How to Increase Charitable Deductions

Americans wrapped up a big year of charitable giving in 2005. Hurricanes, tsunamis, and other events created needs around the globe, and Americans responded with generosity.

Charitable giving is most effective when it is planned. That is why many charities have an official or office with the title Planned Giving. Get the maximum benefit from charitable contributions – and give the charities maximum benefit – by planning now the contributions for this year and even beyond. Decide how much you will give, then decide how the gifts will be made.

There are a variety of ways to give, and selecting the right ways for you to give can maximize your wealth as well as the benefits received by charity.

Most people write checks for their charitable gifts. The contributions are made with after-tax dollars, but the donors plan to get some or all of the taxes back through charitable contribution deductions. For many people, however, there are better ways to give than cash.

First, learn the limits on the tax deductions for your charitable contributions.

The type of charity determines the initial limit. Most gifts are to public charities. These charities have a broad base of donors, and donors generally are allowed to deduct cash contributions to them up to 50% of their adjusted gross income. Deductions for donations of appreciated long-term capital gain property to these charities are limited to 30% of AGI. Other charities, such as private foundations and operating foundations, have lower limits for deductions of contributions. These charities have a limited base of donors. The charity can tell you if it is a public charity or something else.

Contributions that cannot be deducted in one year because of the annual limit generally can be carried forward up to five years or until they are fully deducted, whichever occurs sooner. If you are giving a substantial amount or have questions about a charity’s status, be sure to work with the charity’s tax advisor and your own before making substantial contributions.

Also, be sure to check the stealth taxes. These can reduce or eliminate the tax benefits of your contribution. The “Pease provision” reduces itemized deductions, including charitable contributions, for “high income” taxpayers. For 2006, it kicks in when adjusted gross income is above $150,500 ($75,250 for marrieds filing separately).

Donating property with long-term capital gains is a good way to maximize charitable contributions. Do not sell the property, pay taxes, and make a contribution from the after-tax amount. Instead, give the appreciated property to the charity. You will be able to deduct the fair market value of the property, and no one will pay taxes on the appreciation. Many charities will accept stocks and mutual fund shares, and some will accept real estate.

It is even better to give collectibles, such as art, antiques, jewelry, wine, coins, or other collectibles. That is because the long-term capital gains rate on collectibles still is 28%, not 15%. Yet, you still get to deduct the fair market value by donating them to charity.

Another benefit of donating these items is that you benefit from the full fair market value. If you sell a collectible, it often takes time to find a buyer, then the price has to be negotiated. There also might be sale costs. When property is donated, little time is lost and an appraiser determines the value. The appraised amount is deducted. The only costs likely will be for the appraiser and perhaps for a lawyer to do some paper work.

For the donor to get the full deduction of a property donation, the charity’s use of the appreciated property must be related to the charity’s exempt function. For example, a museum must display artwork (or preserve it for future display). Most tax lawyers recommend that a donor get a letter from the charity acknowledging that it will use the property in its exempt function. If the charity does not use the property properly or sells it, the deduction is reduced by the potential capital gain in the property.

That is another reason it makes sense to plan charitable contributions early in the year instead of waiting until the end. To benefit from a property contribution, the right charity to receive the gift must be located.

You do not need to give away property completely to benefit from the contribution.

For example, you can give a fractional share of artwork or real estate. With artwork, you can give a museum the right to display the art for one third of the year, while you retain the rights for the rest of the year. You deduct part of the art’s value even if the museum doesn’t exercise its right to display the art every year. Or you might own a vacation home. You can give a charity the right to use the property as a retreat or for other purposes during the offseason. You retain the right to use and rent the property the rest of the year.

The amount of your deduction in these cases will depend on the exact details of the arrangement. But these are ways you can generate tax deductions without giving up full ownership of the property.

Life insurance is another way to give to charity. Many people have permanent life policies they no longer need. A good solution is to transfer ownership of the policy to a charity. You get a deduction for the contribution.

If the donation is of an existing policy that is fully paid-up, the deduction is what it would cost today to buy a similar single premium policy from the same insurer. If the donation is of an existing policy for which premiums need to be made to keep it in force, the deduction roughly will equal the cash surrender value. Or you can take out a new policy. In that case, your deduction is the premium paid. If you continue paying the premiums on a policy after the contribution, you get a deduction each year for the premiums paid.

Donations of life insurance can get complicated. Discuss the details with a charity’s Planned Giving office and get advice from your own estate planner.

Gradual, or installment, donations of property also generate tax deductions. They are especially useful for property you don’t want to fully part with or when the charitable deduction from a full contribution would exceed your limit.

Instead of giving full title to property, such as art or real estate, give a fractional share each year. For example, you can give 10% each year for 10 years. Each year you will be entitled to a deduction of 10% of that year’s fair market value. Of course, if the value rises each year, the amount of your deduction increases each year. The charity will be able to exercise its ownership rights for a portion of the year, and you will have rights the rest of the year.

The installment and fractional share contributions might cost more than other contributions. The installment gift will require an appraisal each year.

For either type of contribution, it is best to draw up an agreement with the charity governing the sharing of the partial gifts. The agreement should define the time periods when the charity can make its use of the property and also state the obligations of the charity for insurance and other expenses. If the item is personal property, there also should be an understanding covering pick up and delivery. The written agreement also serves as evidence for the IRS that a legally enforceable donation was made, in case the charity does not exercise its ownership rights during the year.

Charitable contributions of investments and other property can be made through different vehicles, instead of being given directly to a charity. The vehicles can give the donor income or other benefits in addition to a deduction. In next month’s visit we will review the different vehicles, and their pros and cons.