Tax treatment of charitable contribution by a donor - Tax Essay Example
An individual tax payer is eligible to claim more deduction than the corporate tax payer for the contribution made to the charity - Tax treatment of charitable contribution by a donor introduction. Likewise, a single member LLC can also enjoy some tax benefits for the contribution made to charity. This research essay analyses the special tax provisions applicable to an individual tax payer than the corporate tax payer in the treatment of contribution to charitable institution.
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TAX TREATMENT OF CHARITABLE CONTRIBUTION BY A DONOR
What is a charitable contribution?
Under § 170 (a) (1), an itemized deduction for charitable contribution is allowed. As per § 170 (c), charitable contribution are defined as contribution to or for the use of some recognized or listed nonprofit business.
Thus, a contribution made to a charitable institution qualifies for tax exemption
If the contribution is made under § 170 (c) (1) exclusively for public purpose to the U.S.A federal government or to any state government or any other political branches of U.S government which includes any local government ;
If the contribution is made under § 170 (c) (2) exclusively for public purpose to any trust , charitable corporation , fund, community chest or to any foundation if such organisation functions solely for charitable ,religious ,literary, scientific or educational intention and to foster international or national amateur sports competition or for the abolition of cruelty to animals or children .
If the contribution is made under § 170 (c) (4) wholly for a fractional lodge or order but only if the gifts to be employed solely for charitable principles.
If the contribution is made under § 170 (c) (3), (5) to an organisation of a non-profit cemetery corporation or company or war veteran’s organisation.
Grounds on which charitable contribution is disallowed from claiming deduction
It is to be observed that deductions will be disallowed if the contribution comprises of any part of net earnings of the donee organization which is advantageous to any individual or private shareholder or if the donee organization tries to influence either through political campaigns or through legislation. (Bankman, Griffith & Pratt, 2005, p.223).
Exemption given to these charitable organizations will be withdrawn if they indulge in terrorist’s activity, racial indiscrimination or support any terrorist’s activities. In Bob Jones University v United States, it was held that litmus test for exempt status includes a need that organizations function for a public purpose and not function in a style that is in contravention to any public policy.
The modus operandi of claiming of deduction
Under § 62, § 63 (d) , an individual can claim deductions for charitable contributions , home mortgage interest and it is permissible to in calculating the adjusted gross income.
The tax benefit rule offers one another exclusion to the rule of annual accounting. There are two kinds of rules namely the inclusionary and exclusionary tax benefit rule. It is to be noted that both the tax benefit rule have their origin in case law and however, the exclusionary tax benefit rule has been codified in § 111.
As laid down in Hillsboro National Bank v Commissioner , if a taxpayer with an adjusted gross income donates $15000 to a college in the first year and due to some reasons, if that college is forced to return that donation to the tax payer in the next year, then the assessee should include that $ 15000 in his income in the year two. (Bankman, Griffith & Pratt, 2005, p.102).
Section 170 specifies the amount to which donor may claim deduction for their contribution to charitable organizations.
Sections 501-528 specify the treatment of tax for charities that receive contributions.
Section 501 normally exempts the organizations from tax as listed in § 501 (c). The § 501 (c) has the list of organization which is considerably wider the list of organizations as detailed in § 170(c) like labor unions, nonprofit recreational clubs and business leagues. However, contribution by the donors to these organizations cannot eligible for deductions for charitable contribution under § 170(c).
How much can a donor claim deduction for the contribution made?
It is to be noted that if a donor does not receive any substantial benefit as a result of charitable donation made, then he is eligible to claim deduction for the full amount contributed. In Ottawa Silica Co v. United States, if the donor receives some benefit out of the contribution made to any charitable institution, he has to reduce the contribution by the value of benefit received. For instance, under § 170, if a charity is organizing a fund –raising dinner and charges $ 200 for the same , the dinner costs about $25 , then in this case , the charitable contribution will be taken as $175 and not $200 even if the donor does not attend such dinner.
In Ottawa Silica case, it was observed by the Federal Circuit Court of Appeals that benefits enjoyed by a donor will be regarded as ‘substantial’ if it excels the benefits derived due to such charity contribution. Thus, court observed by citing Singer Co v. United States  that Ottawa Silica by donating some land to a high school , some new roads were developed which actually increased the value of other lands owned by Ottawa Silica . Thus, Ottawa Silica enjoyed major benefit by donating some land and hence it was not eligible to claim a deduction for the value of land contributed under § 170. (Bankman, Griffith & Pratt, 2005, p.224).
Under § 170 (1) (1) , a donor may make a contribution to a university or college and due to this , he gets a right to purchase privileged seating tickets especially for athletic events and in such scenarios , the deduction to donor is restricted to 80% of the contribution.
For instance, if a donor pays $ 500 per annum for membership in an athletic scholarship program maintained by a university which is a qualified organisation. The only advantage from the membership is that the donor can have the privilege to buy one season ticket for a seat in a designated part of the stadium whenever there is a football match , then the donor can deduct ( $ 400 (80% of $ 500) as deduction charitable contribution. (Kennedy, Evelyn, Capassakis & Wagman, p.112).
