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George F. Bearup, J.D. Senior Legal Trust Advisor

16-Nov-20

Charitable Deduction Carryovers- They Are Not Automatic

Take-Away:  While charitable deductions that cannot be used in one year can be carried over for another 5 years, there is one ‘trap’ where that will not be the case.

Background: The Tax Code permits a carryover of the income tax deduction with regard to excess charitable gifts. That carryover is up to the next 5 years . The excess deduction occurs when the charitable gift in one year exceeds the various adjusted gross income (AGI) deductibility ceilings for the calendar year in which the charitable gift is made. For example, the gift of cash, other than 2020 when no limit applies, limits the donor to the charitable deduction to 60% of the donor’s AGI for the year. If the charitable gift is marketable securities, then the donor’s charitable income tax deduction is limited to 30% of the donor’s AGI for the year. If the value of the charitable gift exceeds these AGI ceilings, then the excess charitable gift can be carried over for the next 5 calendar years.

Death of Donor: While the 5-year carryover of the charitable deduction is a nice inducement to make large charitable gifts, the problem arises when the donor dies during that 5-year carryover period. As a generalization, the carryover of the excess charitable income tax deduction dies with the donor, which can be a problem when the donor is elderly or not in good health.

Married Donor: Consider a situation of a married donor who files a joint income tax return with his or her spouse. Even though the married couple files a joint income tax return, the carryover of the excess charitable income tax deduction from the a donor’s spouse is lost after the year of the donor-spouse’s death.

  • Example: Fred and Wilma are married. Fred decides to make a large gift of appreciated securities to his alma mater, a charitable gift that is large enough that the charitable income tax deduction is limited to 30% of Fred and Wilma’s reported AGI for the year in which the charitable gift is made. Hence, there is a carryover of the unused excess charitable income tax deduction to the next calendar year. Fred and Wilma file a joint income tax return for the year of Fred’s gift of appreciated marketable securities to his alma mater. Fred dies the next year after the gift is made. Wilma will not be able to use any of the carryover excess charitable income tax deduction, after the year of Fred’s death, because Fred made the charitable gift, not Wilma. In other words, the carryover of the excess charitable income tax deduction is ‘owned’ by Fred, not Wilma, nor is it tied to the joint income tax return on which the original charitable income tax deduction was reported. On Fred’s death, the excess tax deduction disappears.

Preserving the Excess Charitable Income Tax Deduction: Some steps can be taken ahead of time, to preserve the carryover excess charitable income tax deduction. The Fred and Wilma example will be followed to describe the options.

  • #1 Jointly Owned Securities: If the marketable securities were held in both Fred and Wilma’s joint names, Fred’s death after the jointly owned marketable securities have been contributed to Fred’s alma mater will still enable Wilma to benefit from one-half (50%) of the remaining excess carryover charitable income tax deduction, i.e. the portion that is attributable to Wilma’s one-half interest in the donated marketable securities. [Treasury Regulation 1.170A-10(d)(4)(iii).] This is the same result if Fred and Wilma had lived in a community property jurisdiction.
  • #2 Intra-spousal Gift: If the property that is the subject of the charitable gift is held in the name of one spouse, e.g. Fred, whose life expectancy is much shorter than their spouse, the older spouse should give the assets to their spouse, who then makes the charitable gift. The transfer of assets between spouses is subject to the unlimited federal gift tax marital deduction. The (i) gift to spouse; followed by (ii) the gift by the donee- spouse to the charity, will allow the donee-spouse, who is likely to be the surviving spouse, to make use of the charitable deduction excess In short, if Fred is older than Wilma or in poor health, Fred should give the marketable securities to Wilma, and Wilma then gift the marketable securities to Fred’s alma mater.
  • #3 Bequest to Surviving Spouse: Suppose that Fred bequeaths his marketable securities to Wilma with the request that Wilma gifts the same securities after Fred’s death to Fred’s alma mater. If Wilma is an itemizer, she will receive the income tax charitable deduction. This will allow Wilma to benefit by receiving an income tax charitable deduction to off-set her taxable income. However, Wilma’s gift of the marketable securities to Fred’s alma mater should neither be imposed as a condition to that bequest of the securities to Wilma, nor required, nor even mentioned, as a hope, request, or desire by Fred. Obviously, for this to work, Fred must have complete confidence that Wilma will follow through with Fred’s desire for her to gift his securities to his alma mater.
  • #4 Election: A donor like Fred, who makes a charitable gift, can make an irrevocable election to limit his income tax charitable deduction for a contribution of long-term appreciated property to a public charity to his or her income tax basis of the donated property. The charitable income tax charitable deduction ceiling is then increased from 30% to 50% of the donor’s AGI. Accordingly, if Fred’s income tax basis in the marketable securities is reasonably high, and Fred’ age or state of health suggest that he might not live the full 5 years after the charitable gift, Fred can make this election that will permit more of the charitable income tax deduction to be used in the year of the gift.

Conclusion: As we counsel individuals to make gifts to charities as this calendar year comes to a close, it is important that we stress that excess charitable income tax deductions can be carried over for up to 5 additional years. Yet we also need to be mindful that the death of the donor will stop that 5-year carryover of the excess charitable income tax deduction. In sum, while a large charitable gift will be welcome by the charity that receives the gift, some thought needs to be given to structuring the large charitable gift to assure that the excess charitable income tax deduction will ultimately be used to offset future taxable income.