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Pease Limitation on Charitable Deductions Means Donors Pay More for Charity, BNA's Daily Tax Report

January 07, 2013

Reproduced with permission from Daily Tax Report, 04 DTR G-3 (Jan. 7, 2013). Copyright 2013 by The Bureau of National Affairs, Inc. (800-372-1033)<>

While some in the charitable sector said Jan. 4 they were relieved that the fiscal cliff legislation did not result in a flat percentage or aggregate cap on itemized deductions, they were disappointed that the Pease limitation on charitable deductions was reinstated as part of the deal.

The Pease limitation, included in the American Taxpayer Relief Act of 2012 (H.R. 8), puts a haircut on itemized deductions for high-income taxpayers, limiting the charitable deduction on incomes of more than $250,000 for individuals and $300,000 for joint filers (03 DTR GG-1, 1/4/13).

Most itemized deductions will be limited by 3 percent of the amount by which adjusted gross income exceeds those thresholds, said Independent Sector, a coalition of some 600 charities, foundations, and corporate giving programs, calling it "an income-based limitation, intended to serve as a surtax on income above a certain threshold, rather than as a penalty on, or disincentive for, itemized deductions."

The Alliance for Charitable Reform, a group of nonprofit leaders and others who oppose legislative and regulatory proposals that could diminish private giving, was less amenable, calling it "a back door tax."

Exempt practitioners said as an overall limitation on itemized deductions, the Pease limitation cannot be called an attack on charitable deductions, because it is not specific to the charitable deduction.

"It doesn't have a tax policy rationale that is motivated by the charitable deduction," Alex previous hitReidnext hit, an attorney with previous hitMorgannext hit previous hitLewisnext hit & Bockius in Washington, told BNA Jan. 4. "Pease is more of a covert way of raising revenue without appearing to raise marginal tax rates. However, when you consider that the charitable deduction could have been carved out of the limitation, as were gambling losses, it does appear to reflect some tax policy choices that could, and perhaps should, be different."

While the jury is still out on how the Pease limitation will affect charitable giving, it is in no way a worse outcome than a flat percentage or aggregate cap would have been, Diane Aviv, president and chief executive officer of Independent Sector, said Jan. 3. Those approaches were abandoned in the final fiscal cliff negotiations. The limitation is a far less substantial reduction in the deduction than those would have been, she said.

One source, who asked not to be named, said elimination of the Pease limitation from the legislation would have been a poison pill to the administration, because President Obama considered it to be the only way he could keep his campaign promise to raise taxes on people making more than $250,000.

Effect on Charitable Giving Unknown

The Pease limitation was instituted by the Omnibus Reconciliation Act of 1990 and was named after Rep. Donald Pease (D-Ohio). The 2001 tax act reduced Pease by one-third in 2006 and 2007 and by two-thirds in 2008 and 2009 before repealing it entirely for 2010. Subsequent legislation extended the repeal through 2012.

Aviv said that while the Pease limitation was fully in effect from 1990 to 2005, charitable giving increased by 83 percent when adjusted for inflation. However, she said, it is possible even more would have been given had the Pease limitation not been in place during that time.

"We are of the opinion that anything that is less than an incentive to give to charitable causes will be a hit to charitable giving," Alison Hawkins, director of external affairs with the Alliance for Charitable Reform, told BNA Jan. 4. It is not a matter of it only being a smaller amount, she said. "The problem is that charities have been operating under bare bones operations, serving so many more people, that anything that will hurt charitable giving is a problem. We need to be looking for ways to increase giving."

The stakeholders were uniform in their belief that the charitable deduction should not be touched as a part of Obama's quest to raise revenues.

"The charitable deduction doesn't have a place in this debate," Aviv said. "It's not the rich person who loses. Cutting the charitable deduction is yet another cut to the people served by charitable organizations."

The purpose of the charitable deduction is to remove charitable gifts from the tax base so that the federal government and the charitable sector are disentangled, previous hitReidnext hit said, which means it should be carved out.

It's Not Over

Aviv was quick to point out that the law passed Jan. 2 leaves major fiscal and tax policy issues unresolved, and that as discussions resume in Washington about increasing the federal debt limit and addressing the mandatory spending cuts known as sequestration, Congress and the president will once again be looking for additional sources of revenue.

"The big battle is going forward," she said.

The Alliance for Charitable Reform said it would focus on encouraging Congress to revisit the Pease limitation or to exclude charitable deductions from consideration as talks about revenue and debt reduction continue.

previous hitReidnext hit also said that the Pease limitation is an excellent example of complexity in the tax code. It requires taxpayers to make a series of calculations on a 10-line worksheet in the instructions to Form 1040 Schedule A.

Taxpayers must first calculate all the applicable limitations to each itemized deduction. Then the deductions that are not subject to the limitation (such as medical expenses, investment interest, and casualty, theft, or gambling losses) are subtracted. The otherwise allowable total amount of itemized deductions is then reduced by 3 percent of the amount by which the taxpayer's adjusted gross income exceeds the applicable amount.

Since the applicable amounts are indexed for inflation for years after 2013, the applicable amount should increase slightly in 2014. The 3 percent of excess AGI amount is compared to 80 percent of the total itemized deductions to see which amount is less. Finally, the lesser of the two numbers is subtracted from the total amount of otherwise allowable itemized deductions to compute total itemized deductions.

In 2013, a couple filing jointly with adjusted gross income of $400,000 and $100,000 in itemized deductions ($30,000, or 30 percent, of which are charitable donations) would see their charitable deduction reduced by $900, from $30,000 to $29,100.