Under the Revenue Rule 70-47, IRS has ruled that fixed payments made to synagogues or churches for dues , pew rents or to attend specific services are deductible under § 170 irrespective of the fact that the contribution would seem to offer some benefit on the donor.
However, in Hernandez v Commissioner, members of Church of Scientology were not allowed to claim deduction for contributions to the church for “scrutinizing” and “disciplining”. Since, majority was of the opinion that it was a “quintessential quid pro quo exchange” and hence denied deduction under § 170. However, IRS later issued Rev. Rul. 93-73 in which it invalidated its earlier stand and decided that it would permit deductions for amounts “donated” to the Church of Scientology “.
Quantum of deductions
If a donor makes a cash donation, then § 170 deduction is restricted only to the normal deduction restrictions in § 170 (b) (1) (A) (B) and (2) which restrict a taxpayer’s deduction of contribution to charity up to a percentage of contribution base of taxpayer which is normally referred as “tax payers adjusted gross income.” (AGI).
A taxpayer normally make their charitable contributions to the common varieties of charities detailed in § 170 (b) (1) (A) which normally referred as “A” charities. Under § 170, a tax payer is eligible to claim deduction made to “ A” charities up to 50 percent of the taxpayers adjusted gross income in that year. Any excess contribution that is left over unadjusted can be carried forward for five succeeding years and may be adjusted in those years as charitable contribution.
Thus , as per § 170 (d) for an individual taxpayer , only 50% charitable donation made in a particular year can be claimed as deduction in the first year and the balance 50% can be claimed in the succeeding five years. (Bankman, Griffith & Pratt, 2005, p.225).
After determining a charitable donation made is eligible for a deduction, a donor may often astonish to learn that the Internal Revenue Code imposes restriction on the annual deductions. These restrictions are based on an individual’s annual contribution base, normally equivalent to the individual’s adjusted gross income which is known as AGI. Thus, this restriction depends on the type of the charitable organization either public charity or private foundation and the type of the property either long-term capital gain property versus cash. Rules relating to percentage of limitation are also very intricate.
Charitable contribution made to “B” charities will attract a less favorable limitation rules. For donations made to private foundations, the eligible deduction during the year of gift is 30%
This can be explained by way of an illustration. If Smith’s adjusted gross income is $ 1, 00,000. His maximum charitable contribution for cash gift is $ 50,000 if donated to public charities and $ 30,000 if donated to a private foundation. (Kennedy, Evelyn, Capassakis & Wagman, p.21).
Donation of stock
Suppose, an individual assessee wants to gift of $60,000 to a college and he plans to sell stock held by which cost $30,000 which was purchased some years ago yielding a long term capital gain of $ 30,000. Instead of selling and giving the proceeds, the taxpayer donates the stock itself. In this case, the taxpayer is entitled to a contribution donation of $ 60,000 and the unrealizable profit of $ 30,000 will not be considered as taxable income. By donating the stock, the taxpayer taxable income is regarded as $ 30,000 which is less than the stock if it were sold.
This can be explained by another illustration. If a donor sells a publicly traded stock for $75,000 which he bought at $25,000, he has incurred a capital gain of $ 50,000 and has to pay $12,500 as capital gain tax which is the average of 25% of combined both the state and federal rates. Due to this, the donor gets net revenue of $62,250 which he donates to a charity and gets a charitable donation for $ 62,500. On the other hand, if a donor instead gives it as a donation of $75,000 worth of stock to charity, he recognizes no gain and is eligible for a $75,000 contributing deduction. (Kennedy, Evelyn, Capassakis & Wagman, p.21).
One another example of stock donation: Assume that Lucy has some stock of Google Inc. Google Inc is being acquired in a cash transaction by another company say. Microsoft Corp. Lucy wants to give the Google stock she owns as donation to a charity and so as to avoid payment of capital gain tax on the takeover gains. Lucy followed wait and watch approach till the transaction is certain. After the legal formalities, she is entitled to a charitable contribution for the stock and also liable to pay tax on gains. This is mainly as she waited too long to contribute the stock. . (Kennedy, Evelyn, Capassakis & Wagman, p.14).
The ceiling for capital gain property donations is restricted to 30% for gifts to operating foundations and to public charities and presents made to private institutions , it will be 20% In case , if the donor’s contribution are greater than 30% of the AGI’s , the excess can be carried over.
For instance, if Lucy’s AGI is $ 200,000, she can donate a maximum amount of $ 60,000 for appreciated publicly traded stock to a public charity and $ 40,000 for private foundations. (Kennedy, Evelyn, Capassakis & Wagman, p.23).
Real estate donation for charitable purpose
The fair market value on the date of gift made will be taken as the contribution deduction for a gift of real estate. Any mortgage on the property shall be reduced by the amount of debt standing on that date of gift.
