The Tax Cuts and Jobs Act of 2017: Why Charities Are Worried

US Capitol building against a blue sky, with an American flag at the bottom.

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act of 2017 (“the 2017 Act”) into law. The Act amends the Internal Revenue Code of 1986 and has, among its major provisions, a reduction to individual tax rates, removing personal exemptions, eliminating many itemized deductions, doubling the standard deduction, and doubling the estate tax exemption to $11.2 million. Far and away, the most significant impact of the 2017 Act is reducing corporate income tax, which includes a reduction of the highest C Corporation income tax rate from 35% to 21% and reducing income taxes on pass-through entities (S Corporations and tax partnerships).

Comparison to the Tax Reform Act of 1986

Similar to the Tax Reform Act of 1986 (“the 1986 Act”), the 2017 Act was passed, in part, to simplify the income tax code and lower individual income tax rates. However, there are also vast differences between the two acts. While the 1986 Act enjoyed bipartisan support (97-3 Senate vote), the 2017 Act squeaked by the Senate (51-49 vote). The 1986 Act was passed to be revenue neutral, a requirement of President Reagan before he would sign the Act into law. This was accomplished by eliminating tax loopholes, eliminating the investment tax credit, and significantly reducing fraud by requiring social security numbers for dependents. (Remember the family pet who would show up as a dependent?)

While President Trump did not require a similar mandate for the 2017 Act to be revenue neutral, conservative groups have argued that increased economic growth generated by the Act will increase federal tax revenues by close to $900 billion over the next ten years and would, in essence, make the 2017 Act revenue neutral. On the other side of that argument, a collective study by the Committee for a Responsible Federal Budget, the Tax Policy Center, and the Tax Foundation found that the 2017 Act may add more than $1 trillion to the current national deficit, even with increased economic growth due to the act.

Impact of the 2017 Act

Great for High-Income Families, Not-So-Great for Large Families, Terrible for Charities

The 2017 Act will first apply to Form 1040 filers when the 2018 Form 1040 is filed next year. Individual income tax rates for most brackets will be reduced with a reduction of 2% to 4% in most brackets. However, since the income brackets will shift, it’s possible that some 1040 filers will pay more marginal tax. For example, a married couple filing a joint return with taxable income of $165,000 is currently in the 28% tax bracket. Starting in 2018, that same couple will now be in the 32% tax bracket. If you are a high-income family and have taxable income of $500,000 or more, you’ll see a reduction of 2.6% to your marginal tax rate.

Starting in 2018, the personal exemption for 1040 filers has been eliminated and the standard deduction for 1040 filers has doubled. For a family of five (which includes my family), the act will mean a net increase of roughly $9,450 of reportable taxable income, with a filing status of Married Filing Joint. For an average U.S. family size of three (the average American household in 2016 was 2.53), the act will mean a net increase of roughly $1,150 of reportable taxable income, assuming a filing status of Married Filing Joint. If you are a married couple with no kids, you will likely benefit slightly with this change. The rest of us will see increases in reportable taxable income before taking into effect the tax bracket and rate changes. Interestingly, standard deductions (which never have a phase-out for high-income earners) are now doubled, while personal exemptions (which begin to phase out at an adjusted gross income of $261,500 for married couples) are now eliminated. Itemized deductions (which also have a phase-out for high-income earners) are now reduced as well. While many portions of the 2017 Act were sold as “simplification,” many see the 2017 act as benefiting wealthier filers.

The 2017 Act removes or caps certain itemized deductions such as home equity interest (largely removed), state sales and property taxes (capped), tax preparation deduction (removed), and casualty losses (severely limited). Since filers claim either the standard deduction or the total of itemized deductions (not both), it’s clear that the vast majority of Americans will be claiming the now doubled standard deduction, especially since itemized deductions are now reduced. Since charitable contributions are only available for a tax deduction by claiming itemized deductions, it’s also clear that the tax incentive to donate to public charities has been significantly reduced. The National Tax Policy Center estimates that charitable giving nationally will decline by $12 billion to $20 billion in 2018 alone. This represents a decrease of approximately 4% to 6.5% in total nationwide giving as a result of the 2017 Act. Since the estate tax exemption has now doubled, the National Tax Policy Center also estimates that philanthropic bequests will be reduced by roughly $4 billion annually since the incentive to bequeath estate wealth will be reduced. As a tax professional who has prepared thousands of tax returns over the years, I know that increased wealth does not necessarily translate to increased generosity. It has been my experience that a donor’s giving as a percentage of her or his income decreases as wealth increases, especially when high-income donors face a phase-out of itemized deductions.

Charities have been around for hundreds of years, dating back to old England. Charities have existed to provide services that governments and churches either couldn’t or wouldn’t provide. Those of us who are United States citizens and those of us who are business owners know it is our responsibility to pay our fair share of taxes so that our government can provide needed services to our citizens. We also know there are some services that will never be effectively provided by government, but are provided in an effective and efficient manner by public charities. Public charities provide critical services, often to the most vulnerable, and in doing so, they decrease the burden on our government to provide these services. It is projected that many public charities will close as a direct result of the 2017 Act. Whose responsibility will it be to provide these services when the funding dries up?