affect the availability and amount of the charitable contributions deduction with respect to proposed gifts.
In General
Taxpayers who itemize their deductions are allowed an income tax deduction for charitable contributions which are actually paid during the taxable year. For tax purposes, a charitable contribution is a contribution to a "permissible donee" made without expectation of commensurate benefit. A charitable organization which is a "public charity" is qualified to receive deductible contributions.
Capital Gain Property
Gifts of appreciated property often prove advantageous from a tax standpoint because capital gain is usually not required to be recognized when the property is contributed and you receive a deduction for the entire fair market value of the property. If all the assets you are thinking of donating have been held by you for longer than one year, these comments will be limited to the impact of gifts of long-term capital gain property. If you subsequently decide to contribute any property that would not generate a long-term capital gain if sold rather than donated (i.e., held for less than one year), additional considerations would have to be addressed. The starting point for determining the amount deductible for a contribution of appreciated capital gain property is the fair market value of the property. There are, however, two significant limitations on the amount that a donor may deduct:
Capital Gain Reduction: Certain contributions must be reduced by the amount that would have been long-term capital gain if the property had been sold instead of contributed. Such a reduction is required for: (1) gifts of tangible personal property with a use unrelated to the exempt purposes of the recipient organization; and (2) most gifts to private foundations.
Applicable Percentage Limitation: The maximum charitable contributions deduction for any taxable year is limited to a certain percentage of a donor's adjusted gross income. The applicable limitation depends on the identity of the donee, the form of the gift and the type of property contributed. For an outright contribution to a public charity of capital gain property, which is not required to be reduced as discussed above, the controlling percentage limitation is 30% of the donor=s adjusted gross income.
The first required reduction will not apply if you are considering gifts of intangible personal property and real property to a public charity and not a private foundation. With regard to the second reduction, the maximum deduction for your aggregate gifts of such property for the year of contribution would be limited to 30% of your adjusted gross income. Amounts in excess of the 30% limitation may be carried forward and used in the succeeding five tax years.
Election to Reduce Deductible Amount
One variation on the scheme described above should be noted. A donor who contributes capital gain property which is not required to be reduced by the capital gain component may nevertheless elect to reduce the contribution. If the election is made, the applicable percentage limitation is increased to 50%. In other words, by electing to reduce the total amount deductible with respect to a contribution, a taxpayer may increase the maximum amount deductible in the year of contribution. The election is generally advantageous only if the amount of appreciation is insubstantial. Before deciding to make the election, however, you would have to consider all the relevant factors, including your current and expected future income tax rates and the amount of your previous and expected future contributions.
If your company is evaluating how to respond to certain requests for donations from various local charities you should consider these requests in light of the potential tax advantages.
In General
For tax purposes, a charitable contribution is a voluntary payment made without expectation of a commensurate economic or other benefit. In this regard, charitable contributions are distinguished from business expenses, which are transfers that bear a direct relationship to the taxpayer's business and are made with a reasonable expectation of commensurate financial return. It should also be noted that, in the case of a closely-held corporation, a transfer to charity may be treated as a constructive dividend if the shareholders receive property or other economic benefit from the transfer. Only certain types of organizations are qualified to receive deductible contributions. For corporate donors, the permissible donees are governmental units, charitable organizations, war veterans organizations and nonprofit cemetery companies. Normally, a charitable contribution is deductible in the taxable year in which it is paid. Accrual basis corporations, however, may deduct contributions made within two and one-half months after the close of the taxable year if the contributions were authorized by the board of directors during the taxable year.
Amount of the Contribution
The amount of a cash contribution is equal to the amount of cash contributed. The amount of a contribution of property other than cash is determined with reference to the fair market value of the property. Certain property contributions, however, must be reduced by the amount that would have been ordinary income or capital gain if the property had been sold rather than contributed. For example, the amount of a contribution must be reduced by any amount that would be ordinary income or short-term capital gain if the property were sold instead of contributed. Property subject to this reduction includes inventory and property used in a trade or business, to the extent that gain from the sale of the business property would have constituted ordinary income under the depreciation recapture rules. In addition, a contribution of property must be reduced by the amount of the long-term capital gain that would have been generated by a sale in the case of: (1) gifts of tangible personal property with a use unrelated to the exempt purposes of the recipient organization; and (2) gifts to private foundations.
