ATRA Gives Contributors Incentives and Disincentives

Thanks to the American Taxpayer Relief Act of 2012 (ATRA), taxpayers have some new and renewed incentives to make charitable donations in 2013 and beyond. Unfortunately, in some cases ATRA brings disincentives.

Donation deductions may be worth more — or less

Higher-income taxpayers now may have the incentive of a potentially larger tax benefit from their charitable contributions because of the increase in the top marginal tax rate from 35% in 2012 to 39.6% in 2013. The higher rate applies to taxable incomes exceeding $450,000 (married taxpayers filing jointly), $400,000 (singles) and $425,000 (heads of households). Under the 35% rate, the tax savings from a $1,000 deduction was $350, whereas under the 39.6% rate, the savings may be as high as $396.

But in many cases, this incentive may be counteracted by the disincentive of the 2013 return of the itemized deduction phaseout.

The phaseout goes into effect when adjusted gross income (AGI) is greater than $300,000 per married couple, $250,000 for singles and $275,000 for heads of households. It reduces certain itemized deductions, including those for charitable donations, by 3% of the excess over the threshold.

Let’s say that a married couple with AGI of $1 million makes a donation to your nonprofit. The phaseout would be $700,000 ($1 million – $300,000) × 3%, or $21,000.

If the couple’s itemized deductions subject to the phaseout are $100,000, their deduction will be limited to $79,000. At the 39.6% rate, this saves $31,284 in taxes ($79,000 × 39.6%). This is a smaller benefit than if they’d had the same deductions in 2012, when the top rate was 35% but no income phaseout applied, because their tax savings would have been $35,000 ($100,000 × 35%).

But some taxpayers may see a larger tax benefit despite the phaseout. Let’s say our couple has the same $1 million AGI, but their itemized deductions are $300,000. After the phaseout, their deductions total $279,000 ($300,000 – $21,000), for tax savings of $110,484 ($279,000 × 39.6%). In 2012, the tax savings would have been only $105,000 ($300,000 × 35%).

More to like than not

ATRA extends through 2013 the ability of taxpayers age 70½ or older to make tax-free distributions up to $100,000 from an IRA directly to a charity. And by setting a permanent estate tax rate of 40% and an exemption amount of $5 million (annually indexed for inflation), ATRA allows for more informed discussions about planned giving with your donors as they draft estate plans. So, overall, ATRA should be good news for charitable organizations seeking to boost donations.