When it comes to giving money away, it takes a kind heart for anyone to part with his hard-earned cash. However, not all giving is viewed the same way by the IRS. Depending on to whom you are giving the gift, you might be eligible for a charitable contributions deduction, but you could also be making a taxable gift for which you may end up owing gift taxes, so it’s important to know the gifting rules.
Unless you’re making a gift to charity, you’re not allowed to take a tax deduction for gifts you make. In fact, if the gift is big enough, you could even owe gift taxes.
If your gift is made to a charitable organization, you’re allowed to write off the donation on your taxes. To qualify for a deduction, the organization must be formed for charitable, religious, education, scientific or literary purposes or for preventing cruelty to children or animals. In addition, the organization can’t be a foreign group, and it can’t be operated for profit.
Contributions you make to individuals are never deductible, even if it's for the purposes for which an organization could be formed. For example, if you pay for a needy child’s private school or college tuition, you can’t deduct the contribution as a charitable donation even though it was for educational purposes. It doesn’t matter how needy or deserving is the individual to whom you make the gift. In addition, you’re not allowed to deduct contributions to political candidates or organizations, no matter how much better off you think society would be if they were elected.
You can also include expenses you paid out of pocket to do charitable work, such as if you paid for supplies to help build a Habitat for Humanity home. You can also deduct transportation costs. Transportation costs are deductible at the rate of 14 cents per mile as of 2018. However, you’re not allowed to claim a deduction for the value of the services you provide or for your time. For example, say that you are a licensed certified public accountant and you volunteer to file the tax return for a charity about which you care. Even if you would normally charge $600 for a similar return for a client or if you bill at $200 per hour, you aren’t allowed to claim a deduction on your taxes for the value of the return you prepared.
Must Itemize to Claim Deduction
Even if you’ve made gifts to charity during the year, you only receive credit for them if you itemize your deductions. If you want to itemize, you have to give up your standard deduction. Under the Tax Cuts and Jobs Act, this has become substantially less appealing as of 2018 because the standard deductions increased to almost double the 2017 levels: $12,000 if you’re single or married filing separately, $18,000 if you file as head of household and $24,000 if you’re married filing jointly.
You don’t have to have just charitable deductions in excess of your standard deduction to make it worthwhile, however. When you itemize, you also get to write off other expenses, including mortgage interest, up to $10,000 of state and local taxes and the portion of your qualifying medical expenses that exceed 7.5 percent of your adjusted gross income.
Valuing Your Charitable Gift
If you gift cash to a charity organization, it’s very easy to value your contribution for tax purposes because you simply use the amount of the donation. If you’re giving property instead, it can be harder. When you donate assets, you can’t deduct more than the fair market value of the items. The IRS defines the fair market value as what a willing seller would agree to take from a willing buyer when neither is under any pressure to make the exchange.
When valuing items, look at what a similar item would sell for in your area. If you’re donating used goods, the IRS suggests looking at what a similar item would sell for at a thrift store and suggests that the used price is usually substantially less than the price of a new item.
For assets like publicly traded stocks, valuing them is much easier. Plus, you might be able to take advantage of a double tax break. If you sell stocks that have gone up in value and then donate the proceeds, the IRS still expects you to pay taxes on the proceeds, even though you’ve given them all away. However, you’ll still get credit for the full donation. Instead, consider gifting the stock directly to the charity. If the gains would be classified as long-term capital gains, typically meaning that you’ve owned the stock for over one year, you’re allowed to deduct the entire fair market value of the assets. Plus, because you never sold the stock, you won’t have to pay income taxes on the appreciation.
Limits on Charitable Donation Deduction
Generally, you’re not allowed to deduct charitable gifts in excess of 50 percent of your adjusted gross income for the year. For example, if your adjusted gross income is $64,000, your maximum charitable contributions deduction is usually $32,000. If you gave more than that, you can carry over the additional amounts into the next year, for up to five years, until the full donation is used. For example, if you gave $40,000, you could deduct $32,000 in that tax year and then $8,000 in the following tax year.
