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Charitable giving: The silver lining in a tax increase

May 01, 2013

A recent tax increase affecting upper-income Americans may prove to be good news, at least for those who are charitably inclined.

The American Taxpayer Relief Act of 2012 (ATRA) introduced a new 39.6% top marginal tax rate (up from 35%) for single filers earning more than $400,000 and married joint filers earning more than $450,000. If you find yourself in this new bracket, take heart: There may be a silver lining in the form of a higher tax deduction for your charitable gifts.

Take a closer look

A new research paper by Sarah Hammer of the Vanguard Investment Strategy Group and Alisa Shin of Vanguard Asset Management Services™ examines these issues in depth.

Read the report PDF

Generally speaking, if you make a charitable gift, you can take a deduction on your income taxes equal to the amount of the gift multiplied by your marginal income tax rate. In other words, if you're in the new 39.6% tax bracket, $1,000 in charitable giving in 2013 will generally reduce your income tax bill by $396, up from $350 in 2012.

And if you're donating appreciated securities, you'll continue to enjoy not only an income tax benefit; you also won't have to recognize long-term capital gains on such assets.

Charitable giving and itemized deductions

Typically, taxpayers itemize deductions if their total deductions exceed a standard amount. ATRA reinstated a rule, known as the Pease limitation, that limits deductions for many affluent Americans. But if you've been toying with the idea of cutting back on charitable giving as a result, there are good reasons to think twice.

The Pease limitation reduces itemized deductions by 3% of the amount your adjusted gross income (AGI) exceeds $250,000 for single filers or $300,000 for married couples filing jointly. (Generally, the Pease limitation can't reduce a taxpayer's total deductions by more than 80%.)

Consider a married couple with $350,000 in AGI. The Pease provision reduces their allowable itemized deductions by $1,500—that is, 3% of $50,000, which is the difference between the couple's $350,000 AGI and the $300,000 Pease threshold for married couples filing jointly.

If this couple's itemized noncharitable deductions (such as state and local taxes, real estate taxes, or mortgage interest) already amount to more than $1,500 (the couple's Pease limit), they will enjoy the full benefit of their charitable deductions. But if their itemized noncharitable deductions fall below their $1,500 Pease limitation, there will be no benefit to charitable deductions until that limit is met.

The bottom line: If your noncharitable deductions already exceed your Pease limitation, you're more likely to reap the full tax benefit of a charitable deduction.

(If you happen to be subject to the alternative minimum tax, the rules get a little trickier. That's why in situations like this, it's wise to consider speaking with a professional tax advisor before taking any action.)

"The Pease provision has caused some upper-income earners to worry that their charitable gifts won't be as advantageous from a tax standpoint as in the past," said Sarah Hammer, a senior analyst with Vanguard Investment Strategy Group. "But it's important to understand that for a great many taxpayers, mortgage interest and state or local taxes will more than equal the Pease limitation, making charitable gifts just as beneficial as always."

How Vanguard Charitable can help

A donor-advised fund is a tax-effective way to consolidate, accrue, and grant assets to charity.

The personal philanthropic accounts offered by Vanguard Charitable allow you to support your favorite charities without having to perform day-to-day investment management, grantmaking, or oversight activities.

Another benefit of a donor-advised fund is that you can make an irrevocable contribution and immediately take a full tax deduction for the amount of your gift—even if you haven't yet named a specific charity to receive the money. Simply recommend an investment allocation for your contribution and, over time, request grants to the charities of your choice.

Founded by Vanguard in 1997 as an independent 501(c)(3) public charity, Vanguard Charitable has granted more than $3 billion to nonprofit organizations across the country.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • The information here is intended to be educational in nature and shouldn't be construed as a substitute for legal or tax advice. Please consult an independent legal and/or tax advisor for specific advice about your individual situation.
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