On June 24, 2016, House Republications released their Tax Reform Policy Agenda Blueprint (Blueprint). I’ll focus on the proposals in the Blueprint that directly affect charities and their donors. Be mindful that statements indubitably favoring charities and donors can be virtually decimated by the side effects of other proposals.
Side Effects Up Front
Only 5 percent (compared with the present 35 percent) of taxpayers would itemize their deductions; income and capital gains tax brackets would be reduced; the 40 percent estate tax that applies to less than 0.2 percent of estates would be repealed (but that’s where lots of the money is) and the generation-skipping transfer (GST) tax would be repealed.
Encouraging Charitable Giving
Americans are generous people who want to help their neighbors in need. For this reason, this Blueprint encourages charitable giving through a tax incentive.
Today, a taxpayer may claim an itemized deduction for charitable contributions. Because a taxpayer must itemize to claim a charitable deduction, however, only about 35 percent of taxpayers benefit from the current charitable contribution deduction. Moreover, historical data show that the total amount of charitable giving is tied more closely to the health of the overall economy than to any specific tax policies that might be in place. The best way to promote charitable giving to the organizations doing so much good in communities across the country is to improve the overall health of the American economy, which is precisely what this Blueprint will achieve.
Tax Reform Act of 2014
The starting point for the Blueprint’s changes in the charitable deduction and other tax rules is likely to be the introduced, but not enacted, Tax Reform Act of 2014 (H.R. 1).
That bill, introduced in the waning days of the last Congress by former Ways and Means (W&M) Committee Chairman Dave Camp (R-Mich.), has major charitable gift disincentives. And current W&M Committee Chairman Kevin Brady (R-Texas) says that the Camp bill will be the starting point for drafting tax reform legislation in 2017.
Highlights of the Camp bill:
- The invisible elephant in the W&M Committee room. Only 5 percent (instead of the current 35 percent of taxpayers) would itemize their deductions. This would result from the proposed elimination of all currently allowable itemized deductions except the charitable and mortgage interest deductions and an increased standard deduction.
- A 2 percent adjusted gross income floor for charitable deductions.
- No fair market value (FMV) deduction for long-term appreciated real estate and non-publicly traded securities. But FMV deductions would still be allowable for long-term appreciated publicly traded securities and related-use tangible personal property.
- Distributions would be required by donor-advised funds and excise taxes imposed on salaries of highly compensated executives of charities.
- Nothing to cheer about—college athletic-event seating rights. The special rule that provides a charitable deduction of 80 percent of the amount paid for the right to purchase tickets for athletic events would be repealed.
- The adjusted gross income (AGI) limitations on deductible contributions would be “substantially simplified.” The 50 percent limitation for cash contributions and the 30 percent limitation for contributions of capital gain property to public charities and certain private foundations would be “harmonized” at a single limit of 40 percent. The 30 percent contribution limit for cash contributions and the 20 percent limitation for contributions of capital gain property that apply to organizations not covered by the current 50 percent limitation rule (private foundations) would be “harmonized” at a single limit of 25 percent. Thus, contributions to this latter group of organizations would be allowed to the extent they don’t exceed the lesser of: (1) 25 percent of AGI or (2) the excess of 40 percent of AGI for the tax year over the amount of charitable contributions subject to the 25 percent limitation. Simplified?
- Gifts of qualified conservation easements would generally continue to be deductible at FMV (but remember the 2 percent AGI floor). And additional special benefits would be allowed for conservation easements and land gifts by farmers and ranchers.
Charitable giving, the Blueprint states, is fueled by economic growth. Experts and advocates for charitable organizations have presented many policies over the years for reforming the deduction for charitable contributions to make it more effective and efficient. The W&M Committee will develop options to ensure the tax code continues to encourage donations, while simplifying compliance and record keeping and making the tax benefit effective and efficient.
Individual Income Tax Rates
Today, there are seven regular tax brackets for individuals, with a top individual income tax rate of 39.6 percent. The Tax Reform Blueprint will make the individual tax system simpler, flatter and fairer. This Blueprint will consolidate the current seven tax brackets to three brackets (12, 25 and 33 percent). Going forward, these income tax brackets will be indexed for inflation.
Individual Alternative Minimum Tax (AMT)
This would be repealed.
Income from Savings and Investment
Families and individuals will be able to deduct 50 percent of their net capital gains, dividends and interest income, leading to basic rates of 6 percent, 12.5 percent and 16.5 percent on such investment income depending on the individual's tax bracket.
