The United States will technically go off the fiscal cliff, triggering automatic tax increases, spending cuts and monetary policy that will impact almost every facet of American finance.
But, wait. Not really. Although neither side will confirm it, insiders have told The NonProfit Times that the framework for a deal is in place. Part of that deal is allowing the increases to go into effect and then rolling them back so lawmakers can say they voted for a tax cut.
That doesn’t mean it won’t all fall apart. Most pressing for charities is the potential increase in the estate tax and a cap on what taxpayers who itemize can take as deductions. While the cap is total deductions, it would include the charitable deduction.
The deal also pushed $1.2 trillion in sequestration budget cuts down the road a few months, allowing contracts with charities to continue.
The estate tax is projected to increase to 40 percent from 35 percent on a $5 million threshold. Giving by bequest was up an estimated 12.2 percent, reaching $24.4 billion in 2011, according to the 2012 edition of Giving USA. Under this deal, according to nonprofit Capitol Hill sources, the so-called Bush-era tax cuts would be extended permanently for individuals with income of $400,000 and joint filers with incomes of $450,000. The top rate on ordinary income would be 39.6 percent.
According to the experts at the Urban–Brookings Tax Policy Center in Washington, D.C., the provisions reportedly being discussed is known as Pease, which was fully repealed beginning in 2010. According to Joseph Rosenberg, a research associate at the center, it reduces the amount of itemized deductions by a fixed percentage for each dollar of income (AGI) above a specified amount (up to 80 percent of the total). In this case, it would be 3 percent above whatever threshold is agreed to. Reporting on the Pease threshold varies by source.
“Since it is based on income (not the amount of deductions), it essentially operates as an income tax surtax, not a cap on itemized deductions (i.e., deductions retain the full marginal tax value for most taxpayers),” said Rosenberg. “In other words, it does not change the tax incentive associated with charitable giving. The only channel in which Pease can affect the tax incentive on giving is if a taxpayer’s disallowed deductions exceed 80 percent of their itemized deductions.”
The same thresholds would be applied for capital gains and dividends, with the top rates in that case going up to 20 percent — a concession to Republicans. The rate on dividends was set to return to 39.6 percent, but not far from the president’s position during the campaign.
“The bottom line is that the cliff has not had a calendar year 2012 impact on us because no one saw it coming quickly enough. The cliff impact will be felt in 2013 with likely diminished giving,” said Bob Mims, controller at Ducks Unlimited, a national conservation group based in Memphis, Tenn.
Many social service agencies stand to lose if the deal is not reached. Goodwill Industries International agencies run AbilityOne contracts, which is a federal set- aside program for people with significant disabilities. According to Lauren Lawson of Goodwill headquaters in Bethesda, Md., the majority of these contracts are within the U.S. Department of Defense, and “could be severely restricted should sequestration take effect. In addition, proposed limits to charitable giving have unfortunately been a part of the discussions. Any limits or caps on this important incentive will harm the country’s diverse philanthropic and charitable sector at a time that organizations like Goodwill are seeing an increase in need,” she said.
Should the deal go down in flames, David A. Shuster, JD, LLM, a tax principal and director of tax controversy services at Grassi & Co., in New York City and Jericho, N.Y., provided a checklist for the potential changes.
- Expiration of Payroll Tax Holiday –An additional 2 percent tax on wages and self-employment income on earnings up to $113,700.
- Additional Medicare Tax – An additional 0.9 percent tax on wages and in excess of $200,000 ($250,000 combined on a joint return, $125,000 for married taxpayers filing separate returns).
- Medicare Contribution Tax on Net Investment Income – An additional 3.8% tax on lesser of; 1) net investment income (net income on interest, dividends, capital gains, and the like) or 2) income in excess of $200,000 ($250,000 combined on a joint return, $125,000 for married taxpayers filing separate returns). Capital gain that may be excluded from income tax on sales of personal residences will not be subject to this tax.
- Long-Term Capital Gains – The top rate goes from 15 percent to 20 percent. Coupled with the Medicare tax on investment income, long-term rates will increase to nearly 24 percent for those in the highest income tax brackets.
- Qualified Dividends – The top rate went 15 percent to 39.6 percent for those in the highest income tax brackets. Coupled with the Medicare tax on investment income, rates will increase to more than 43 percent for those in the highest brackets.
- Expiration of the so-called “Bush Tax Cuts” on Individual Income Taxes – The current income tax rates ranging from 10 percent to 35 percent increased to rates ranging from 15 percent to 39.6 percent. The increased rates might not result in additional income tax for certain taxpayers subject to the Alternative Minimum Tax (AMT), as the additional tax from the increased rates might, in certain instances, be accompanied by an offsetting decrease in AMT.