The Consolidated Appropriations Act, 2021 (the CAA), signed into law on December 28, 2020, maintains and expands the charitable contribution incentives originally enacted by the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act).
Planning for the enhanced qualified charitable contributions
The enhanced charitable contribution deduction benefits apply solely to qualified charitable contributions, which are contributions made in cash to a public charity or “50% charity.” For these purposes, this includes a private operating foundation and a flow-through private foundation (generally a foundation that distributes all of its income and current year contributions), but it does not include a donor advised fund (DAF), a supporting organization, or a private non-operating foundation.
Planning for non-itemizers
The CAA extends through 2021 the charitable contribution deduction for non-itemizers. As implemented in the CARES Act, non-itemizers may deduct up to $300 of qualified charitable contributions in computing their 2021 adjusted gross income (AGI). The CAA also expands the deduction up to $600 for a joint return.
Planning for itemizers and the 100% AGI election
Additionally, the CAA extends through 2021 the 100% of AGI limit for qualified charitable contributions made by itemizers. Absent this provision, these contributions generally would be limited to 60% of AGI. To claim the enhanced AGI limit, an individual must make an affirmative election on his or her Form 1040, Schedule A, Line 11. According to the 2020 Schedule A instructions, the individual indicates his or her election by entering the amount of qualified contributions on the dotted line next to the line 11 entry space. The instructions indicate that the election can be made with respect to “any contributions,” which suggests that the election is on a gift-by-gift basis. In other words, the IRS will not automatically presume that because a 100% of AGI deduction election was made for one charitable gift that the election was made for all charitable gifts to qualifying public charities made in 2020 and 2021.
Planning related to the ordering the use of current year contributions and contribution carryovers
In light of the above, there are significant questions to be considered in choosing which deductions will yield the most favorable results. An individual computes their charitable contribution deduction by applying the AGI limits first to current year charitable contributions that do not qualify for the 100% of AGI deduction and then to carryover contributions within each category: 60%, 50%, 30% other than capital gain property, 30% capital gain property, and 20%. In other words, current year contributions of 30% capital gain property will be followed by the contribution carryover of 30% capital gain property; and both will precede 20% current year contributions and 20% contribution carryover. Page 14 of IRS Publication 526 provides a more detailed explanation. The carryover period for charitable contributions is five years.
After taking those deductions and utilizing any remaining carryovers, the individual can use qualified charitable contributions of up to 100% of AGI. For example, assume in 2021, an individual with an AGI of $1,000,000 contributes $300,000 of cash to a DAF and $300,000 of qualified appreciated stock to a private non-operating foundation. The individual would deduct the $300,000 DAF contribution in full, $200,000 of the stock contribution and carryover the remaining $100,000 stock contribution to 2022. Under the CAA, the individual may still deduct up to an additional $500,000 of any qualified charitable contributions made during 2021. See below for planning considerations. See also page 18 and 19 of IRS Publication 526 for calculation worksheets.
The impact on charitable contribution carryovers, and the five year carryover period, should be considered when making the qualified contribution deduction election. The election may help use prior year contribution carryovers since current contribution carryovers are used before qualified contribution deductions when applying AGI limits.
Planning related to traditional IRA and Roth IRA Planning
For charitably inclined individuals, the 100% AGI deduction provides an excellent opportunity to convert a traditional IRA to a Roth IRA because the taxpayer can offset the increased income recognized on the conversion with the qualified contribution deduction. The taxpayer should use cash outside of the Roth IRA to make the qualified contribution deduction so that the Roth IRA will grow on a tax free basis undiminished by the charitable contributions.
Similarly, individuals with traditional IRAs can take distributions in 2021 and offset their increased income by making the qualified contribution deduction with the cash proceeds. This planning opportunity may work well for philanthropically motivated individuals who intend to leave the balance of their IRAs to public charities at their death.
Planning requires income tax projections
Under these intricate ordering rules, using the 100% qualified charitable contribution deduction may not be the panacea for a high-income taxpayer that it appears to be. For example, making the 100% election could result in a smaller tax benefit than would have been achieved at the maximum ordinary income tax rate, such as when qualified charitable contributions reduce long term capital gains or qualified dividend income. Additionally, maximizing qualified charitable contributions may result in wasting itemized deductions which could result in a tax loss during one year that wouldn’t otherwise result in a net operating loss. Other business deductions not taken in determining AGI should also be considered. The ability to offset 100% of AGI with qualified charitable contributions may be a once in a lifetime opportunity. With the possibility of increased tax rates and a reduction in the benefit of itemized deductions in the future, it is essential to take into consideration current year issues, multi-year carryovers, fluctuations in overall tax rates and tax law changes into consideration.
For any questions or to discuss tax planning opportunities in 2021, please contact Carol Warley, Alexandra Mitchell, or your RSM tax professional.