The current presidential administration proposes capital gain rates to increase from the maximum of 20% to 39.6% for taxpayers with earnings in excess of $1 million. This presents a great opportunity to incorporate charitable giving into tax planning.

How does this work? First, the deduction for charitable contributions must be understood.

Tax Treatment of Charitable Contributions

For individuals and pass-through entities, charitable contributions are deducted on the 1040 Individual Income Tax Return on the Schedule A, Itemized Deductions. The Tax Cuts and Job Act of 2018 made significant changes to this schedule.

Deductions on the Schedule A now include only:

• 1

  Medical Expense Deduction—which must be in excess of 7.5% of Adjusted Gross Income (AGI). If your AGI is $350,000, you cannot deduct medical expenses until the first dollar after $26,250. Very few take this deduction unless there are extraordinary medical costs.

• 2

  State and Local Taxes (SALT)—these have been capped at $10,000. This includes state income taxes, real estate taxes and personal property taxes. For most taxpayers living in states with a high tax rate and high real estate taxes, this cap precludes thousands of dollars in deductions over the $10k.

• 3

  Mortgage Interest—Post 2018, the amount that can be deducted is capped at $750k of an underlying mortgage. If the mortgage was entered into prior to 2018, the amount is capped at $1M.

• 4

  Charitable Contributions—This is one of the only four categories that presents a tax savvy strategy while simultaneously helping worthwhile organizations accomplish their mission. The CARES Act extends to 2021, the ability to deduct up to 100% of your AGI in CASH donations to charity, with a 5-year carryforward. The limit reverts to 60% of AGI in 2022. A taxpayer may donate up to 50% of their AGI in NON-CASH contributions with a 5-year carryforward.

Corporations take the charitable contribution on their 1120 Corporate Income Tax return and the amounts are limited to 10% of net income, with some specific add-backs, with a similar 5-year carryforward.

The value of the deduction is dependent upon the taxpayers effective (average) tax rate, with the inclusion of the state effective tax rate for those states that allow a deduction for charitable contributions. If a taxpayer has an effective tax rate of 45%, every $1 of donation has a net benefit of $.45.

Types of Charitable Contributions

Non-cash charitable contributions include fine and decorative art, furnishings, antiques, collectibles, household contents, real estate, as well as stock. For appreciating assets (those which have increased in value since time of purchase) a taxpayer may deduct the Fair Market Value of the property and avoid paying capital gains tax on the increase in value from the sales price less the basis. It is also important to note that collectibles are taxed at a 28% capital gains rate. This includes fine and decorative art, antiques, and collections such as gems as coins.

Example: A donor procured a painting in 2000 for $5,000. The painting has appreciated and is now worth $15,000 in IRS defined Fair Market Value. Perhaps the painting ends up selling for $10,000, not reaching its Fair Market Value at either consignment or auction. Under current law, the taxpayer would owe 28% in capital gains tax on the difference between $10k-$5k= $5k x 28%= $1,400. Additionally, selling art is not accomplished with the snap of a finger. Often, consignment or auction outlets must be employed, adding additional expenses (such as selling, storage and transportation) as well as significant time awaiting a sale. If a piece does not sell at auction by meeting the minimum acceptable sales price, termed the reserve, the piece is considered “bought in” or “burned”, which affects the future Fair Market Value negatively. Additionally, selling a painting at the Fair Market Value is not guaranteed and it could sell for less, as in this example.

Taking this same example, should the capital gains tax rates increase to 39.6%, this would result in taxes of $10k-5k=$5k x 39.6%= $3,960. The net after tax cash benefit to the client is $10,000-$3,960=$6,040.

This example can be extrapolated to selling appreciated stock. By donating to charity, the donor is not liable for paying capital gains tax and can instead deduct the Fair Market Value of the stock at the time of donation.

Donation Example: The taxpayer donates the painting to charity, procures an IRS Qualified Appraisal by an IRS Qualified Appraiser and the Fair Market Value of $15,000 is deducted on their Schedule A as a non-cash deduction. Note that the IRS defined Fair Market Value results in a value based upon a willing buyer and seller, no compulsion and adequate exposure time to sell and can often be greater than the price realized at auction or consignment. This results in a net benefit of $6,750 if the taxpayer has an effective (average) tax rate of 45%: $15,000 x 45%=$6,750. Also, the donor donates and is done. There is no awaiting an auction or consignment sale and hoping for a high sales price.

Beyond Tax Implications

Nationwide, charities deal with under-funding, overworked staff, and an underserved population dependent upon their services. Some taxpayers do not realize that donating items like fine art, collectibles, furnishings, antiques and other property can directly benefit charities and those they serve. Some charities may use the art for display in art shows. Furnishings can be given or sold for low cost to families moving into their first stable housing situation. Imagine the boost one feels when living in an apartment with high-quality furniture pieces to beautify their space. Additionally, donating stock allows nonprofits the financial latitude to retain the investment or sell as needed to provide working capital to fund their missions. Educational initiatives, animal rescue services, drug treatment programs, housing assistance, and manifold charitable initiatives benefit from donations.

At Probity Appraisal Group, we work with numerous charitable organizations who receive these donations and expand their outreach and services as a direct result. The upcoming change in the capital gain tax rate will make this an increasingly beneficial tax planning choice. The intangible benefits of helping charities fulfill their missions makes the choice to donate even sweeter.