However, there are a few exceptions to this rule. First, if you’re donating appreciated property, you can’t claim a deduction for more than 30 percent of your adjusted gross income. Second, if you’re donating only cash, the limit increases to 60 percent of your adjusted gross income before the deduction must be carried forward. Finally, lower contribution limits apply when you are making a gift to certain types of charities that aren’t considered public charities, like veterans’ organizations, fraternal societies and private foundations. The limit for deducting gifts to these charities is generally 30 percent of your adjusted gross income per year, but if you’re gifting appreciated property, the limit drops to just 20 percent of your adjusted gross income.
IRS Gift Tax
If you aren’t making gifts to a charitable organization, you could find yourself owing gift taxes on what you’re giving away. Even though you are the one giving the money, the IRS holds you responsible for filing the gift tax return and, if applicable, paying the gift tax. The gift tax applies to anything you give away or sell for less than fair market value. For example, if the fair market value of a house is $350,000 but you “sell” it to your child for $100,000, you’ve made a $250,000 gift to that child.
Exemptions From Gift Tax
The annual exclusion is the only exemption that most taxpayers will need to avoid having to file a gift tax return. As of 2018, the annual exclusion is set at $15,000, which means that you can give any person up to $15,000 in a year without having to file a gift tax return. For example, if you gave each of your four children $14,000, you wouldn’t even have to file a gift tax return. However, if you gave one child $20,000 and nothing to the rest of them, you would be required to file a gift tax return because your gift to that child was $5,000 more than the annual exclusion.
Two other unlimited exceptions allow you to give as much as you want on behalf of someone else as long as you pay the gift directly to a hospital or school for the tuition or medical expenses. For example, if a friend had a $25,000 surgery, you could pay the entire bill without making a taxable gift as long as you paid it directly to the hospital. Similarly, if a nephew’s college tuition is $30,000, you won’t owe any gift taxes as long as you pay the school directly. However, if you give the money to your friend to pay the hospital or your nephew to pay the school, those gifts don’t qualify for the exceptions, even if the person actually uses it for the intended purpose.
The tax code also includes an unlimited exemption for gifts to your spouse. The term "spouse" includes the person to whom you are legally married, whether it is a heterosexual marriage or same-sex marriage. It doesn’t include registered domestic partners or civil unions. Finally, you can gift as much money as you want to a political organization without paying gift taxes. However, you still won’t receive a charitable deduction.
Lifetime Gifting Exemption
If you do make a gift that’s larger than the annual exclusion, it’s likely that you still won’t have to pay any gift taxes, even though you would have to file a gift tax return. That’s because each person has a lifetime exclusion on top of the annual exclusion. This exclusion is cumulative for both taxable gifts during life and any assets included in your estate at death. As of 2018, the exemption is $11.18 million. Only after you’ve exhausted your entire lifetime exclusion do you pay gift or estate taxes. However, if you do owe gift taxes, the tax rate is 40 percent.
So, if you gifted a friend $115,000, the first $15,000 would be covered by the annual exclusion. Then, the remaining $100,000 of the gift would reduce your remaining lifetime exemption from $11.18 million to $11.08 million. Alternatively, if you are very wealthy and generous and had already used up your lifetime exclusion, your $100,000 gift would result in you owing the IRS $40,000 in gift taxes.
When you die, your remaining lifetime exemption can be used to exempt your estate from estate taxes. If your estate is larger than your remaining exemption, your estate will be subject to federal estate taxes on the excess. For example, say that during your life you had made $5.18 million in taxable gifts, reducing your lifetime exemption to $6 million. If the value of your estate is $8 million, your estate will pay $800,000 in estate taxes, which is 40 percent of the amount by which your estate exceeds your remaining exemption.
2018 Tax Law Changes
The Tax Cuts and Jobs Act boosted the gift and estate tax exemption to $11.18 million per person, making it even less likely that you will ever owe gift taxes, even if you make gifts in excess of the annual exclusion. The $11.18 million per person limit includes any taxable gifts made in prior years. For example, if in 2010 you made a $4 million taxable gift and haven’t made any other taxable gifts, you would have $7.18 million remaining.
In addition, the gift tax exclusion went up to $15,000, so you can give an additional $1,000 to each person before you make a taxable gift.
2017 Gift Tax Exemptions
Prior to the Tax Cuts and Jobs Act, the lifetime limit before gift and estate taxes are due was $5.49 million per person. The lifetime limit had been set at $5 million as of 2010 and then indexed for inflation, so each year it was creeping upward. The gift tax exclusion in 2017 was just slightly lower than 2018 at $14,000 per year.