Gift of Life Insurance policy for Charitable Institution
In this case, the taxpayer is eligible for deduction which may be equivalent to cash surrender value of the policy, its tax basis or its replacement value or its “interpolated terminal reserve” value. However, the donor’s tax basis in the policy cannot exceed the deduction made.
A Bargain Deal
Under this, if the property is sold above the market value, then excess value sold will be taken as charitable contribution to the organization. Normally, each part of a bargain sale is reportable event so that donor or taxpayer reports both the contribution and the sale.
Reminder interest in a life asset personal residence or a personal residence
The present value of future interest in a farm or in a personal residence will be taken for income tax deductions for the purpose of charitable contribution.
Charitable Gift Annuity
Under this concept, a donor buys from a charitable institution an annuity contract for more than its fair value. The contribution is tax-deductible from the donor’s taxable income on the year of purchase of annuity.
Charitable Remainder Unitrust
Under this, a donor will set up a charitable remainder trust and place some assets or cash or clear –titled real estates or publicly traded securities or a trust that finally benefit a charity. The donor transfers assets into a trust thereby creating an income interest in the assets so transferred in favor of charitable organization for some years or during the life period of a donor. Thus, the remainder interest is either given to a noncharitable beneficiary usual a member of his family or is returned to the donor after completion of period of trust. The donor claims income tax deduction immediately after collection of payments from the trust. Charities should devise adequate strategies before accepting the management of a charitable remainder trust.
Pooled Income Fund
This fund contains of separate contributions of property from various donors. This fund does not arrange its payout to its income beneficiaries under fixed interest formula. The annual rate of payment is determined by the rate of return that the fund earns each year. (Busby, 2005, p.165).
Charity Payments Credit Card
Many charity organizations accept gifts made through credit cards. It is deductible by the donor in the year charge is made.
For individual taxpayer who is interested in charity giving, retirement assets are the best devise to leave to charity. Since retirement assets are eligible for a step-up in source neither after nor before the repeal of the estate tax and they also exempt from capital gain taxes. Hence, the impact of income tax rates can be minimized by leaving the retirement assets rather than contributing in cash or by other property. (Kennedy, Evelyn, Capassakis & Wagman, p.23).
Single –Member LLC and Charity
A single member LLC is intentionally incorporated with the tax feature of being disregarded.
Tax exempt organizations are employing the creative usage of the single-member LLC and some illustrations are given hereunder:
A charity managed by a single-member LLC is engaged in addressing the essential for affordable downtown –parking of a city. By means of bond issue, it acquired two parking lots and a parking garage, It was ruled by IRS that LLC was a disregarded entity and its operation would not endanger the charity’s tax-exempt position as the charity , through LLC , was minimizing the yokes of government .( here it refers to city administration).
A single member charity LLC can accept a gift of property with some encumbrance like legal liability with premises tort liability or environmental liability.
A private museum which is a tax-exempt entity can be run by a single-member LLC and IRS held that these activities were functionally associated business.
A single member LLC can be used to construct, own and lease student housing for the advantageous for a tax-exempt college by issuing tax-exempt bonds and employment opportunities to the community.
A single-member LLC can be used to conduct trade shows of a tax-exempt trade association which qualified as a business entity ignored for the purposes of federal tax. It was held by IRS that income generated from the LLC’s activities would not be unassociated income from business to the organization since the LLC entity was ignored and the trade shows organized by LLC qualified for the statutory exemption for such trade shows.
In the unassociated business scenarios, a supporting organization affiliated with an operating educational institution was the single-member LLC. It was ruled by the IRS that when the single-member LLC received real property encumbered by debt, supporting organisation and single-member LLC would be given an exemption from the rules regarding acquisition indebtedness for the purpose of concluding debt-financed income. (Hapkins, 2006, p.212).
Thus, an individual tax payer has much advantageous provision in the Federal Income Tax Act so that he can keep his taxable income at the minimum level. An individual donor to charity is not only can claim deduction up to 50% on his AGI on the year of contribution to a Charity but also can forward and adjust the balance in the following five years also. Further, a single member LLC is also a best devise to minimize the tax incidence of an individual tax payer for the reasons mentioned above.
Bankman Joseph, Griffith Thomas D & Pratt Katherine. (2005) Federal Income Tax. New York: Aspen Publishers Online.
Busby Daniel D. (2005). Zondervan Church and Nonprofit Tax and Financial Guide. For 2005 Returns. New York: Zondervan.
Kennedy Michael B, Evelyn M, Capassakis & Wagman Richard S. (2002). Price Waterhouse Coopers Guide to Charitable Giving. New York: John Wiley & Sons.
Hapkins Bruce R. (2006). The Tax Law of Unrelated Business for Nonprofit Organizations. New York: John Wiley & Sons.
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 449 E 2d 413,423 (CL. Ct .1971)
 490 U.S 680 (1989)