The charitable deduction is one of the most widely known tax deductions. However, the mechanics of it are often misunderstood.
The intent of the deduction is to encourage more charitable donations. And while tax savings typically aren’t our clients’ driver for donating, getting the maximum tax savings from their charitable giving is worth understanding.
Charitable donations are a “Schedule A” tax deduction
Let’s first clarify one thing: not all ‘tax deductions’ are the same. What we mean by that is that different deductions go on different pages of your tax return, and with that result in different implications to your final tax bill.
There are three general types of deductions: (1) “above the line” deductions (e.g. student loan interest), (2) “itemized deductions” (e.g. charitable deductions), and (3) “business expenses” (e.g. gas for an Uber driver).
When we discuss charitable deductions, we’re referring to itemized deductions. Each taxpayer has the option of “itemizing”, which means adding up all the eligible expenses for this deduction type, or taking the standard deduction. Of course, the maximum tax savings for you will come from choosing to take whichever is bigger between the standard and itemized deductions.
The standard deduction in 2018 is $12,000 for single taxpayers and $24,000 for married-filing-jointly taxpayers, so those are the thresholds that you must exceed for itemizing to be more optimal. The most common itemized deductions are state income and property taxes (capped at $10,000 for both single and married filers), mortgage interest (subject to limitations), and charitable deductions (also subject to limitations outlined below).
The key takeaway is that if you take the standard deduction, rather than itemizing, then there is no tax savings generated from your charitable deductions. There are some tricks though that might help you still save on taxes that you can read here.
Donations can be money or property, such as old clothes. But keep receipts!
Clearing out your closet and making a Goodwill donation? That counts as a deductible charitable donation. Be honest with your estimated value and keep detailed receipts. The same can be said when you give away an old car or anything else.
Of course, the bigger the value of the donation, then the higher likelihood of audit risk. So make sure you’re keeping especially good records. For any donation over $500 in value, you will need a qualified appraisal.
All of your donations, whether cash, goods, or stocks, get aggregated onto your tax return. So, when you’re considering the tax implications of your total charitable giving, include the sum of all these donations when determining your optimal strategy.
The charitable deduction is subject to limitations
While most average Americans aren’t donating enough in any given year to worry about the limitations, it is worth pointing out that the deduction is not uncapped. The limitations vary based on whether (1) the donation is in cash or other property (such as appreciated stock) and (2) the donation is to a public charity or private foundation.
The tax deduction for cash donations to public charities is now capped at 60% of your AGI (adjusted gross income). However, there are lower limits if giving to a private foundation or making a non-cash donation (or both).
The new tax law effective starting 2018 will result in many more taxpayers taking the standard deduction rather than itemizing. That may eliminate any potential tax savings from charitable contributions. To learn how to still maximize the tax benefit from your generosity, check out this article on simple charitable contribution strategies.
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