Donations to charity are tax deductible, but depending on whether you give cash, stock, or personal items you get a different type of deduction. Last year Congress created a new charity deduction called the Cares Act Charitable Contribution allowance. It allows a cash charity deduction without itemizing your tax return (more on that later). However, if you gift stocks or personal items to a qualified charity it’s not so simple and it’s easy to make a mistake.
We are going to teach you what you need to know when you donate to charity, how to avoid making mistakes, and get the highest deduction so you can pay the least amount of tax.
What types of charity deductions are there?
There are many ways to donate to charity to and get a deduction. The most common donations are:
- Cash
- Personal items
- Old Used Vehicles
- Stocks and equities
- Qualified Charitable Donations from IRAs
- Using a Donor-Advised Funds
Before we go over the different types of deductions, let’s see what type of organization can you donate to.
What is a Qualified Charitable Organizations?
First things first, for your donation to count, you can only donate to a qualified charitable organization (sometimes referred to as a 501(c)3 charity). A 501(c)3 organization is one that has been approved by the IRS. In order for an organization to become approved it must apply with the IRS on a Form 1023. Over the years they’ve made it easier to apply. Here is a link to the application (Form 1023-EZ).
In order for your donation to be deductible, the charity must meet some basic rules:
- The IRS must recognize the charity as a 501(c)3 organization
- The donation earnings of the charity cannot go to any shareholder of the charity
- The organization must not be trying to influence state law or legislation
- Political campaign contributions don’t count (i.e., they aren’t deductible)
- You must have good record keeping of your contributions to charity
- If the gift is over $250, you must have a “contemporaneous” acknowledgement from the charity (more on this below).
What about donations to crowdsourced fundraisers like GoFundMe or Kickstarter? Most of the time donations to those websites are considered personal gifts, and not charitable donations. If the receiver of the money is a 501(c)3 organization, then it’s tax deductible. You’ll have to check with each campaign individually to see if they count.
$250 IRS Requirement | “Contemporaneous”
If your donations is over $250, the IRS requires that you receive a “contemporaneous written acknowledgement” from the qualified charity. Contemporaneous means “existing or occurring in the same period of time.” The IRS defines contemporaneous as before you file your tax return. Also, if you receive any service or benefits from the charity, a portion of your gift is not deductible. Here’s an example:
You are attend a $500 Gala in June of 2021. At the Gala they offered dinner as part of the event. In January of 2022, the Gala sent you a written letter that says thank you for your $500 donation, and that the dinner was $50 out of the $500 you paid, and the rest went to charity. That means you can deduct $450 for your contribution charity, since you received a benefit (dinner) for the other $50. If they never sent you a letter, you don’t get the deduction.
Cares Act Charitable Contributions
Charity Donations are normally deductible only if you itemize your deductions on your tax return (itemizing is when you list out a bunch of small deduction so it’s greater than your standard deduction. If you need a refresher on how to itemize, we wrote an article about it here.) However, now you can get a deduction even if you don’t itemize.
Starting in 2020, Congress passed The Cares Act Allowance, which allows you a cash charity deduction, even if you don’t itemize. But guess what? It has limits.
| Cares Act Charitable Contribution Limits |
|---|
| Tax Year | Single | Married |
|---|---|---|
| TY: 2020 | $300 | $300 |
| TY: 2021 | $300 | $600 |
You can deduct up to a $300 in 2020 and $600 in 2021 (if you’re married). For you to qualify for the Cares Act Allowance, the donation must be cash and to a public charity (not a family foundation, corporate foundation, or donor advised fund).
Donating Personal Items
When you donate personal items to 501(c)3 charities, such as Goodwill or Salvation Army, you are allowed a deduction for those items. However, there are special rules you must follow to be allowed your deduction. Below are the three most important things you need to know:
Fair Market Value (FMV) of items donated
Your deduction is the FMV on the date you donated the item, not how much you purchased it for.
Example: you purchased a sweater for $100 in 2018 and in 2021 you decide to donate it to Goodwill. The value of the sweater is only $20 when you donate it. Your deduction is $20, not the $100 you originally paid for the sweater. This is a common mistake that the IRS loves to catch. Don’t accidentally deduct the purchase amount.
$500 Limit
If the value of the items you are donating are over $500 total, you must provide the IRS with additional information on a special form included on your tax return (Form 8283). The IRS will now want to know:
- The date you donated the items,
- When you originally purchased them,
- The name & location of the charity, and
- How you came up with the value of the items.
