Tax reform changed a lot of things about the tax laws. Most of the attention on reform efforts focused on the tax cuts that it provided to individual and corporate taxpayers, as well as some of the tax breaks that were eliminated to pay for those tax cuts. Yet some of the biggest impacts from tax reform could come from second-order effects that many wouldn't have realized at first.
One example of a potential unanticipated consequence of tax reform comes from the increase in the standard deduction. Many taxpayers praised the move, as they'll see a larger deduction without going to the trouble of itemizing. For the tens of millions of taxpayers who make donations to charity, however, a higher standard deduction could prove to be a disincentive to future giving. That's bad news for the charities that depend on the hundreds of billions of dollars in donations that they receive each and every year.
How tax deductions for charitable donations work
Donations to qualified charities are eligible for an itemized deduction both under previous law and under the new tax reform provisions. Charities must demonstrate a religious, education, scientific, or literary purpose and apply for tax-exempt status with the IRS to accept tax-deductible contributions. To deduct a donation, you have to make it by the end of the tax year for which you're claiming the tax break. For most taxpayers, you can claim a maximum of 50% of adjusted gross income for charitable donations.
The U.S. is a nation of giving, and a substantial number of taxpayers take the charitable deduction on their tax returns. More than 36.6 million taxpayers itemized charitable deductions during the most recent year for which IRS data were available, claiming a total of almost $222 billion. That works out to an average deduction of $6,058 for every taxpayer who used the tax law provision for donations to charity.
2 kinds of gifts
The IRS allows deductions for two primary categories of gifts. Cash or checks make up one category, and it's the most popular, with 33.2 million taxpayers claiming cash or check donations. Those gifts amounted to $162.6 billion, or almost three-quarters of the total claimed on tax returns for overall charitable deductions, and they have minimal documentation requirements to support a deduction.
The other category of giving includes items other than cash or checks. Donations in this category include gifts of physical items like clothing, vehicles, or canned goods, as well as financial instruments like stocks. More than 22.5 million Americans made gifts of this type, with many donors giving in both categories. Here, documentation conditions are stricter, requiring special forms or even third-party appraisals in some cases.
Why are charities worried?
The problem with charitable donations is that you have to itemize to claim them. With the standard deduction going up, fewer people will have enough total itemized deductions to warrant not simply taking the standard deduction. For those who claim the standard deduction, making a charitable donation will have no tax benefit.
Other provisions of the reform law will also potentially affect the ability to claim the charitable deduction. State and local tax deductions are capped at $10,000, reducing another key itemized deduction. Mortgage interest on new loans will be limited to $750,000 in principal value. Combined with lower marginal rates that reduce the tax benefit even for those who can successfully itemize deductions, the tax break for charitable giving will decline markedly even for those who do itemize.
Policymakers already expect a big impact. The National Tax Policy Center estimates a drop of $12 billion to $20 billion in charitable giving in 2018, amounting to 4% to 6.5% of total giving. Meanwhile, the doubling of the estate tax exemption could cut the number of charitable bequests by 15% to 30%, costing charities another $4 billion.
Doing good without a tax break
Charitable deductions aren't the only reason why Americans make gifts to worthy causes, and giving won't evaporate entirely as a result of tax reform. Still, many taxpayers will never again have reason to claim a tax break on their donations going forward. For charities that are already struggling financially, taking away any incentive for donors to give is yet another challenge they'll need to overcome to survive and succeed in their charitable missions.