A new $300 tax break for people who make charitable donations adds to the IRS’s workload while not necessarily boosting the nonprofit sector.
The above-the-line deduction—meaning people who take the standard deduction can claim it—was included in the third coronavirus response package (Public Law 116-136) and applies for tax years beginning in 2020. Since the existing charitable giving deduction is only available to those who itemize their taxes, the change makes the tax incentive more widely available.
But some are skeptical about what it will do and say it will be nearly impossible for the IRS to prevent tax cheats from claiming the perk, given past experiences with similar measures.
“If history is any indication, a lot of those amounts claimed as deductions will never end up in the hands of charities,” said Marcus S. Owens, a partner at Loeb & Loeb LLP and a former head of the IRS’s Exempt Organizations Division.
The Penn Wharton Budget Model estimates that the provision will cost about $2 billion and will only increase total charitable contributions this year by about $110 million, or just 0.03% above what was originally projected. Raising the ceiling on the deduction could provide more incentive, but it would also cost the government more.
More Charitable Giving?
Philip Hackney, a law professor at the University of Pittsburgh School of Law, said the new deduction is badly designed and he would have preferred for Congress to enact a tax credit.
A tax credit directly lowers a person’s tax bill by providing a dollar-for-dollar reduction of the amount of taxes owed. Deductions reduce the amount of income subject to tax.
Direct funding to nonprofits may have also been a more effective way to help tax-exempt organizations responding to Covid-19, said Hackney, who previously worked in the IRS Office of Chief Counsel.
Still, despite flaws with the current provision, it could help get money to charities that need it, including food banks or those assisting healthcare workers, he said. But lawmakers, nonprofits, and the IRS need to advertise the tax break to potential donors, he added.
“At this time, where we have great need, I think we need everybody’s hands out there helping as much as they can,” he said.
Some nonprofit advocates don’t think the current provision goes far enough.
“The inclusion of a universal, non-itemized deduction that every American taxpayer can use is a step in the right direction, but Congress needs to both significantly increase the $300 tax incentive and extend it to 2019 tax returns to get donations flowing to nonprofits immediately,” Tim Delaney, president and chief executive officer of the National Council of Nonprofits, said in a statement after seeing final text of the stimulus deal.
The concept of a universal charitable deduction isn’t a new one. Taxpayers who used the standard deduction were able to deduct a portion of their donations from 1982 through 1985. The donations were fully deductible in 1986—after which the tax break expired and wasn’t renewed because it was too difficult to enforce and there was little evidence to show it actually increased charitable giving.
Treasury opposed extending the perk in a 1984 report to then-President Ronald Reagan, saying an above-the-line deduction “creates unnecessary complexity, while probably stimulating little additional giving and presenting the IRS with a difficult enforcement problem.”
It will be just as difficult for the IRS to regulate the tax break today, Owens said. There isn’t a reporting mechanism in place to allow the agency to automatically cross-check a charitable donation to determine if it’s legitimate—as there is to verify a person’s paycheck, dividend payment, or interest payment from a bank because of Form 1099 and W-2 requirements, he said.
It’s possible that the IRS could create a reporting requirement to making enforcing the deduction easier but it would require charities to begin issuing a new form, and previous commissioners have shied away from that “almost like it was the proverbial third rail,” Owens said.
Charitable deductions, in general, can be ripe for abuse because of the lack of a reporting system, said Eugene Steuerle, an institute fellow and Richard B. Fisher Chair at the Tax Policy Center. The recent legislative changes add to the potential for abuse, he said.
The IRS’s remaining option is to audit individual taxpayers, but practitioners said that would be impractical given the agency’s limited resources and the dollar amounts involved with the new deduction. The IRS’s latest data book shows that it audited about 0.5% of all returns filed in 2017.
A possible negative outcome of the new deduction and the likely enforcement issues is that people might get used to the idea of cheating on their taxes, Owens said.
“In the long run that has a corrosive effect on voluntary tax compliance across the board,” he said.