Tax Incentives—An Economic Basis for Charitable Giving
By Bob Enders
Graduate Student, Grand Valley State University
Charitable giving by individuals and businesses is an important source of funding for nonprofit organizations. These charitable donations are influenced by various factors. For donors in the state of Michigan, "the more common reasons to give to nonprofits are to help others (45.7 percent), to support an organization or cause they believe in (15.5 percent), and felt a moral obligation to contribute (13.4 percent)" (Wilson 2002). While these factors vary for each individual or business, research indicates that tax implications influence the size of the donation.
Donors receive economic benefit from a reduction in the amount of paid taxes. The motivation to reduce taxes by contributing to a nonprofit is known in economic terms as a tax incentive . Tax incentives are incorporated in the tax codes at all levels of government: federal, state and local. The donation is reported on the tax return and used in calculating the ultimate tax liability. The most common tax incentives are either tax deductions or tax credits . The federal tax structure currently employs the use of tax deductions for charitable contributions while state and local governments use both forms in varying degrees.
Charitable tax incentives are a factor in both income and estate taxes . Income tax is an annual levy placed on taxpayers while estate tax is required only when taxpayers die and transfer wealth to their heirs.
Taxes have been an economic factor in most of recorded world history. In the United States, Abraham Lincoln implemented federal income taxation in 1862 in order to finance the Civil War. Although this income tax was repelled in 1872, the 16 th Amendment established the Internal Revenue Service in 1913 and the federal income tax system has been in existence since that year (Internal Revenue Service "History").
"President Franklin D. Roosevelt's New Deal programs forced an increase in taxes to generate needed funds. The Revenue Act of 1935 introduced the Wealth Tax, a new progressive tax that took up to 75 percent of the highest incomes. Many wealthy people used loopholes in the tax code" (Internal Revenue Service "Wealth").
Taxpayers inherently seek methods to reduce their personal tax burden in order to increase their discretionary income. Charitable contributions offer one way to reduce taxes. Consequently, "Incentives to donate to charity have existed in the tax code almost as long as the income tax itself" (Greene and McClelland 2001, 433).
In the 1980s, under the Ronald Reagan administration, the tax structure was simplified and tax rates were lowered for taxpayers. "The Tax Reform Act of 1986 reduced the amount of money owed by the wealthy. The government hoped to encourage them to pay taxes and also hoped that the wealthy would invest their money in a way that would eventually benefit all workers and taxpayers" (Internal Revenue Service "Tax").
Nonprofits receive funds from three major sources: fees charged, government grants and charitable giving. The largest source is fees charged, accounting for 54 percent pf total revenue. Government grants rank second, providing 36 percent of total funds. Charitable giving funds the remaining 10 percent of revenues.
Although charitable giving appears to provide only a small portion of overall nonprofit funding, the source becomes more significant in certain sub sectors of the nonprofit community. Charitable giving is 20 percent of the revenue for social service agencies while the art, culture and recreation nonprofits depend on the donations for 41percent of their income (Salamon1999). The significance becomes greater within each of these segments as some agencies receive 100 percent of income solely from donations.
Donations represent a significant amount on an annual basis. "Charitable giving reported to the Internal Revenue Service (IRS) in 1997 amounted to over $120 billion, about 1.5 percent of GPD. Giving USA reported charitable giving in 1997 of $153.77 billion (about 2 percent of GPD), which includes giving by foundations and non-itemizing individuals; these figures are not obtainable from tax returns" (Greene and McClelland 2001, 433). Individuals give 77 percent of these donations. The remaining 23 percent is received from bequests, corporations and foundations.
The magnitude of charitable giving highlights its role in sustaining nonprofit agencies. A recent study indicates, "Americans give not out of empathy, but for tax write-offs. The report concludes that a flat tax or a national sales tax where charitable write-offs are eliminated, donations would drop by nearly a third or more" (National Center for Policy Analysis 1987).
Ties to the Philanthropic Sector
The trend of government abandoning some needed services makes the need critical for philanthropy. "Every culture depends on philanthropy and nonprofit organizations to provide essential elements of a civil society" (Center for Philanthropy at Indiana University).
