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Let's Think Smarter About the Charitable Tax Deduction

January 14, 2013

Jan Masaoka is CEO of the California Association of Nonprofits (CalNonprofits), publisher of Blue Avocado, and author of The Best of the Board Café, Nonprofit Sustainability (with Jeanne Bell and Steve Zimmerman) and The Nonprofit's Guide to Human Resources.

Jan_masaoka_headshotOn New Year's Day, lawmakers in Washington finally agreed to disagree and passed a bill to avert the so-called fiscal cliff. But with the federal government looking at another trillion-dollar deficit and record levels of debt, no idea for balancing federal expenditures and revenue will be off the table for long.

For many nonprofits, keeping the charitable tax deduction off the table is the issue. But while the issue itself may seem straightfoward, there are more nuances and choices to it than meet the eye. There are many ways, for example, to increase taxes that would not have a directly negative impact on nonprofits -- which, after all, are a huge part of the safety net for the poor, the elderly, the unemployed, and many others.

The deal made to avoid the fiscal cliff left the charitable tax deduction untouched for the most part -- and for the time being. To be clear: neither eliminating the deduction nor reducing the deductibility rate was discussed; the administration's proposal would have lowered the current cap on the deductibility of charitable gifts from 35 percent to 28 percent of one's income. The one tiny change passed was the reinstatement of the Clinton-era Pease Amendment, which will raise taxes on some of the wealthiest donors by perhaps $2,000 each.

However, the intensity of the debate served to highlight some thought-provoking issues for those of us in the nonprofit and philanthropic communities, especially as the potential for revisiting the charitable deduction (and other tax breaks) looms large.

Some nonprofits are conflicted about the charitable deduction: on the one hand, nonprofits benefit from donations that often are influenced by their tax-deductible status; on the other, many of these same nonprofits support higher taxes for the wealthiest in our society. Indeed, a reduction in the charitable deduction does two contradictory things for nonprofits: it reduces the financial incentive for people to give, and it also brings in more tax revenue -- revenue that could be used to fund nonprofit services.

Of note, the current deduction formula affords greater tax relief to higher-income individuals than to lower-income individuals, for three reasons:

  • Higher-income individuals are more likely to itemize;
  • Because it's applied to taxable income, the deduction helps higher-income individuals more since their marginal tax rates are higher; and
  • The cap only affects individuals who donate a third or more of their taxable income. (Lower-income individuals are unlikely to be able to give away such a large percentage of their income.)

Other proposals, such as establishing a "floor" for the charitable deduction (a minimum percentage of adjusted gross income by which charitable contributions could qualify for deduction), could be more equitable and arguably could raise more tax revenue while having little or no impact on charitable giving. We should also look at ideas for extending the charitable tax deduction to non-itemizers, changing the formulas on deductions for donated stock, and making the estate tax more of an incentive for bequests. 

All of us at the California Association of Nonprofits encourage our colleagues in the nonprofit sector to advance the longer-term conversation about the charitable deduction as it relates to the balance between sector sustainability, equitable taxation, and fiscal responsibility.

But while we all must work to protect the deduction, we cannot allow the main message from the nonprofit sector to be only about tax breaks. We feel strongly that the Bush tax cuts of 2001 and 2003 have been harmful to our economy and our communities, while benefiting very few Americans. In the fiscal cliff deal, current marginal tax rates were extended indefinitely for individuals earning less than $400,000 and couples earning less than $450,000 -- approximately 98 percent of all U.S. taxpayers. While the revenue that will be realized by raising rates on the highest-earning 2 percent of taxpayers is less than what President Obama originally proposed, it's a step in the right direction for equitably increasing tax revenue as part of a longer process to bring the federal budget into balance.

We believe the responsible position is to support the charitable deduction and to support policies that result in increased revenue. In order to do that, we all will need to consider additional options as a new Congress begins to craft policy around these important issues.

-- Jan Masaoka

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Posted by Steve Swanson  |   January 15, 2013 at 03:20 PM

can someone with a small income still do deductions?

Posted by Jan Masaoka  |   January 15, 2013 at 04:43 PM

Yes. But with limited impact. Anyone can choose to either "take the standard deduction" or "itemize deductions." For example, if you are a single adult, you are allowed a standard deduction of $5,950 for 2012. Note that this reduces your TAXABLE INCOME by $5,950, not your taxes. So if you think that you had more than $5,950 in deductions you can identify and document, it would be in your financial interest to do so. (There are some adjustments if you are over 65 years old or blind.)

The Tax Policy Center estimates that about 70% of tax filers take the standard deduction.

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