The Code as a Tool
The Internal Revenue Code is one of the tools employed by Congress to encourage certain behaviors that it has determined are in society’s long-term best interest and, therefore, worthy of the public’s financial support. Among the socially-desirable behaviors to which the Code is applied, perhaps the best-known is that of charitable giving by individuals and businesses to privately founded charitable organizations. The Code promotes the tax-paying public’s financial support for charitable organizations and their missions by allowing taxpayers to claim a deduction for certain charitable contributions, thereby subsidizing such contributions by reducing the taxpayers’ federal income tax liability.[i]
By its nature, the Code, like most statutes, takes a long-term view toward achieving the goals to which it has been dedicated; after all, human behavior can rarely be modified overnight. However, there are instances in which the Code may be, and has been, used to direct funds as quickly as practicable from the general public to those of its members that, as a result of some unforeseen disaster, natural or otherwise, are in greatest need.
What to Do?
While considering the recently enacted Coronavirus Aid, Relief and Economic Security (“CARES”) Act, Congress looked into its toolkit to see what means it had available for addressing the various consequences of the economic emergency arising from the government-ordered shutdown of many businesses, nonprofit organizations, and social institutions in response to the spread of COVID-19.
In the end, Congress decided to include in the CARES Act[ii] – along with other measures[iii] – a greatly enhanced charitable contribution deduction,[iv] based on the theory that those taxpayers who can afford to make such contributions either will be encouraged to do so or, if they were already predisposed, will be motivated to make gifts in larger amounts than they were otherwise planning.
Before describing those provisions of the Act that are directed at charitable giving, it would be helpful to understand, generally, how the Code promotes such giving.
The Charitable Contribution Deduction
In order to be deductible in determining a taxpayer’s federal income tax liability for a given year, the taxpayer’s transfer of property to a charitable organization (in the broadest sense) must meet several requirements: (i) the recipient must be an organization that Congress has determined is eligible to receive tax-deductible charitable contributions;[v] (ii) the transfer must be made with gratuitous intent and without the expectation of receiving a benefit of substantial economic value in return; (iii) the transfer must be complete (generally, it cannot be contingent);[vi] (iv) the transfer must be of a taxpayer-donor’s entire interest in the contributed property (generally, it cannot represent a partial interest);[vii] (v) the transfer must be made within the taxable year for which the deduction will be claimed; (vi) the transfer must be of money or property – not a contribution of services;[viii] and (vii) the transfer must be properly substantiated.[ix]
In the case of an individual, the taxpayer must be one who itemizes eligible expenditures[x] on their federal income tax return in determining their taxable income, rather than claiming the so-called “standard” deduction.[xi]
Limits – Generally
Ironically, at the same time that the Code encourages charitable giving by a taxpayer, it also imposes certain limitations upon the amount of the deduction that may be claimed by the taxpayer. Thus, the deductibility of a taxpayer’s charitable contributions in a given year is limited to a percentage of the taxpayer’s income for such year.[xii] Similarly, other special rules limit the deductible value of a contributed property.[xiii] In each case, the application of these limitations depends upon the nature of the property transferred and upon whether the recipient organization is a public charity[xiv] (one which generally receives its financial support from a broad segment of the public) or a private foundation (one which generally receives its support from a single family or business).
For example, an individual’s charitable contribution deduction for a taxable year is limited to a specified percentage of the individual’s gross income for such year (with certain adjustments; the “contribution base”). More favorable percentage limits apply to contributions of cash, than to in-kind contributions of capital gain property. One reason for this distinction is the fact a taxpayer who donates an unencumbered appreciated capital gain asset to a charity is not required to recognize the gain inherent in the property, yet may still claim a fair market value charitable deduction therefor.
More favorable limits also generally apply for contributions to public charities than for contributions to grant-making private foundations; this distinction is based, in part, upon the fact the former are “accountable” to the general public, while the latter are less so.
