From tax rates and tax extenders to the revival of the Pease limitation, the act includes a host of provisions affecting tax-exempt organizations.
On January 2, President Barack Obama signed the American Taxpayer Relief Act of 2012 (ATRA) into law. The law averts the scheduled income tax rate increases and spending reductions required by the Budget Control Act of 2011. Highlighted below are several of the many ATRA tax provisions of interest to tax-exempt organizations.
ATRA extended the following tax-exempt-related provisions until December 31, 2013:
Effect of Pease Limitation on the Charitable Contribution Deduction
One consequence of reviving the overall limitation on itemized deductions (section 68 of the IRC) is the limitation on the amount by which a taxpayer's charitable contribution deductions reduce his or her tax liability. The provision, which is commonly referred to as the "Pease" limitation after Congressman Don Pease from Ohio who originally proposed it, was first enacted in 1990 as a way of raising tax revenue without raising tax rates, but it has been repealed since 2006.
To calculate the Pease limitation, all limitations applicable to each deduction are applied first, then the otherwise allowable total amount of itemized deductions is reduced by 3% of the amount by which the taxpayer's AGI exceeds the applicable amount. The applicable amount is $300,000 for taxpayers who file jointly, $275,000 for heads of household, $250,000 for individuals, and $150,000 for married individuals filing separately. The applicable amounts are indexed for inflation for years after 2013. Certain deductions are not subject to the Pease limitation, including medical expenses, investment interest, and casualty, theft, or wagering losses. The total overall limitation is the lesser of (i) 3% of the amount by which AGI exceeds the applicable amount and (ii) 80% of the total itemized deductions.
For example, if an individual with an AGI of $500,000 in 2013 has deductible charitable contributions of $20,000, mortgage interest of $50,000, and state taxes of $30,000—for a total of $100,000 of deductions—the individual's Pease limitation would be $7,500, which is 3% of $250,000 (the amount by which the taxpayer's AGI exceeds the $250,000 applicable amount). As a result, the individual would be able to claim only $92,500 of deductions ($100,000 – $7,500), rather than the full $100,000.
The Pease limitation is applied in addition to the charitable contribution percentage limitations. Under current law, charitable contributions by individual taxpayers are limited to a specified percentage of the individual's contribution base. The contribution base is the taxpayer's AGI for a taxable year (disregarding any net operating loss carryback to such year). In general, the contribution limit is higher for contributions of cash and ordinary income property than it is for contributions of capital gain property, and it is higher for contributions to public charities (and certain operating foundations) than it is for contributions to nonoperating private foundations.
The Pease limitation was enacted on a temporary basis as part of the Omnibus Budget Reconciliation Act of 1990, effective for taxable years beginning after December 31, 1990, but prior to January 1, 1996. The legislative history states that the objective of the provision was to better reflect taxpayers' ability to pay taxes. It was believed that the higher an individual's AGI, the less likely that an otherwise deductible expense would significantly affect the individual's ability to pay taxes. The Omnibus Budget Reconciliation Act of 1993 permanently extended this limitation on total itemized deductions. The legislative history states that the permanent extension of the overall limitation on itemized deductions would enhance the progressivity of the federal individual income tax system.
The Economic Growth and Tax Relief Reconciliation Act of 2001 phased out and ultimately repealed the Pease limitation. The legislative history states that Congress believed that the Pease limitation was an unnecessarily complex way to impose taxes, that the "hidden" way in which the limitation raises marginal tax rates undermines respect for the tax laws, and that repealing the Pease limitation would reduce complexity for affected taxpayers. For example, computing the Pease limitation requires a 10-line worksheet that includes numerous computations using information from Schedule A of the Form 1040.
In a January 1, 2013, press release, House Committee on Ways and Means Chairman Dave Camp (R-MI) stated that tax reform is next on his committee's agenda. The Senate Committee on Finance has also indicated a willingness to take up tax reform, having held hearings for the past several years on various tax reform topics. It is therefore possible that the 113th Congress will address issues of interest to tax-exempt organizations, such as reforming the charitable deduction, in the coming legislative session.
The Pease limitation adds considerable complexity to calculating the amount by which itemized deductions, including the charitable contribution deduction, reduce income tax liability. It is unclear how this added complexity will affect charitable giving in 2013 and future years. Donors who are subject to higher marginal tax rates as a result of ATRA may have a greater incentive to make charitable contributions than they previously had. Exempt organizations may wish to apprise donors of the advantages of making charitable gifts through IRAs and other enhanced charitable deduction incentives that ATRA has extended until December 31, 2013.
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