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Marginal tax rate reduction could impact charitable giving

June 16, 2017
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The chatter on tax reform continues. What tax reform will actually look like when all is said and done is still to be determined in many respects. There is much speculation on who the possible winners and the losers may be as a result of some of the possible items that any tax reform may include. Of course, this assumes tax reform is a zero-sum game and there needs to be winners and losers. This isn’t always the case, as there may be additional economic and social benefits that may result from any tax law changes.

Changes in individual taxes also have been proposed along with corporate changes. One of the items highlighted in the April 26 one-page release from the White House on tax reform was the standard deduction would be increased to $24,000 for those filling joint returns (an increase from the current $12,700). This change is in addition to reducing the top federal marginal tax rate from 39.6 percent to 35 percent. In addition, some deductions are proposed to be limited or removed from the tax code. This includes the deduction for state and local taxes. At the same time, it also was indicated home mortgage interest and charitable deductions still would be available.

For those who itemize deductions on their individual tax return, any reduction in federal marginal tax rates results in deductions being less beneficial. For example, a deduction at a 40 percent marginal tax rate reduces tax liability by 40 percent of the deduction. So, reducing the top federal marginal tax rate from nearly 40 percent to 35 percent reduces the benefit of deductions by 5 percent of the deduction or $500 per $10,000 of deductions for those individuals paying the top federal marginal tax rate.

As with any tax legislation, the economists and statisticians go to work trying to use their models with mathematical algorithms in an attempt to estimate the fiscal impact on the Treasury of any tax changes. The use of the models is not an exact science, and factors considered in the model and those not considered in the model can impact the ultimate outcome. We just need to look at the elections last fall to see how models can’t pick results with absolute precision.

I have seen several recent reports of comments and studies of what may happen with respect to charitable deductions if the standard deduction is increased and the marginal tax rates are reduced. The wild card in that analysis also may be how the economy performs and the confidence of consumers in the economy and their own well-being. I did see some reference to one report, and I actually went online and pulled the report to read their analysis.

The Indiana University Lilly Family School of Philanthropy was commissioned by the Independent Sector to analyze such an impact. In their report entitled “Tax Policy and Charitable Giving Results,” there are a number of conclusions discussed. The report is more than 50 pages long and does go into a fair amount of detail.

Taxpayers who itemize deductions tend to donate to charities and donate more than those who don’t itemize. Taxpayers who itemize typically earn more than those who don’t itemize. One of the conclusions in the report is an increase in the standard deduction and a reduction in the top marginal tax rate would have a negative effect on charitable giving of between 1.7 and 4.6 percent from the giving levels pre-tax law change. While not a dramatic change, it does indicate the change in marginal tax rates and deductions may impact charitable giving.

That analysis may have some merit, as the change in a large upward adjustment in the standard deduction would result in some current taxpayers who itemize deductions no longer being benefited by itemizing deductions since the standard deduction would exceed the level of actual deductions. The reduction in marginal tax rate may change some behavior of certain taxpayers as the benefit (reduction in tax liability) is reduced when the marginal tax rate is reduced as pointed out earlier.

Another change included in tax reform that may impact charitable deductions is the proposal to eliminate the estate or “death” tax. Often, bequests to charities are made at death by the wealthy that are subject to the estate tax. In some instances, such bequests may have been motivated in part by the historically high estate tax rates that are based on the value of the transfer rather than the inherent gain of the asset transferred. Estate tax marginal rates have dropped in recent years from more than 50 percent to the current rate of 40 percent.

What if any actions should be considered with possible tax reform changes that may impact individual federal marginal income tax rates? Over the years, a couple of strategies have been considered in times when tax rates are in the process of being changed. If tax rates in the future are set to increase, a strategy often employed was to accelerate income and defer deductions. In the opposite situation of declining tax rates, the strategy that is sometimes considered is to defer income and accelerate deductions. This type of planning isn’t as easy as it sounds in many cases. There may be specific rules that apply to certain types of income and deductions and how they are treated for and the timing of the treatment for income tax purposes. In addition, the particular fact situation of an individual may be impacted by other tax attributes, such as certain carryovers (charitable, capital loss, tax credit or other tax loss carryovers), alternative minimum tax considerations and state tax treatment of items.

If there is a decline in individual marginal tax rates in future years, 2017 may be a year to consider whether to take advantage of the high rate and consider charitable deductions. The recent stock market performance may allow for benefits of donating appreciated stock of public companies held for more than a year to receive a deduction at the fair market value of the shares transferred (subject to any limitations on deductions and any reporting requirements of the transfer).

There isn’t a one-size-fits-all tax planning strategy. Facts and circumstances need to be reviewed with one’s professional tax adviser to make an assessment for what alternatives there may be available for planning in a tax reform/change environment. And of course, tax reform won’t eliminate income taxes, it will just change how they are determined and computed. Our founding father Benjamin Franklin was dead-on when he said “in this world nothing can be said to be certain except death and taxes.”

William Roth is a tax partner with the local office of international accounting firm BDO USA LLP. 

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