by Robert F. Sharpe, Jr.
Along with health care and other pressing issues, Congress is now seriously considering far-reaching tax reform measures, including a number of possible changes to the treatment of charitable gifts for tax purposes.
Given the numerous proposals for the limitation of charitable deductions, now may be a good time to review the role of state and federal income taxation when clients are considering what to give, when to give and how much they would like to devote to charitable purposes.
Over 2,300 years ago, Aristotle commented on the challenges one faces when considering how to make larger charitable gifts:
To give away money is an easy matter and in anyone’s power, but to decide to whom to give it, how much to give, when to give, and to give for the right motive and in the right way, is neither in everyone’s power nor an easy matter. Hence, it is that such excellence is rare, praiseworthy, and noble.1
Aristotle knew, as we do today, that every gift is comprised of five elements: (1) Who makes it? (2) Why is it made? (3) What’s given? (4) When is it given? and (5) How is the gift structured?
Our work with clients typically focuses on various aspects of the what, when and how of larger charitable gifts. Now, however, it may be wise to step back and explore the foundational elements underlying the who and why of charitable gifts.
Who makes gifts?
Americans have always been an extraordinarily generous people, with an estimated 98 percent of Americans saying they support one or more charities each year.2 Some 36.4 million taxpayers deducted charitable gifts totaling $194 billion from their tax returns in 2013, the most recent year for which statistics are available.3 Itemized charitable gifts have averaged 80 percent of total individual giving for many years.
Recent IRS data reveals that individuals over the age of 55 give a disproportionate amount of the country’s charitable gifts, in terms of numbers and dollar amounts, with the 21 percent of itemizers over 65 giving one-third of all deducted gifts. These taxpayers also make gifts nearly twice as large as the average. (See “Introducing the ‘Gerontrophilanthroplutocracy’,” Give & Take, January 2017.)
The reasons individuals choose to make charitable gifts are as varied as each personality. In my experience, however, there are several primary motivators at play in shifting combinations.
Religious beliefs. Perhaps the broadest motivation for giving is rooted in religion. Many of the world’s major religions stress the importance of charitable giving. According to Giving USA, religious-based organizations are by far the largest recipients of charitable gifts each year. In some cases, even donors giving to secular causes may wish to keep their giving anonymous for religious reasons.
Social motivations. In other instances, donors may believe their leadership status in their communities demands they shoulder financial and oversight responsibilities for certain social and other needs.
Political theory. Another group of individuals believes it isn’t the role of government to impose taxes and make decisions regarding a multitude of societal needs, but rather the province of individuals making voluntary contributions of time and money to meet these needs. Emotion. Love, anger, compassion, pride and any number of other feelings have long motivated charitable gifts.
Tax considerations. In my experience over the past 35 years, I’ve rarely seen the desire to eliminate taxes rise to the level of prime motivator for a charitable gift. And even when tax considerations were paramount, the individual ultimately decided on the charitable recipient based on one or more of the above-mentioned motivators.
Why is this the case?
First, a rational person doesn’t give away a dollar to save 40 cents in taxes. That gift still “costs” the person 60 cents. This is true in the case of both income and estate taxes.
Second, while there are exceptions, the tax savings will usually be the same regardless of which charity receives the gift. The rates that will be paid on charitable remainder trusts, gift annuities and other split-interest gifts are typically quite similar, if not the same. That being said, the final amount, its timing and the property used to fund it are often heavily influenced by tax considerations.
The government’s role in charitable giving
The outcome of the current debate over the charitable giving aspects of tax reform will ultimately be determined by how we approach the relationship between government and the nonprofit sector.
One view is that the tax code should include “incentives” that encourage taxpayers to support charities. Implicit in this view is that the government has a “right” to a certain amount of one’s income and can decide to give up that right in the form of a “tax expenditure,” whereby the government voluntarily forgoes a portion of taxes if the funds are directed in acceptable ways.
A very different view is that government’s ability to tax should be limited, and funds voluntarily directed by taxpayers to meet broader social needs shouldn’t be considered part of taxable income. This view was apparently the origin of the charitable deduction as we know it when it was introduced 100 years ago.
From the very beginning, however, Congress concluded that as citizens, individuals shouldn’t be allowed to devote an unlimited amount of their income to charitable purposes, and everyone should contribute some amount to fund the central roles of government. Hence, limits based on a percentage of adjusted gross income (AGI) have represented a cap on the amount that can be deducted since 1917.
A practical perspective
The difference in these approaches can be illustrated from a cash flow perspective. If someone earns $100,000 and gives $10,000 to charity, and there’s no personal income tax, it requires $10,000 worth of income to make that gift.
If, on the other hand, there’s an income tax of 33 percent, and the $10,000 gift isn’t excludable in some way from taxable income, the donor must earn $15,000 before tax to make the same gift. That represents a 50 percent higher “cost” of the gift. Those who would eliminate or place more restrictive limits on charitable deductions would bring about this result to a greater or lesser extent.
While individuals may not require a tax incentive to make gifts, the reality is that the reversal of a century-long policy of not taxing charitable gifts would very likely have a chilling effect on those who must suddenly earn much more to give the same amount.
Governments sometimes tax behaviors society wishes to curtail. This typically includes activities that are harmful to one’s health or to the health of a society as a whole. Query whether charitable giving is an activity that should be discouraged in this manner.
At this critical juncture, we as a society should think long and hard before we take actions that could upset a delicate balance of factors that have been at the root of funding vital components of our society for the past 100 years.
This feature is based on an article directed to advisors in the March 2017 issue of “Trusts & Estates.” To read the original article, click here. To learn more about the role of taxes in charitable giving, consider attending one of Sharpe’s popular gift planning seminars. Click here for details. ■
1. Aristotle, Nicomachean Ethics Book II, Chapter 9 (350 B.C.).
Robert F. Sharpe, Jr. is Chairman of Sharpe Group.