More On Tax Planningfrom The Advisor's Professional Library
- Charitable Giving Charitable giving can reduce your clients’ tax liabilities. However, the general and verification rules for the deduction of charitable gifts must be understood in order to take full tax advantage of such gifts.
- Taxation of Real Estate Real estate may be used to shelter income and may offer certain tax benefits. However, the type of real estate investment may result in different tax treatment. Learn how to use these investments to help your clients.
It’s easy for non-specialists to be confused by U.S. tax law. Take recent concern among nonprofit groups about a provision in the new tax law enacted at the beginning of this year.
The American Taxpayer Relief Act of 2012 reinstated the so-called Pease limitation on itemized deductions for high earners, raising concerns that charitable contributions would suffer as a result.
The Pease limitation cuts back itemized deductions by 3% of the amount by which an individual taxpayer’s adjusted gross income exceeds $250,000 ($300,000 for married couples), but not more than 80% of the total.
Nonprofit organizations lobbied hard against reinstatement of the limitation, which came into effect in 1991 and was phased out between 2006 and 2010. Some groups raised alarms after President Barack Obama signed the new tax bill into law. Certain high-profile individuals, such as former White House press secretary Ari Fleischer, said they would have to be stingier in their charity this year.
A new paper by the Urban Institute Center on Nonprofits and Philanthropy should allay these concerns. Its analysis of the new law finds that “the Pease limitation has negligible effects on the tax incentive for charitable giving.”
The reason is that Pease is driven by the taxpayer’s income, not by the amount of his or her deductions. “Taxpayers who elect to itemize their deductions can continue to deduct charitable contributions at their full marginal income tax rate,” according to the paper.
In fact, the new law increases their incentive to do so. The top tax rate on ordinary income has jumped from 35% in 2012 to 39.6% in 2013 on taxable income over $400,000 for individuals ($450,000 for married couples). This makes each dollar of itemized charitable deduction worth nearly 40 cents this year, compared with 35 cents last year.
Consider this example from the Center on Budget and Policy Priorities.
A married couple with $350,000 of AGI in 2013 ($50,000 over the Pease ceiling) claims $40,000 in deductions. Pease would reduce that amount by $1,500 (3% of the $50,000) to $38,500.
Critically, however, the couple could receive full tax benefit for any additional charitable donation they might make—say $10,000. Even with that contribution, Pease would still reduce the total itemized deductions by the same 3% of $50,000.
Without the additional $10,000 donation, the couple would be able to deduct $38,500; with it, the deduction jumps to $48,500. Their taxable income would be reduced by the entire $10,000 donation.
The couple in the example would be in the 33% tax bracket, so with the $10,000 donation their tax liability would fall by 33 cents on each dollar, or $3,300. The Pease limitation would play no part in this.
The Urban Institute paper says the new tax law has increased the incentive for top-bracket donors to be generous. It says contributions to tax-exempt groups will rise by $3.3 billion this year, 1.3% more than if last year’s tax provisions had been extended.
The paper attributes this to increases in the top marginal tax and in the highest marginal tax rate on capital gains—from 15% to 20%, benefiting those who donate appreciated property to charity.
The paper lists other provisions that will also influence charitable giving:
- The charitable IRA rollover provision was extended until Dec. 31
- The enhance charitable deduction for contributions of food inventory was similarly extended
- The basis adjustment to stock of S corporations making charitable contributions of property was also extended to Dec. 31
Check out AdvisorOne’s special report home page: 20 Days of Tax Planning Advice for 2013.