Congress has passed legislation to address the impending tax increases and automatic spending cuts scheduled to begin in January 2013 and commonly referred to as the "fiscal cliff." The American Taxpayer Relief Act of 2012 (H.R. 8) preserves the 2001 and 2003 tax rates for the middle class, reinstates a number of tax provisions known as extenders, including the IRA charitable rollover and other giving incentives, provides permanent parameters for the estate tax and a "fix" for the alternative minimum tax, and makes changes to the treatment of capital gains for certain income thresholds. The legislation also provides a patch for Medicare reimbursement, an extension of unemployment insurance benefits, the extension of key tax provisions like the American Opportunity Credit, and delays for two months the implementation of the scheduled automatic sequestration spending cuts.
Read the IS Statement on the Fiscal Cliff Agreement
Impact on Deductions
While the legislation does not include a percentage or aggregate cap on itemized deductions, it does reinstate the Pease provision, which will place limits on itemized deductions, including the charitable deduction, on incomes above a certain threshold.
The Pease limitation on itemized deductions, first instituted by the Omnibus Budget Reconciliation Act of 1990 and named after former Congressman Donald Pease (D-OH), reduces most itemized deductions by 3 percent of the amount by which adjusted gross income (AGI) exceeds a specified threshold. Itemized deductions cannot be reduced by more than 80 percent for any taxpayer. Under the agreement just reached, the threshold is set at $300,000 for joint filers and $250,000 for individuals. Income under $300,000 for joint filers and $250,000 for individuals is not subject to the limitation.
As an income-based limitation, the Pease provision is intended to
serve as a surtax on income above a certain threshold, rather than as a
penalty on, or disincentive for, itemized deductions. Recent
analyses by the Urban Institute Tax Policy Center and the Center on
Budget and Policy Priorities have concluded that the Pease provision's
impact on charitable giving would be negligible “because the dollar reduction in itemized
deductions under Pease depends on a taxpayer’s income rather than on the amount
he or she donates, Pease doesn’t affect decisions on whether to give more to
Examples of Impact (Joint Filers):
- In 2013, a joint-filing couple has an AGI of $400,000 and $100,000 in itemized deductions ($30,000, or 30 percent, of which are charitable donations)
- The income above the $300,000 threshold for joint filers must be calculated: $400,000 - $300,000 = $100,000 in excess income
- The $100,000 excess income is multiplied by 3 percent to determine the deduction limitation:$100,000 x .03 = $3,000 limitation on itemized deductions
- The limitation is then subtracted from the otherwise allowable itemized deductions:$100,000 - $3,000 = $97,000 in allowable deductions
- For these taxpayers, the Pease provision has reduced itemized deductions from $100,000 to $97,000.
- The impact on the charitable deduction can be found by multiplying the amount of the limitation ($3,000) by the percentage that charitable donations comprise of total of deductions (30 percent):$3,000 x .30 = $900
- The Pease limitation has reduced the charitable deduction by $900 from $30,000 to $29,100.
For a point of comparison, previous proposals to cap itemized deductions at 28 percent for taxpayers in the then highest tax bracket of 35 percent would have reduced the charitable deduction for these taxpayers by $6,000.
- In 2013, a joint-filing couple has an AGI of $5 million and $1.25 million in itemized deductions ($375,000, or 30 percent, of which are charitable donations)
- The income above the $300,000 threshold for joint filers must be calculated:$5,000,000 - $300,000 = $4,700,000 in excess income.
- The $4,700,000 excess income is multiplied by 3 percent to determine the deduction limitation:$4,700,000 x .03 = $141,000 limitation on itemized deductions.
- The limitation is then subtracted from the otherwise allowable itemized deductions:$1,250,000 - $141,000 = $1,109,000 in allowable deductions.
- For these taxpayers, the Pease provision has reduced itemized deductions from $1,250,000 to $1,109,000
- The impact on the charitable deduction can be found by multiplying the amount of the limitation ($141,000) by the percentage that charitable donations comprise of total of deductions (30 percent): $141,000 x .30 = $42,300.
In comparison, previous proposals to cap itemized deductions at 28 percent for taxpayers in the then highest tax bracket of 35 percent would have reduced the charitable deduction for these taxpayers by $75,000.
limitation does not apply to deductions for medical expenses, investment
interest, casualty and theft losses, and gambling losses.
Key Tax Provisions
Income tax rates
- Current income tax rates are extended permanently on income below $450,000 per year ($400,000 for individuals). The highest marginal tax rate rises from 35 percent to 39.6 percent on income above those thresholds.
- The IRA charitable rollover and the enhanced deductions for the donation of food and real property for conservation purposes are extended for two years, retroactive to 2012, through 2013. Charitable rollovers can be made in January 2013 for 2012, and individuals who took mandatory distributions in December 2012 can donate that money to public charity and not have the distribution subject to tax.
- The legislation also extends for two years the basis adjustment to stock of S corporations making charitable contributions of property.
- The estate tax is permanently set with a $5.12 million exemption (indexed for inflation) and a 40 percent rate.
PEP and Pease (see above)
- The personal exemption phaseout and the Pease provision - which were gradually phased out by 2001 tax cut legislation - are reinstated for families earning over $300,000 per year ($200,000 for individuals).
- The alternative minimum tax (AMT) is patched permanently and indexed for inflation.
Investment tax rates
- The top capital gains and dividend rate remains at 15 percent for those below the $450,000/$400,000 income thresholds, and is increased to 20 percent for those with incomes above those amounts.
Key Spending Provisions
- The scheduled automatic, across the board spending cuts are delayed for two months, through March 1, 2013.
- The $24 billion cost to delay the cuts is offset by $12 billion in further spending reductions by lowering the discretionary caps for fiscal years 2013 and 2014 established by the Budget Control Act and $12 billion from a Roth individual retirement account conversion provision.
Other Key Provisions:
- The 50% bonus depreciation provision is extended for one year.
- The American Opportunity Credit, the enhanced Child Tax Credit, and the Earned Income Tax Credit are extended for 5 years.
- The legislation includes an extension of the Medicare "doc fix" and the Transitional Medicare Assistance program.
- The legislation also rescinds all un-obligated funds for the new Consumer Oriented and Operated Plans (CO-OPs) established as part of the health care reform law. A contingency fund of 10 percent of the current amount on un-obligated funds to further assist CO-OPs that have already been created. Previously obligated funds are unaffected.