Select Charitable Giving Provisions of the American Taxpayer Relief Act of 2012
On January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (the “Act”) which President Obama later signed into law. The Act includes provisions that affect a number of areas of tax law, including income, gift, and estate taxes. The following information is a summary of our interpretation of several aspects of the Act which relate directly to charitable giving. Perhaps most importantly from a charitable perspective, the Act did not place a cap on charitable deductions as originally proposed by the Obama administration.
1. Increased Tax Rates Mean Greater Tax Benefit to Charitable Giving
The Act increased the marginal income tax rate from 35% to 39.6% for married couples filing jointly with income in excess of $450,000, heads of household with income in excess of $425,000, and single filers with income in excess of $400,000. As a result, the potential federal income tax savings from each $1.00 given to charity has increased from 35¢ to 39.6¢ for these taxpayers. The Act also increased long-term capital gains tax rates from 15% to 20% for the same group of taxpayers which further increases the potential tax benefit of making charitable gifts of appreciated marketable securities and other assets which would otherwise be subject to long-term capital gains tax on disposition.
2. “Pease Limitation” Won’t Affect Charitable Deduction for Most Taxpayers
While we were somewhat surprised and disappointed to see the provisions limiting itemized deductions (often referred to as the “Pease limitation” after the Ohio Congressman who initially helped author the rule) included in the Act, based on our understanding, the “Pease limitation” should essentially have no effect on the deductions that most taxpayers receive in connection with their charitable gifts. Under the “Pease limitation,” taxpayers with incomes in excess of a threshold amount will have their itemized deductions (e.g., charitable contributions, state taxes, real estate taxes, mortgage interest) reduced by the lessor of: (1) an amount equal to 3% of the difference between their adjusted gross income (AGI) and such threshold amount, or (2) 80% of the total value of the taxpayers’ itemized deductions. Under the Act, the threshold amount is $300,000 for married couples filing jointly; $275,000 for heads of household; and $250,000 for single filers.
For example, in 2013, a married couple filing jointly with an AGI of $600,000 will generally see their itemized deductions reduced by ($600,000 - $300,000) x 3%, or $9,000. So if their allowable itemized deductions would have been $150,000, their itemized deductions will instead be reduced to $141,000 ($150,000 - $9,000).
On closer examination, it appears that the “Pease limitation” will essentially have no impact on the deduction that most taxpayers (even those with incomes above the thresholds noted above) are able to take in connection with their charitable gifts. Looking at the example above, let’s assume that $50,000 of their allowable itemized deductions were for items other than charitable gifts (e.g., state taxes, real estate taxes, mortgage interest) that would have been incurred regardless of whether any charitable gifts were made, and that the remaining $100,000 was attributable to charitable gifts that the couple considered optional. Based on these assumptions, if the couple made no charitable gifts, their allowable itemized deductions should be reduced to $41,000 ($50,000 - $9,000). If the couple also chooses to make the $100,000 in charitable gifts, as noted above, their allowable itemized deductions would have been reduced to $141,000 ($150,000 - $9,000). Thus, the couple made $100,000 in charitable gifts and their itemized deductions after the “Pease limitation” increased by $100,000. As illustrated by this example, most taxpayers will, in effect, receive the full deductions associated with their charitable gifts if they have other itemized deductions that are greater than the reduction under the “Pease limitation”.
With respect to the 80% limitation, this merely establishes the maximum reduction that can be made to a taxpayer’s itemized deductions and effectively helps counteract the “Pease limitation.” The 80% limitation should only come into play if the reduction determined by the above formula (e.g., $9,000) would reduce the otherwise allowable itemized deductions by more than 80% (i.e., in the example above, if the couple’s total allowable itemized deductions were less than $11,250). For example, if the couple above had total allowable itemized deductions of $10,000, instead of being reduced to 0 (because the $11,250 reduction exceeds the $10,000 in deductions), the amount would only be reduced by 80% which would still allow a deduction of $2,000 ($10,000 x 20%). This 80% limitation will generally only be applicable when taxpayers with very high AGIs make relatively small charitable gifts and have very few other itemized deductions.
3. IRA “Charitable Rollover” Extended Through 2013
The Act also temporarily extended the ability of individuals to make tax-free distributions from an individual retirement account (IRA) to eligible charities (commonly referred to as an IRA charitable rollover). Specifically, individuals who have reached age 70 1/2 may make a distribution of up to $100,000 from an IRA to an eligible nonprofit organization in 20131. By making such a distribution, an individual may exclude the amount distributed from his or her gross income.
Most distributions to public charities will qualify for the IRA charitable rollover; however, distributions made to Donor Advised Funds or Supporting Organizations will not qualify. For donors who are interested in partnering with Foundation For The Carolinas, IRA rollover distributions can be made to FFTC’s Operating Fund or to Designated Funds and Scholarship Funds, as well as to Field of Interest and Unrestricted Funds that support FFTC’s community grantmaking. Qualified charitable distributions can also be made in support of the Robinson Center for Civic Leadership, or specific civic leadership initiatives such as Project L.I.F.T.
1 Special transition rules had also allowed donors to retroactively take advantage of the IRA charitable rollover for 2012 by acting prior to January 31, 2013.
Based on our understanding of the Act, charitable giving should be at least as beneficial from an income tax perspective for most taxpayers in 2013, and, as noted above, taxpayers in the highest marginal tax bracket should actually see an increase in the tax benefit they receive from making charitable gifts under current law. While additional changes to the federal tax laws which could affect charitable giving are being considered in Washington, DC, we understand that there are no formal proposals at this time.
We hope this memorandum was helpful and welcome opportunities to work with you in 2013.
Important Information Regarding This Memorandum
This memorandum represents our interpretation of select provisions of the American Taxpayer Relief Act of 2012 and is for your general information. It is not intended as legal or tax advice. You should discuss the implications of the American Taxpayer Relief Act of 2012 with your tax advisor to determine how its provisions might apply to your specific facts and circumstances.