Many taxpayers and their advisors are familiar with the various limitations that might affect itemized deductions, including those for charitable gifts. Others are not, and may inadvertently make what could prove to be costly mistakes.
Charitable gifts of cash may be deducted up to 50% of a donor’s “contribution base,” which is basically the taxpayer’s adjusted gross income (AGI). Qualified gifts of appreciated property are subject to a lower limit—up to 30% of AGI. In both cases, deduction amounts exceeding these limitations may be carried forward for use in future years, up to a maximum of five.
When combining gifts of cash and appreciated property, the overall limitation is 50% of AGI each year with cash gifts applied first, including any “carryover” from prior years.
In recent years, another limitation on itemized deductions has begun to affect a growing number of taxpayers and has had a chilling impact on some contribution decisions— even when the limitation would have no negative impact on the gift under consideration. The limitation referred to is one on total itemized deductions taken by relatively high-income taxpayers. Such taxpayers are subject to a phase-out of the benefit of their itemized deductions over a certain level. While the bark of this limitation is usually worse than its bite, it may serve to discourage contributors if they are not properly informed regarding the true impact of the limitation.
How it works
If AGI exceeds a certain inflation-adjusted level—approximately $130,000 for married couples—they are required to reduce their itemized deductions by an amount equal to 3% of AGI in excess of the threshold amount. For example, if a taxpayer’s AGI is $50,000 over the applicable threshold amount, the taxpayer must reduce itemized deductions by $1,500 ($50,000 x 3%). To determine the after-tax cost of the reduction, the individual’s income tax rate must be considered. For maximum rate taxpayers, the reduction in the previous example results in a lost tax benefit of $600 ($1,500 x 40%).
Limited impact on gifts
As a practical matter, this limit affects few charitable gifts. Since the timing and form of charitable gifts are within the control of the donor, the reduction would logically impact those deductions that are not within the donor’s control, such as mortgage interest, property, and other taxes.
If a gift were not made in a given year, the reduction would still apply to these “first-in” or non-voluntary itemized deductions. Therefore, a donor who makes a special gift will receive an additional deduction for his/her gift at the margin, which is in turn fully deductible while subject to the limits mentioned above.
Unfortunately, many potential donors and their advisors have only passing familiarity with the application of this limitation and, therefore, may erroneously assume a negative impact on the donor’s situation. The best way to avoid losing gifts unnecessarily is to familiarize yourself with these provisions and be prepared to deal with potential objections on a case by case basis. Keeping donors completely and accurately informed will be the key.