While tax deductions are rarely the primary motivation behind an individual’s decision to make a charitable gift, tax considerations can and often do affect the size, timing and the form a gift may take. But who will benefit most from the charitable deduction?
Since 1917 the charitable deduction has recognized that a donor is foregoing any personal benefit or use of amounts that are voluntarily given for qualified charitable purposes as defined in Internal Revenue Code Sections 170 and 501. It is important to note that not all gifts to nonprofits are tax deductible and that the Internal Revenue Service and federal tax code include regulations and limits that govern the tax treatment of various types of charitable gifts.
To avoid taxation of amounts that donors decide to voluntarily give, the tax code allows a deduction (not a credit) of up to 50 percent or 30 percent of adjusted gross income (AGI) depending on whether the gift is made using cash, publicly traded securities, real estate or other assets.
Larger gifts of cash and other property are subject to a variety of valuation and substantiation rules. For example, if a deduction exceeds the amount that can be claimed in a single year, the excess amount may be carried forward and subsequently deducted in up to five additional tax years. Generally speaking, the higher one’s marginal income tax rate, the greater the tax savings due to the deduction and the lower the after-tax cost of the gift.
According to the IRS and Giving USA figures, the majority of charitable gifts from individuals comes from taxpayers with incomes over $100,000 who itemize their deductions. Based on their income tax bracket, the after-tax cost of their gifts is 60 to 75 cents on the dollar. Those with higher incomes who are subject to a combination of income tax and the Medicare contribution tax can reduce the after-tax cost of gifts to as little as 57 cents for each dollar itemized for charitable gifts.
For example, if a donor in a 33 percent income tax bracket decides to make a charitable gift of $10,000, the $10,000 itemized deduction will reduce his or her federal income tax liability by $3,300 and provide welcome relief at tax time. If funded with noncash property, such as $10,000 of stock originally purchased for $1,000, the donor will also bypass capital gains tax on the $9,000 increase in value. By contrast, if the gift were not tax deductible, the donor would have to earn just under $15,000 and then pay the tax on that amount in order to net the $10,000 for the desired gift.
After the enactment of the American Taxpayer Relief Act last January, there was a group of higher-income taxpayers who saw significant increases in their tax bills this past April. The implementation of new higher income and capital gains tax rates, combined with other taxes and adjustments, gave this group a tax shock on their 2013 tax returns.
It is no secret that this high-income group is responsible for a disproportionally large percentage of tax revenue. It is estimated that the top 20 percent of taxpayers pay over 90 percent of all federal income taxes. Further, the top 1 percent is responsible for almost a third of federal income tax revenue.
These high-income taxpayers have borne the brunt of most of the recent changes to the tax code. For instance, they are most likely to be in the new 39.6 percent tax bracket and subject to the new 20 percent capital gains tax as well as the extension of the 3.8 percent Medicare tax to include investment income. This group also faces the reduction or loss of the benefit of personal exemptions and some itemized deductions (although charitable gifts are not generally affected).
How to proceed.
Those impacted by these tax increases are still recovering from the “tax shock” and many are now open to ways they might reduce their tax bill for 2014. For many, the answer may be to carefully reconsider their charitable gift plans. In addition to charitable gifts of cash, gifts of appreciated assets such as stocks or mutual funds will be newly attractive. Donors can save up to 39.6 percent for every dollar of itemized donations and avoid up to a 23.8 percent tax on appreciation representing the combination of the 20 percent capital gains tax and the 3.8 percent Medicare tax. There may be state tax savings as well. Further, if they fund a charitable remainder trust or gift annuity, they generate immediate tax savings now while creating a new source of tax-favored income that can grow in a tax-exempt environment for life or another allowable period of time.
The key for fundraisers is to identify those most likely to be subject to these targeted tax increases and tailor gift planning marketing and communications to them, without confusing the majority of regular contributors who are not affected by the recent changes in any significant way.
In fact, the American Taxpayer Relief Act extended the Bush tax cuts for the vast majority of taxpayers. But those who can benefit the most from the tax benefits of charitable gifts will be found in the upper ranks of your donors, regardless of age. By reaching out to this special group before the end of the year, you will help keep your funding needs at the top of your donors’ minds as they reconsider their charitable planning this fall.