Of course giving is its own reward, but most people appreciate the tax breaks that come along with charitable giving. Attorneys on both sides of the transaction — prospective donors and California nonprofit charitable organizations — need to understand these tax incentives to maximize the benefit of charitable giving for those who make these contributions and the charities that receive them.
The principal tax incentive for charitable giving is the charitable contribution income tax deduction. For many donors, it’s important to maximize the charitable income tax deduction because the tax saving arising from this deduction lowers the effective cost to the donor of making a charitable gift.
Here’s how it works: If a dollar of income that is used to fund a charitable gift would have been subject to California and federal taxes totaling 40 cents, the true cost to the donor of making the charitable gift is only 60 cents instead of a dollar, if the contribution qualifies as both a state and a federal charitable income tax deduction.
The second major income tax subsidy for charitable giving applies to gifts of appreciated assets to charity. Generally, the appreciation in the asset will not be subject to California or federal income taxation. Moreover, a donor who contributes certain assets may be able to claim deduction equal to the fair market value of those assets, depending on the type of charity to which the assets are conveyed.
This results in a double tax benefit for the donor—the untaxed appreciation avoids tax, and the deduction (equal to the fair market value of the property) reduces the tax on the donor’s other income. This double subsidy can effectively reduce the cost of a dollar of the charitable gift to 40 cents or less.
When using an appreciated asset to make a charitable gift, keep in mind the “assignment of income” doctrine. A commonly used technique for avoiding capital gains tax on an asset that is about to be sold is to contribute the asset to a charitable entity near the time that the sale is to occur and then let the charity complete the sale. If properly carried out, the donor is not treated as the seller of the asset and so pays no tax. In addition, because the charity is exempt from tax, it doesn’t have to recognize gain or pay the resulting tax. Depending on the type of property contributed, the donor may be able to claim a charitable contribution deduction equal to the property’s fair market value.
But be very careful that the sale negotiations haven’t progressed to the point at which the asset has ripened into a fixed right to receive cash or other property before it’s contributed to the charity. If the donor allows a transaction to progress to the point at which it is virtually certain that the sale will occur before he or she contributes the property to charity, the donor may be considered to be the seller of the asset (and, thus, responsible for paying the resulting income tax on the gain) and to have merely contributed the proceeds of the sale to the charity. See Ferguson v Commissioner (9th Cir 1999) 174 F3d 997.
When representing nonprofits and/or donors, you need to understand all the ins and outs of charitable giving. CEB has you covered with chapters on this topic in Advising California Nonprofit Corporations and California Estate Planning.
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