The Fate of Charitable Giving Resides on the Fiscal Cliff

"I have seen Americans making great and sincere sacrifices for the key common good and a hundred times I have noticed that, when needs be, they almost always gave each other faithful support."  

-Alexis de Tocqueville, Democracy in America, Vol. 2, 1840

It took a foreigner- Alexis de Tocqueville- to first recognize the generosity of ordinary Americans. In the early 1830s de Tocqueville, a French civil servant from an aristocratic family, embarked on a nine-month tour of the young United States, taking copious notes about what he observed about this emerging country. This new country was ruled not by royalty or a handful of wealthy landowners, but by ordinary people(1), and he published his comments and observations published under the title, Democracy in America, a two-volume set.

Among other things, de Tocqueville was struck by the tendency of Americans to form what he called “associations:”

"In the United States, as soon as several inhabitants have taken an opinion or an idea they wish to promote in society, they seek each other out and unite together once they have made contact. From that moment, they are no longer isolated but have become a power seen from afar whose activities serve as an example and whose words are heeded."

Today, we call such groups “charities.” Instead of relying on the benevolence of some lord, king or the government, de Tocqueville noticed that citizens of this emerging democracy banded together to take care of each other. Those who shared common interests and purposes formed associations to further their cause:

"Americans group together to hold fêtes, found seminaries, build inns, construct churches, distribute books, dispatch missionaries to the antipodes. They establish hospitals, prisons, schools by the same method. Finally, if they wish to highlight a truth or develop an opinion by the encouragement of a great example, they form an association."

More than 180 years later, Americans are collectively recognized as the most generous people in the world. Princeton economist Robert Shiller, who predicted the subprime mortgage debacle, recently wrote an op-ed piece in The New York Times arguing that America’s open and giving spirit is one of the characteristics that marks us as a nation. We put our money where our mouths are to support causes ranging from the devastation left by Japan’s tsunami to medical research, environmental issues and literacy. Charity, of course, begins at home. We donate time and money, often via religious institutions, to help other Americans: victims of 9/11, hurricanes, food banks, homeless shelters- as well as to causes that promote the welfare of those who cannot speak for themselves: children, animals and the elderly.

The point is, for whatever reasons, rallying together and sharing one’s time, talents and/or wealth to support common causes is in our DNA, we don't do it for tax breaks.

Eighty years after de Tocqueville remarked about this uniquely American trait, the federal government formally recognized the important role that philanthropy and non-profit organizations fill. Swamped by debt from World War I, Congress added a provision to the War Tax Revenue Act of 1917 allowing private citizens to deduct charitable contributions. This was later added to the federal tax code as Section 170:

“Contributions or gifts actually made within the year to corporations or associations organized and operated exclusively for religious, scientific or educations purposes, or societies for the prevention of cruelty to children or animals…not in excess of fifteen per centum of the taxpayer’s net income…[s]hall be allowable as deductions.”

Congress has played with the rules that govern tax-deductible contributions to charity ever since. But on Jan.1, the charitable deduction is facing its own catastrophe if we fall off the fiscal cliff. The expiration of Bush-era tax cuts plus the introduction of the 3.8% Medicare surtax under Obamacare could cause donations to non-profit organizations to be much less financially attractive to those who can theoretically afford to give the most: upper income taxpayers.

This, of course, is just one of several tax issues in limbo thanks to the political gridlock in Washington, D.C. But since most charitable contributions are made in the fourth quarter of the year, time is running out for donors who are trying to decide whether to write the check now or wait to see what happens next year. Most are not taking any chances. “We’re seeing moderate-to-high net worth individuals concerned about the deduction being taken away,” says Eileen Heisman, CEO of National Philanthropic Trust, a charity that manages more than a billion dollars in donor assets. Those who can afford it are “front-loading” their 2013 gifts by making them before this year runs out and she describes the attitude as, “Let’s take it now when we know what it will be.”

The difference can be significant. Take the case of a married couple in the (2012) top tax bracket of 35% who want to give $100,000 to help fund research into autism. If they make their donation by Dec, 31, their generosity will reduce their 2012 federal income tax bill by $35,000.