Special Exceptions
Because of the required ordinary income reduction, the amount of a contribution of a gift of inventory is usually limited to the basis of the inventory. Three special exceptions, however, make certain corporate contributions of inventory and other business assets more advantageous than others. If an exception applies, the required reduction is limited to one-half of the ordinary income component, provided that the amount of the contribution cannot exceed twice the basis of the property. The first exception applies in the case of contributions of inventory to be used by the donee solely for the care of the ill, the needy or infants. The second exception applies to gifts of scientific equipment constructed by the donor that will be used by the recipient for research or experimentation. The third exception applies to gifts of computer technology and equipment to be used in an elementary or secondary school. None of these exceptions are available for contributions by S corporations.
Amount Deductible
The maximum amount deductible by a corporation in any taxable year is limited to 10% of the corporation's taxable income, computed with certain adjustments. Contributions in excess of the 10% limitation may be carried forward for five succeeding tax years.
All charitable contributions must be substantiated in the manner prescribed by the IRS. The extent of substantiation required depends on the type and claimed value of the property donated. All contributions of $250 or more must be substantiated by a written acknowledgment from the donee organization before a deduction is allowed. The acknowledgment must state the amount of money or description of property and whether any consideration was given in exchange for the contribution. Thus, you must be sure to obtain such an acknowledgement at the time you make the contribution.
For property, other than publicly traded securities, with a claimed value exceeding $5,000, a donor must obtain a qualified appraisal to substantiate the value of the property. A qualified appraisal is an appraisal prepared by an independent appraiser that contains specific information about the property, the value of the property, the valuation method and the qualifications of the appraiser. A summary of the qualified appraisal, which must be signed by the appraiser and the donee, is required to be attached to the donor's tax return. Less stringent substantiation requirements are imposed in the case of gifts of publicly traded securities and gifts of property not exceeding $5,000 in value. The question of valuation of contributed property should not be taken lightly. If the claimed value is excessive, a donor may be subject to an overvaluation penalty as well as other sanctions.
The following is a summary of the IRS rules for the substantiation of charitable contributions made to a qualified public charitable organization. If the organization is a qualified public charity, donors are generally allowed to deduct the entire amount of their contributions to it. The deduction, however, is contingent upon the donor's compliance with a number of substantiation requirements, most of which require the involvement and cooperation of the charitable organization.
Contributions of $250 or More
Any donor who makes a charitable contribution of $250 or more after 1993 must obtain a substantiation of the contribution to obtain a deduction. The substantiation must consist of a written acknowledgment of the donation from the organization. If the donation is made in cash, the acknowledgment should state the amount; if the donation is of property, it is sufficient to simply describe the property without having to estimate its value. There is no required format for the acknowledgment; it can be made by post card, letter, or computer-generated form. At a minimum, it should contain the name of the donor, the donee organization's name and address, the date of the donation, and the amount of cash donated or a description of any donated property. It is not necessary to obtain or include the donor's tax identification number. The IRS requires that the donor receive the acknowledgment before he files his tax return for the year in which the contribution is made. Thus, the donee organization should provide the acknowledgment at least by year-end.
If the donee organization provides some tangible benefit to the donor in return for his contribution, the value of that benefit must be included on the acknowledgement form. For example, if the organization gives contributors a coffee mug or a tote bag in return for their contributions, the acknowledgement form must include the value of that item. There are, however, three exceptions to this rule. The first is for intangible religious benefits (such as the right to attend religious services in return for a contribution); the second is when the item has only a token value. The IRS annually adjusts the value of such "token" items, and we can provide you with the current amount. The third exception is when the donee organization provides membership privileges for a contribution of $75 or less. Such privileges would include free admission to events, free parking, and discounts on member purchases.
The donee organization is not required to aggregate contributions in determining if a particular donor's contributions have reached the $250 threshold which triggers the substantiation requirement. Each contribution is viewed separately, even if made as part of a series of payments, such as monthly or weekly pledge payments. All contributions made on the same date, however, should be combined for purposes of determining if the donor has exceeded the $250 level. If the organization receives contributions through a community giving program, such as the United Way, the organization has no obligation to satisfy the substantiation requirement with respect to individual donors. This responsibility falls upon the community organization which is the initial recipient of the donations.
