Fiscal Cliff Notes

By Pete Kennedy, CPA, CVA

GetInvolved Nonprofit Guide Article published in the January 2013 News Journal

At Cover & Rossiter, we don’t care how much Jessica Simpson weighs, we don’t know Gangnam from Gingham, we don’t know boo about “Honey Boo Boo,” we don’t keep up with the Kardashians, and, after seeing Justin Beiber on New Year’s Eve, my only lasting thought was “What’s with those pants?” But we do follow the latest changes to the tax code.

If there was an award for the most overused cliché of 2012, the “Fiscal Cliff” would win. The Cliff was intended as an artificial crisis to spur Congress and the President into action to reduce the federal deficit. But just as our elected officials can create artificial crises, they can postpone them. The American Taxpayer Relief Act, which passed in the wake of the initial “Cliff,” is a stop-gap measure that includes some significant changes to the tax code about which all nonprofits should be aware. Since the reduction of the employee portion of the Social Security tax from 6.2% to 4.2% was not extended, all workers will by now have an additional 2% taken out of their gross pay. There is a bit of irony to calling a law which effectively raises the taxes on all workers the “American Taxpayers Relief Act.” I suppose we should count our blessings that they didn’t work in a tortured acronym as well – how about the “Senators And Representatives Can’t Agree So Much” Act (SARCASM)?

The Fate of the Charitable Contribution Deduction

After the release of the Simpson-Bowles report, there was widespread concern regarding the future of the charitable contribution deduction. The 2010 report called for a vast reduction in the tax benefit of the deduction by replacing it with a very limited credit. The good news is that the deduction was not fundamentally changed, although it has been indirectly altered.

After a hiatus, the “Pease” limitation is back. This will limit all itemized deductions – including the charitable deduction - by 3% for every dollar above a stated income threshold ($300,000 for married couples for 2013). For example, let’s assume a couple with $500,000 in taxable income donates $20,000. The Pease limitation would reduce the $20,000 by $6,000 [($500,000 - $300,000) x 3%] for an effective deduction of $14,000. The limit is itself limited to 80% of the deduction, meaning that if the same couple had only donated $5,000, they would still get to claim a $1,000 deduction (since $6,000 is greater than $5,000, the limit would be limited to $4,000 ($5,000 x 80%) leaving $1,000 to claim).

In some quirky situations, the charitable deduction could actually be worth more to the donor in 2013 than it was in 2012. If the same donor above gave $110,000 to charity, the Pease limitation would leave $104,000 to deduct. But since the top tax rate has changed to 39.6% from 35% for incomes over $450,000, the economic benefit to the donor would actually be greater (all other things being equal). Obviously, this is a simplistic example and not intended to represent tax advice, but it serves to illustrate that the charitable deduction has not changed dramatically from 2012 and prior rules.

At the end of the day, donors do not give for strictly economic reasons. If that was true, they would most likely just keep their money in their pocket, pay the tax due and be farther ahead financially than gifting the money regardless of the tax break. The impact of the overall economy does far more to dictate charitable giving than changes to the tax treatment of the donation.

Other Nonprofit Tax Issues for the New Year

Direct rollover IRA contributions survived for another year as did gifts of conservation easements. The same strict rules and caveats still apply to both of those. Favorable tax treatment of contributions of book inventories and used computer equipment, however, were not allowed to continue.

The estate tax changed slightly – the top rate went from 35 to 40%, but there is a permanent $5,000,000 exclusion per person which can be transferred between spouses to create a joint $10,000,000 exclusion before the first dollar of federal estate tax kicks in. There was some concern that doing away with the estate tax altogether – as proposed during the presidential campaign – would severely curtail planned giving efforts at many charities.

Anyone who is involved in any capacity with a non-functionally integrated Type III Supporting Organization (hopefully you know who you are) received a bit of a Christmas present. IRS final rules defining the required distributions for those organizations were issued, but at 3.5% of assets instead of the 5% they had previously advertised. The requirement will be effective for 2014 based on 2013 asset values.

If your organization has questions about any existing or new tax laws for nonprofits, please contact Pete Kennedy, or any other member of our Nonprofit Practice team, at Cover & Rossiter at (302) 656-6632.

See the printable version of the article here.