Next year, thanks to the reversion to a top income tax rate of 39.6% plus the 3.8% Medicare surtax this couple will likely face a tax rate of 43.4%- 8.4% higher. This means a potentially bigger tax break of $43,400. Another thing to consider is that if they make the donation today, they lose the possibility of earning a return on their $100,000 over the next year.

Alas, as with most tax-related issues, the decision is not so straightforward. First of all, given today’s historically low interest rates, they’re not giving up that much income by making their contribution today. If they instead invested their $100,000 in a one-year CD paying 1%, they’d end up with only $1,000 more a year from now.

The bigger factor is that, after a three-year hiatus, the phase-out of itemized deductions returns and this reduces how much of your total itemized deductions you can actually use. It’s determined as the lesser of:

• 3% of the excess of AGI over the threshold amount ($100,000, inflation-adjusted), or
• 80% of your total itemized deductions.

Further complicating the timing of when to make your contribution is what- if anything- might happen to the expiring Alternative minimum Tax (AMT) rules. The income levels are going to revert to thresholds not seen in years. A change in your AMT rate might change the attractiveness of the charitable deduction.

Even if “The Cliff” is retroactively averted, Heisman says the charitable deduction is still in jeopardy because both parties have proposed its elimination. For instance, instead of capping the annual deduction to 35% of adjustable gross income (AGI), the White House wants it reduced to 28% for the so-called “wealthy.” Another proposal would simply limit total deductions to a specific dollar amount, such as $25,000, which would include mortgage interest, charitable contributions and other currently deductible amounts.

“The government should not balance the budget on the backs of charities” insists Heisman. “Charitable giving is ingrained in our culture. It’s supporting local organizations and community groups that provide services the government can’t- and probably would never- provide.”

She maintains that the tax deduction is like the icing on the cake and has never been the primary motivation for making a gift. “Most people give because they want to make the world a better place.”  Even if a minority of donors care about the tax deduction, given the sorry state of the economy, do you really want to discourage them from donating to causes that are helping neighbors cope with such things as unemployment, medical and heating bills and trying to recover from natural disasters?

Furthermore, Heisman points out that “it’s not as though people are exploiting the charitable deduction. It’s not some clever technique” or fancy accounting gimmick designed simply to avoid paying taxes.

Given the uncertainty surrounding the charitable deduction, the best advice seems to be, why wait? The most optimistic scenario is that current tax law will be extended another year so both sides have more time to haggle. The worst is that next year your tax bracket is considerably higher and/or your deductions are reduced, so you end up with a much smaller benefit.

If you make a donation this close to the end of the year, be sure to get a written receipt with a 2012 date so there is no question as to what year applies. One of the best and easiest ways is to contribute online using a credit card to a charity that immediately generates an emailed receipt.

Heisman makes these additional recommendations for charitable giving:

• Try to concentrate your donations. Give three larger ones instead of spreading the same amount among 10 different organizations. Your gift will have a bigger impact.
• Don’t change the charities you give to each year.  It costs the charity more because it has to spend more time and money to reach new donors. “If you really love the charity, you want them to succeed in their mission."
• When judging a non-profit, don’t just look at the percent of money spent on “administrative” costs. Heisman points out that by their nature, newer charities have higher administrative costs simply because they’re just getting off the ground. But these can be exciting, worthwhile organizations. Other factors to consider are who makes up the board and the staff. What are their backgrounds? Are there people with experience in finance? Program development? “If you see a number of people who are related, something’s wrong."
• Keep an eye out for “mission drift.” A reputable charity should have a clear mission statement and can provide data on its accomplishments. Are the two aligned? Ask about who some of the other donors are. According to Heisman, if funding is coming from private foundations, the charity is probably reputable. Foundation officers perform due diligence before agreeing to release money to charity, so “there’s a good chance they’ve had their tires kicked.”

1. Granted, there were notable omissions: women as well as slaves.

Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

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