New Tax Act's Impact on Planning for Charitable Donations

by Manatt, Phelps & Phillips, LLP

New Year's Day brought new tax legislation passed by Congress, called the American Taxpayer Relief Act of 2012 (the "Act"), which President Obama has signed into law.  The Act has made some important changes to the tax law that will impact the income tax deduction that donors may receive from gifts to charity.    

IRA Charitable Rollover

The Act has extended the tax-free IRA charitable rollover until January 1, 2014. By making use of the IRA charitable rollover, an individual who is 70 1/2 or older may transfer up to $100,000 per year from an IRA to charity.  The benefit to utilizing the charitable rollover is that the transfer is excluded from the individual's gross income and thereby avoids both income taxation and any percentage limitations on charitable deductions; however, it will count as part of his or her required annual minimum distributions from the IRA. 

As with the prior law, only public charitiesand not private foundationsmay be recipients of these funds. Further, a rollover gift may not be made to a donor advised fund or to a supporting organization.

Generally, in order to qualify, an individual must instruct the IRA custodian to transfer the assets directly to the recipient charity.  This rule could have been problematic in 2012 because individuals were required to take their minimum distributions in that year, yet Congress did not authorize the IRA charitable rollover until January 2013. 

The Act provides two possible elections for those that wish to take advantage of the charitable rollover in 2012:

  • If an otherwise eligible individual received an IRA distribution during December 2012, he or she may transfer cash (up to the lesser of his/her distribution or $100,000) to an eligible charitable organization during the month of January 2013.  The gift to the charity will be treated as a qualifying IRA charitable rollover.
  • Alternatively, an individual can direct his or her IRA custodian to make a transfer of funds to a qualifying charity during January 2013, and if the appropriate election is made (as the IRS will later prescribe), the distribution will be treated as being made on December 31, 2012.  

Please note that, in order to take advantage of either special election, the window of opportunity is brief and action needs to be taken this month.

Limitation on Itemized Deductions Is Reinstated

Although there was a great deal of discussion that Congress might significantly modify or even eliminate the income tax charitable deduction in order to reduce the deficit, it remains intact.  However, high-income earners are once again limited by the amount of certain itemized deductions that they may take, which includes the charitable deduction. 

Effective January 1, 2013, the Act has reinstated the so called "Pease limitation," which had been eliminated by the 2010 Tax Relief Act for the 2011 and 2012 tax years.  That limitation caps the amount of certain itemized deductions, including the charitable deduction, that an individual may take if his or her adjusted gross income exceeds a certain threshold amount called the "applicable amount."  The Act has set the applicable amounts as $250,000 for a single individual, $300,000 for a married couple filing a joint return, and $275,000 for head of household, and such amounts are adjusted for inflation after 2012.  The rule provides that, if a taxpayer's adjusted gross income exceeds the applicable amount, certain of the taxpayer's itemized deductions will be reduced by the lesser of (i) 3% of the amount that a taxpayer's adjusted gross income exceeds the applicable amount, or (ii) 80% of all itemized deductions that are subject to the Pease limitation for the tax year.

For a high-income donor who makes a large gift to charity, the Pease limitation may significantly reduce the amount of itemized deductions that a donor might otherwise expect to report. If you are contemplating making a large charitable contribution, you should speak to your advisor regarding the impact that the Pease limitation may have on the charitable deduction and other itemized deductions that you may take on your income tax return. / NonProfitLaw@manatt


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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