Experts have long questioned the impact of tax incentives on the philanthropic motivations of American donors. We have followed projections about proposed federal tax law changes on giving to nonprofits across the United States with interest, especially prompted by the corporate tax deadline today and knowing that we are only one month away from the annual federal income tax filings for almost all Americans our thoughts focus on taxes and giving.
Our recent analysis about taxes and their impact on giving suggests unclear projections and calls into question the importance of taxes as a tax motivator for giving, especially on the decision-making processes by high net worth donors. However one looks at the questions, it becomes more than a little complicated.
As we developed our analysis, our basic observation follows that giving will go up in 2012 and down in 2013if proposed changes take place. We arrived at this projection by looking at past performances and insights from others who provide financial service guidance and advice to wealthy Jewish Americans!
Here is an overview:
The Obama Administration’s FY2013 budget proposal to alter the tax code may have absolute implications for charitable giving. Presently, United States tax law permits individuals who itemize to claim contributions for charitable organizations as legitimate deductions on their income tax returns. Under the 2010 Tax Relief Act, the United States’ existing tax rate structure was preserved for two years, keeping alive certain Bush-era tax cuts. One noteworthy aspect of the 2010 Act was that it temporarily extended a full repeal on the limitations placed on itemized deductions, thereby prolonging incentives to contributors to charitable organizations.
The tax code changes contained within the proposed FY2013 budget seek to revive the limitations placed on itemized deductions for higher income tax payers (those with incomes above $200,000 for single individuals and $250,000 for married couples filing a joint return). Included within the President’s proposal is a limit to the tax rate in which individuals and couples at the higher incomes can take itemized deductions: limits amount to a maximum of 28% (it now stands at 35%). Additionally, the changes would allow the top tax rate to increase from 35% to 39.6%, increasing the tax liability for all taxpayers with taxable income over $390,050.
According to The Center on Philanthropy at Indiana University, the proposed tax code changes would have a greater impact on the potential giving of high net worth individuals. Looking at the proposed 28% cap on itemized deductions, The Center on Philanthropy estimates a decline of .064% on charitable giving by itemizers. In combination, the two proposals are estimated to detrimentally affect household giving by tax itemizers by 2.4%. (Generally, individuals account for most charitable gifts.)
Changes in the tax code historically have had relatively modest effects on charitable giving, and it is likely that the proposed 2013 tax code changes will influence some contributions. However, we contend that tax motivations primarily determine the structure and timing of major gifts, not influencing charitable intent.
Note that the last major revisions to the tax code, in 1986, witnessed donors making significant year-end charitable gifts, often paying ahead on gifts they would have otherwise made in 1987. In fact, Giving USA reported a substantial decline in giving in 1987, primarily attributed to the 1986 tax changes. Giving levels returned to previous rates in 1988 and 1989.
We believe the President’s proposed limit of itemized deductions to a maximum of 28% could affect charitable giving. And for those potential donors who plan their giving based on the ability to reduce their tax liability through charitable deductions, this cap could potentially provide them with reduced financial incentives to give.
By increasing the tax rate from 35% to 39.6%, as proposed, those potential donors in this top marginal tax bracket would likely realize a reduction in their disposable income since a greater percentage of their income would be directed towards fulfilling their increased tax liability. We believe that with reduced disposable income, it is possible that these wealthy givers could ultimately reduce their charitable donations. It is important to reiterate that tax liability implications typically do not cause a major donor to withhold a gift. In the short term, however, as we saw in the last major change in the Reagan Administration, a major donor may reconsider the timing on donation payments.
Our discussions with two tax experts suggest some other issues, primarily impacting high net worth donors. Julie H. Zakroff, CPA, of Dresher, Pennsylvania, foresees some potentially detrimental results on the contributions from Jewish donors as a result of the proposed tax code changes. Unless they are unusually charitable or have a particularly strong affinity for an organization, her wealthy clients almost always approach charitable giving strategically. From this perspective, she believes that by increasing the tax rate to 39.6%, her wealthy clients will be less likely to donate as they will have less to draw from: a potential danger sign for Jewish nonprofits.
The proposed tax code changes will likely affect different donors in a variety of ways. Stuart Katz, CPA, a tax manager in Philadelphia, Pennsylvania, believes that generally, charitable contributions by “the six-figure married couple” are not tax motivated. They will either give or not give. By contrast, many of his higher net worth clients are motivated by tax issues. He predicts that high net worth donors will be more hesitant to increase their charitable contributions with the proposed 2013 tax code changes, rather than reduce their overall giving.
As expected, the proposals have not been received well by many nonprofits. Nathan J. Diament, the Washington, D.C. director for the Orthodox Union, was quoted as saying, “We were hoping this would not come up again this year. We asked that they not renew it, but unfortunately the request was not taken. It’s a real concern.”
Clearly, the negative implications of the proposed tax code changes on charitable giving are greater as a result of tax rate increases rather than through limitations on itemized deductions. However, we believe that the amount available for someone to give is more demonstrative of that person’s ultimate decision on whether or not to donate rather than any incentives provided by the ability to itemize deductions for charitable giving and to reduce their tax liability. Typically, the biggest donors plan their gifts strategically and are motivated to contribute regardless of the tax implications. The mission, vision or other commitments to the charity is usually motivation enough and trumps any itemized deduction opportunities. However, it is possible that mid-range donors, less driven by strategy and for whom the deduction plays a significant role in their giving, could be affected.
More often than not, changes to the overall economy directly affect household circumstances and wealth has the greatest impact on charitable giving as compared to changes in tax rates. While we hold that the proposed tax code changes may affect mega gifts rather than average donations, an improving economy is the critical factor for increasing giving across all income levels. Nonprofits should continue to effectively communicate their importance to prospective donors regardless of which way the taxing pendulum swings. Donors continue to press for improvement, growth and transparency at all levels. We predict that those nonprofits that consistently meet these demands head on, and going beyond them, can essentially transcend tax considerations.