Indiana Business Law Blog
Although the tax reform bill just passed by the U.S. House of Representatives retains the income tax deduction for individuals who make contributions to charitable organizations (i.e., organizations that are tax exempt under Section 501(c)(3) of the Internal Revenue Code), it may nonetheless have significant effects on the amount of charitable giving by Americans. The reason lies in the increase in the standard tax deduction for individuals and the elimination of other deductions.
Increasing the Standard Deduction
The tax code provides several types of deductions that reduce the amount of tax owed by individual taxpayers, including deductions for home mortgage interest and contributions to charitable organizations. However, the tax code also provides a minimum “standard deduction” for taxpayers who have less than that amount in itemized deductions. Taxpayers who itemize deductions receive a tax benefit by making a charitable contribution, but not those who take the standard deduction. For example, the after-tax cost of a $100 contribution by most itemizing taxpayers in the 25% tax bracket is only $75. For taxpayers who take the standard deduction, the cost of a $100 contribution is $100 in both before- and after-tax dollars.
The current standard deduction for a married couple filing jointly is $12,700. Under the House bill, the new standard deduction would be increased to $24,400. In other words, under the House bill, fewer taxpayers will itemize deductions, which means that fewer taxpayers will receive any tax benefit from making contributions to charitable organizations.
Elimination of other Tax Deductions
The House bill would also eliminate most itemized deductions. Those retained include deductions for charitable charitable contributions, state and local property taxes (subject to a cap of $10,000 a year), and home mortgage interest (subject to a cap of $500,000 in principal for new mortgages, down from $1 million). All others would be eliminated, including those for state and local income taxes, medical expenses, tax preparation expenses, and student loan interest. As a result, fewer taxpayers will have enough deductions to itemize, even before taking into account the increase in the standard deduction.
The Effect of Tax Deductions on Charitable Giving
It is logical to assume that individuals who support charitable organizations consider the tax consequences of donations, but how much will the above changes affect charitable giving? In May 2017, the Indiana University Lilly Family School of Philanthropy published a study, Tax Policy and Charitable Giving Results, estimating that increasing the standard deduction to $24,000 (which is close to the standard deduction of $24,400 contained in the House bill) would reduce charitable giving by 3.9%. That number likely understates the decline in charitable giving because the study did not consider the effect of eliminating other deductions, with its corresponding additional decrease in the number of people who itemize deductions.
The overall number is not the entire story because the estimated effect of increasing the standard deduction differs significantly with the taxpayer’s income level. For households with less than $50,000 of annual income, many of whom probably do not itemize deductions now, the decrease in charitable giving would be only 1.2%. For middle-income households, those with annual incomes between $50,000 and $100,000, the decrease would be 6.9%. For households with annual incomes greater than $100,000, the reduction in charitable giving would be 3.3%.
Naturally, the Indiana University study has its uncertainties. The estimates quoted above are subject to certain assumptions, and changing those assumptions also changes the estimates. In addition, the House tax bill contains other provisions that may affect charitable giving, such as the increase or elimination of certain limits on charitable deductions.
Even so, Section 501(c)(3) organizations that rely on contributions from individuals should plan for the possibility of decreased revenues if reform similar to the House bill becomes law. Moreover, those organizations that rely on donations from middle-income individuals should expect the greatest impact.