Due diligence required when taking charitable deductions – Insight on Estate Planning April/May 2012

Estate planning and charitable planning often go hand in hand. For many people, leaving a legacy of philanthropy is as important as providing financial security for their families. If your estate plan includes charitable contributions, be sure you understand their tax implications. The availability of income tax deductions for lifetime donations affects a contribution’s cost and, therefore, the amount you can afford to give without jeopardizing your other estate planning goals.

One important requirement for charitable deductions is that the recipients of your largesse be organizations that are eligible to receive deductible contributions. These include qualified public charities, schools, museums, churches, certain supporting organizations and private foundations. To ensure that your contributions are deductible, it’s critical to monitor the tax-exempt status of the organizations you support.

Check the list

Generally, the easiest way to check whether an organization is likely eligible for tax-deductible contributions is to make sure it’s listed on IRS Publication 78. Publication 78 also indicates whether a listed organization is a public charity or a private foundation. This is significant because income tax deductions for contributions to private foundations are subject to lower percentage-of-income limits than contributions to public charities.

Another option is to consult the IRS Business Master File (BMF). In fact, if you’re donating to a private foundation, the BMF is preferable because, unlike Publication 78, the BMF indicates whether a public charity is considered a “supporting organization.”

To maintain their tax-advantaged status, private foundations that make grants to certain supporting organizations must exercise “expenditure responsibility,” which means monitoring how the supporting organization receiving the grant spends the foundation’s funds and ensuring the funds are used as intended. So an added benefit of reviewing the BMF is that this may give you peace of mind that your contribution will be used for what you intended.

Watch out for revocations

Just because an organization is listed in Publication 78 or the BMF, however, doesn’t necessarily mean that it’s currently eligible to receive tax-deductible contributions. An organization’s tax exemption can be revoked.

For example, an organization’s tax-exempt status is revoked automatically if it fails to file an annual information return (the Form 990 series) for three consecutive years. There’s a bit of a lag from the point of revocation to the time the organization is removed from the lists.

If an organization’s status is revoked for such failure to file, will you lose your tax deduction? Perhaps. The organization may correct the deficiency, however, by filing the required returns.

Further, under recently updated IRS rules, it has been clarified that, if an organization loses its tax-exempt status, contributions or grants to the organization are still allowable provided the donor 1) is unaware of the revocation and 2) makes the contribution or grant before the IRS makes a public announcement that the organization no longer qualifies.

Generally, these announcements are made on the IRS website and in the Internal Revenue Bulletin. But they may also be published “by such other means designed to put the public on notice of the change in the organization’s status.”

Do your homework

To ensure that your charitable contributions are tax-deductible, check to see whether potential recipients are eligible and remain in good standing with the IRS before you get out your checkbook. It’s also a good idea to document the steps you take to confirm an organization’s status — such as checking Publication 78 and the IRS website — to protect yourself in the event of an IRS challenge. •