At first blush, this may seem like good advice. After all, the mathematical formulas don’t lie. If a person in the 28% tax bracket does not make a charitable gift, he would owe $2,800 in income tax on $10,000 of income. If the same person makes a gift of $10,000, his tax bill would be reduced by $2,800. If the same $10,000 were given by someone in the 35% tax bracket, the tax savings would rise to $3,500, a difference of $700.
Figures such as these have sparked the interest in how higher tax rates could increase the savings from charitable gifts and reduce the after-tax cost of giving. And because capital gains tax is bypassed when appreciated stocks and certain other properties are used to fund charitable gifts, tax savings may increase even more when capital gains taxes also increase.
Unless Congress acts in the meantime, on January 1, 2011, taxes on ordinary income and capital gains are scheduled to rise to maximum rates of 39.6% and 20% respectively. Taxes on dividends could rise from 15% to 39.6% as well.
The importance of timing
Traditional tax planning advice dictates that a donor take as many deductions as he or she can for the current year and delay as much income as possible to a later year. This plan results in minimizing income taxes in the current year, while delaying additional taxes until a later date.
If, as now, income tax rates are scheduled to rise in the future, this strategy is normally reversed, with income accelerated into the low-tax-rate year and deductions delayed until higher tax rates make them worth more in the future. (See page 8 of the July 19, 2010, edition of Forbes.)
But is this the best idea for charitably inclined persons this year? Not necessarily. Because of the uncertainties surrounding tax legislation for 2011, there are a number of reasons why it may be a better idea for donors to maximize their gifts in 2010.
Why donors may want to give now
First, there are “cash flow” considerations to be taken into account. Suppose someone would like to make a charitable gift of $10,000. If the gift is made this year, it could be deducted against a maximum tax rate of 35%. The after-tax cost of the gift would be $6,500. If that person chooses instead to delay his or her gift until 2011, an additional $3,500 in taxes will be owed next April on the income not given in 2010, leaving just $6,500 to give next year.
Second, the rule that reduces itemized deductions by 3% of the amount by which adjusted gross incomes (AGIs) exceed certain amounts is scheduled to be reinstated in 2011, reducing the benefits of giving for many in higher tax brackets. This could serve to reduce the value of deductions for some by more than the additional savings offered by higher tax rates.
Finally, federal budget proposals have been pending that would further reduce the benefits next year for charitable gifts and other itemized deductions under federal income tax law. If, as has been proposed, deductions for charitable gifts are limited along with other deductions to the 28% tax bracket, the tax savings for the $10,000 gift previously described would be limited to $2,800 and a donor in the new 39.6% bracket would then owe as much as $1,160 in additional tax on the $10,000 gift. If this occurs, some have predicted that major donors will be advised to give less next year because of the need to hold back cash to pay the newly levied taxes on amounts they donate to charity. In the case of the $10,000 gift, a donor might be advised to reduce the gift to just under $9,000 and hold back $1,000 to pay the tax that would suddenly be owed on the $9,000 that was donated.
As a result, for many donors the most tax-wise strategy this year will be to accelerate income where possible and offset the additional taxable income by increasing deductible charitable gifts.
Fundraisers may also wish to inform donors who have a history of encountering 30% and 50% of adjusted gross income limits on deductions that there is a possibility that AGI limits could make it difficult if not impossible to reap any possible benefit from delays.
For example, assume a person with an adjusted gross income of $200,000 would like to give highly appreciated stock to fulfill an outstanding pledge commitment. He can deduct 30% of his AGI for 2010, or $60,000. He decides to postpone his gift until next year after he reads an article online that suggests he may save more in income taxes by delaying the gift until 2011. Imagine his surprise when he is told next year that he can’t double up and give $120,000 in 2011 because, with no change in his AGI, he is still limited to the same $60,000 he could deduct in 2010. In that case he will have lost forever the ability to take the $60,000 deduction in 2010. In a 35% tax bracket, that amounts to $21,000 in tax savings he will never enjoy. The same principle applies to donors subject to the 50% of AGI limit on gifts of cash.
As they say, an ounce of prevention is worth a pound of cure. It will be more important than ever this fall that donors understand that the choice of what to give can determine how much they can afford to give. But this year, the timing of gifts can also be an important key to making gifts in the most cost-effective ways.
For more on the benefits of giving in 2010, see “Year-End Giving Could Get a Lift From Political Tax Debates” by Holly Hall in the September 6, 2010, edition of The Chronicle of Philanthropy.
Editor’s note: This article is excerpted from the online presentation “How to Win in 2010, Tips and Techniques to Increase Giving,” available for viewing on demand at sharpenet.com. Sharpe is also pleased to offer a special end-of-year publication designed to help you communicate the ideas contained in this article to your constituents. See page 5 or www.sharpenet.com/maximizing for more information.