"TAX TIPS: Benefits to charitable giving could change in coming years"
The first reason why a charitable contribution in 2016 may provide a bigger benefit than in future years is the possibility of a reduction in overall tax rates. Unlike a tax credit, which is a dollar-for-dollar reduction of the amount of tax owed regardless of a taxpayer's marginal tax rate, a tax deduction, such as a charitable deduction, reduces taxable income. The value of the benefit of a deduction therefore depends on the taxpayer's tax bracket.
For example, for a taxpayer in the 25% tax bracket, a $1,000 tax deduction reduces taxes by $250. But if a taxpayer is in the 35% tax bracket, the same $1,000 tax deduction would reduce taxes by $350. The value of a deduction therefore decreases as tax rates decrease.
Under President-elect Donald Trump's tax plan, the highest individual tax rate would be reduced from 39.6% to 33%, a reduction of almost 17%. If this reduction comes to pass, the benefit of a charitable contribution will be decreased by this same percentage for those in the top tax bracket. Trump's plan is not the only plan for reductions in tax rates. Other tax reform plans from Republican legislators, such as House Speaker Paul Ryan, have also called for a simplification of tax rates, including an overall reduction in the highest rates.
The second reason to consider a charitable contribution this year is that the itemized deduction for charitable contributions may be reduced or eliminated next year. Trump's proposal includes limiting itemized deductions to $200,000 for married couples filing joint returns. Currently, the cap on chartable contributions is 50% of adjusted gross income for contributions to most charities, and 30% of adjusted gross income for contributions to private foundations. A taxpayer with an adjusted gross income of $1 million would therefore be able to contribute $500,000 to most charities this year, but (under the proposed plan) would be limited to $200,000 for all deductions including charitable contributions, interest, medical expenses and taxes. The limits under the Trump proposal would therefore significantly impair the ability of high-income taxpayers to take advantage of the tax savings that incentivize charitable giving.
Another part of Trump's proposal would limit a very effective tax planning technique: contributing appreciated property (usually stock) to charitable organizations. Although subject to myriad rules, securities with long-term unrealized gains may be donated to charity without paying capital gains tax on the unrealized gain. In addition, the taxpayer can generally take the fair market value of the securities as a charitable deduction. So a contribution of stock with a basis of $10 and a value of $1,000 can give you a $1,000 charitable contribution deduction without having to recognize the $990 gain. This very beneficial rule has been the target of tax reform advocates over the years. While short on details, Trump's tax plan includes a proposal to limit the benefit of this planning technique for contributions made to a private foundation.
While many taxpayers might be reluctant to make a significant contribution this year and reduce or eliminate contributions in later years, one solution is a contribution to a donor-advised fund. A donor-advised fund is a separate account or fund that is maintained by a public charity. Often described as a "charitable savings account," a donor-advised fund allows a taxpayer to contribute cash or appreciated assets in the current year to receive a tax benefit in that year and then advise the fund on grants to be made to specific charities in later years.
As with any tax strategy, it is important to consult with qualified professionals and consider the impact of the strategy on other aspects of your tax planning. This could be an interesting opportunity for many charitably-inclined taxpayers because the Trump and the Ryan proposals both provide income tax rate decreases and restrictions on the ability to take a deduction for charitable contributions in future years.
It is difficult to predict whether and when the proposed changes will occur, but in light of these proposals, taxpayers who give to charity, particularly those who are considering substantial charitable contributions, should factor the possibility of these changes into their planning for contributions in 2016.
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