On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law by President Trump. Numerous revisions to the tax code, most which have taken effect as of January 1, 2018, have some nonprofit organizations concerned about the potential impact on individual charitable giving. A closer analysis reveals that both positive and negative aspects stem from the new tax law.
A major provision of the TCJA increases the standard deduction for individuals through 2025. For 2017, taxpayers who claim the standard deduction can reduce income by $6,350 for single filers and $12,700 for married couples filing jointly. For 2018, under the new law, those amounts will increase dramatically to $12,000 for single filers and $24,000 for married couples filing jointly. This increase, coupled with the reduction or elimination of other itemized deductions, will cause many taxpayers who previously itemized to claim the standard deduction instead. In fact, the Tax Policy Center estimated in their latest analysis that the number of taxpayers who itemize would decrease by almost 60%—from an estimated 46.5 million in 2017 to only 19.3 million in 2018 (http://tpc.io/2Hz25wU).
The 46.5 million taxpayers who are believed to itemize when they file their 2017 income tax returns represent only approximately 30% of all taxpayers. The question that many nonprofits are asking is whether the expected reduction in taxpayers claiming the itemized deduction—and therefore essentially receiving no tax benefit for charitable contributions—will impact individual giving. While the study of how individuals give and whether taxes play any part in the amount of those donations is nothing new, the research still provides little true insight into exactly how the TCJA will impact nonprofits’ bottom line.
Individual giving continues to be the largest source of donations for nonprofits. According to Giving USA, of the total charitable donations of $390.05 billion made in 2016, $281.86 billion, or 72%, reflected giving by individuals (https://givingusa.org/tag/giving-usa-2017/). This represents a 3.9% increase from 2015. Charitable giving by both corporations and foundations each also increased during 2016. During the same time, giving by estates or bequest decreased sharply. While some of these giving trends were undoubtedly affected by the election year and political climate, donations are generally much more affected by larger economic influences.
Looking at the Research
For example, giving by individuals has been shown to increase in correlation with national financial indicators such as disposable personal income, personal consumption, and the S&P 500 Index. All three of these indicators have been shown to be directly associated with spending and financial stability for U.S. families. During 2016, these factors continued to increase. Personal consumption and disposable personal income increased by 4.0% and 2.6%, respectively, with Americans spending $12.82 trillion dollars in total (https://fred.stlouisfed.org/series/PCECA, https://fred.stlouisfed.org/series/A067RC1A027NBEA). The S&P 500 index also had a strong year during 2016, ending up 9.5%. Historically, charitable giving has been shown to increase by approximately one-third of the increases in the stock market (http://foundationcenter.org).
TCJA Impact on Charitable Giving
According to the U.S. Trust Study of High Net Worth Philanthropy, conducted by U.S. Trust and the Indiana University Lilly Family School of Philanthropy (http://bit.ly/2FKhDxq), 91% of high-net-worth individuals gave to charity in 2015, down from 98.2% in 2007. A majority (58.8%) of the total population gives to charity in 2015, based upon the 2013 Philanthropy Panel Study on giving (http://bit.ly/2FJ8GEF). Of those high-net-worth individuals who give to charity, the primary reason to do so, as indicated by 54.1% of respondents, was belief in the mission. The second most prevalent motivation was belief that their gift can make a difference (44%), and third was personal satisfaction, enjoyment, or fulfillment (38.7%). Receiving a tax benefit was seventh on the list, with only 18% indicating they donate simply to receive a charitable deduction.
The survey responses indicating that receiving a tax benefit is not a major motivation behind charitable contributions changed, however, when respondents were posed a slightly different question. The same study asked individuals whether their charitable giving would increase, decrease, or stay the same if no income tax deductions for donations were provided. In 2013, 50.4% of high-net-worth individuals indicated that their charitable contributions would decrease if no deduction was in place. That number decreased to 33.4% in 2015. Similar swings in how respondents have answered this question have been found in the past. At times when the future of the charitable deduction is in question, the number of individuals indicating their giving would decrease rises substantially. This is most likely because, as the hypothetical comes close to reality, individuals seem to value the tax benefit more.
