Article 1040EZ: What Does the Obama Tax Compromise Mean for Nonprofits?

Between 2001 and 2003, the Bush administration passed a series of tax cuts to reinvigorate the faltering economy. Featuring built-in “sunset” provisions, the reforms were set to expire on January 1, 2011 unless renewed by Congress. With that deadline rapidly approaching in an increasingly contentious political environment, the Obama administration has proposed a compromise plan, which recently passed a cloture vote in the Senate. Under the bill, many of the stipulations of the Bush tax cuts would remain in place until 2012; however, the plan faces opposition from some Republicans, as well as House Democrats. 

Below, we have summarized the aspects of the planned legislation most likely to affect major gift donors, although we note that the final shape of the bill could easily change before its passage. While research has consistently shown that few individuals give primarily for tax reasons, nonprofits that understand tax laws can better meet their donors’ needs, ultimately strengthening relationships with these individuals.

Disclaimer: Please note that this article should not be construed as tax preparation advice. For information regarding how changes in legislation could affect you or your organization’s returns, consult a licensed tax professional.

Effects on Charitable Giving

A variety of provisions in the proposed legislation promote charitable giving, including:

  • Maintaining the current tax extenders, which permit IRA owners over age 70 1/2 to arrange tax-free gifts from their accounts (a special provision moves the deadline for making 2010 IRA gifts to January 31, 2011)
  • Repeal through 2012 of cutbacks in certain itemized deductions – including charitable deductions – for individuals with high incomes
  • A two-year extension of low tax rates on long-term capital gains and qualified dividends, meaning people who receive income from charitable gift annuities and charitable remainder trusts will pay tax at only a 15% rate (0% in some cases) 
  • In 2010 and 2011, increased deductibility gifts of appreciated real estate for conservation purposes, gifts of food inventory by businesses, gifts of book inventories from C corporations to public schools and corporate gifts of computer equipment and software to public schools
  • Favorable tax treatment of shareholders in S corporations that contribute property to charity in 2010 and 2011

The Estate Tax

Benjamin Franklin once wrote, “Nothing can be said to be certain but death and taxes;” however, the status of estate taxes—or, in the words of some pols, “death taxes”—remains slightly more ambiguous. Beginning with the 2001 Bush legislation, the estate tax gradually decreased each year before its repeal in 2010.  Unless Congress updates the current law, estates valued at more than $1 million will be subject to taxes of up to 55 percent after 2011. Under the Obama plan, estates valued at more than $5 million would be taxed at a 35 percent rate. Democrats in the House of Representatives have proposed an amendment to the bill, based on earlier legislation, that would levy a 45 percent tax on estates more than $3.5 million.

Only a handful of estates would owe tax under a $5 million estate tax exemption, but estate tax savings will continue to be a motivating factor for wealthy individuals considering charitable bequests. All donors, regardless of wealth, should be reminded that estate planning goes far beyond estate taxes, and that they need to plan for a thoughtful distribution of their assets at death. Important considerations include the reduction of estate expenses such as probate, state estate taxes, income taxes on retirement accounts, as well as the donor’s legacy to future generations. In the final analysis, everyone needs a will and should be encouraged to consider bequests to the organizations they supported during life.

Income Tax

The compromise would extend the Bush-era tax cuts, effectively:

  • Maintaining the current tax brackets (note that the table lists the maximum income in each bracket):

10%

15%

25%

28%

33%

35%

$8,375

$34,000

$82,400

$171,850

$373,650

Any greater

 

  • Extend the modified child tax credit, which allows taxpayers with children to claim a $1,000 credit on their returns.“Child Tax Credit” 
  • Continue the  marriage penalty relief policies, which double the income levels in each tax bracket for married couples. “Marriage Penalty” 

Capital Gains Tax

Like income tax rates, taxes on long-term capital gains (which include income from the sale of stocks, bonds, real estate and other assets sold at a higher price than their initial cost) are also due to return to earlier levels, effectively increasing from 15 to 20 percent. Taxes on dividend income, also currently at 15 percent, would revert to the asset holder’s tax bracket rate.  (For instance, if a stockholder fell in the 25 percent tax bracket, her dividends would also be taxed at 25 percent.)  Under the current compromise, both the capital gains and dividend income tax rates would remain at 15 percent.