Simple, Fair Postcard Tax Filing
Because these changes will significantly reduce the complexity and compliance burdens of the current system, the approach reflected in the Blueprint will mean that the revised tax filings for most Americans will be simple enough to fit on a postcard. The Tax Code currently includes five basic family tax deductions and credits, each with its own rules, eligibility criteria and calculations. Three benefits—the basic standard deduction, additional standard deduction and personal exemption for taxpayer and spouse—are intended to protect a minimum level of income from federal income taxation, with the level depending on whether the taxpayer is single or married. The other two—the personal exemptions for children and dependents and the child tax credit—are intended to deliver additional tax benefits to households with children and dependents. Consolidating these five benefits into two simpler benefits—larger standard deduction and an enhanced child and dependent tax credit—will achieve the same policy and distributional goals as current law, while making the Tax Code much simpler for low- and middle-income families.
Consolidation of Deductions
The Blueprint will consolidate the basic standard deduction, the additional standard deduction and the personal exemptions for families and individuals. The new larger standard deduction will be $24,000 for married individuals filing jointly, $18,000 for single individuals with a child in the household and $12,000 for other individuals. These amounts will be adjusted annually for inflation.
To simplify tax filings further for middle-income families, the Blueprint reflects the elimination of all itemized deductions except the mortgage interest and the charitable contribution deductions. These two provisions help accomplish two important goals that strengthen civil society: home ownership and charitable giving.
Home ownership. Historical data show that the strength of the nation's housing market is tied more closely to the health of the overall economy than to any specific tax policies that might be in place. The best way to promote a thriving housing market is to improve the overall economy, which is precisely what comprehensive tax reform will achieve.
Today, individuals may contribute to individual retirement accounts, including traditional IRAs and Roth IRAs, subject to a variety of rules providing for contribution limits and income phase-outs. Individuals who are covered by a 401(k) or another employer-based retirement plan may have options for traditional accounts or Roth accounts within the plan. These accounts are subject to maximum elective contribution amounts.
The W&M Committee will explore the creation of more general savings vehicles, using as a model the retirement accounts that have proven so successful. Many individuals have proposed universal savings accounts over the years as a way to eliminate the double taxation of savings and investment for families. These are accounts into which individuals could contribute cash and over which they would have full control of investment decisions. Account holders could withdraw both contributions and earnings at any time, and for any reason, without penalty.
Other Provisions Affecting Individuals
Numerous other exemptions, deductions and credits for individuals riddle the Tax Code, making it less fair for those who can’t take advantage of those provisions and more complicated for everyone. These special interest provisions require higher tax rates to compensate for the lost revenue, thus raising taxes on others and hurting the economy by reducing the incentives to work, save and invest. This Blueprint will repeal these special interest provisions to make the system simpler, fairer and flatter for all families and individuals.
Estate and GST Taxes
The estate and GST taxes would be repealed. This will eliminate the death tax, which can result in double, and potentially even triple, taxation on small businesses and family farms.
Tax Rate Structure for Small Businesses
Today, 95 percent of businesses in the United States are operated as sole proprietorships or pass-through entities such as partnerships, limited liability companies (which are taxed in the same manner as partnerships) and S corporations.
Moreover, more than 50 percent of business income in the United States is earned through sole proprietorships or pass-through entities. Business income earned through a sole proprietorship or a pass-through entity today is reported by the owner or owners of the business on their individual tax returns and is taxed at an income tax rate as high as 44.6 percent. This Blueprint will limit the tax rate that applies to small business and pass-through income to the 25 percent bracket. In other words, the 33 percent bracket won’t apply to the active business income of sole proprietorships and pass-through entities. This represents the lowest top tax rate on the income of such businesses since before World War II.
A Historic Corporate Tax Rate Reduction
The effective double taxation of corporate income will be reduced through the reduction in the tax on dividends and capital gains of individual shareholders. As discussed above, individuals will be taxed at just half the regular individual tax rate on both dividends paid on corporate shares and capital gains recognized on dispositions of corporate shares. The corporate AMT would be repealed.
A New Internal Revenue Service for the 21st Century
An integral element of this Blueprint will be to rebuild the IRS into a modern and efficient 21st-century administrator of the nation's tax system. The new IRS will have a streamlined structure aligned with the simpler and fairer tax system for families and individuals and businesses of all sizes.
The Path Forward
After the release of this Blueprint, the W&M Committee will turn its attention to the work of building the tax reform legislation that will encapsulate the policies and provisions reflected in the Blueprint. The legislation that the W&M Committee will develop will be ready for legislative action in 2017.
The Blueprint lays out the vision for a new tax system that is built for growth. As with any changes to the tax code, especially changes of the magnitude of the reforms set forth in this Blueprint, a smooth transition from the current system to the new system will be necessary.
© Conrad Teitell 2016. This is not intended as legal, tax, financial or other advice. So, check with your advisor on how the rules apply to you.