Income Tax Benefits of Charitable Deductions
It’s never too early to plan ahead, and when it comes to year-end income tax and charitable giving strategies, starting sooner rather than later ensures you have enough time to put your plans into action. Starting early also means you’ll avoid the dreaded year-end rush!
Despite the COVID-19 pandemic, successful individuals and families may be experiencing higher than usual income this year due to milestones and life events, such as the sale of a business, significant capital gains on investments, equity incentive awards, or payments from a deferred compensation plan in retirement or after changing jobs.
While it is difficult to avoid realizing compensation-related income (unless you are ready to retire), a key income tax strategy to offset the impact of unavoidable increases in income is by utilizing charitable deductions to reduce taxable income.
How do I use charitable deductions to reduce my income?
One requirement for reducing income with charitable deductions is that you are an itemized deduction filer on your personal income tax return. If you aren’t sure about your deductions, take a look at your 2019 return on page one, line nine, or consult with your tax preparer. Remember that your total itemized deductions (including charitable giving) reduce taxable income, which in turn reduces tax liability based on the tax tables. Itemized deductions are not a tax credit that reduce tax liability on a dollar-for-dollar basis.
Charitable deduction limits on personal income tax returns
A new rule is in effect for 2020 only. Due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, individual taxpayers may deduct qualified charitable gifts of cash up to 100% of their adjusted gross income (AGI) in 2020, which is up from the usual 60% of AGI. For example, if your AGI is $300,000 in 2020, you may deduct cash charitable gifts up to $300,000 if the receiving organization satisfies the criteria for 501(c)(3) tax-exempt status. Be sure to verify that your intended charitable recipient qualifies for this beneficial tax treatment before making your gifts.
If you don’t currently have a significant amount of cash on hand, but you do have an appreciated investment portfolio, you can still take a charitable deduction if you choose to make a charitable gift of non-cash property. The deduction limit for charitable gifts of property other than cash is typically limited to 30% of AGI and the same is true under the CARES Act, but there is a sweetener for long-term appreciated assets. If the donated asset would qualify for long-term capital gain treatment upon sale (held for at least 366 days), a taxpayer may deduct the fair market value of the position as of the donation date (subject to the 30% AGI limit) rather than the asset’s original purchase price.
We can’t be certain if Congress will extend the CARES Act and its increased 100% of AGI deduction limit on cash charitable gifts into 2021 so now is a great time to accelerate giving if you have excess income and a sizeable cash position. Alternatively, it’s always a good year to consider making a gift of appreciated stock if you have excess income and long-term gain property but not a large cash position.
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Bankers Trust Company and its affiliates and their representatives do not provide tax or legal advice. This article is intended for informational purposes only and should not be construed as tax or legal advice. You should consult with your tax and legal advisors regarding your unique situation and needs.