December is a big month in the U.S. for donations to charity. Americans open their hearts and wallets to charitable organizations who feed the hungry, shelter the homeless and educate our youth as well as to many other worthy causes. Philanthropy has been part an important part of the American identity since before the Declaration of Independence was signed.
The U.S. government recognized the importance of American philanthropy almost one hundred years ago when the charitable deduction was introduced into tax law during World War I. As you may be aware, if you itemize on your tax return, your contributions to qualified charities may be deducted from your adjusted gross income to reduce the amount of tax you owe. This powerful incentive can encourage increased largesse from those with charitable intent.
Unfortunately, there have been instances where taxpayers have abused this well-intentioned deduction. In response, the IRS looks very closely at the amount of charitable deductions taken by a taxpayer. Earlier this year, the IRS listed “overstated” charitable contributions as one of its “Dirty Dozen” tax scams.[i] As a result, large charitable contribution deductions can trigger an IRS audit.
If you are making charitable contributions this year and plan to take the deduction for them, take steps now to make sure you don’t run into problems down the road. Follow the rules carefully and precisely. In an audit situation, if the requirements for deducting charitable contributions are not followed, deductions may be disallowed, leading to additional taxes, penalties and interest. In more severe instances, taxpayers may even face criminal prosecution for tax evasion or other serious offenses.[ii]
To prevail in a charitable deductions audit, here are some general guidelines to follow in advance:[iii]
Only Make Contributions to Qualified Charitable Organizations
Only those charitable contributions made to qualified organizations under Section 170(c) of the Internal Revenue Code may be deducted by a taxpayer. You can verify whether an organization qualifies by using the IRS EO Select Check tool. This tool allows taxpayers to determine if they are eligible to receive a tax deduction for a contribution made to a particular exempt organization (EO).
EO Select Check also allows the taxpayer to view the deductibility status of the charitable organization. For instance, if the organization is a public charity, “PC” will appear meaning that a deduction of up to 50 percent of the taxpayer’s adjusted gross income donation will generally be permitted. Meanwhile, a donation to a private foundation, listed as a “PF”, will generally permit a deduction of up to 30 percent.[iv]
For charitable contributions to qualify, you can only take deductions for the year in which they were actually made. Generally, December 31st will be the last day for making a charitable contribution. Depending on the substance and payment method of the contribution, when a contribution is considered to actually have been made may differ. Here’s a list of common types of contributions and when the IRS considers them to have been made:
Check – Contributions made by check are typically considered made when mailed, not when cashed. If it’s a large donation, it may be a good idea to go directly to the Post Office and use certified or registered mail and request a return receipt.
Credit card – These contributions are considered made when the charge is made, not when it posts.
Stock – A properly made charitable contribution of appreciated stock permits the donor to both receive a charitable deduction and avoid potential capital gains tax. This can be a very beneficial charitable giving strategy. However, contributions of stock may need extra time.
If the stock is a paper certificate, it needs to be properly endorsed and then the mailing date will count as the date of contribution.
If the stock is held in a bank or brokerage account, then the contribution is considered to have been made when the ownership of the stock changes. This can take a few days, so don’t wait until the last minute. Also, if the price of the stock is fluctuating, be aware that the amount of the donation may differ from the date when the instruction was given.
Substantiation is Required – No Exceptions
You must keep records of your donations if you are claiming a deduction for them. There is no de minimis exception. What type of substantiation is needed will depend on two criteria:
(1) Was the donation a cash or non-cash donation, and
(2) Was the donation $250 or more?
Cash: Cash contributions include donations paid by cash, check, wire, debit or credit card or payroll deduction. To claim the deduction, you must have some form of a bank record, a letter of acknowledgment from the qualified organization or a payroll deduction record. If the cash donation is $250 or more, then the deduction may only be taken if you have a written acknowledgment from the qualified charitable organization. Other additional documentation is required if the donation was made by payroll deduction.
Non-Cash: Substantiation of a non-cash donation, such as clothing, jewelry or other property, gets a little more involved. With this type of donation, you must be aware of four important thresholds:
Non-cash Contributions of Less than $250: A receipt is typically required from the qualified charitable organization. In addition, the taxpayer needs to have “reliable written records” to support the value of the deduction identifying the date and location of the donation, and a description of the property. The cost, fair market value and method of determining the fair market value, among other things, must be part of these records.
