While our income, estate, and gift tax systems all include powerful incentives to encourage philanthropic giving, it is important to remember that charitable giving in America, and in earlier cultures, preceded all of our current tax systems. Many of America’s leading charitable organizations were created and continuously funded through generous outright gifts, bequests, and life income gifts, prior to the establishment of the modern federal income tax in 1913, the estate tax in 1917, and the federal gift tax in 1935.
Tax savings just one motivation
Contrary to what one might believe from reading the popular and financial press, philanthropic giving is not purely an economic activity that responds predictably to elasticity of demand and other principals of economic theory. For example, there were well-publicized studies in the mid-1980s that indicated a cut in federal income tax rates, the elimination of the non-itemizer charitable tax deduction, and the creation of an alternative minimum tax preference on the appreciation element of gifts of property would have a devastating impact on charitable giving in this country because they would effectively increase the “cost” of charitable giving. At the time economists forecast that charitable giving could decrease by as much as $11 to $16 billion.
In spite of the dire predictions, charitable giving actually continued to increase in the years after the Economic Recovery Tax Act of 1981 (ERTA), the Tax Reform Act of 1986 and more recent legislation that reduced incentives for charitable giving was passed. While there can be little doubt that the heightened cost of giving did have some detrimental impact on charitable giving in America, the impact was much less than many expected.
Tax breaks or not, giving continues
During the late 1960s, there was a federal income tax surcharge on high-income individuals that placed a few taxpayers in the 91% marginal tax bracket! For persons in this bracket, the after-tax cost of making a gift of cash was less than 10 cents on the dollar. Gifts of appreciated property further reduced the cost of giving by avoiding the capital gains tax on contributed assets. There was no discernable spike in giving despite the fact that the after-tax cost of making gifts by the wealthy was next to nothing.
Since that time, there has been a general downward trend in the maximum federal income tax rate from 70% in the 1970s, 50% in the 1980s, to 39.6% today. As the federal income tax rates fall, the cost of giving increases. For example, from the 1960s to the present, the lowest cost of giving cash has steadily increased from 9 cents on the dollar, to 30 cents, 50 cents, 67 cents, 72 cents, then down to 64 and most recently 60 cents on the dollar.
Yet, based on Giving USA estimates, charitable gifts from individuals have steadily increased over the years. The chart to the right shows the gradual upward trend in giving from the 1960s to today.
The more things change…
When considering planned gifts and the role of tax incentives, keep in mind that bequests via wills remain by far the largest source of planned gifts, comprising an estimated two-thirds of the billions contributed to charity in the form of planned gifts.
Remember that very few bequest donors receive any tax benefits from their gifts. There is no income tax deduction for a bequest, no capital gains tax avoidance, and for as many as 95% of donors who make bequests, no estate tax savings. Only approximately 14,000 of the estimated 180,000 who died and left charitable bequests last year filed estate tax returns and utilized charitable deductions to reduce the size of the taxable estate.
Tax benefits are thus only one of the factors that drive donors to make charitable gifts. Gift planners should be cognizant of, and thoroughly understand, the many other layers of philanthropic motivations, such as a donor’s emotional attachment to an organization or institution, a desire to leave a legacy to the community, a sense of duty based on religious beliefs, and a host of other reasons or combinations of them.
The role of tax incentives
That said, taxes can, and do, play an important role that can affect the size, form, and timing of gifts. For example, there was a significant increase in the establishment of charitable remainder trusts after the passage of the Tax Reform Act of 1986.
Relatively high capital gains tax rates and few ways to diversify assets without paying these taxes lead to increased interest in charitable remainder trusts. Giving USA and other reports indicate that, with the rise of investment market values, much of the recent increase in charitable giving in America has been driven by persons making gifts of appreciated securities, on account of additional tax advantages associated with such gifts.
In coming years, as in the past, we are likely to hear conversations about additional tax cuts which will have the effect of once again increasing the cost of charitable giving. There’s no doubt that if the cost of giving increases, there will be some impact on certain ways of giving. That being true, however, even with fewer tax incentives, and arguably even if there were no tax incentives whatsoever, history proves that Americans will continue to generously support the charitable organizations of their choice.
Barlow T. Mann is an attorney and chief operating officer of the Sharpe company. He designs planned giving programs for a Source: Giving USA
Next month’s myth: “The key to success in planned giving is through irrevocable gifts.”