Each year, roughly one-third of American households itemize deductions on their federal income taxes. If you're among that group, there are a several important actions you need to take by year's end in order to take full advantage of available deductions.
For example, by December 31 you must pay for any uninsured medical expenses, state and local income and property taxes, and unreimbursed employee expenses you want to deduct from your 2011 taxes. You also need to decide how much to contribute to charitable organizations and either charge your credit/debit card or postmark a check by midnight on the final day of the year.
Here are a few issues to keep in mind when choosing how you'll make – and report – your charitable contributions:
Confirm the organization's tax-exempt status. The IRS revoked the tax-exempt status of approximately 275,000 nonprofit organizations because they hadn't filed annual reports for three consecutive years, as required by law. Although donations you may have made to those organizations prior to their being disqualified still count as tax-deductible, going forward, such organizations are no longer eligible to receive tax-deductible contributions unless they're reinstated by the IRS. Go to www.irs.gov/charities to see if your donations are affected.
Charitable auction purchases and donations. If you buy an item at a charitable auction, you're only allowed to claim a deduction for the amount you pay that's above its fair market value, so be sure to get documentation from the organization (e.g., a catalog showing a good-faith estimate). On the other hand, if you donate an item for a charitable auction, you're only allowed to claim your "tax basis" in the item – that is, the amount you originally paid for it, vs. its current fair market value.
IRA distributions. For many, one of our tax code's downfalls is that unless you itemize deductions you cannot reap tax advantages from your charitable contributions. However, an important exception is made for senior citizens, many of whom no longer carry a mortgage and thus don't itemize deductions: People age 70½ or older may contribute up to $100,000 from their IRAs directly to charity and have it count toward their 2011 Required Minimum Distribution (RMD).
Although the RMD contribution itself isn't tax-deductible, the amount won't be included in your adjusted gross income (AGI), thereby providing several potential tax benefits:
- A lower AGI could reduce taxes on your Social Security benefits.
- It could make you eligible for tax breaks that are tied to AGI.
- The contribution will lower your overall IRA balance, which in turn reduces the size of future mandatory distributions.
Choose wisely. Before making a donation or volunteering your time, make sure the non-profit organization is well-run. Ideally the organization applies at least 75 percent of contributions to programs that serve its beneficiaries, as opposed to spending them on salaries, advertising, fund-raising and other administrative expenses.
The IRS' Tax Information for Contributors website (www.irs.gov/charities-non-profits/charitable-contributions) website features a search engine for eligible organizations, information on reporting and substantiating charitable deductions and other helpful tips. Also, GuideStar's website (www2.guidestar.org) features helpful questions to ask potential recipients and tips for choosing a charity.
The personal rewards that come from donating your time and money to worthy causes certainly far exceed mere tax breaks, but still, it pays to know how the rules work in case you do qualify.