Quid Pro Quo Contributions
The organization may hold fund raising events at which donors receive something of value in return for their donation. This is sometimes known as a "quid pro quo" contribution. Examples are auctions of donated goods and services, and gifts of "premiums" in return for a contribution. After 1993, any time a donor makes a contribution of $75 or more, and receives something of value in return, the IRS requires that your organization provide a disclosure statement to the donor.
The disclosure statement must inform the donor that the deductible amount of his or her contribution is limited to the excess of the amount of the contribution over the value of the goods or services received in return. The organization must also provide a good faith estimate of the value of such goods or services so that the donor can determine the amount of his deduction. The disclosure statement should include the donor's name and the name and address of your organization. It is not necessary to include the donor's tax identification number.
The disclosure statement must be given to the donor at the time of the solicitation or the payment of the contribution. In the case of a charity auction, this requirement could be satisfied by listing the fair market value of each item in the auction catalog. It is not necessary to aggregate separate payments to reach the $75 threshold, unless the payments are all part of the same transaction. Failure to make a required disclosure statement could result in the imposition of IRS penalties on your organization.
Certain quid pro quo contributions are not subject to the disclosure requirements. These exceptions are identical to those for the $250 substantiation requirement, discussed above, and include contributions for which the donor receives only religious benefits and the receipt of items which have only a token value.
Contributions of Property with a Value of More Than $5,000
If the donee organization should receive a contribution of property with a value of more than $5,000, it may be subject to certain IRS reporting requirements. These requirements apply if: (1) the organization received a contribution of property (other than cash or publicly traded stock) for which the donor took a deduction of more than $5,000; and (2) the organization sells the property within two years of its receipt. If these conditions apply, the organization must report the sale to the IRS, primarily so that the IRS has a means of determining that the amount of the donor's deduction was not overstated. This requirement applies regardless of whether the donor is an individual or a corporation.
The report is filed on IRS Form 8282, and must include: (1) the name, address, and taxpayer identification number of the donor; (2) the donee organization's name, address, and identification number; (3) a description of the property; (4) the date of the contribution; (5) the date of disposition of the property; and (6) the amount received for it. Because of this reporting requirement, it is advisable that any time the organization receives a contribution of property (other than cash or publicly traded stock) with a value of more than $5,000 it must also obtain the donor's name, address, and taxpayer identification number. The organization may need this information if it is later required to report a sale of the property to the IRS.
Summary
The reporting requirements imposed on charities in connection with contributions have become increasingly burdensome and complex. Your organization should, however, be careful to comply with the requirements described above to avoid IRS penalties and to assist your donors in receiving the largest possible tax deduction. I would be glad to advise a donee organization on the application of these rules to its current fund raising practices, as well as to any new fund raising programs that it may be contemplating. If you have questions or would like evaluation of the tax consequences of any specific proposed fund raising, please contact the author by clicking on the Contact Information button.
If you plan to make a substantial charitable gift as part of your overall estate plan, there are a number of options for charitable giving other than an outright gift. These options, often referred to as "deferred" giving plans, usually allow you to retain the benefit of the donated funds, with a gift to charity at a later date. The advantage of such plans is that you can receive an immediate income tax deduction for the value of your gift and can avoid the payment of any capital gains tax on a gift of appreciated property. Following is an outline of the various options for making deferred gifts.
The simplest, and perhaps most common, form of deferred giving is the pooled income fund (PIF). These funds, established by charities to encourage deferred giving, are usually offered by universities, churches, and other major charitable groups. In return for your contribution of cash or property to the PIF, the PIF agrees to provide you and/or your spouse with a life income. There is no guarantee of the amount of income, as it is based upon the investment return of the PIF. The PIF will provide you with a history of its past investment results, as well as its investment philosophy, to give you some idea of the income you can expect. At the death of you and/or your spouse, the income interest will terminate, and your capital account in the PIF will be given to the sponsoring charity.
A PIF has clear tax advantages. You will be entitled to an income tax deduction in the year in which you make your contribution to the PIF. The amount of the deduction is the value of the interest which passes to the charity at your death or the death of your spouse. This amount will vary, depending upon your life expectancies and the investment return of the PIF. As an example, if a 60-year old donor transfers $100,000 to a PIF which has an 8.5% return, and retains a life income interest, the amount of his charitable deduction will be $26,758.