Non-cash Contributions of at Least $250 but Not More than $500: For these types of donations, you need the documentation described above, but the receipt from the qualified charitable organization must now reflect additional information such as whether the taxpayer received goods and services as a result of their contribution and the value of such goods and services. Also, this documentation must a “contemporaneous, written acknowledgment” meaning that it was provided:
On or earlier then the date you file your return for the year you make the contribution or
The due date including extensions for filing the return.
Note: An important word about contemporaneous written acknowledgments – they are the donor’s responsibility to obtain. If you plan to take a deduction for a contribution which requires one, make sure you have it in the timeframe required.
Non-cash Contributions of Over $500 but Not More Than $5,000: All of documentation listed immediately above is required, but the supporting taxpayer documentation now must include more detailed information about the property. Importantly, the taxpayer needs to attach Form 8283 to their Form 1040 at the time of filing. If the form is not submitted, the IRS may disallow the amount of these charitable contributions.
Non-cash Contributions Over $5,000: This may apply to one contribution of $5,000 or to a grouping of items which in the aggregate total over $5,000. For these types of contributions, a contemporaneous written acknowledgment is required along with supporting documentation identified above. Also Form 8283 must be attached to Form 1040. However, at this level of donation a qualified written appraisal by a qualified appraiser is generally needed.
Quid Pro Quo Contributions
Quid Pro Quo are those types of donations where the charity provides a good or service in return for the donation. If the amount of the good or service provided by the charitable organization is over a certain threshold value, the written acknowledgment letter must state how much of the donation was attributable to the good or service and how much was a charitable deduction. A charity must provide a written disclosure to the donor if the quid pro quo contribution is in excess of $75.
For example, if you make a payment to a charity for $100 but receive a ticket to an event they are hosting worth $60 in return, you can only claim a $40 deduction. Since the payment of the total contribution was in excess of $75, you should receive an acknowledgment from the charitable organization to this effect. If you don’t be sure to obtain one.
Token gifts are the exception. If the value of the gift from the charity is classified as insubstantial by the IRS, no statement from the charity is required. A token gift would be a keychain or a similar small item.
Qualified Charitable Distribution
A Qualified Charitable Distribution (QCD) is limited basically to IRA owners age 70 ½ and over who must take required minimum distributions (RMD). In place of taking part or all of their RMD, the IRA owner can direct their trustee to directly transfer an amount up to $100,000 to a qualified charitable organization.
If done correctly, the amount transferred does not get included in taxable income. This is particularly helpful to taxpayers who want to reduce the amount of their adjustable gross income to avoid various income thresholds which may incur additional taxes or limit important tax benefits. Mistakes occur when people don’t realize that the amount of the QCD transferred to the charity doesn’t get included as a charitable deduction either.
If you make large charitable donations, be extra sure to follow the rules in advance of filing your federal tax return. It’s no secret that the IRS looks closely at charitable deductions. If your tax return is selected for a charitable deduction audit, most likely it will be too late at that point to put the required documentation together.
In particular, remember that it’s the donor’s responsibility to obtain a timely contemporaneous written acknowledgment. A later obtained acknowledgment will not be acceptable to the IRS in an audit. In more complicated situations involving substantial donations, obtaining knowledgeable charitable planning advice at the outset can pave the way for charitable deductions which will pass the scrutiny of the IRS.
[i] See https://www.irs.gov/uac/newsroom/irs-wraps-up-the-dirty-dozen-list-of-tax-scams-for-2016.
[ii] Criminal prosecution requires willful conduct to evade taxes on the part of the taxpayer.
[iii] See IRS Publication 526, Charitable Contributions, and Treas. Reg. § 1.170A-13 for more details.
[iv] The amount of a charitable contribution which may be deducted is limited to either 50%, 30% or 20% of the taxpayer’s adjusted gross income (AGI) depending on the type of property contributed and the type of organization to which it was contributed. Generally, charitable deductions which exceed the limitation may be carried-over for a period of five years.