While reducing taxes is not the primary motivation for most charitable gifts, many donors appreciate the fact that their gifts to charity may help lower their overall tax burden.
The federal tax system does not, however, allow taxpayers to completely opt out of paying taxes by giving all of their otherwise taxable income to charity. Certain restrictions serve to limit the deductible amount to fixed percentages of a donor’s adjusted gross income (AGI).
How is the AGI determined?
Not all income received in a tax year is considered part of an individual’s AGI. Tax-exempt income and, in some cases, Social Security income are among the types of income excluded from the AGI. In addition, certain contributions to retirement accounts and selected losses are deducted before determining the AGI. That means that some taxpayers may have higher incomes than the amount of their AGI would indicate. As noted below, these persons are most likely to encounter deduction limits based on AGI.
What are the current AGI limits?
- Gifts of cash may be deducted up to 50 percent of the donor’s contribution base, which is his or her AGI computed without regard to loss carrybacks. Cash contributions to non-operating private foundations are subject to a 30 percent of AGI limit.
- Gifts of long-term appreciated capital gain property (typically stocks and real estate) to such charities are generally deductible up to 30 percent of AGI. A donor may elect to deduct such gifts against the 50 percent limit by reducing the contribution deduction by the amount of the appreciation. Gifts of this type of property are deductible up to 20 percent of AGI if contributed to private non-operating foundations.
- There is a carry-forward provision for contributions exceeding these limits. The portion of cash or property gifts which otherwise exceed the 50 percent or 30 percent limits may be carried forward for a maximum of five years.
Who is affected?
AGI limits typically apply to persons making gifts that are relatively large compared to their AGI. Often, very wealthy individuals have relatively low AGIs despite their large net worth.
Example 1: Charlotte has stock worth $5 million that produces dividends of 2 percent, or $100,000. She also has tax-exempt investments of $2 million that yield 3 percent, or $60,000. Her yearly income is $160,000, but her AGI is just $100,000.
Under AGI limitations, she would be able to deduct cash contributions of 50 percent of her AGI, or $50,000. Alternatively, she could deduct up to $30,000 worth of appreciated securities. Given her large stock portfolio, it is likely she might decide to give an amount in excess of what she could deduct in a single year.
Example 2: Jerry, 75, has assets worth $3 million and an AGI of $45,000. He decides to fund a gift annuity with $100,000 in appreciated stock. His charitable deduction would be $38,500, but AGI limitations restrict his deduction this year to 30 percent of his $45,000 AGI, or $13,500. He will need to carry forward his deduction for three years to use his full deduction amount.
AGI limitations can have a real effect on the size, shape, and timing of charitable gifts for a number of individuals—including many wealthy, sophisticated donors. Surprisingly, a group of persons the size of Portland, Ore., is affected each year and some 78 percent of them are over the age of 65 (see chart above).
Understanding these limits is an important first step for any gift planner hoping to build long and fruitful relationships with their most valued donors.
Note: This article was excerpted from the popular Sharpe seminar “Gift Planning Fundamentals.” See Page 7 or visit www.sharpenet.com/seminars for more information.
Carry-Forward Charitable Deductions
According to IRS reports, the inability to fully utilize charitable deductions because of AGI limits is more widespread than many might believe.
In 2008, 439,000 taxpayers—a group roughly equal to the population of Portland, Ore.—deducted amounts that were actually given in previous years. These carried-forward deductions totaled $26 billion, more than the amount received from charitable bequests in most recent years.
Most of those who gave more than they could deduct were age 65 and over.