There are also advantages to contributing appreciated property, such as stock, to a PIF. Although the stock will be valued at its fair market value in determining your charitable deduction, no capital gains tax will be imposed on you or the PIF. A contribution to a PIF will also help to reduce your estate tax since the amount passing to the charity after your death will be deductible for estate tax purposes.
A charitable remainder trust (CRT) is similar to a PIF in that, in return for your payment, the trust will pay you income for a fixed period of time, with the principal eventually paid over to charity. A CRT, however, is more flexible than a PIF since it provides you with more options for the payment of the income. Rather than tying your income to the investment return of the trust, a CRT can pay you either a fixed annuity payment or a "unitrust" payment. A unitrust payment is advantageous in inflationary times since it is a fixed percentage of the value of the trust assets, revalued annually. Thus, as the trust assets appreciate in value, your payment will increase. A CRT also offers the advantage that you may decide whether the income interest is to be paid to you for life or for a specified number of years.
A CRT, if successfully implemented will: (1) avoid the payment of capital gains tax on appreciated property; (2) provide you with an immediate charitable deduction on your income tax return; (3) include an annuity for you and/or your spouse; and (4) reduce your liability for gift and estate taxes. Because there are costs associated with establishing and maintaining a CRT, it is appropriate for contributions of substantial amounts; $50,000 is usually the recommended minimum.
An alternative form of deferred giving is the charitable gift annuity. Similar to a commercial annuity, a gift annuity is a gift to charity in return for which you receive a lifetime annuity. Because the annuity payments will be less than those received from a commercial annuity, a portion of the payment to the charity is considered a gift and results in a charitable income tax deduction.
From the donor's point of view, a gift annuity offers greater security than the other options, since the annuity payment is an obligation of the issuing institution. Unlike a pooled income fund or charitable remainder trust, the annuity payment is not dependent upon the investment results of the fund in which the donation is deposited, but is a fixed amount which is guaranteed by the institution.
Summary
As shown above, you have a number of options for making a deferred gift. The option you choose depends upon both the amount and type of property you wish to contribute, as well as the nature of the income you would like to receive following your gift. We will be glad to work with you and the intended charitable recipient to decide which deferred gift vehicle will work best for you.
Sample Prior-Month Election for Valuing Charitable Trusts
Section 7520(a) allows a taxpayer claiming an income, gift, or estate tax charitable deduction to elect to use the Applicable Federal Rate in effect for the month of the transfer or the rate in effect for either of the two months preceding the transfer. By electing the most favorable of the three interest rates, the taxpayer can increase the allowable charitable deduction.
The taxpayer makes the prior-month election by attaching a statement to the appropriate income tax return that contains: (1) a complete description of the interest transferred; (2) the valuation date; (3) the names and identification numbers of the beneficiaries; and (4) the names and birth dates of the measuring lives, with a statement, if a measuring life is terminally ill, of how the illness was taken into account in valuing the interest; and (5) a computation of the deduction. [Regs. '1.7520-2(a)(4)].
For the income tax charitable deduction, the election statement must be attached to the taxpayer's income tax return or to an amended return for the year the transfer was made that is filed within 24 months after the later of the date the original return for the year was filed or the due date for filing the return. Regs. § 1.7520-2(b)(1).
The prior-month election for income tax purposes may be revoked by filing an amended return within 24 months after the later of the date the original return for the year the transfer was made was filed or the due date for filing the return. Regs. § 1.7520-2(b)(3). For elections made on or before June 10, 1994, an election could only be revoked with the IRS' consent. Regs. § 301.9100-8(a)(4)(ii).
An automatic six-month extension of time to make the election is available under Regs. § 301.9100-2(b). Because the date for making the election is not prescribed by statute, the IRS should have discretionary authority under Regs. § 301.9100-3 to grant an additional extension of time to make the election.
The foregoing discussion was designed to give you a general idea of the principal issues that arise in connection with charitable contributions by corporations. If you have questions or would like evaluation of the tax consequences of any specific proposed gift, please contact the author by clicking on the Contact Information button.