Billions to be lost in taxing times for American charities

The biggest division in the Australian community sector is between the organisations that have deductible grant recipient (DGR) status - which means they can offer tax breaks to donors - and those that don't. There are about 500,000 not- for-profits (NFPs) in Australia, of which about 180,000 have some form of incorporated legal status. There are only 20,000 DGRs.

The decision to grant DGR status is up to the Tax Office, on the basis of arcane English case law dating back to the time of Queen Elizabeth I. Among NFPs, DGRs are likely to be older, larger, richer, and engaged in direct services. Small, innovative groups have a harder time getting on the list.

The new head of the ACNC, for one, isn't sure that the tax status of all DGRs is justified. Gary Johns wrote in his 2014 book The Charity Ball: How to Dance to the Donors' Tune:

"...the case for exempting donations to churches, museums, opera houses, community centres, public parks, universities, elite private schools from taxation may be questionable..."

Anyway, we're about to see the outcome of a fascinating experiment that's highly relevant to Australian not-for-profits. It's taking place in the USA, but it's still worth a look, and it concerns the new Republican tax bill.

Most American taxpayers, when they file their tax returns, have a choice in the way they calculate their deductions:

(a) They can claim a "standard deduction", which is a set dollar amount subtracted from income before tax payable is calculated. In 2017, the basic standard deduction for individual taxpayers was US$6350.

or

(b) They can claim "itemised deductions", which means claiming specific tax-deductible expenses. This second option is similar to the Australian system.

The new tax bill will almost double the standard, automatic deduction, increasing it to US$12,000. In effect, it's a big tax cut.

It's estimated that about 94% of Americans will claim the standard deduction in 2018, up from about 74% now. This means that for about 94% of Americans, there will be no tax incentive to donate to charity.

This is because they can't claim the standard deduction and claim donations to charity on top of that. They have to choose either the standard deduction or itemised deductions. The vast majority will get a bigger tax break from the standard deduction than from itemised deductions, so they'll choose the standard deduction.

There's nothing to stop people who choose the standard deduction from making charitable donations, but there's no tax advantage in doing so.

In addition, changes to the inheritance tax mean the tax advantages of leaving bequests to charity have been wiped out for anyone who has less than US$10 million to give away.

The combined effect of these changes, plus a decrease in the top marginal tax rate, comes in at up to US$24 billion per year in lost charitable donations, according to the Council on Foundations. In a total donations pool of about US$258 billion, that could represent a loss of nearly 10%.

What would happen in Australia if we similarly cut back on the tax advantages of charitable donations? Would we lose 10% of donated funds, or less, or more?

It could be more. On the online donations platform GiveNow, about 30% of each year's donations are made in June, at tax time. If June was like other months, that would be a drop of around 25% in the total take.

Why do Australians think this way? It's not as if we make money giving to DGRs; we just lose slightly less than we otherwise would. Regardless, we do respond to the government's financial endorsement of our decision to donate.

It's difficult to argue that the current DGR rules are optimum, or based on any rational foundation, but it's likely that any sudden change would bring carnage.

In America, it's been suggested, under the new rules there, "... charity could become less of a middle-class enterprise and a more exclusive domain of the wealthy, who tend to give to arts and cultural institutions, research facilities and universities. Their use of the charitable tax deduction is less likely to be affected by the new law."

Just in case, Australian not-for-profits should start thinking about how they can persuade Australian citizens to unlink their charitable giving from the idea of tax minimisation.

MORE:

Explainer: Why are donations to some charities tax-deductable? (The Conversation)

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