Often, government action is based on the assumption the nonprofit sector will fill the remaining void. In filling this void, nonprofits become more dependent on charitable giving to fund the services. Since philanthropy is comprised of three major traditions: "voluntary association, voluntary giving, and voluntary action" (ibid.), charitable giving is an essential part of the philanthropic sector. Tax incentives encourage the type of behavior required to create effective philanthropy.
Current tax incentives are limited to those taxpayers itemizing deductions or designating bequests. This structure leads to lost opportunities in higher levels of donations. A recent study indicates that tax deductibility encourages charitable giving at all levels of income (Independent Sector "Deducting"). Philanthropic advocacy focused at expanding the base of taxpayers giving to charities could lead to responsive tax legislation.
Key Related Ideas
Form 990 is the document that tax-exempt organizations file with the Internal Revenue Service on an annual basis. The form reports the organizations' financial results for the year as well as other pertinent data. These 990 forms are useful to donors in their determination of charitable organizations' worthiness. Federal laws require charitable organizations to have the forms open to public inspection.
Tax credits are one mechanism to provide taxpayers with the incentive to give to charitable organizations. Currently, charitable donation tax credits are not used in the federal income tax structure but are used at the state and local level. A tax credit reduces the taxpayer's income liability after calculation of income tax. For example, assume a taxpayer's taxable income equals $35,000 and the state tax rate is one percent. The resulting income tax liability is equal to $350. If the taxing authority provides a 50 percent charitable tax credit for donations to qualifying nonprofits, this particular taxpayer's donation of $500 creates a charitable tax credit of $250. This amount is subtracted from the tax liability of $350 and the taxpayer owes only $100. An example of an actual charitable tax credit is the state of Michigan's Homeless Shelter/Food Bank Credit. "A partial income credit tax is allowed when a donation is made to a qualifying shelter for homeless persons, a food bank, a food kitchen, or other entity whose primary purpose is to provide overnight accommodations, food or meals to indigent persons" (State of Michigan).
Tax deductions are allowed by the Internal Revenue Service to provide taxpayers the incentive to give to charitable organizations. Currently, only taxpayers filing a tax return using the itemized deduction schedule receive the benefit of this tax incentive. Tax deductions reduce the amount of taxable income before calculation of tax liability. For example, assume a taxpayer's taxable income before itemizing deductions equals $35,000. Further assume this particular taxpayer donated $500. This amount is subtracted from the $35,000 to arrive at the taxable income of $34,500. If this taxpayer's applicable tax rate is 20 percent, the tax liability is $6,900 ($34,500 multiplied by the tax rate of 20 percent). If the taxpayer did not make the donation, the tax liability is $7,000 ($35,000 multiplied by the tax rate of 20 percent). By donating $500, the taxpayer realizes a tax savings of $100 (the difference between $6,900 and $7,000).
Tax-exempt Organizations are the nonprofit agencies that do not have to pay income taxes. The Internal Revenue Service recognizes these agencies as 501c(3) entities. Donations made to these organizations can be applied as an itemized deduction.
Important People Related to the Topic
Andrew Carnegie: Carnegie is a notable philanthropist. "Many persons of wealth have contributed to charity, but Carnegie was perhaps the first to state publicly that the rich have a moral obligation to give away their fortunes. In 1889, he wrote The Gospel of Wealth , in which he asserted that all personal wealth beyond that required to supply the needs of one's family should be regarded as a trust fund to be administered for the benefit of the community" (Carnegie Corporation). Tax incentives for charitable giving would be unnecessary if taxpayers shared Carnegie's thoughts and philosophy.
President Franklin Roosevelt: President Roosevelt was the thirty-second president of the United States. His administration spanned and was challenged by the Great Depression of the 1930s. He received considerable criticism for his response to the economic downturn. Roosevelt "responded with a new program of reform: Social Security, heavier taxes on the wealthy, new controls over banks and public utilities, and an enormous work relief program for the unemployed" (White House). His influence on the income tax structure set the stage in supporting tax incentives for charitable giving.
