Charitable donations are an excellent way to help your favorite cause, church, foundation, school, or other registered charitable institution of your choice. Americans made $484.85 billion in charitable donations in 2021, which was 4% higher than 2020. The average annual household contribution was $2,534. In 2021, the majority of charitable dollars went to religion (27%), education (14%), human services (13%), grantmaking foundations (13%), and public-society benefit (11%).
Charitable donations are also a powerful tool to reduce your overall tax liability to the IRS. By carefully following the tax law and IRS rules, you can substantially increase the impact of donations. Here is what you can do.
1. Meet the requirements for charitable donations
You can receive tax deductions for your donations as long as they meet specific requirements. Some of the most important rules are:
- You have to give to qualified charitable organizations approved by the IRS. The charity can be public or private. Usually, public charities receive more favorable tax treatment.
- You need to have a receipt for your gift.
- You need to itemize your tax return.
- Donations apply for the same tax year when you make them. For most individuals, the tax year and calendar year are the same. For some companies, their tax year may end on a different date during the calendar year (for example, November 1 to October 31)
- All gifts are valued at fair market value. Depending on your donation, the fair market value may not be equal to the initial cash value.
- You have to transfer the actual economic benefit or ownership to the receiver of your gift.
There are many ways to give. Some are straightforward, and others are more complex and require professional help. Each has its rules, which you need to understand and follow strictly to receive the highest tax benefit.
2. Give cash
Giving money is the easiest way to help your favorite charitable cause. IRS allows for charitable donations for as much as 50% of your aggregated gross income. You can carry over in future years any amounts of more than 50%.s. However, you must keep a record of your cash donations.
3. Give Household goods
You can donate clothes, appliances, furniture, cars, and other household items in good condition. The items will be priced at fair value. In most cases, the value will be lower than what you paid for them. This category is also subject to the 50% limit of the AGI.
Donating household items is a perfect way to clean your closet of old clothes and shoes that you haven’t worn for years. You can even donate your old car collecting dust in the garage. Moreover, if you plan to remodel a kitchen, you can give your old cabinets and appliances to charities like the Salvation Army. Remember to keep the receipts of these items in case the IRS asks you for them.
4. Donate Appreciated assets
One of the most popular tax-saving strategies is donating appreciated assets directly to charitable organizations. This approach is subject to 30% of AGI for donations given to qualified public charities. Appreciated assets can include publicly traded stocks, restricted stocks, real estate, privately held companies, collectibles, and artwork. The main caveat to receiving the highest tax benefit is giving the appreciated asset directly to charitable donations instead of selling it and gifting the remaining cash. This way, you will avoid paying a capital gain tax on the sale of your asset and deduct the full fair value of your asset.
Let’s look at an example. An investor in a 28% tax bracket is considering donating an appreciating stock to her favorite charity. She can sell the stock and give the proceeds or donate the shares directly. The current market value of the stock is $100,000. She purchased it more than one year ago for $20,000. The total capital gain is $80,000.
The investor is achieving three essential goals by giving the stock directly to her favorite. First, she is not paying a capital gain tax on the proceeds of the sale. Second, she can use the entire fair value of the stock (instead of the proceeds from the sale) to reduce her tax liabilities. Third, the charitable organization receives an asset with a higher value, which they can sell tax-free.
5. Make direct IRA charitable rollover
Donations made directly from your IRA and 401k accounts are another way of reducing your tax bill. If you reached 72 (70 ½ if you turned 70 ½ in 2019), you could make up to $100,000 a year in gifts to a charity directly from your IRA or 401k accounts. Those contributions count towards the required annual minimum distributions you must take once you reach 72 or 70 ½, respectively. They also reduce your adjusted gross income. To be compliant, you have to follow two simple rules.
Your plan administrator has to issue a check payable to your charity of choice. Therefore the funds have to transfer directly to the charitable organization. If the check is payable to you, this will automatically trigger a tax event for IRS. In that case, your IRA distribution will be taxable as ordinary income, and you will owe taxes on them. The second rule, you have to complete the transfer by December 31 of the same calendar year.
6. Consolidate your donations
Tax Cuts and Jobs Act of 2017 increased the standard deduction for all individuals and families. Therefore relatively small charitable donations may not be tax-deductible at all.
Standard deduction amounts
|2021 tax year||2022 tax year|
|Married couples filing jointly||$25,100||$25,900|
|Heads of households||$18,800||$19,400|
If you want to increase the tax impact of your donations, you may have to consolidate the small annual contributions in a single year.