The Impact of Tax Reform on Charitable Deductions and Nonprofits

By October 8, 2019 July 30th, 2020 Not-for-Profit, Tax
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When the Tax Cuts and Jobs Act (TCJA) passed in 2017, there was general concern around nonprofit organizations about the future of charitable giving in the United States. In fact, research performed by the Indiana University Lilly Family School of Philanthropy prior to the passage of the TCJA predicted a reduction in charitable giving by $13.1 billion. The Tax Policy Center estimated an even larger drop of $20 billion. Tim Delany, president and CEO of the National Council of Nonprofits, explained that the Act was “worrisome” as “Congress is also trying to cut spending on domestic programs. That will lead to more people having more needs. We’re just concerned that this is going to overwhelm the nonprofit community.”

So, here we stand nearing the close of 2019. What actually happened to charitable giving in 2018? What new tax policies had the greatest impact? And where do nonprofits go from here?

What changes did the TCJA bring for charitable giving?

Federal tax reform introduced five changes with potentially significant effects on charitable giving. Among the most notable are:

1. Standard deduction increase

One of the most striking changes of the TCJA is the near doubling of the standard deduction for individuals and families. More specifically, in 2017 taxpayers claiming the standard deduction could reduce income by $6,350 for single filers and $12,700 for married couples filing jointly. However, under the TCJA, starting in 2018 these amounts drastically increased to $12,000 for single filers, $18,000 for head of household filers, and $24,000 for married couples filing jointly. This increase occurred alongside the reduction or elimination of other itemized deductions. Therefore, taxpayers who previously itemized their deductions are now inclined to claim the standard deduction instead.

The change in itemized deductions sparked concern among nonprofits. The 46.5 million taxpayers believed to itemize deductions in their 2017 income tax returns represented 30% of all taxpayers at the time. This raised the question of whether or not the expected reduction in taxpayers claiming itemized deductions – and thus a reduction in people receiving a tax benefit for charitable contributions – would impact the number of individuals donating to charities and nonprofits.

This change promises to have the most notable impact on charitable giving. Note that in 2015, 82% of all taxpayers who itemized their deductions claimed a charitable contribution. In 2017, 75% of taxpayers in the 90th to 95th income percentile (meaning a lower household income) claimed the deduction. Following the passage of the TCJA, however, barely 33% of those same taxpayers will be able to deduct their charitable gifts.

Taxpayers may still claim a charitable contribution deduction; however, doing so only reduces your taxes if all of your itemized deductions exceed the newly raised standard deduction.

2. State and Local Tax (SALT) deduction cap

In addition to the standard deduction increase, the TCJA capped the state and local tax (SALT) deduction at $10,000. This means a taxpayer’s deduction for state and local income, sales and property taxes is limited to a combined total deduction of $10,000. Anything above the amount is not viable for deduction. Between the elevated standard deduction and limited SALT deduction, it is more likely that those whose taxes surpass the thresholds may opt against itemizing their deductions since the greater benefit lies with the standard deduction.

This particularly created a very real potential problem for citizens living in states with high income or property taxes such as Florida, New York and California.

3. Adjusted Gross Income (AGI) limit

The TCJA also increased the limit on deductions for charitable contributions from 50% to 60% of adjusted gross income (AGI). The increase, though, is only beneficial to those able to claim a charitable giving deduction. With an elevated standard deduction, fewer people are able to itemize their deductions and therefore claim the charitable deduction.

4. Estate tax exemption

Per the TCJA, estate and gift tax exemptions doubled for individuals and couples. The estate tax exemption jumped from $5.49 million to nearly $11 million for individuals, and $10.48 million to almost $22 million for married couples. As a result, there is a lowered tax burden on their heirs. This change reduces the incentive for wealthy contributors to consider charitable bequests as part of their estate planning, as more property can now be transferred to their beneficiaries tax-free.

This provision expires in 2026, returning the exemption to its pre-TCJA level.

5. Corporate tax rate

One of the most significant adjustments under the TCJA was the corporate tax rate which dropped from 35% to 21%. The reduction not only catalyzed corporate profits and improved the economy, but also reduced the tax benefits gained through charitable giving.

