Charitable Deduction....Often Confusing

by Gary Snyder

The Impact on the Charitable Deduction of the New Phase-out of Itemized Deductions
By David Wheeler Newman, Mitchell Silberberg & Knupp, Los Angeles

As has been widely reported, a concerted effort by a coalition of charitable organizations in the middle of the “fiscal cliff” negotiations successfully preserved the charitable contribution income tax deduction against proposals from both the Administration and members of Congress to cap or otherwise limit the charitable deduction. The celebration over this legislative victory was muted, however, as a result of the return to the Internal Revenue Code of the phase-out of itemized deductions. 

Many in the charitable sector view this phase-out as somehow taking back some of the hard-earned victory to preserve the charitable deduction. Charitable gift planners are concerned that the phase-out will reduce tax incentives for charitable gifts and therefore result in reduced giving. However, for most donors this is simply not the case.

The phase-out of itemized deductions under the American Taxpayer Relief Act of 2012 will not reduce the value of charitable contribution deductions for most taxpayers. It is critically important for gift planners to educate donors on this point, and to demonstrate that charitable contribution deductions will in most cases be unaffected by the new tax act.

Starting in 2013, itemized deductions are phased out for taxpayers with adjusted gross incomes above a threshold, which is $300,000 for married taxpayers filing jointly, $250,000 for single taxpayers, $275,000 for heads of households, and $150,000 for married taxpayers filing separately. These thresholds will be adjusted for inflation. The reduction resulting from this phase-out is the lesser of (a) 3% of the excess of adjusted gross income over the threshold or (b) 80% of otherwise allowable itemized deductions.

“Pease” Provision in Fiscal Cliff Deal Doesn’t Discourage Charitable Giving and Leaves Room for More Tax Expenditure Reform
By Chye-Ching Huang, Chuck Marr, and Robert Greenstein, Center on Budget and Policy Priorities, January 29, 2013

The recent “fiscal cliff” deal reinstated a limit on itemized deductions for high-income taxpayers known as the “Pease” provision, which policymakers created as part of the 1990 bipartisan deficit-reduction package but which the Bush tax cuts phased out between 2001 and 2010. In recent days, some pundits and leaders of some charitable organizations have suggested that because Pease limits the total amount of itemized deductions that high-income filers can claim, it will reduce the incentive for taxpayers to donate to charity. That suggestion is incorrect, however, as a close look at Pease makes clear.

As an important new paper from the Urban Institute and Tax Policy Center (TPC) shows, the fiscal cliff law’s tax provisions will increase charitable giving, not reduce it. The analysis — whose authors include C. Eugene Steuerle, a leading expert on these issues — estimates that the new law will boost charitable giving by $3.3 billion a year, or 1.3 percent, compared to what it would have been if policymakers had extended the tax laws that were in place in 2012. The increase results mainly from the rise in the top marginal income tax rate to 39.6 percent, which raises the value of the charitable deduction.

The Urban Institute-TPC analysis also explains that “the Pease limitation has negligible effects on the tax incentive for charitable giving” (emphasis added). It shows that for people in the top income tax bracket, the tax benefit of making charitable donations will rise from 35 cents in less tax liability for each additional dollar in charitable giving to 39.6 cents per dollar — an increase in the tax incentive that Pease does not affect. 

How Pease Works — And Why Various Assumptions About It Are Mistaken

“The impact of the Pease limitation on charitable contributions,” the Urban Institute-TPC analysis aptly notes, “is the subject of much confusion.” Many people who aren’t tax policy experts understandably assume that because Pease limits the total amount of itemized deductions that a high-income taxpayer can claim, this limit is based on the amount of a taxpayer’s deductions and reduces the marginal incentive to donate. That’s not correct, however.

In its reinstated form, Pease will reduce the total amount of a taxpayer’s allowable itemized deductions by 3 percent of the amount by which the taxpayer’s adjusted gross income (AGI) exceeds certain thresholds — $300,000 for married couples filing jointly and $250,000 for single filers. (For this reason, Pease affects fewer than the top 2 percent of households and doesn’t touch anyone else.) Let’s say that a married couple has AGI of $350,000, or $50,000 above the threshold; Pease would shave the total amount of the couple’s allowable itemized deductions by 3 percent of this $50,000, or $1,500.

This structure of Pease has important implications. It means that Pease doesn’t reduce a taxpayer’s incentive to give more to charity because (except in extremely rare cases, as the appendix explains), its impact depends on the taxpayer’s income — not on how much the taxpayer donates.
Tax incentives such as itemized deductions are typically intended to subsidize certain activities and encourage taxpayers to do more of them. That’s true for the deduction for charitable giving; it lowers the “price” of giving, making it more attractive. When taxpayers in the 39.6 percent top income bracket deduct a $100 gift to charity from their adjusted gross income, that deduction reduces their taxable income by $100 and their tax bill by $39.60. In effect, the $100 donation costs them only a little over $60.

Pease does not change that. For taxpayers in the 39.6 percent bracket, an additional dollar in charitable deductions will lower their income tax by 39.6 cents with or without the Pease provision. Hence, Pease doesn’t affect their marginal incentive to donate. As the Urban Institute-Tax Policy Center analysis explains, Pease really operates by slightly increasing the top marginal tax rates, not by reducing incentives to engage in deductible activities. 

Economists agree that the most important question about how a tax provision such as Pease affects total charitable giving is how it influences a taxpayer’s decision to make an additional dollar of donations. Because the dollar reduction in itemized deductions under Pease depends on a taxpayer’s income rather than on the amount he or she donates, Pease doesn’t affect decisions on whether to give more to charity. As the non-partisan Congressional Joint Committee on Taxation wrote in 2001, when President Bush proposed eliminating Pease:
There generally is little or no difference in the tax-motivated economic incentive to give to charity for a taxpayer subject to the [Pease] limitation compared to a taxpayer not subject to the limitation. .  .Economists would say that the “tax price” of giving is not altered by the limitation. (This was excerpted, in part, from Paul Streckfus’ EO Tax Journal 2013-22)

Nonprofit Imperative gathers its information principally from public documents...some of which are directly quoted. Virtually all cited are in some phase of criminal proceedings; some have not been charged, however. Cites in various media: Featured in print, broadcast, and online media outlets, including: Vermont Public Radio, Miami Herald, National Public Radio, Huffington Post, The Sun News, Atlanta Journal Constitution, Wall Street Journal (Profile, News and Photos), FOX2, ABC Spotlight on the News, WWJ Radio, Ethics World, Aspen Philanthropy Newsletter, Harvard Business Review, Current Affairs, The Chronicle of Philanthropy, St. Petersburg Times, B, USA Today Topics, Newsweek.com, Responsive Philanthropy Magazine, New York Times...and many more Nonprofits: On the Brink (2006) Silence: The Impending Threat to the Charitable Sector (2011)