Are tax deductions allowed for restricted donations?

Are tax deductions allowed for restricted donations?

A jar full of donations with a plant growing out of it

By Zachary S. Kester, JD, LLM, CFRM, at Charitable Allies

Are tax deductions allowed for restricted donations? Here are a few common examples we’ll walk through to answer that question:

Sally Sponsor wants to restrict her donation to sponsor a specific child in your child sponsorship program.

 Andy Abode wants to be sure Don Displaced directly benefits from his donation to the homeless shelter; Displaced is a homeless man with a history of addiction whom Abode met while serving weekly meals at the organization’s mission building.

 Bookish Benefactor wants to endow an archivist position at the local historical society and wants to ensure that Abby Archivist, the current archival director, directly benefits from his donation.

Are Restrictions on Contributions Acceptable?

These three gifts are restricted, but are they improperly restricted so as to negate the tax deductibility for the donor? Are Sponsor, Abode, and Benefactor entitled to deduct these gifts as charitable donations?

When fundraising, nonprofits tell the stories of needy individuals; these stories are often compelling. This is one way we introduce our major supporters to our programs, and therefore, to those we serve.

Donors are increasingly sophisticated. They often want to be sure their donations are used according to certain conditions or are restricted for specific uses. This is understandable.

But improper conditions or restrictions can actually negate the donation’s tax deductibility. Such restrictions can also result in litigation with the donor. A donor should understand that the charity ultimately has final say in the use of the donation—a restriction required to preserve tax-deductibility for a donor.

Clarity Needed

In order to protect nonprofits from becoming embroiled in a controversy surrounding a charitable gift, there needs to be clarity about which conditions and restrictions are permissible, and which may be too risky.

To qualify as a charitable contribution, a gift must be complete (i.e., no “strings” attached) and irrevocable. The charity must have full control of the donated funds, and discretion as to their use to carry out the organization’s charitable functions and purposes.

Certain restrictions do not destroy the “complete” nature — and therefore deductibility — of a gift. Generally, acceptable restrictions include the right of a donor to:

  • advise how the funds can be used,
  • direct that funds be used overseas by a charity that does work overseas,
  • receive income from the donated property (in complex giving situations like charitable remainder trusts),
  • direct that the donation be used for a specific program, or
  • challenge perceived waste of a donation (such as it being redirected or misused).

Generally problematic restrictions that negate deductibility include attempts by the donor to:

  • restrict gifts for the use of specific individuals or a non-charitable class of individuals, especially if the individuals are related to the donor,
  • exercise significant control of the gift, such as the right to choose investments of the gift, or
  • restrict the use of the gift for non-charitable purposes (i.e., for an individual that is not a member of a charitable class).

So are Sponsor, Abode, and Benefactor entitled to deduct these gifts as charitable donations?

  • Sponsor’s gift is tax-deductible. Most child sponsorship programs raise awareness about and seek funding for, specific children who are a part of a charitable class (i.e., needy). So long as the organization retains the right to exercise final control over the funds, the gift is deductible.
  • Abode’s donation is most likely deductible as long as the organization retains the right to exercise final control over the funds. Displaced is a member of a charitable class (i.e., homeless/needy), and as long as Displaced is not a relative of Abode, the gift meets the requirements for deductibility.
  • Benefactor’s donation is deductible but only if there is no direct, explicit or implicit, tie between the gift and Archivist’s benefit. The gift cannot be for the Archivist’s benefit, but for the organization’s. With careful negotiations and documentation, the deduction should be preserved.

As with these complex examples, charities will generally want to seek experienced legal counsel in assessing the risk to their organizations of accepting a donation with restrictions, and in preserving its deductibility for the donor.

Charitable Allies is a 501(c)(3) charity that serves the legal and administrative needs of nonprofits in Indiana and beyond.