Are you planning to make substantial charitable donations? It could be a helpful tax move. One of 2020’s CARES Act provisions temporarily suspended limits on tax deductions for certain charitable gifts. And the Consolidated Appropriations Act (CAA) extended this relief to charitable gifts made in 2021. Unlimited charitable deductions could enable you to reduce your 2021 tax bill to zero. However, a more measured approach might ultimately lead to more favorable tax results. It’s time to make a few decisions.

Observe Limits

Ordinarily, if you itemize, you’re permitted to deduct charitable gifts up to a specified percentage of your adjusted gross income (AGI). Excess gifts may be carried forward and deducted — subject to applicable limits — for up to five years.The AGI percentage varies depending on the type of assets donated and the type of charitable organization that receives them. For example:

• Cash donations to religious organizations, educational institutions, donor-advised funds, supporting organizations and other public charities generally are limited to 50% of AGI.
• Gifts of capital gain property, such as appreciated stock or real estate, usually can’t exceed 30% of AGI.
• Donations of cash and capital gain property to private foundations are limited to 30% and 20% of AGI, respectively.
• Cash gifts to public charities top out at 60% of AGI for gifts made through 2025.

For gifts made in 2020, the CARES Act gave taxpayers the option of deducting “qualified charitable contributions” up to 100% of AGI, and the CAA extended the 100% limit to gifts made through the end of 2021. Qualified charitable contributions generally include cash gifts to public charities other than donor-advised funds or supporting organizations.Note: Itemizers aren’t the only taxpayers able to deduct charitable contributions. In 2021, non-itemizers can take an above-the-line deduction of up to $300 ($600 for joint married filers) for cash gifts to public charities other than donor-advised funds and supporting organizations.

Preserve a Portion of Deductions

If you have the resources and the desire to make substantial charitable gifts, in theory, you can make a qualified charitable contribution large enough to offset all of your taxable income in 2021. That may be an enticing proposition, but it’s not the most effective way to generate tax savings.When you use charitable gifts to reduce your taxable income to zero, a portion of those gifts offset income that would otherwise have been taxed at low rates, essentially diminishing their tax-saving power. In most cases, you’re better off preserving a portion of these deductions for future years, when they can be offset against higher-taxed income.

Consider an Illustration

To illustrate the concept, consider Adam and Natasha, a married couple in their late 50s. They have taxable income of $450,000 per year and wish to make a $450,000 cash donation to a local hospital. Without the charitable deduction, they would be in the 35% tax bracket, with a tax bill of $106,589. So, if they donate $450,000, they’ll save $106,589 in taxes.Another approach would be for the couple to donate enough to bring their tax bracket down to 12%. This year, the top end of that bracket is $81,050, so that would mean donating $368,950 this year and the remaining $81,050 next year.Presuming for illustrative purposes that a) this is the only charitable contribution that they’re considering, b) their deductions other than the charitable contributions would allow them to itemize, and c) the 2021 tax rates are used for the 2022 calculations, the couple’s tax bill is $9,328 in 2021 and $79,718 in 2022. This makes for a total tax savings of $124,132 (a $97,261 tax reduction in 2021 ($106,589 – $9,328) and a $26,871 tax reduction in 2022 ($106,589 – $79,718.)What if it’s important to Adam and Natasha to donate the full $450,000 this year? In that case, they could simply elect not to treat the gift as a qualified charitable contribution. The normal limits, 60% of their adjusted gross income, would apply, meaning that any amount that went unused this year would be carried forward to next year. Presuming their tax picture — other than the charitable contribution — is the same in both years, their total tax savings over the two-year period would be $128,941.

Holistic Approach

Most charitably minded taxpayers are better off spreading out substantial gifts over two or more years. However, you should discuss options with a financial professional who can take a holistic view of your income, assets, tax exposure and estate planning objectives.

For More Information

Contact your tax advisor to learn more about the ERC. We can help you understand how it applies to your nonprofit.