Thursday, March 5, 2015

What's Up With the Charitable Deduction?

President Obama's call for a limit to the charitable deduction and the subsequent massive protests by Republicans and mainstream nonprofits made me realize how little I truly knew about the history and mechanics of taxes. Here's what I learned:
  • When was the charitable deduction first introduced? The first income tax (2% on income greater than $4,000) was instituted in 1861 to pay for the Civil War. A year later it was ruled unconstitutional. The 16th Amendment, approved in 1913, gave Congress the legal authority to collect income taxes. The highest rate was set at 7%, and only the top 10% of wealthy Americans had to pay. The charitable deduction followed in 1917. War was the impetus once again - in order to cover the costs of World War I, the top rate had been raised to 77%. The deduction was initiated to help the war effort by underwriting contributions to the War Chest and the Red Cross.
  • How do charitable deductions work? For itemizers, the tax write-off is tied to your income tax bracket. Folks in the 2014 top 35% tax bracket get a tax savings of 35 cents for every donated dollar. If you're in the 35% bracket and earn $1,000, you'd be required to pay $350 in taxes (keeping $650). But if you make a charitable gift of $100, your taxable income goes down to $900, your gross tax bill (now $315) is reduced by $35 - and voila! your $100 donation only ends up costing you $65.
  • How have charitable deductions changed over time? During World War II, income taxes went up again (top rate: 94%) and expanded such that 70% of Americans were required to file and pay. This meant more folks could take advantage of the charitable deduction. It also meant that more people had to deal with long complicated tax forms. So Congress came up with the standard deduction which lowers your taxable income by a fixed amount and makes filing easier - but doesn't allow you to write off charitable gifts.
  • Do tax rates and the charitable deduction actually make a difference in the level of giving? Loud voices in mainstream philanthropy would say otherwise, but history does not support this position. In 1944 when the standard deduction was introduced, nonprofits lobbied heavily against it, insisting that it would the death of charitable giving - but it wasn't. In 1981, Congress dropped the top bracket from 70% to 40% - and charitable giving did not suffer. In 1992 and 2003, the top bracket was lowered first to 39% and then to 35%, and still charitable giving did not take a dive. In fact, statistics from Giving USA indicate that individual giving over the past 25 years has remained remarkably consistent.
  • What motivates people to give? I know that for myself, the tax deduction is not a primary factor. I make thoughtful, focused gifts to organizations that I care about and know to be effective. If the charitable deduction were abolished tomorrow, I would do the same. And in my 40+ years of experience as a nonprofit Executive Director (and fundraiser), that was what I saw from donors. Folks give because they care, not because they can deduct.

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