Related Nonprofit Organizations
- GuideStar seeks "to revolutionize philanthropy and nonprofit practice with information. GuideStar envisions the evolution of an increasingly efficient nonprofit marketplace where information about the operations and finances of nonprofit organizations is readily accessible and actively utilized by decision makers throughout the nonprofit sector, donors seek out and compare charities, monitor their performances, and give with greater confidence, nonprofit organizations pursue more effective operating practices, embrace greater accountability, and enjoy lower fund-raising costs, society benefits from a more efficient, generous, and well-targeted allocation of resources to the nonprofit sector" ( www.guidestar.org ) (GuideStar).
- The Independent Sector works "to promote, strengthen, and advance the nonprofit and philanthropic community to foster private initiative for the public good" (Independent Sector). This nonprofit is a valuable source for information on funding for nonprofits ( www.independentsector.org ).
- The Urban Institute is "a nonprofit, nonpartisan policy research and educational organization that examines the social, economic, and governance problems facing the nation. Institute researchers identify and measure social problems, assess their solutions, spot trends, evaluate social and economic programs and policy options, and offer technical assistance in policy and program development" (Urban-Brookings Tax Policy Center).
- The Urban-Brookings Tax Policy Center was "created to fill the growing need to clarify and analyze the nation's tax policy choices. It provides timely, accessible analysis and facts about tax policy to policymakers, journalists, interested citizens, and researchers" ( http://taxpolicycenter.org/aboutus/ ) (Urban-Brookings Tax Policy Center).
Related Web Sites
The BBB Wise Giving Alliance Web site, at http://www.give.org, collects and distributes information on hundreds of nonprofit organizations that solicit nationally or have national or international program services. The site offers Charity Reports, a Giving Guide, News and Alerts, Tips on Giving, Charity Standards and FAQs.
The Charity Navigator http://www.charitynavigator.org/ offers ratings on over 2,500 U.S. charities, classified by type of charity and cause and rated according to industry standards and actual performance. Tips and Resources are also provided including Giving Statistics, Questions to Ask, Giving Calculators and Online Giving Ethics.
The Internal Revenue Service (IRS) Web site , at http://www.irs.gov, includes historical and current information on the United States tax structure. It also has a large section for "Charities and Nonprofits" http://www.irs.gov/charities/index.html .
The Network for Good Web site, at http://www.networkforgood.org, provides individuals with resources and tools in donating to charities including a Giving Calculator, tax tips and advice on giving wisely and giving safety online.
Bibliography and Internet Sources
Carnegie Corporation. "Biography of Andrew Carnegie." Carnegie Corporation.
The Center on Philanthropy at Indiana University. "Home Page.
Greene, Pamela and McClelland, Robert. "Taxes and Charitable Giving." National Tax Journal. LIV (2001): 3, 433-449.
GuideStar. "About GuideStar and Philanthropic Research, Inc." GuideStar.
Independent Sector. "About Us - Independent Sector's Vision, Mission and
Statement of Values." The Independent Sector.
Internal Revenue Service. "Student Lesson Plan - Tax Reform in the 1960s and 1980s."
Internal Revenue Service. http://www.irs.gov/app/understandingTaxes/jsp/whys/lp/IWT2L6lp.jsp.
Internal Revenue Service. "Student Lesson Plan - The Wealth Tax of 1935 and the Victory Tax of 1942" Internal Revenue Service.
National Center for Policy Analysis. "The Impact of Taxes on Charitible Giving." http://www.ncpa.org/sub/dpd/index.php?Article_ID=23905
Salamon, Lester M., America's Nonprofit Sector A Primer. New York: The Foundation
Center, 1999. ISBN: 0879548010.
Urban-Brookings Tax Policy Center. "The Cost of Giving: How Do Changes in Tax Deductions Affect Charitable Contributions?." http://www.taxpolicycenter.org/publications/url.cfm?ID=310256
Urban-Brookings Tax Policy Center. "Library" http://www.taxpolicycenter.org/library/publications.cfm
White House. "Franklin D. Roosevelt Biography." The White House.
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