6. Income Limitations on Charitable Deductions, Part 3 of 3

6. Income Limitations on Charitable Deductions, Part 3 of 3

Article posted in General on 18 November 2015| comments
audience: National Publication, Russell N. James III, J.D., Ph.D., CFP | last updated: 19 November 2015
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VISUAL PLANNED GIVING:
An Introduction to the Law and Taxation
of Charitable Gift Planning

By: Russell James III, J.D., Ph.D.

6. INCOME LIMITATIONS ON CHARITABLE DEDUCTIONS, Part 3 of 3

Links to previous sections of book are found at the end of each section.

Fortunately, the question of which gifts are deducted first follows the same pattern of preference seen with regard to which gifts have the highest income limitations.  In other words, the more preferred gifts will be deducted first and the less preferred gifts will be carried over first.  So, favored property (not long-term capital gain property valued at fair market value) given to a favored charitable recipient (e.g., a public charity), will be deducted first.  Second, less-favored property (long-term capital gain property valued at fair market value) given to a favored charitable recipient (e.g., a public charity) will be deducted.  Third, favored property (not long-term capital gain) given to a less-favored charitable recipient (e.g., a private foundation) will be deducted.  Finally, the last type of gift to be deducted – and the first type of gift to be carried forward into future years – is less-favored property (long-term capital gain) given to a less-favored charitable recipient (e.g., a private foundation).  This is the order that determines which type of gift will be counted first.  If there is spillage out of a glass containing multiple types of gifts, such as the first glass which must contain all gifts, this ordering determines which type of gifts are deducted in the current year, and which type of gifts must be carried forward.
In this next example, the donor, once again, has $100,000 of income.  During the course of the year, the donor has made a total of $30,000 of cash gifts to public charities and $30,000 of long-term capital gain property gifts (valued at fair market value) to public charities.
The first glass holds up to 50% of income (in this case $50,000) and must contain all deductible charitable gifts of any type.  However, the donor has made a total of $60,000 of deductible charitable gifts during the year.  This $60,000 cannot fit entirely into the $50,000 glass.  Thus, there will be spillage and therefore carryover.  There are no similar problems with the second glass which can hold up to $30,000 of long-term capital gain gifts because only $30,000 of such gifts were made during the year.  (These long-term capital gain gifts were not subject to the “special election” because they were valued at fair market value, i.e., “FMV” in the accompanying slide.)  No gifts were made to private foundations during the year, so nothing goes into glasses three or four.  There will be carryover due to the spillage from glass one.  But, which gifts will have their deductions carried forward?

Because glass one cannot hold all $60,000 of deductible gifts made during the year, some gifts will have to be carried forward.  The $30,000 of cash given to a public charity is the most favored kind of charitable transaction.  Consequently, this gift will be deducted first.  This means that the $10,000 of carryover will come entirely from the capital gain property gifts made to public charity.

What happens if there are different gifts within the same category?  For example, if there are gifts of short-term capital gain property to a public charity and also gifts of cash to a public charity, which one gets carried forward?  The answer is that it doesn’t matter, because both of these types of gifts are treated identically for tax deduction purposes.

Because there is $10,000 that cannot fit into the first glass, this $10,000 of charitable deduction for fair market value capital gain property must be carried forward into future years.

In this next example, the donor still has $100,000 of income.  During the course of the year, the donor makes a total of $2,000 of cash gifts to public charities, $56,000 of gifts of long-term capital gain property (valued at fair market value) to public charities, and $5,000 of cash gifts to private foundations.  Will this giving fit into the income limitation “glasses”?

The first glass can hold up to $50,000 and includes all deductible charitable gifts made during the year.  In this case, the donor has made a total of $63,000 of deductible charitable gifts.  Consequently, there will be $13,000 of spillage out of this first glass.  The second glass can hold up to $30,000 and includes all gifts of long-term capital gain (except that subjected to a “special election”).  The donor, however, has made $56,000 of long-term capital gain property gifts (valued at fair market value, and therefore not “special election” property).  Thus, there will be $26,000 of spillage out of the second glass.  The third glass contains all gifts to private foundations and can hold up to 30% of income, which in this case means $30,000.  The total gifts to private foundations were $5,000, so there is no spillage out of this glass.

Which gifts are carried forward?  The first glass will have $13,000 of spillage because there were a total of $63,000 of deductible charitable gifts and 50% of income is only $50,000.  Gifts of cash to a public charity are the most favored type of gifts and so will be deducted first.  Gifts of long-term capital gain to a public charity are deducted next.  However, the cash to a public charity of $2,000 and the long-term capital gain property to public charity of $56,000 exceed the $50,000 holding capacity of this glass.  Thus, $8,000 of the long-term capital gain property gifts to public charity must be carried forward into future years, because it has spilled out of the glass.  Gifts of cash to a private foundation are deducted third (after gifts of cash to a public charity and gifts of long-term capital gain to a public charity).  As a result, all of the $5,000 in cash gifts to private foundations “spills out” of the first glass and must be carried forward into future years.

