Updated: Dec 31, 2021
In this blog, we will offer a quick explanation behind charitable donations, and provide a general step by step how to guide. We will use the 2020 tax year. Please consult with your personal financial advisor before deciding to use these tips because ASTC is not a professional accounting service.
The rationale behind deducting from your tax liability is rooted in the idea that taxpayers are allowed the opportunity to subsidize charities to improve the failings of the government and the free market. Nearly 115 years ago with the passage of the sixteenth amendment the federal government began taxing income, and soon later the charitable deduction was created to provide monetary rewards and recognition to taxpayers who gave to social enterprises (Greene, & McClelland 2001). Cash contributions can be deducted from your Adjusted Gross Income (AGI) as long as you do not receive any economic benefit from the charity. An example of receiving benefits would be a business donating to a charity and then the charity sends its members to the business for paid services (Busvek (2019).
An additional bonus to improving society is that the donor can also subtract the money they donate from their AGI. However, there is a limit (restriction) to how much you can remove (recover) from your AGI. If this was not put in place, many people would not have any taxable income. These limits are very high and range between 40%-60% and don't apply to most donors. A donation to a 501(c)(3) is capped at 60% for cash donation. For example if you decided to make a donation to a nonprofit and your AGI is $30,000, your deduction limit would be $18,000 ($30,000 X 60%). Any donations above $18,000 and you can’t subtract it from your AGI. The IRS will actually help you out and carry the excess amount over to the next five years. This would be ideal if someone needed to get rid of relatively large sums of money at one time and wanted to reduce their AGI over a 5 year period (Busvek (2019).
In 2020, Congress passed the CARES Act which created several important changes to consider. The most significant change is that you can claim an unlimited itemized deduction for a charitable contribution! Again, normally the cash deduction is limited to 60% of a person’s adjusted gross income, so it was clear that the government was really incentivizing charitable contributions for 2020!
Also, the Act allowed for an above-the-line deduction of up to $300 if you took the standard deduction and did not itemize your deductions (Arritola et al 2020). Both of these changes will be illustrated just below.
General Step by Step Guide
The first thing to do is to confirm that the organization you wish to donate to has a IRS 501(c)(3) status. You can go do this by following this link, https://apps.irs.gov/app/eos/, or asking for a copy of the nonprofit’s organization letter. The next thing to do is properly document (bank statements) of what you donate. Next you should look at the big picture on your taxes and pick one of two choices.
If your total deductions are more than what your standard deduction ($12,400 for a single person in 2020), you should consider going with the Schedule A form and itemizing each deduction. This would be the best route to take to receive the most money back when you file. However, for 2020, if you do not have enough total deductions to go over for example $12,400, you can donate a maxim of $300 and still claim the full standard deduction. This is known as a “above the line” deduction and will be subtracted from your Income to make your Adjusted Gross Income (AGI).
Remember, you can’t itemize and take the standard deduction, you must pick one route.
The goal with itemization is to subtract as much as possible from your AGI. However, there is a limit (restriction) to how much you can remove (recover) from your AGI. Again, If this was not put in place, many people would not have any taxable income.
Thanks for reading.
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Arritola, C, & Friedman, H, & Rubin, A. (2020). The Impacts of the CARES Act on Nonprofits. The National Law Review, Volume X, (Number 308), https://www.natlawreview.com/article/impact-cares-act-nonprofits
Busvek, A. (2019). A CRITIQUE OF THE TAX CUTS AND JOBS ACT: MODIFYING THE CHARITABLE DEDUCTION TO RESTORE TAXPAYER PLURALISM. Stetson Law Review, 49(1), 175.
Pamela Greene, & Robert McClelland. (2001). Taxes and Charitable Giving. National Tax Journal, 54(3), 433-453.
Charity navigator https://www.charitynavigator.org/index.cfm?bay=content.view&cpid=31