While the TCJA will still see most high-net-worth individuals itemize and therefore receive a benefit from charitable contributions, individuals with lower incomes may not. The question then becomes: Which of these groups of individuals give the most to nonprofits? According to the National Center for Charitable Statistics (http://urbn.is/2HB5bAB), the IRS’s 2011 statistics of income showed a U-shaped relationship between adjusted gross income (AGI) and charitable giving, meaning that those at either extreme (high or low income and wealth) are likely to give a higher percentage of their income to charity compared to middle-class individuals. Those with income that ranges between $100,000 and $200,000 contribute approximately 2.6% of their AGI, which is lower than those with income either below $100,000 (3.6% of AGI) or above $200,000 (3.1% of AGI). The majority of households with income exceeding $75,000 itemize, while a still large amount (41.7%) itemize with income between $50,000 and $75,000. With a larger standard deduction under the TCJA, many individuals with income between $50,000–$200,000 may no longer itemize.
The TCJA’s lower marginal tax rates for most individuals will also undoubtedly impact charitable contributions. In 2013, Jon Bakija of Williams College published “Tax Policy and Philanthropy: A Primer on the Empirical Evidence for the United States and Its Implications” (http://web.williams.edu/Economics/wp/Bakija-Tax-Policy-and-Philanthropy-Primer.pdf), which showed that when tax rates are highest, individuals tend to give the most. During the 1970s, the highest marginal tax rate was 70%; at that time, the wealthiest Americans gave almost twice as much to charity compared to 2007, when the top individual rate was only 35%. Ultimately, a higher tax rate encourages charitable giving as it provides a larger tax benefit and therefore a lower cost of giving. For example, if one is in the 15% marginal tax bracket, each $1 donation costs only 85 cents after recognizing the benefit of an itemized deduction. If, however, one is in the 39.6% marginal tax bracket, each $1 of charitable giving costs only approximately 60 cents after factoring in the tax deduction.
The Big Picture
Not-for-profit organizations and their advisors need to be prepared for the changes identified above to potentially have a negative impact on individual giving, and thereby the overall financial well-being of the entity. The effect of decreased charitable giving could impact the economy in general. As of 2013, there were approximately 1.41 million nonprofits recognized by the IRS. These entities contributed $905.9 billion to the U.S. economy (5.4% of GDP) during that year. As of 2010, the nonprofit sector also accounted for 9.2% of all wages and salaries paid (http://urbn.is/2FGDEBc). Any impact on nonprofit revenue could have a ripple effect on the economy as a whole, including individual earnings and overall jobs.
Not-for-profit organizations and their advisors need to be prepared for potentially negative impact on individual giving, and thereby the overall financial well-being of the entity.
Some positive notes for charities, however, include that the TCJA is expected to increase GDP by 1.7% in the long run through lower marginal tax rates and cost of capital. As detailed above, increased GDP is generally correlated with increased charitable giving. During the next 10 years, GDP is expected to increase by 2.9% from current forecasts, equating to almost $5 trillion. In addition, individual taxpayers are expected to pay $1.1 trillion less in taxes during that same time, providing individuals with an increase in disposable income.
In addition, while many itemized deductions have been removed or restricted under the TCJA, charitable contributions have been expanded for taxpayers who will still itemize. Individuals will now be able to contribute 60% of their adjusted gross income, increased from the previous 50% limit. This revision alone would be considered a win for nonprofits; however, another change in the law will cause many individuals to lose any tax benefit they previously received from charitable contributions starting in 2018.
Bequests to nonprofits as part of individual estate planning may also increase under the TCJA. Under prior law, the applicable estate tax exclusion amount would have been $5,600,000 for each taxpayer in 2018, but it will now be $11,200,000 ($22,400,000 for married couples). While the marginal tax rate for estates remains unchanged at 40%, the increased exclusion will ultimately make estate planning a non-issue for most individuals. In the U.S. Trust–Indiana University survey mentioned above, when high-net-worth individuals were asked how charitable giving in their estate plans would be affected should the estate tax being permanently eliminated, 23.3% of respondents in 2015 indicated that they would increase giving, with only 4.6% of individuals indicating that their planned giving would decrease.
It remains unclear how much of an actual impact these factors, positive or negative, will have on the financial longevity of U.S. not-for-profit organizations in the coming years. What is certain, however, is that advisors, directors, officers, and employees of these organizations will need to continue to develop ideas to attract new donors while working hard to deepen relationships with existing benefactors.