In this case there is also spillage out of the second glass, which makes things more complicated.  The second glass can hold a total of $30,000 (30% of income).  However, the donor made $56,000 of this type of long-term capital gain gifts.  Thus, $26,000 of these long-term capital gain gifts spill out of the glass and must be carried forward into future years.  $8,000 of that $26,000 of long-term capital gain gifts were already being carried forward because of the spillage resulting from the first glass.  However, this just means that this particular $8,000 of long-term capital gain gifts will be carried forward for two different reasons (spillage out of glass one and spillage out of glass two). 

Note that the gifts for the year must fit into each glass separately.  The calculation for each individual glass is not affected by what happens in the other glasses.  It is not appropriate, for example, to say that only $30,000 of fair market value long-term capital gain property gifts must go into glass one, because the rest has spilled out of glass two already.  Each glass is calculated without regard to the other glasses.  This means that the same gift could be carried over for multiple reasons (i.e., the same gift spills out of multiple glasses), as happened here with the $8,000 of long-term capital gain gifts that spilled out of both glasses one and two.

The result here is a carryover of both $26,000 of fair market value long-term capital gain property gifts to public charities and $5,000 of cash gifts to private foundations.  Thus, $31,000 of charitable deductions, in total, must be carried forward into future years.  The donor made a total of $63,000 of deductible charitable gifts, and $31,000 must be carried forward into future years.  As a result, only $32,000 may be deducted this year. 

(Remember, the glass analogy is used to calculate the amount of carryover.  To calculate the amount that can be deducted in the current year, simply subtract this total gifts carried over from the total deductible charitable gifts for the year.  Do not attempt to calculate the deductible gifts for the year by using the dollar amounts with checkmarks by them in the accompanying image.)

                  Note that the $5,000 in gifts to private foundations was well below the maximum for glass three, but this gift was still carried forward because of the spillage from glass one.
Returning to the three categories of gifts made by the donor during the year, the $5,000 of cash given to private foundations generated no deduction for this year, but did generate $5,000 of carryover deductions for future years.  That $5,000 of carryover deductions will, in future years, still be treated as deductions for gifts of cash to private foundations.  Thus, in order to be used, these carryover deductions must be able to fit into the relevant income limitation glasses for the future years.  The $2,000 of cash gifts to public charities will all be deducted this year.  Finally, the $56,000 of fair market value long-term capital gain property gifts to public charities resulted in a current year deduction of $30,000 and $26,000 of carryover.  Again, this $26,000 of carryover will, in future years, still be characterized as fair market value long-term capital gain property gifts to public charities.
In this next example, the donor has given $20,000 of fair market value long-term capital gain property gifts to public charities and $20,000 of long-term capital gain property gifts to private foundations during the year.
These gifts total $40,000 which fits into the first glass.  However, all of these gifts are of long-term capital gain and all $40,000 will not fit into the second glass which holds only $30,000.  Thus, there will be $10,000 of carryover.  The third glass holds up to $30,000 in this case, and contains all gifts to private foundations.  Only $20,000 of gifts were made to private foundations this year.  Therefore, there is no carryover resulting from glass three.  Glass four can hold up to $20,000 in this case, and contains all gifts of long-term capital gain property given to private foundations.  Exactly $20,000 of this type of gift was given, and consequently there is no spillage from this fourth glass.
The previous slide indicates that $10,000 of deductible charitable gifts will have to be carried forward because of the spillage from glass two.  But which type of gift is carried forward?  Because long-term capital gain property gifts to public charities are deducted before long-term capital gain property gifts to private foundations, all $10,000 carried forward will be gifts of long-term capital gain property given to private foundations.
Thus, even though the entire capital gain property gift given to private foundations fits into glasses one, three, and four, $10,000 of this gift must still be carried forward into future years, because of the spillage from glass two.
In ending this examination of income limitations on charitable deductions, it is perhaps useful to recognize that this material is among the most complex in all of charitable gift planning.  The analogies, explanations, and themes used in this chapter are intended to help the reader understand the rules intuitively.  However, the comparisons made using spillage out of glasses and describing favored and less-favored property and favored and less-favored charitable entities are not examples or terms that come from the tax code or the IRS.  These are put here only to be helpful.  To the extent that these ideas do not help to visualize and internalize these rules, feel free to disregard them and focus more directly on the exact language of the Internal Revenue Code.

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