The Tax Implications of Obama’s Nobel Peace Prize

After it was revealed last week that U.S. President Barack Obama had won the Nobel Peace prize, Obama was quick to announce that he would be donating the $1.4 million cash prize to charities. This has led many experts to wonder, what tax implications will his prize have on Obama’s next income tax return?

Pat Regnier, of CNN Money, explains that Obama should not have to worry about any tax problems as long as the money goes directly to a charity. Additionally, he might even be ok if he does not have a charity selected when he receives the award since you can deduct charitable contributions up to 50% of AGI, and many suspect that the income he earns from his book this year will not outweigh the prize money.

However, Leonard E. Burman of the Tax Prof Blog brings up another interesting point. Check out her analysis of Obama’s taxes below.

Ellen Aprill's analysis of President Obama's Nobel Prize is fascinating, but left out an important factor in favor of using § 74(b) to avoid the recognition of income. If the president claims the prize as income and then makes a charitable contribution, he'll pay more tax because of the § 68 limitation on itemized deductions. The $1.4 million increase in income will reduce President Obama's itemized deductions by $42,000 (3% of $1.4 million), raising his taxes by $14,700. The problem arises because income is effectively taxed at a higher rate than deductions for people subject to the deduction phase-out.

Other phase-outs cause the same problem. AMT taxpayers in the § 55 phase-out range for the AMT exemption, for example, can face a big tax hit if they include an honorarium or award in income and then make an equal gift to charity. Every dollar transferred reduces the AMT exemption by 25 cents, costing 6.5 or 7 cents in tax depending on whether the taxpayer is in 26% or 28% AMT bracket. (This example has particular salience for me.)

I won't cry myself to sleep thinking about the president's extra tax burden because he can reduce other charitable contributions if he wants, but it is another example of how complex and counter-intuitive our tax system can be.

New Law Encourages Cash Donations for Midwest Disaster Relief

According to their newest press release, the IRS is encouraging “Taxpayers who make qualifying cash contributions for disaster relief efforts in the Midwest could benefit from a recently passed law that suspends the percentage-of-income limits that would normally apply when taxpayers deduct the contributions on their 2008 federal tax returns.

Under the Heartland Disaster Tax Relief Act, an individual taxpayer who itemizes deductions may choose to deduct qualifying cash contributions up to 100 percent of his or her adjusted gross income, reduced by deductions for other charitable contributions. Similarly, an electing corporation may deduct qualifying cash contributions up to 100 percent of its taxable income, reduced by deductions for other charitable contributions.

Cash contributions qualify for this special treatment if they are made to a public charity for disaster relief efforts related to certain areas in Arkansas, Illinois, Indiana, Iowa, Missouri, Nebraska or Wisconsin. The areas must have been declared federal disaster areas on or after May 20 and before Aug. 1 of this year as a result of severe storms, tornados or flooding, and the areas must have been designated to receive individual assistance from the federal government because of the damage resulting from the disasters.

The contributions must be made no later than Dec. 31, 2008. “Cash” includes payments made by check or credit card. Qualifying cash contributions do not include payments to a supporting organization as described in section 509(a)(3) or for the establishment of a new, or maintenance of an existing, donor-advised fund.

Qualifying cash contributions of more than the amount allowed as a deduction can be carried over and deducted in succeeding tax years, subject to the normal limits. To substantiate the deduction, a taxpayer must obtain from the charity a written acknowledgment that the contribution was or will be used for relief efforts related to one or more of the Midwestern disaster areas.

In addition, deductions by individuals for qualifying contributions are not treated as itemized deductions for purposes of the overall limitation on itemized deductions. This means that, for taxpayers with higher adjusted gross incomes, the deduction for these qualifying contributions is not limited the way other itemized deductions are limited.”