Tax and Financial Articles

Substantiating Charitable Contributions

The tax code encourages charitable giving by allowing individuals to claim then as itemized deductions. However, in order to sustain these deductions in an IRS audit, it is important to be mindful of the substantiation rules.

For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record or a written communication from the charity showing its name, plus the date and amount of the contribution. For a contribution of property other than money, you generally must maintain a receipt from the charity showing its name, the date and location of the contribution, and a detailed description (but not the value) of the property.

Stricter substantiation requirements apply in the case of charitable contributions with a value of $250 or more. These donations must be substantiated by a contemporaneous written acknowledgement of the contribution by the charity. The acknowledgement must include the amount of cash and a description (but not value) of any property other than cash contributed, whether the charity provided any goods or services in consideration for the contribution, and a good faith estimate of the value of any such goods or services.

In general, if the total charitable deduction you claim for non-cash property is more than $500, you must attach a completed Form 8283 (Noncash Charitable Contributions) to your return or the deduction is not allowed. In general, you are required to obtain a qualified appraisal for donated property (excluding publicly-traded securities) with a value of more than $5,000, and to attach an appraisal summary to the tax return.

If you receive goods or services, such as a dinner or theater tickets, in return for your contribution, your deduction is limited to the excess of what you gave over the value of what you received. For example, if you gave $100 and in return received a dinner worth $30, you can deduct $70.

Please call us if you have any questions about these rules.

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The information contained in this communication is intended as general guidance on matters of interest only. The application and impact of laws can vary widely based on specific facts involved. Given the changing nature of laws, rules and regulations, and the inherent hazards of electronic communication, there may be delays, omissions, or inaccuracies in information contained in this transmission. The information contained herein should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisors. Pursuant to Regulations Governing Practice Before the Internal Revenue Service, any tax advice contained in this communication, unless explicitly provided otherwise, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

How Floridians Indirectly Pay State Income Taxes

Those of us who live in Florida are fortunate to live in a state where there is no state income tax.  But are we completely off the hook?  Not exactly.  High state income states can actually shift some of the tax burden that they impose on their residents onto taxpayers elsewhere through the state income tax deduction available on the federal tax return.

For example, let’s take a high earner who lives in New Jersey and makes about a million dollars. That taxpayer will pay about $70K per year in NJ state income tax.  On his federal return, he can deduct $70K on Schedule A as an itemized deduction.  Using a 35% marginal rate, the taxpayer saves approximately $25K on his Federal taxes. Therefore, the $70K in NJ tax only costs the taxpayer $45K.  But NJ gets the full $70K.  

Who pays the other $25K?  That $25K is lost revenue to the Federal Treasury, so in effect, the tax burden is shifted to everyone else.  Because residents of other high state income tax states also receive a similar deduction, the tax burden ultimately gets shifted to those taxpayers in low state income tax states.   

In addition, the higher the Federal income tax rate, the greater the subsidy effect.  In other words, if the top marginal income tax rate at the federal level was 50%, the $70K would only cost the NJ taxpayer $35K, shifting  the other $35K to taxpayers everywhere else.

There are some proposals floating around Capitol Hill to lower Federal rates and eliminate deductions, including the deduction for state and local income tax.    However, because the deductibility of state income tax combined with a high Federal rate is a great way for states to shift tax burdens, those proposals are likely to get a lot of resistance from those states with high state income taxes.

Taxation of stock options

The tax law creates a special type of employee stock option called an Incentive Stock Option (ISO).  ISO’s receive preferential tax treatment relative to “nonqualified” options. The advantages are as follows:

• The tax basis in the purchased shares at the time of exercise is the employee’s out of pocket cost (the “strike price” times the number of shares).
• No income is recognized until shares are sold, providing an option to defer the tax.
• Any gain recognized at the time of the sale is considered capital gain.

 To illustrate, assume the following example:

In year 1, Mr. Smith is issued stock options to purchase 2,000 shares of XYZ stock @ $50/share.  At the time the stock options are granted, XYZ stock is trading at $50/share.  Because the strike price is equal to the market price, no taxable income is recognized.  In year 5, the options are exercised when the stock is trading at $120/share, and the shares are sold simultaneously. 

If the options qualify for ISO treatment, the tax is calculated as follows in year 5:

                     Gross proceeds:  $120/share, or $240,000

                     Out of pocket costs to exercise options:  $50/share, or $100,000.  This is considered basis.

                     Net proceeds of  $140,000.  Proceeds are considered capital gain, and taxed at rate of 15%.

                     Total tax cost assuming 15% capital gains tax rate is 21,000.

Note that with ISO’s, the taxable event is triggered not by the exercising of the options, but by the sale of the stock.  Therefore, if the taxpayer chose to exercise the options but not sell the stock, the taxpayer would defer any tax until  the stock is eventually sold.

If the options were nonqualified, then the $140,000 in income would be considered ordinary income.  Assuming a marginal tax rate of 35%, the tax due on the transaction would be $49,000. 

In addition, with nonqualified options, the taxable event is triggered by the exercise of the options.  Therefore, the taxpayer does not have the option of deferring the tax if he chooses not to sell the shares.

Warren Buffett’s billionaire friendly tax return

Warren Buffett sent this letter to Congressman Tim Huelskamp disclosing some key figures from his 2010 Form 1040:

• Adjusted Gross Income (line 37):  $62,855,038
• Taxable Income (line 43):  $39,814,784
• Federal Income Tax (line 60):  $6,923,494

When you include the $15,300 in payroll taxes, Buffett’s effective income as a percentage of taxable income is only 17.4%.

Buffett will not disclose his full tax return, but the majority of Buffett’s income is most likely made up of Qualified Dividends and Long Term Capital Gains, both of which are taxed at a rate of 15%. 

Also noteworthy is the large difference between Adjusted Gross Income and Taxable Income.  The difference is his itemized deduction totals – probably a combination of charitable donations and investment interest.

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