Washington's talk of eliminating or changing the tax deductibility of charitable gifts as part of a solution to the fiscal cliff has charities rallying its troops. A close look at the two most discussed options shows that one would vastly curtail the tax benefits to upper-middle-class taxpayers.
Hundreds of nonprofit groups are bringing officials to Capitol Hill this week to plead with the nation's congressional members and their staff to leave the charitable deduction intact. They argue that any new limits on these deductions will undermine giving and ultimately hurt those who rely on nonprofit services.
The change that President Barack Obama has trumpeted would cap the charitable deduction at 28% of income for couples making more than $250,000 and individuals earning more than $200,000. The current deduction for these groups is as high as 35%.
But an alternative that Republican presidential candidate Mitt Romney discussed on the campaign trail has recently resurfaced. That approach would limit all personal deductions to $25,000, including those taken for home mortgage interest, child tax credits, local and state taxes, and charity.
“Especially for higher-dollar donors, the dollar cap would be much, much worse than a percentage cap of 28%,” said Evan Liddiard, tax policy expert at Urban Swirski & Associates LLC, who advises on charities. “We should be focused on all kinds of caps, but particularly dollar caps because they will have the most devastating impact on the nonprofit community.”
With a dollar cap on deductions, it's expected that Americans would first use up their allotted tax savings with items such as their mortgage interest and state taxes, and that there would be none or just a small amount left for giving tax-efficiently to charities, said Steve Taylor, senior vice president for public policy at United Way Worldwide.
“Wherever you draw that line, you effectively eliminate the charitable deduction for some class of donors,” Mr. Taylor said.
To compare the impact of the two proposals, Mr. Liddiard looked at how a married couple with two children earning $400,000 and contributing $40,000 to charity would be hit. The 28% cap would provide $4,500 less in tax savings for that family, which under today's law can deduct 31%.
That same family would lose about five times that amount in tax benefits under the $25,000 cap (assuming that the family qualified for a total of $91,000 in deductions for charity, mortgage interest, and state and local taxes). The $66,000 spent beyond that cap would translate to about $22,000 less in tax savings, Mr. Liddiard said.
For a family making $3 million and donating $300,000, the 28% cap would take away $42,000 of their tax savings, assuming that they could take the maximum 35% deduction. The $25,000 cap would wipe out more$200,000 of their tax benefits, assuming that they claimed a total of about $600,000 in deductions.
Howard Gleckman, a resident fellow at the Tax Policy Center, said the two approaches are difficult to compare, because it depends on a person's tax situation, such as whether they have paid off their mortgage.
Regardless, the deduction for charitable contributions always benefits high-income people far more than those with lower income because many lower- and middle-income families don't itemize, he said. In fact, 70% of taxpayers don't itemize and just take the standard deduction. For those taxpayers, a change either way won't make a difference.