Special benefits related to tax deduction of charitable contribution


The role of charitable contributions

COVID has been a destroyer and a disruptor. It has taken millions of lives and even more jobs. People have lost their livelihoods. The gap between the haves and have-nots has widened. This is where charity comes in and plays a vital role.

There is one thing that is common to the following names-Katy Perry, Gwyneth Paltrow, Ashton Kutcher, Billy Joel, Elton John, and Angeline Jolie.

They have all donated to charities during the pandemic. They have also influenced hundreds and thousands of their followers to do the same. The amount doesn’t matter, the act does.

It is said that charity benefits the giver more than the receiver. The psychological and mental benefits are said to include an increase in happiness, health, and a strong sense of community. Research claims that people who donate and give are 40% more likely to be happy than those who do not donate.

These are not the only rewards that the giver gets. The Government also rewards charitable contributions in the form of tax breaks and deductions. The Government does this because that is, ultimately, the goal of paying taxes – building resources and communities that benefit the entire society, and consequently the entire country.

What are the deductions available for individuals this year and how are they different?

For individual taxpayers and married individuals filing separately, the standard deduction for charitable contributions that they can claim on their federal income tax for 2021 is up to $300. This applies only if a qualifying cash contribution is made to a qualified charitable organization. This deduction is applicable on top of the existing standard deductions.

For married individuals filing jointly, the special standard deduction for the same is up to $600.

For example, if you are married filing separately and made a contribution of $100, you will get a deduction of $100 on your tax bill. You will not get the entire $300. If you donated $400, then you will get a deduction of $300 since that is the limit.

Some benefits have been extended to cover the 2021 tax year. One such benefit is that the contributions do not need to be itemized to claim the additional standard deduction. This option is ordinarily not available for 90% of the tax-filers as they cannot claim standard deductions for charitable contributions. Low and middle-income taxpayers will particularly benefit from this change. So this is a significant pivot and a boost for encouraging charitable contributions towards qualified charitable organizations. The reporting also becomes easier if Form 1040 is filed electronically in 2022.

The only conditions for claiming these deductions for non-itemizers are:

  • a cash contribution (currency, checks, debit/credit cards. online transfers)- they do not include the value of volunteer service, securities, or household items.
  • made to a qualifying charitable organization
  • made in the calendar year 2021

However, if you are someone who itemizes his contributions, you can claim a deduction for a qualifying cash contribution for up to 100% of your Adjusted Gross Income (AGI). Typically, the limits for deducting cash contributions are around 20% to 60% of your AGI and depend on the type of contribution made. The increase in the ceiling of deductions is not automatically applied. The individual taxpayer must elect for it while reporting their contributions in Form 1040.

These two changes, namely standard deductions for non-itemizers, and 100% deduction for itemizers – are only temporary laws but Congress could extend these incentives for the 2022 tax year as well, so keep an eye out for that.

If you are over 70.5 years of age and are making a contribution from your IRA (Individual Retirement Arrangement), then it is termed a Qualified Charitable Distribution. The assets are donated directly to the charity you choose and you can avoid paying tax on this distribution. This is limited to $100,000 per year. Technically, this wouldn’t really be called a deduction, but at the same time, you would not be required to pay taxes on it either. It will also not be included in your AGI. This might cause you to fall into a lower tax bracket and help reduce your premium on Medicare and Social Security taxes.

What about deductions for businesses?

Coming to businesses, a business registered as a C-corporation is allowed a deduction that is 25% of its taxable income. Pre-pandemic, the limit was only 10%. Now even businesses are incentivized to make qualifying contributions to qualified charitable organizations. But this does not get applied automatically. The corporation must elect for the increased limit on every contribution made.

For businesses registered as an S-corporation, Limited Liability Company, or a Partnership, the charitable contribution is shown on the shareholder’s Form K-1.

Sole-proprietors will show the deductions in their own returns.

Businesses can also donate a part of their food inventory to shelters and food banks. This also enhances their deductions for the tax year 2021. The deduction limits under this type of contribution have also changed. What was earlier 15% is now 25% of their taxable income.

But what is a “Qualified Charitable Organization”?

A Qualified charitable organization is essentially an organization that has a tax-exempt status given by the IRS. It is also referred to as a 501(c)(3) organization.

Apart from organizations established solely for charitable purposes, the list of eligible entities also includes organizations that operate for scientific, educational, religious, and literary purposes. Organizations working towards preventing animal cruelty, the welfare of veterans can also come under this list.

If you did contribute to an organization that is not under this category or list, then it will not qualify for special deductions applicable to the 2021 tax year. Contributions towards supporting organizations and contributions that are carried forward do not count either. Donation towards helping a specific individual (like his medical expenses) also does not qualify for deductions.

Donating to a neighborhood lemonade stand or a friend in need will not make you eligible for deductions.

Donations to your favorite political candidate are also not tax-deductible.

What about states? Do they offer deductions?

Apart from the deductions at the federal level, some states and local governments that tax income also provide deductions or credits.

States like Alabama, Missouri, Delaware, and New York tax an individual’s income and also give benefits towards charitable contributions. The minimum rate of tax benefit varies from state to state. The benefits are also subject to certain limitations that can change. You should check the terms based on your state of residence.

States like Connecticut, Illinois, Indiana, and Pennsylvania tax individuals’ income but do not offer any benefits towards donations made by them.

States like Alaska, Florida, Washington, and Wyoming do not levy an income tax at all, so there’s no question of deductions or benefits.

What other things should I keep in mind about my contributions when filing my taxes?

The deadline for making the charitable contributions for the tax year of 2021 has already passed on December 31st. In the case of online payments or credit card payments, they should have been made before the end of 2021. In the case of check envelopes, they must have been marked by the US Postal service on or before December 31st, 2021.

For the sake of convenience, maintaining a record of receipts, or acknowledgment letters from the charity will also help in case there is some confusion in the filing process. Especially if the contribution is more than $250, then make sure you received an acknowledgment letter from the qualified organization indicating the amount received, whether you received some gift in exchange and the current market value of the gift.

For contributions where you get some kind of gift in exchange for the donation, the value of the memento must be subtracted to determine the actual value of the donation.

Let’s say you get a pen stand, whose market value is $5, in return for your contribution of $50. Then your effective donation would come to $50-$5= $45.

In the future, before making a contribution, make sure to check if the organization you are donating to is qualified. You can do this using the ‘IRS Tax Exempt Organization Search tool’.

The IRS also requests the public to be wary of fake charities that come up only when incentives are announced. Criminal elements tend to take advantage of such situations and convince some charitable members of the community to donate to their charity, which is in fact not a charity at all.

Charities and donations are usually not done with tax deductions in mind. But if that’s the incentive being provided by the government itself, then it is only reasonable to claim it. Before filing your returns, make sure you are aware of the various deadlines, exemptions, filing statuses, etc. that apply to this tax year. It is recommended that you use the assistance provided by a CFO consulting service under such circumstances.