(Note: The following article is based on tax rules in effect at publication. These rules are, to say the least, subject to change, and a tax adviser should be consulted for current rules.)
The holiday season may be over, but for many gift-giving goes on all year long. There are plenty of considerations for giving either to charity or to families and friends in need.
Many people are aware that the annual limit for gifts to a non-spouse is now $14,000. Non-cash gifts such as securities are valued at the time of the gift, but retain the original cost, so when the recipient eventually sells the gift there could be significant taxable gains if the item had been purchased long ago. Gifts within this annual limit generally require no tax filings or payments.
Gifts above the annual limit require the filing of the dreaded IRS gift tax form. Even then, though, taxes are not paid until the cumulative gifts given by the same donor to all recipients exceed the lifetime gift exemption (currently $5.12 million). The tax form must be filed even if no taxes are due, and the lifetime exemption could change as Congress debates estate and gift tax policies. Such gifts simultaneously deplete the amount for passing an estate without estate tax; in other words, the assets can be transferred either by gift or through an estate, but not both. Transactions between family members involving hard-to-value assets such as real estate or stakes in family businesses should be supported by an independent valuation to prevent the possibility that the IRS would claim that the sale was a disguised gift.
There are a number of ways to stretch the annual limit without eating into the lifetime exemption. The annual limit is for gifts from one individual to another, so if a married couple is making gifts to another couple, there could actually be four $14,000 gifts for a total of $56,000. (If those gifts are made from a joint account, a filing is required to attest that the gift is being split between the donor couple.) There are exclusions for tuition or medical expenses paid for someone else, which are not considered a gift as long as the payments are made directly to the educational institution or medical provider. If the payments are instead made to the individual as reimbursement for tuition or medical expense, they will be considered a gift.
A 529 plan, which is operated by a state or educational institution to pay for post-secondary expenses for a designated beneficiary, also offers an opportunity to make a larger gift. These plans allow a contribution of up to five years’ worth of exclusions in one year. While this does not increase the total gift value, it does allow the gift to be made and invested earlier and hopefully be able to grow more. Gift tax forms must be filed in each of the five years to claim the annual exemption and any other gifts made during those five years to the same recipient would also have to be reported.
Contributions to charitable organizations are generally tax deductible to taxpayers who itemize deductions on their tax returns. Any organization with a 501(c)3 tax-exempt status, as well as churches and other religious organizations, qualify for charitable deductions. Contributions to political organizations, labor unions and for-profit schools or hospitals do not qualify. The gift must be of cash or property; a pledge to donate is not deductible until you actually pay, nor is the value of your donated time deductible.
Cash donations of over $250 require acknowledgement from the organization and non-cash contributions over $500 require a tax form indicating the cost and fair market value of the donated goods. Contributed property worth more than $5,000 must have a written appraisal of its value. Deductions for cash contributions are limited to 50% of adjusted gross income, while deductions for property are limited to 30% and deductions for capital gains assets such as securities are limited to 20%. Contributions in excess of these limits can be carried over and deducted for up to five years. All itemized deductions, including charitable contributions, are phased out beginning at income of $300,000 for couples ($250,000 for singles).
Gifts of securities that have appreciated in value provide a double tax break. The gift is valued at the current value of the securities, but when the charity sells the securities they pay no capital gains taxes because they are tax-exempt. So, the donor gets a deduction at current value and avoids any capital gains taxes they would have paid if they had sold the securities first and then donated cash.
Arizona offers an additional tax advantage through its tax credit programs for contributions to education and organizations that serve the working poor. This tax credit reduces state taxes dollar for dollar, unlike a deduction which just lowers the amount on which you are taxed. For joint tax returns, the limits for the state tax credit are $400 for the working poor and for public schools and $1,034 for private school tuition organizations and a taxpayer can claim all three credits. Not only are these contributions a tax credit for Arizona taxes but they can be deductible for federal tax purposes, so a taxpayer that itemizes may receive a total tax benefit that is greater that the amount of the contribution.
There are many vehicles and strategies to accommodate charitable giving. A donor-advised fund, administered by a public charity, enables a large contribution and maximum tax deduction in one year while providing a cost-effective means for the donor to direct the distribution of funds to specific charities over time. A charitable gift annuity is a contract between a donor and a charity where, in exchange for a contribution, the donor receives an immediate partial tax deduction and a lifetime stream of annual income and the charity keeps the gift when the donor dies. The amount of the deduction and the annual income are determined by a number of factors including the donor’s age.
Any gift should be motivated first and foremost by a desire to help others. Still, it is important to understand the financial implications to make gifts as effective as possible.