IRA Qualified Charitable Distribution Reinstated

IRA Qualified Charitable Distribution Reinstated

There are very few opportunities to conduct tax planning for 2012 once the calendar year flips to 2013.  However, a unique, very limited opportunity is available for the 2012 tax year.  One of the provisions of the recently passed American Taxpayer Relief Act of 2012 was the reinstatement of the Qualified Charitable Distribution (QCD) from an IRA to a charity.  To be eligible for QCD treatment and count toward an owner’s required minimum distribution (RMD) obligation for the year:

• You must transfer funds directly from your IRA to a charity
• Distributions must be made from an IRA account (not another retirement plan like a 401(k))
• The IRA owner must be 70 ½ years of age or older on the date of the donation from the IRA to the charity.
• The limitation per person in a single year is $100,000
• The donation must be to a public charity (most private foundations, CRATs, CLATs and some other entities do not qualify)

Many of you may now be asking the question, “How can I do this now when the year-end has already passed and I have received my RMD for 2012?”  Congress added special “look-back” provisions for the QCD since the legislation did not pass until January 1, 2013.  There are two options available:  one option is to elect to have a QCD made in January of 2013 count as if it was made on December 31, 2012, and option two is to re-characterize a distribution made in the month of December 2012 as a QCD as long as the same amount is donated to a qualified charitable organization by January 31, 2013.

The second question many of you may ask at this point is “why would this be worthwhile?”  IRA owners are required to take required minimum distributions out of their IRA once the taxpayer turns 70 ½ years of age.  In some instances, a taxpayer may not be able to realize the full benefit of a charitable contribution.  For instance, their income may be so low that they don’t exceed the standard deduction threshold (i.e. not able to itemize), or their charitable contributions may be so high in a year that they exceed the charitable contribution limits.  In these situations a QCD will enable them to “circumvent” thresholds to obtain the full taxable deduction for their contribution.

If you are interested in using this planning strategy for 2012, please contact Marie Holliday at (302) 691-2211 or MHolliday@CoverRossiter.com.

 You can also access this article on our website here.

The Fiscal Cliff

Talk of “going off the fiscal cliff” has been haunting me over the last several months. I started researching the provisions, and realized that the impact was much more far reaching than I had originally understood. The combination of the expiration of the Bush-era tax cuts as well as the impending start of the Obama Care tax provisions would have resulted in significant tax increases for virtually all of the American population, which could potentially cripple economic recovery. However, most people believed that these negotiations were related only to higher income taxpayers. For several months now, Cover & Rossiter has been providing emails, conducting seminars and even meeting individually with our clients to inform them of the impact of the pending changes. It was extremely difficult to adequately predict what would actually transpire because of the differing proposals from the Democrats and Republicans. I suspected these negotiations would go to the last minute, but hoped that legislation would pass with significant time to assist each one of you with year-end planning opportunities.

However, in true Congressional fashion of recent years, nothing was agreed upon until January 1, 2013. The tax side of the fiscal cliff was averted when the American Taxpayer Relief Act of 2012 was signed into law by President Obama on January 2. Outlined below are many of the provisions of this law:

• The Bush-era tax rates were extended for taxpayers with incomes below $400,000 (single) and $450,000 (married filing jointly); a new ordinary income tax bracket of 39.6% was created for taxpayers who exceed those thresholds. Originally, President Obama proposed that these increases would apply to AGI levels of $200,000 (single) and $250,000 (married filing jointly).
• Capital gains and qualified dividends for taxpayers that exceed those thresholds will now be 20% (to the extent that their income exceeds the thresholds). Taxpayers below the thresholds will continue to be taxed at the 15% rate on this income.
• The payroll tax holiday, which reduced Social Security tax from 6.2% to 4.2% in 2011 and 2012, was not extended. All wage earners will see a 2% increase in their Social Security tax withholdings for 2013.
• Trusts will continue to be taxed at the Bush-era tax rate levels except for the highest bracket. Trusts with income in excess of $11,950 will be taxed at the top rate of 39.6%.
• A permanent Alternative Minimum Tax (AMT) “patch” was enacted increasing the 2012 exemption levels to $50,600 for single taxpayers and $78,750 for married filing jointly taxpayers. In future years, the amounts will be indexed for inflation.
• Itemized deductions will once again be subject to phaseouts when income exceeds the threshold of $250,000 for single and $300,000 for married filing jointly.
• Personal exemption phaseouts will be reinstated as well once incomes exceed the threshold levels also indicated for itemized deductions.
• The maximum federal estate tax rate will be 40% for decedents dying after December 31, 2012 who have taxable estates in excess of approximately $5.12 million. The portability election between spouses will now be permanent.
• The child tax credit level was scheduled to be reduced to $500 in 2013, but has been permanently extended to $1,000.
• The 50% bonus depreciation provisions were extended through 2013.

There are many other provisions that were extended with this Act, so if you have specific questions please feel free to contact Marie Holliday at (302) 691-2211 or MHolliday@CoverRossiter.com.  
You can view this article on our website here.