The tax impact of delaying a charitable gift by just a couple of weeks (until 2013) could be large, but it may not be positive for US taxpayers.
The potential tax savings from claiming a charitable income tax deduction for a donation depends on a number of factors.
A gift of cash to a public charity can offset as much as 50% of a taxpayer’s adjusted gross income (AGI) for the year in which the gift is made, and any of the deduction not used that year can be carried forward for five years. (Gifts of appreciated assets and gifts to private foundations can also be used to offset AGI, but at lower levels.) This suggests that if the expiration of the Bush/Obama-era income and capital gains tax cuts will boost a donor’s tax rate, the value of such an income tax deduction will be larger next year.
Here’s a case study of a donor we’ll call Donna who had $1 million in AGI in 2012 and expects to have the same in 2013. She and her husband want to contribute $100,000 to their favorite charity. If their top marginal federal income tax rate in 2012 is 35%, then they should get an economic benefit of $35,000 (35% of $100,000) if they donate in 2012. However, if their top rate in 2013 rises to 43.4% (the 39.6% top marginal tax rate scheduled for 2013, plus the 3.8% Medicare surtax also scheduled for 2013), they could benefit by $43,400. That certainly seems like a good reason to delay the gift until 2013!
But the expiration of the Bush/Obama-era tax cuts would also mean the return of the 3% phaseout of itemized deductions in 2013. Taxpayers who itemize their deductions and have AGI of at least $174,450 would see their allowable itemized deductions fall by as much as 3% of their AGI above the $174,450 threshold. So, Donna and her husband wouldn’t be able to deduct the first $24,767 of the gift.
So in 2013, Donna and her husband would get only the value of a donation of $75,233 ($100,000 donation reduced by the $24,767 phaseout). The value of that deduction would be only $32,651—less than the 2012 benefit of $35,000, as the top row of the display below shows. That makes gifting in 2012 seem the wiser course.
But wait—there’s more!
These figures would apply only if Donna and her husband were residents of a state without an income tax, such as Florida or Texas; they are actually residents of a state with a 5% income tax. When we factor in that additional tax, the value of their charitable income tax deduction would be $38,250 in 2012. And while paying state taxes might seem like a dark cloud, it has a silver lining in this case: In 2013, Donna and her husband’s state tax payments should use up the 3% of her phased-out itemized deductions, allowing them to take advantage of the full $100,000 donation. That would boost the estimated value of the deduction to $46,230 (see the bottom row of the display). Therefore, Donna should wait until 2013 to make her gift, shouldn’t she?
Unfortunately, it’s still not that simple.
You may have heard that some folks in Washington, DC, are working to avert the so-called fiscal cliff. At least one proposal would limit the ability to apply charitable income tax deductions to taxable income at the federal income tax bracket of 28% and lower. This would significantly change the math for Donna and other wealthy philanthropists.
While the details of this proposal are not clear, we have estimated the impact it would have on Donna’s tax deduction, if enacted. If Donna lived in a state with no state taxes, her deduction in 2012 would be worth $35,000, but in 2013, it would be worth only $21,065. But since Donna and her husband live in a state with a 5% income tax, their deduction would be worth $38,250 in 2012, and $31,600 in 2013. From this perspective, Donna should make her donation in 2012.
This last example is based on pure speculation as to what Congress and the President will agree to. While we continue to believe that there will be some pact agreed to before the year is out, we clearly do not know what form that pact will take. The only certainty is that Donna and other philanthropists should take the time to carefully consider the income tax implications of making gifts now versus waiting to make them in 2013.
This article attempts to quantify the economic benefit of a charitable gift by a hypothetical couple that pays income tax at the highest marginal rate. The outcome depends, in part, upon (i) the timing of the gift, (ii) the couple’s tax domicile for state income tax purposes, and (iii) the future of the federal income tax laws. A similarly situated couple’s actual economic benefit and tax liability may vary significantly from the figures shown. Bernstein does not give tax or legal advice. Taxpayers should consult professionals in those areas before making any decisions.