Nonprofit groups sent hundreds of representatives to Capitol Hill last week to warn lawmakers that limiting the tax deductibility of charitable gifts as an element to avoid the fiscal cliff would hurt Americans dependent on charities for vital services.
But a close look at the two most discussed options shows that one would curtail the benefits to upper-middle-income taxpayers significantly more than the other.
President Barack Obama favors capping 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%.
The alternative that Republican presidential candidate Mitt Romney discussed on the campaign trail, and which has resurfaced, would set a dollar limit on all personal deductions. One proposal would cap them at $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, a partner and tax policy expert at Urban Swirski & Associates LLC. “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 allotted tax savings would be consumed by items such as mortgage interest and state taxes, and that there would be virtually nothing left for charitable donations, according to 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,” he said.
Mr. Liddiard compared the effects of the two proposals on a married couple with two children earning $400,000 and contributing $40,000 to charity.
The 28% cap would provide $4,500 less in tax savings for that family, which under today's law deducts 31%.
The 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 than $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 people's overall 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, merely taking the standard deduction. For those taxpayers, a change either way won't make a difference.
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