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What is the impact on nonprofit organizations?

Much of the TCJA provisions affecting charitable giving took hold in 2018. Now nearing the end of 2019, we are able to assess the research on charitable giving in the first year post-tax reform.

Quite simply, charitable giving in the United States suffered its greatest drop since the Great Recession of 2008-09. Research places part of the blame on the reformed tax policies. The Giving USA 2019: The Annual Report on Philanthropy for the Year 2018 provides valuable insight.

According to the Giving USA report, total charitable giving increased 0.7% measured in current USD over the revised total of $424.74 billion contributed in 2017. However, after inflation adjustments, total giving showed a decline of 1.7%. In addition, the Fundraising Effectiveness Project noted a 6% decline in charitable giving in the first three months of 2018.

Breaking Down the Numbers

According to the Giving USA report, total charitable giving rose 0.7%. Here is the breakdown by groups (unadjusted for inflation):

  • Individual giving (68% of total donors) declined 1%
  • Foundation giving (18% of total donors) increased 3%
  • Bequests (9% of total donors) remained flat
  • Corporate giving (5% of total) increased 4%

The good news was that donations increased in two major sources: foundations and corporations. However, the individual giving decline is alarming. In 2018, individual giving declined by 1.1% to $292.09 billion. Adjusted for inflation, this number is a stark decline of 3.4%. Furthermore, the total number of individuals decreased as a percentage of the total from 70% in 2017 to 68% in 2018. Also of note, most of the donations to religious institutions is done through individuals, rather than corporations or foundations. Therefore, charitable giving to religious institutions also took a hit.

The decline in individual giving was the first since 2013 and a stark change of pace from the 5.7% increase in 2017.

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What steps can nonprofits take to tackle tax reform?

We are still unsure whether the variation in charitable giving last year was a blip on the radar or the start of a new trend, but the reality is that the implications of the TCJA will be in place until 2025. So what can you do in the meantime?

1. Be proactive and engage with corporate and foundation donors to find out how the new tax law affects their philanthropy strategy. These two groups showed an uptick in charitable contributions so follow the money. By understanding their perspective, you can strategize to help them achieve their goals. In addition, you can revisit corporate donors who previously declined your donation requests and make them aware of your mission.

2. In terms of individuals, the best approach is to think high and low. Lower tax rates paired with a strong market means high net-worth individuals are likely to have more disposable income. This opens up the possibility for a larger first-time gift or an increase from their prior donation levels. The raised standard deduction, while impacting lower income households, actually yields a smaller effect on high net-worth donors.

3. On the opposite end of the scale are the lower-level donors. These individuals are significantly more affected by the standard deduction raise and have less incentive to itemize their deductions. With the loss of itemized deductions comes the loss of an incentive for a charitable contribution. Therefore, to attract these donors and encourage them to continue giving, focus on the mission of your organization, not the tax benefit. Achieve this by ramping up direct appeals, such as direct mail and annual outreach, to these donors and making a strong case for why you need their help now more than ever.

4. Initiate conversations with your tax advisor. The TCJA brought about tax reform of a magnitude we have not witnessed in a generation. It requires intense focus to understand not only how to apply the changes at a federal level, but also how to navigate the complex ripple effects on state taxation as well. We are here to help.

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What’s in store for the future?

Admittedly, when the TCJA passed in December 2017, it sparked grave concern among nonprofit organizations. The biggest cause for worry was the increase in the standard deduction and an indirect loss of a charitable contribution deduction for lower income filers.

However, 2018 ended up being a good year for many nonprofits. For the time being, the tax reform policies may depress individual giving, but a strong economy has the public feeling positive and generous. Plus, corporations and foundations are giving considerably more than in the recent past.

Understand your donors. Get to know their tendencies when economic changes take effect and from there develop a long-term strategy. Adjust your message and your outreach to make the most of the economic and tax climates.

For more information, the National Council of Nonprofits offers a plethora of resources specifically related to the how the federal tax law impacts charitable nonprofits. Find the list HERE.

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Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.

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