One of the most controversial changes of the new tax law is the limitation on state and local taxes to individual taxpayers. The limit of $10,000 will not only keep some from being able to get the full deduction for their real estate taxes, it also makes it more difficult for them to itemize their deductions.
With the standard deduction increasing to $24,000 for married couples, itemized deductions must exceed that amount in order to generate greater tax savings. Since a cap of $10,000 is allocated for state and local taxes, taxpayers must generate $14,000 from mortgage interest and charity in order to itemize their deductions (assuming no major medical expenses).
Previously, taxpayers could itemize at anything above $12,700, meaning that pretty much every dollar of charitable giving increased the itemized deduction. That is not the case any longer, and charities are concerned. In fact, Indiana University estimated that charitable giving nationwide will drop by $13.1 billion.
Let’s look at an example of why this is a concern. We’ll assume a taxpayer (married, filing jointly) has the following situation.
In this example, the taxpayers have $11,100 of state and local taxes, which will be capped at $10,000. They also have $8,000 of mortgage interest, so they have $18,000 of potential itemized deductions. In 2017, they would already be itemizing, deducting their tax bill proportionately for every additional dollar of charitable giving. In 2018, they need to give over $6,000 to see any difference in their tax liability.
Let’s assume that the family wants to give $7,500 to charity. Not only does the first $6,000 do nothing to their tax liability, they are in a lower tax bracket than they had been before due to the law changes. The tax effect of the contribution, as calculated below, is much smaller in 2018 than in 2017 and is a much lesser percentage of the total gift.
The bottom line is that, for some donors, the tax incentive to give has been greatly reduced. However, nonprofits need not be completely dismayed, and there are three reasons to maintain a positive attitude in light of potentially negative appearances.
Reason 1: Donors of significant funds will be impacted less by the law
The example above assumes a couple has moderate giving tendencies. Had they committed to giving 10 percent of their income to charity, hardly an uncommon exercise, the effect of the giving would go from 4.4% to 13.2%. The more an individual gives, the less drastic the impact of the changes in itemized deductions.
Furthermore, foundations, many of whom have hundreds of thousands of dollars, are subject to different tax laws and treatment and may not reduce their giving just because of a tax law change.
Reason 2: A donation is still cash out of one’s possession.
Regardless of the tax impact of giving, any donor who is giving solely for the tax benefit, would be better off just keeping the money and paying tax on it, as opposed to giving it away. Very few donations reduce tax liabilities dollar-for-dollar, with PA’s scholarship program being one general exception. Donors who are solely interested in saving money will not give at all.
Reason 3: Impact
I believe that donors typically give because of what their donation will do for the recipient. The tax deduction is a secondary reward. Nonprofit entities may have to be more deliberate in explaining what a $5,000 donation would do for the organization, and they will have to keep their donors apprised as to what is happening within the charity. Donors who believe they are making a difference are likely to give more. The tax law change, like many potential setbacks, has the potential to create an opportunity for nonprofits where initially a threat is perceived. Getting in front of more donors and explaining the mission, values, and accomplishments of the organization can make 2018 the best year yet for donations.
By Dan Massey, CPA, Principal