The deduction for charitable contributions is a centenarian that’s been through a lot since its 1917 inception. The coronavirus crisis could set the stage for the next major revision of section 170, and the most popular option seems to be expanding the deduction.
It’s unsurprising that there’s now a call to expand for tax return filers who claim the standard deduction the above-the-line deduction for charitable gifts up to $300, introduced in the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136). When the Tax Cuts and Jobs Act raised the standard deduction from $6,500 to $12,000 for individuals and from $13,000 to $24,000 for married filing jointly taxpayers, nonprofits and economists said the resulting increase in non-itemizers would hurt charitable giving.
The result of those changes is a 4 percent dip in total charitable giving, and, “for middle- to upper-middle-income tax filers, the doubling of the standard deduction is responsible for nearly all the change in giving,” Alex Brill and Derrick Choe, both of the American Enterprise Institute, explained in a 2018 analysis. The lower marginal rates for high-income taxpayers enacted in the TCJA likely will largely decrease charitable giving by that group as well. The impact on the number of taxpayers who itemize their deductions for 2019 should be fairly dramatic.
Reducing the cost of generosity for non-itemizers has a budgetary drawback that might be difficult for Congress to swallow, particularly anytime soon. The Joint Committee on Taxation estimates that the one-year allowance of an above-the-line deduction for charitable contributions up to $300 will cost $1.5 billion. Increasing the amount of the deduction would increase the price tag, which could be a deal-breaker when Congress starts to tally up the costs of the next phase of coronavirus relief.
There’s precedent, and perhaps some bipartisan momentum, for a larger above-the-line deduction. In what seems to have been Congress’s only prior experiment with a truly universal deduction, the Economic Recovery Tax Act of 1981 briefly made it available to non-itemizers, but only a percentage of a specified cap of $300 was permitted between 1982 and 1984. In 1985 taxpayers could claim 50 percent of an uncapped amount, and in 1986 there was a 100 percent deduction with no cap. The provision expired in 1987, and Congress hasn’t looked back since.
Above-the-Line Proposals
On March 22 Senate Finance Committee member James Lankford, R-Okla., proposed a much more generous above-the-line charitable deduction amount of $4,000 for individuals and $8,000 for married couples filing jointly. Like the CARES Act provision, Lankford’s version would have lasted only a year. The amendment was cosponsored by a bipartisan group of senators. Nonprofits much preferred the Lankford version to the one passed.
There have been other recent attempts to similarly expand the deduction. In February 2019 Reps. Christopher H. Smith, R-N.J., and Henry Cuellar, D-Texas, introduced a bill that would have made charitable deductions universal, uncapped, and above-the-line by changing the definition of adjusted gross income to exclude deductions allowed under section 170. In December 2019 Rep. Mark Walker, R-N.C., introduced the Lankford bill’s predecessor, which would allow non-itemizers to take a deduction for charitable gifts.
Progressivity and Temporal Problems
Lawmakers should reexamine the tension between the below-the-line charitable deduction and a progressive scheme of taxation. An important diversity interest is served by a broad-based charitable giving incentive that the current rules don’t fully support. The deduction effectively imposes a higher cost of giving on those who take the standard deduction than on those who itemize, because the cost of $1 of giving for those who take the standard deduction is $1. The charitable tax benefits are highly concentrated among the 20 percent of taxpayers with the highest incomes, but as an analysis by the Urban-Brookings Tax Policy Center notes, the dollar amount of charitable contributions is also concentrated among that group.
As a matter of progressivity, it’s worthwhile to more closely align the treatment of charitable giving by lower- and middle-income taxpayers with that of higher-income taxpayers. Low- and high-income taxpayers both “tend to give a larger fraction of their incomes to charity than middle-income tax filers do,” Brill and Choe confirmed. An analysis by James Andreoni of the University of California, San Diego, and Jon Durnford of DataLake Nonprofit Research showed that because of the changes, the deduction was limited to about 10 percent of taxpayers, over half of whom have incomes exceeding $100,000. (Prior analysis: Tax Notes Federal, Aug. 26, 2019, p. 1399.)
