Year-End Tax Planning for Charitable Contributions
Guest post by Michele A. W. McKinnon, Partner at McGuireWoods
Donors support charitable organizations and causes for a variety of reasons, including belief in the organization’s mission and that their gift can make a difference, as well as personal fulfillment. No one gives to charity solely to obtain a tax deduction, and personal reasons for giving usually outweigh the tax benefits.
However, experience shows that donors do want to receive the tax benefits associated with their philanthropy and they structure their giving in a tax efficient manner. In this article, you will find a review of information helpful to donors planning their gifts now, including:
- Tax legislation enacted during the COVID pandemic that offers some additional tax benefits in 2021,
- Planned giving techniques that continue to be attractive in the current environment, and
- Proposals for income tax changes expected to become effective in 2022.
Enhanced Tax Benefits for Charitable Gifts in 2021
For taxpayers who do not itemize: COVID relief legislation enacted in December 2020 expanded certain benefits provided to taxpayers for 2020. These temporary provisions include a new partial above-the-line deduction for certain contributions made by non-itemizers. It is available only for cash contributions up to $600 (for a married couple filing jointly or $300 for an individual) made in 2021. Contributions to a private foundation (other than a private operating foundation), a charity classified as a supporting organization, or a donor advised fund do not qualify.
For taxpayers who itemize their deductions: The legislation modified the percentage limitations for cash contributions to certain charities. For contributions made in 2021, individuals may deduct qualified contributions to the extent of their contribution base (i.e., 2021 adjusted gross income without regard to any net operating loss carryback). This essentially allows a taxpayer to deduct a qualified contribution up to 100% of the contribution base in 2021. A 5-year carryforward continues to be available for contributions in excess of these modified percentage limitations, but will be subject to the applicable percentage limitations in the carryover years. Like the temporary above-the-line deduction rules for 2021, a cash gift will not qualify under this provision if made to a private non-operating foundation, a supporting organization, or a donor advised fund.
The expanded deduction available to itemizers in 2021 also may be attractive for a donor eligible to make penalty-free withdrawals from an IRA or other retirement plan. While taxpayers over age 70½ may direct up to $100,000 to be distributed from an IRA to charity without recognition of income, a donor might consider a withdrawal from an IRA or other retirement plan to a qualifying charity in 2021 with recognition of income and a corresponding cash contribution to offset this income. This provides another resource for funding a charitable contribution in 2021 without the age and dollar limitations that apply to qualified charitable distributions from an IRA. Similarly, donors who have income realization events or wish to sell a highly appreciated asset in 2021 may want to consider a cash gift to a qualifying charity by year-end to offset the income recognized. They should consider whether the sale of the asset followed by a cash contribution offers a better tax result than a gift of the underlying asset. Donors considering any of these transactions should consult with their tax advisors to confirm the tax treatment of transactions under their particular tax circumstances.
Certain Planned Gifts Techniques Remain Attractive. The current low interest rate environment is attractive for certain planned giving techniques, including charitable lead annuity trusts (CLAT) and gifts of a remainder interest in a personal residence or farm. The low interest rate environment favors zeroed out charitable lead annuity trusts under the federal tax rules that apply for purposes of valuing the charitable lead interest. This technique allows donors the opportunity to transfer significant amounts to charity during the term of the trust and then the potential to transfer significant assets to children at the end of the trust term, free from transfer tax depending upon the investment performance of the trust during the term. The CLAT may be attractive for donors who have little or no remaining gift tax exclusion.
Charitable remainder trusts continue to be attractive for donors who wish to avoid (or defer) capital gains on the sale of appreciated property. A charitable remainder trust can provide a donor with a current income tax deduction without the loss of an income stream from the property. Donors with existing charitable remainder trusts who no longer need the income stream may wish to consider a gift of the retained unitrust or annuity interest to a charitable organization.
Legislative Proposals. When planning 2021 and 2022 charitable gifts, a donor should also consider the tax benefits associated with possible increased 2022 income tax and capital gains tax rates in legislation being considered in Congress.