Public Law No. 115-97, enacted Dec. 22, 2017, and informally known as the 2017 Tax Cuts and Jobs Act (the “2017 Tax Act”), contains several provisions that, in the aggregate, may have a substantial effect on charities and their donors.
Charities breathed sighs of relief when President Trump’s initial seven-point description of his tax reform plans included a pledge to preserve the charitable contribution deduction. Indeed, the 2017 Tax Act did retain the basic structure of the charitable deduction for both income and transfer tax purposes, as well as the general rules for valuing contributions and carrying forward those that exceed annual percentage limitations.
Other changes to the income and transfer tax systems, however, could greatly influence the size and nature of donors’ continuing contributions from now through the end of 2025, when most individual changes are scheduled to expire if a future Congress does not intervene.
Summary of Key Changes
- The 2017 Tax Act made sweeping changes that reduce income and transfer tax for many individuals, including:
- Increasing the gift, estate and generation-skipping transfer tax exemption from $5.49 million in 2017 to $11.18 million for 2018. Using their two individual transfer tax exemptions, a married couple now can shelter a combined estate of $22.36 million from transfer tax.
- Compressing and adjusting income tax brackets so as to lower the rates for most taxpayers. The top individual bracket dropped from 39.6 percent to 37 percent.
- Almost doubling the income tax standard deduction — from $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for married couples filing jointly.
- Repealing the “Pease limitation,” which forced high-income taxpayers to reduce their itemized deductions by as much as 80 percent.
- Allowing an aggregate annual deduction of up to 60 percent of income for cash gifts to public charities.
Other changes, however, curtail or eliminate many popular deductions, including:
- Repealing personal exemptions that individuals have claimed for themselves or their spouses and dependents.
- Limiting deductions for most state and local income and property taxes to $10,000 per year.
- Curtailing deductions for home mortgage interest and eliminating deductions for interest paid on home equity loans.
- Repealing other common deductions, such as personal casualty losses not incurred in a federally declared disaster, unreimbursed employee expenses, tax preparation fees, and payments for priority seating at college athletic events.
The breadth and variety of tax changes make it impossible to reach firm conclusions about the effects of the 2017 Tax Act on charitable donors. Instead, each donor’s situation must be reviewed individually. Nevertheless, several potential effects are worth noting.
Effects of Transfer Tax Reduction
Larger transfer tax exemptions will leave donors with larger after-tax estates. At the same time, they also may reduce the perceived need for charitable contribution deductions as tax reduction devices and may increase the after-tax “cost” of making charitable gifts. It is unclear which effect will predominate, but in all events, the larger transfer tax exemptions are likely to shift donors’ attention to income tax planning. That, in turn, will put the tax focus on lifetime giving, which can generate valuable deductions.
Effects of Income Tax Changes
Approximately 30 percent of taxpayers have itemized their deductions in recent years and thus have been eligible to receive a tax benefit from charitable contribution deductions. Studies suggest that by doubling the standard deduction, eliminating personal exemptions, and restricting several popular itemized deductions, the 2017 Tax Act is likely to cause 90 percent to 95 percent of all taxpayers to claim the standard deduction. Only 5 percent to 10 percent of the population will continue to itemize and thus derive income tax benefit from future charitable contributions.
High-income taxpayers who remain able to itemize, however, may look to the charitable deduction to offset reductions in other benefits, such as the deductions for state and local taxes and mortgage interest. Many may find that because the Pease limitation no longer caps itemized deductions, their contributions actually produce greater tax benefit in 2018, even with slightly lower tax rates. And donors who make only cash gifts to public charities will be able to claim deductions up to a higher annual limit.
Effects of Non-tax Factors
Despite the recent focus on tax law changes, most donors do not give solely — or even primarily — for tax benefits. The 2016 U.S. Trust Study of High Net Worth Philanthropy Executive Summary found that the top three reasons for giving are belief in mission (54 percent of donors), belief that a gift can make a difference (44 percent), and personal satisfaction, enjoyment, or fulfillment (39 percent). Other reasons include religious beliefs, giving by other high-profile donors, public recognition, appreciation of the organization, emotional connection, family values, legacy, desire to give back to the community or share good fortune, self-image, example for younger generations, and tax reduction.
These findings mirror donors’ reactions to prior tax law changes. When transfer tax exemptions increased sharply in the early 2000s, commentators predicted charitable giving might decline substantially. Instead, many donors chose to add charitable components to their tax plans or expand existing components. Their larger potential estates enabled them to provide all they thought necessary (or healthy) for their families, while still having a portion left to give back to their communities.
Messages for Donors
Due to the extent of changes in federal tax law and the degree of confusion and misinformation those changes have generated, charities should already have begun to communicate several basic messages to their supporters:
- Donors give to support particular causes and to benefit their communities. Charities should remind their donors that the needs of the community have not diminished and that other sources of direct support may be shrinking — due, for example, to cuts in funding for government programs or the increasing popularity of private foundations and donor-advised funds as gift vehicles.
- Donors want their gifts to produce results. Charities should highlight new programs and measurable achievements to show donors that their gifts will make a difference. They also should be open to conversations about donors’ interests, not just about the charities’ wants or needs.
- Negative press coverage and rumors in the weeks leading up to the 2017 Tax Act (and since) may have led even some wealthy donors to believe that the charitable contribution deduction is no longer available or can no longer be a useful tool in tax planning. Charities should re-emphasize the continuing utility of familiar techniques. Examples include gifts of appreciated property, charitable gift annuities, charitable lead and remainder trusts, and gifts of residence remainders. Qualified direct distributions from IRAs can be particularly beneficial even to non-itemizers.
- Charities should be prepared to help donors explore alternative forms of support. Interest-free loans, “bunching” multiyear contributions in a single year, impact and mission-related investments, and gifts through related social welfare organizations all can be efficient vehicles for donors looking to broaden their charitable efforts. For more information about how charities can engage in mission investing, see McGuireWoods’ legal alert “Charities and Mission Investing.”