The chief problem with the time-limited above-the-line deduction in the CARES Act is that it’s unlikely to change taxpayer behavior meaningfully. It might be a nice gesture, but it seems unlikely that many taxpayers who don’t already itemize pay much attention to changes in the tax law until it comes time to file their returns the following year. As Margaret Ryznar of Indiana University noted in a recent article, the timing problem is magnified this year, because charities that are trying to respond to the coronavirus pandemic need contributions now. (Prior analysis: Tax Notes Federal, Apr. 20, 2020, p. 463.)
Presumably, nonprofit organizations eager for donations will help publicize the new deduction, and that should expand the universe of taxpayers who know about the change. But it seems more likely that many would-be donors won’t know that they’re eligible and therefore will fail to make a donation before the benefit expires, and others may make donations but fail to document them, rendering themselves ineligible for the deduction. The likeliest outcome is that the bulk of the benefit will go to taxpayers who make donations anyhow and realize in 2021 that they have receipts that make it possible to claim the deduction.
A permanent expansion would be more likely to change the behavior of other taxpayers and so is probably the better option. If the price tag of the bill is the reason it’s temporary, allowing taxpayers to take the deduction for donations made through April 15, 2021, might have a greater impact. That would allow them to use the deduction at the time they’re most likely to learn about it — when they file their 2020 returns.
If the CARES Act provision’s goal is to encourage taxpayers to be especially generous to organizations directly involved in coronavirus-related efforts, the most efficient statutory change would be to target those types of donations. However, Congress shouldn’t direct donations and is unlikely to try it.
Floors and FSAs
Moving part of the charitable deduction above the line isn’t the only choice, even if it might be one of the best. Another option for encouraging giving is to establish a credit for doing so above a specific percentage of a taxpayer’s income or AGI. Roger Colinvaux of the Catholic University of America proposed a credit instead of a deduction for gifts that exceed a minimum amount to promote giving that might not otherwise occur. (Prior analysis: Tax Notes, Mar. 4, 2019, p. 1007.)
The goal of Colinvaux’s proposal is to reconcile the cost of allowing all taxpayers to claim a tax benefit for charitable giving with the tremendous cost of an unlimited incentive. Under his conception, the minimum amount would be set according to a taxpayer’s income level. He advocates for a credit instead of a deduction to fix the rate problem the deduction creates. If the credit rate were set, the subsidy for donations wouldn’t vary according to the taxpayer’s tax bracket and the problem of regressivity would be reduced.
The concept of a donation floor could be applied to a deduction for all contributions above a set percentage of the taxpayer’s AGI. Establishing a floor for a minimum amount of donations is probably wise because taxpayers will likely engage in a substantial amount of giving regardless of the current tax policy and the budgetary constraints Congress faces.
Former House Ways and Means Committee member Erik Paulsen and a bipartisan group of cosponsors introduced a proposal in response to the TCJA in July 2018 to create a program for charitable giving that would resemble flexible spending accounts. (Prior coverage: Tax Notes, Aug. 13, 2018, p. 1043.) The proposal would have allowed employees to divert up to $5,000 per year from their paychecks into flexible giving accounts offered by their employers.
That plan would appear to impose heavy administrative burdens and costs on both taxpayers and employers that should make it much less attractive than some of the alternatives. It’s also unclear whether it would do much to target donations made by lower- and middle-income taxpayers, because taxpayers in the lower-wage-percentile groups have less access to the healthcare version than their higher-paid counterparts, and the same pattern could repeat itself for a charitable giving option.
Any legislative movement on the charitable deduction prompted by the coronavirus crisis will run into strong headwinds from the outset given the fiscal outlook. But it should be possible to make reasonable, permanent changes that strengthen the incentive for charitable giving across all income levels.