The voices of Tax Policy Center's researchers and staff
The special tax treatment Congress has granted to non-profits and tax deduction it gives their donors are broken. So broken, in fact, that it is worth asking: Should the entire system be scrapped, or at least radically overhauled?
A group of experts in tax and non-profits convened this week at the Tax Policy Center to debate taxes and the future of philanthropy. Their prognosis was not optimistic.
Under today’s system, non-profits are exempt from paying taxes—not only federal business income taxes but often state and local levies such as property, income, and sales taxes. And some donors to certain exempt organizations get an income tax deduction for their gifts.
Effects of the TCJA
But the system is in trouble. The 2017 Tax Cuts and Jobs Act (TCJA) reduced the number of households claiming the charitable deduction by more than half, to 21 million. It didn’t directly attack the deduction. But by increasing the standard deduction and with other changes, the TCJA made it less attractive for tens of millions of taxpayers to itemize their deductions. Thus, it left them with no tax benefit for their charitable gifts.
Now, fewer than 10 percent of households claim the charitable deduction. And the Tax Policy Center estimates that three-quarters of the benefits go to the highest-income 5 percent, those making about $350,000 or more. Middle income people get an average tax break of $20.
As my TPC colleague Gene Steuerle often argues, a tax preference that benefits only a relative handful of Americans (and the richest to boot) is politically unsustainable. At some point, the 150 million households that get little or no tax subsidy for their charitable donations will catch on, and the politicians will respond.
Salvaging the tax preference
The tax preference for giving might be salvageable, but only if it is dramatically restructured. Gene and others have suggested two big changes. First, they’d turn the itemized deduction for charitable giving into a universal deduction, available even to non-itemizers. Second, the deduction would only be available for total annual gifts that exceed a floor--say 1 or 2 percent of Adjusted Gross Income.
But addressing the special tax treatment of the organizations themselves may be a far tougher.
Start with oversight of these groups. In exchange for their tax-exemption, non-profits are subject to regulation by the IRS and the states where they reside.
States are supposed to oversee whether tax-exempt organizations meet their fiduciary duties to their donors and adhere to their stated missions. Some large states, such as New York and California, keep a relatively close eye on their non-profits. Smaller states with limited resources do not.
The IRS is charged with determining whether non-profits comply with federal tax law. Nearly 1.6 million organizations have tax-exempt status. But they simply are not a priority for the agency.
Most don’t owe taxes, and the IRS is more interested in entities that do. They often are political hot buttons—remember the 2013 Tea Party scandal. And the amount of tax the agency could collect from organizations that are not eligible for tax-exempt status is relatively small.
The effects of IRS inattention are troubling. At this week’s event, former National Taxpayer Advocate Nina Olson reported that as many as 42 percent of the applicants IRS approved for tax-exempt status failed to meet the standards for the designation. Overwhelmed by applications, IRS staff apparently did not even read the paperwork.
Keep in mind that the IRS does not oversee the quality of the services provided by tax-exempt organizations. It only determines whether they meet the legal standard for tax-exemption. It has limited authority to close a dangerous non-profit hospital or lice-infested homeless shelter. Unsuspecting donors may think tax-exempt status signals government endorsement of a group’s quality. It does not.
A splintered sector
But poor oversight is not the only problem. Some mega-rich donors are moving away from tax-exempt foundations in favor of more flexible structures. For example, Mark Zuckerberg and his wife, Priscilla Chan have created a limited liability corporation, the Chan Zuckerberg Initiative to give away their money. And they are not alone.
Already, what often is called the “charitable sector” is deeply splintered. Harvard University with its $40 billion endowment and the local soup kitchen that struggles to pay rent operate under the same provisions of the tax code but otherwise have nothing in common. Alternatives such as Chan Zuckerberg will fracture traditional ideas of tax-exemption even more.
We are left with this: The tax deduction for charitable giving is irrelevant to nearly all low- and middle-income people and, increasingly to the super-rich. While more charitable organizations are applying to the IRS for tax-exempt status, fewer people are donating, in part because givers have lost trust in the organizations. The model is broken, perhaps irrevocably.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.
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Photograph by Noah Zwiefel