For affluent charitable givers>, this year is different thanks to an unresolved uncertainty in the tax code for 2010 and an unfavorable development scheduled to take effect in 2011. Here s what you need to know, along with some recommendations.
For years, high-income individuals had to worry about their charitable donation write-offs being phased out. Then the phase-out rule itself got phased out as part of the Bush tax cuts, and it was eliminated completely for 2010. Starting in 2011, however, the phase-out rule will be back on the table unless Congress changes the deal, which I think is unlikely. Assuming I m right, moving some charitable donations from next year into this year could be a tax-smart move.
Here s how the phase-out rule will work next year if it comes back as expected. Your 2011 charitable donation write-off (plus write-offs for mortgage interest, state and local taxes, and miscellaneous deduction items) will be reduced by 3% of excess adjusted gross income. Excess AGI is equal to the number shown on the last line of page 1 of Form 1040 minus an inflation-adjusted threshold that changes each year. For 2011, the threshold is estimated to be $171,100 or $85,550 for those who use married filing separate status (if your AGI is at or below the threshold, you re off the hook). If you re a victim of the rule, the maximum amount that can be phased out will be limited to 80% of your affected deductions.
Confusing? You bet. Here are two examples to help clarify things.
Example 1: Say your 2011 charitable donations to IRS-approved charities, mortgage interest, state and local taxes, and miscellaneous deduction items will total $40,000, including your usual $10,000 of annual charitable donations. Say your 2011 AGI will be $400,000. Under the phase-out rule, your deductions will be reduced by $6,868 [3% x ($400,000 - $171,100) = $6,868]. That amounts to a 17.17% cutback, and it means your 2011 charitable write-off will be reduced by the same 17.17% to $8,283. Obviously, the phase-out rule s impact is not a huge cause for concern in your case, and it might be partially offset if you wind up paying higher federal income tax rates next year (because each dollar of deduction would be worth more next year than this year). Even so, you still might want to consider moving some donations that you would otherwise make next year into this year. That way, you re assured of being able to deduct 100% of whatever you donate this year.
Example 2: Say your 2011 charitable donations, mortgage interest, state and local taxes, and miscellaneous deduction items will total $75,000, including your usual $25,000 of annual charitable donations. Say your 2011 AGI will be a whopping $2.5 million. Under the phase-out rule, your 2011 deductions will be reduced by the maximum 80%. Your charitable write-off will be reduced by the same 80% to only $5,000. What if you donate $50,000 this year --your usual $25,000, plus next year s $25,000? Good idea! You ll get the full tax-saving benefit of the $50,000 charitable donation write-off on your 2010 return, because the phase-out rule is gone for this year. Now, if you re really upset about the phase-out rule, you could decide to donate a bunch of extra money this year to take full advantage of the rule s absence. All your 2010 contributions will be 100% deductible.
Charitable Donations from IRAs Are on Hold
For the last few years, folks who were 70 and older had the option of making donations to IRS-approved charities directly out of their IRAs. While no itemized charitable deduction was allowed for this maneuver, the impact was effectively the same as a deduction -- IRA money that would eventually be taxed was sent directly to charities. In fact, this drill had more tax-saving power than normal charitable donations because it bypassed all the usual restrictions on itemized charitable write-offs (including the phase-out rule we just talked about). Unfortunately, the IRA charitable donation option expired at the end of 2009. Although nearly everyone (including me) expected Congress to extend it through this year, we re still waiting.
Stay Tuned for Developments
The tax environment for well-off charitable givers might improve before year-end. Although I expect the itemized deduction phase-out rule to return next year as scheduled, I could be wrong. The November election results might cause Congress to decide that sticking it to affluent taxpayers in 2011 is not such a great idea after all. Regardless of how the election turns out, I think the IRA charitable donation option will be restored for this year. So if you re interested in that idea, be prepared to quickly pull the trigger when the time comes.