The Future of the Charitable Deduction
By Pete Kennedy, CPA, CVA
GetInvolved Nonprofit Guide Article published in the September 2012 News Journal
No matter who wins the election in November, tax reform will be at the top of the agenda. If there’s one thing both sides can agree on (quite possibly the only thing they can agree on), it’s that the tax code needs to be fixed. The broad outline of the Democrats plan is the “Buffet Rule,” where those making large amounts of money should pay a higher percentage in tax. For the Republicans, it’s “broaden the tax base, reduce the rates.” As with most things, the devil is in the details. Every detail in the tax code is there for a reason – the loopholes that exist are not accidents. If either side was to provide details of a tax plan, it would assuredly cost them votes so they will remain vague for as long as possible.
The charitable deduction stands as one of the best examples of social engineering through the tax code. By encouraging charitable giving through tax benefits, the tax code has at least in part helped to create a network of organizations that provide for society’s needs in areas of housing, education, healthcare, historic preservation, religion, etc. That said, the same deduction is routinely listed as one of the IRS’s “Dirty Dozen” tax scams. While it can’t be denied that abuse occurs, it is my belief that it happens primarily at the individual level or at “charitable” organizations no one has ever heard of – which should never have been granted exempt status in the first place. The notion that a true publicly supported charity would risk its very existence by abetting a tax scam makes little sense. Cheaters will cheat, and if the charitable deduction is closed off as an avenue to cheat another will be found. Be that as it may, for economic reasons, the subsidy represented by the charitable deduction is on the block along with everything else.
Regardless of who wins the election, the “Fiscal Cliff” looms in January 2013. The Fiscal Cliff is a self-imposed set of spending cuts and tax increases that were designed to be so dire and onerous they would force the Congress into bi-lateral action. It was originally intended to be enforced in 2011, but was delayed until after the 2012 election cycle. The Simpson–Bowles plan was intended as a bi-partisan blueprint for deficit reduction to be enacted as an alternative to the “Cliff.” Republican nominee Romney states in his campaign literature that the Simpson-Bowles report will be used as a starting point (and VP Nominee Ryan was on the Committee itself). While Democrats are even less forthcoming as to their plans, many believe that given the small time window between the election and the “Cliff,” Simpson-Bowles (or a plan derived from it) is the only realistic option.
As John Aloysius Farrell and Nancy Cook of the National Journal wrote in an August 17, 2012 article entitled The Legend of Simpson-Bowles, “There is a reason that so few of the commission’s 70-odd recommendations – and none of its major planks – have made it past the hypothetical. Simpson-Bowles hurts.” As one of its guiding principles, the Simpson-Bowles report states that “America’s tax system is broken and must be reformed.”
So what would Simpson-Bowles mean for the charitable deduction? Would nonprofits escape the pain? First, a little bit of good news …Under the Simpson-Bowles illustrative plan, there is no longer a decision point between itemizing and using the standard deduction, meaning that a taxpayer would no longer need to eclipse the standard deduction level in itemized deductions before benefiting from their contributions. Okay, that’s a very little bit of good news, especially considering the bad news …The concept of itemized charitable deductions is eliminated under the illustrated plan and replaced with a 12% nonrefundable credit coupled with a 2% AGI floor. That’s a mouthful, but here’s a simple example to demonstrate the difference:
Let’s assume that a taxpayer, who would itemize deductions anyway, currently has $100,000 in taxable income and is in the 28% tax bracket. If he/she contributes $5,000, they would receive $1,400 in benefit ($5,000 x 28%).
Under the Simpson-Bowles plan, however, the same taxpayer would receive only $360 in benefit ($5,000 minus $2,000, representing the 2% floor, x 12%) – a reduction of $1,040, or 74%.
We are obviously still in the hypothetical stage at this point. After the election cycle, however, the changes will come fast and furious. Or the “Cliff” may be pushed out once again. While Congress may not be able to move mountains, they have proven they can move cliffs.
At the end of the day, people make charitable contributions for different reasons. With the possible exception of those donating their old clothes (they were brand new, still had the tags on them – honest!), no one can be singularly motivated by the tax benefit to make a charitable donation – if they were, why not just keep the $$ and pay the tax? The extent to which a reduction in the tax benefits of charitable contributions such as the one discussed above would impact giving overall is an open question – only time will tell.
If your organization has questions regarding the charitable deductions, please contact Pete Kennedy, or any other member of our Nonprofit Practice team, at Cover & Rossiter at (302) 656-6632.
Cover & Rossiter, P.A. (www.CoverRossiter.com) is one of the most respected and experienced CPA firms serving the accounting, tax and audit needs of the nonprofit community in Delaware.