If you don’t keep meticulous records of your charity donations, it may be safer to report the FMV under the $500 limit, but still make sure to get a receipt from the organization to show what it is you donated.
$5,000 Value
If any one item (or group of similar items) you are donating are over $5,000, you must get a qualified appraisal of the item(s). This is usually when you are donating Art, Collectibles, Vehicles, Equipment, Real Estate, etc.
You may have to attach a copy of the appraisal to your tax return. In other words, if there’s no appraisal, the IRS says no way.
Donation of Stocks to Charity
Donating stock is one of the best tax strategies used by the the rich. That’s because if you donate appreciated stock to a qualified charity, you get two tax benefits at the same time:
- You don’t have to pay tax on the appreciation of the stock
- You get a deduction for the stock at the FMV on the donation date
Example: In 2019, you buy 10 shares of Apple Inc. stock for $50 a share ($500 total). In 2021 you see that the stock is now worth $160 per share ($1,600 total). If you donate the stock to a qualified charity, you don’t pay tax on the gain of $1,100 ($1,600 minus $500) and you also get a $1,600 deduction.
Don’t make these mistakes when donating stocks to charity
Be careful when donating stocks to charities. These are the 3 biggest mistakes people make:
Mistake #1 – selling the appreciated stock first and then giving cash to the charity. If you do it this way, you will have to pay tax on the sale of the stock first, which means the IRS gets more of your money. It’s almost always better to donate the appreciated stock directly.
Mistake #2 – don’t donate stock that is worth less than what you bought it for (in other words, stock you are losing money on). If you give a charity a stock that lost value, you don’t get to write-off the loss. If you have a stock that is running at a loss, it’s better to sell that stock, write-off the loss on your personal tax return and then give the charity cash from the sale of the losing stock.
Mistake #3 – not holding the stock for over a year. If you hold a stock for under 1 year, even if the stock went up in value, you must pay short-term capital gains (how capital gains works, here) and your donation deduction is not the FMV, but the cost you paid for the stock. Therefore, the best strategy when donating appreciated stock is to make sure you hold it for at least one year before donating it.
Remember, the best way to use this deduction is to donate appreciated long-term capital gain stock. That way you don’t pay the long-term gains tax, and you get a deduction for the FMV on the date you donated it.
What is a Qualified Charitable Distribution (QCD) from an IRA?
A Qualified Charitable Distribution (QCD) Contribution is a nontaxable distribution from an IRA to a qualified charity. The QCD is paid directly from an IRA.
As everything else with the IRS, there are some rules you need to follow regarding QCDs:
- You must be over 70 ½ years old
- The QCD cannot exceed $100,000 ($200,000 if you’re married)
- It will be included in your required minimum distributions (RMD)
- It must be from an IRA, not an ongoing SEP-IRA or SIMPLE IRA
These are very popular with people in their elder years. It allows them to give more money to charity and less money to the IRS. It also allows them to fulfill their RMD requirements (what’s a RMD? When you reach a certain age, the IRS makes you take money out of your IRA, otherwise you will get a penalty). You can read more about IRAs and RMDs in our article: Traditional and Roth IRAs.
What is a Donor-Advised Fund?
Donor-Advised Funds (DAFs) are funds set up by charitable advisor groups, such as Fidelity or Schwab Donor Advised Fund, that donate money to various charities on your behalf. The tax strategy behind donating to a DAF is you get the entire deduction at once but can have the fund distribute the money over many years. Here’s an example:
In 2021 Henry sells his startup tech company for $10 millions dollars. He knows that he wants to donate $2 million to charity, but over many years, not all at once.
Henry donates $2 million to a DAF in the same year he sells his company. He gets the entire deduction at once, so he only pays tax on $8 million in 2021 (not the $10 million he sold the company for). However, he can direct the DAF to distribution the money to various charities over his lifetime, not just in the year of his donation.
Another advantage of DAFs is the assets can grow over many years, while you decide which grants and qualified charities you want the DAF to donate your money to.
Conclusion
We covered what I think are the most important topics regarding charitable donations. In the future we will cover more technical charity topics, such as Private Foundations, and setting up your 501(c) Organization. Until then, please remember that the IRS code is complicated and that you should always hire a CPA or tax professional before using any of the strategies listed above.