Specifically, the deduction for charitable contributions of cash by an individual taxpayer to a public charity may not exceed 50 percent of the taxpayer’s contribution base.[xv] (But see below regarding a temporary change by the Tax Cuts and Jobs Act.) In contrast, a cash contribution to a private foundation may be deducted up to 30 percent of the taxpayer’s contribution base.[xvi]
An individual taxpayer’s contributions of appreciated capital gain property to a public charity generally are deductible up to 30 percent of the taxpayer’s contribution base.[xvii] Contributions of such property to a private foundation are deductible up to 20 percent of the taxpayer’s contribution base.[xviii]
In the case of a corporate donor, the charitable contribution deduction is limited to 10 percent of the corporation’s taxable income for the year (with certain adjustments).[xix]
A taxpayer’s charitable contribution that exceeds the applicable percentage limit generally may be carried forward by the taxpayer for up to five years.[xx]
In general, charitable contributions of cash are deductible in the amount contributed, subject to the percentage limits discussed above. In addition, a taxpayer generally may deduct the full fair market value of long-term capital gain property contributed to a public charity.[xxi]
In certain cases, however, the Code limits the deductible “value” of the contribution of appreciated property to the donor’s tax basis in the property. This limitation generally applies for: (1) contributions of inventory or other ordinary income or short-term capital gain property;[xxii] (2) contributions of tangible personal property if the use of the property by the recipient charitable organization is unrelated to the organization’s tax-exempt purpose (for example, the donation of a rare violin to a hospital);[xxiii] and (3) contributions of any property to a grant-making private foundation (other than contributions of stock that is long-term capital gain property for which market quotations are readily available on an established securities market).[xxiv]
Special Inventory Rule
Although most charitable contributions of property are valued at fair market value or at the donor’s tax basis in the property, certain contributions of appreciated inventory and other property (for example, contributions of “apparently wholesome food”[xxv]) may qualify for an enhanced deduction that exceeds the donor’s tax basis in the property, but which is less than the fair market value of the property.[xxvi]
A donor who claims a deduction for a charitable contribution must maintain reliable written records regarding the contribution, regardless of the value or amount of such contribution. No charitable contribution deduction is allowed for a separate contribution of $250 or more unless the taxpayer-donor obtains a contemporaneous written acknowledgement of the contribution from the recipient charity indicating whether the charity provided any good or service (and an estimate of the value of any such good or service) to the taxpayer in consideration for the contribution.[xxvii]
If the total charitable deduction claimed for noncash property is more than $500, the taxpayer must attach a completed IRS Form 8283 (Noncash Charitable Contributions) to the taxpayer’s federal income tax return or the deduction is not allowed. If the deduction claimed is more than $5,000, the taxpayer must also obtain a qualified appraisal and attach a summary thereof to the tax return.[xxviii]
The Tax Cuts and Jobs Act (“TCJA”) of 2017
As part of the tax legislation passed in 2017,[xxix] Congress increased the income-based percentage limit for certain charitable contributions of cash by an individual taxpayer to public charities from 50 percent to 60 percent. To the extent such contributions exceed the 60 percent limit for any taxable year, the excess is carried forward and treated as a charitable contribution that is subject to the 60 percent limit in each of the five succeeding taxable years in order of time.[xxx]
This enhanced deduction provision applies to the amount of charitable contributions taken into account for taxable years beginning after December 31, 2017, and before January 1, 2026.[xxxi] The 50 percent limit is reinstated for cash contributions to public charities for taxable years beginning on or after January 1, 2026.
The CARES Act
The Act revisited the income-based percentage limitation for charitable contributions. Specifically, it amended this, as well as other related provisions – effective for taxable years ending after December 31, 2019[xxxii] – with the goal of maximizing the influx of immediately available funds to charitable organizations that are directly engaged in activities for the benefit of the general public.
Under the Act, an individual who itemizes deductions and makes a cash payment as a charitable contribution to a public charity during the calendar year 2020,[xxxiii] may elect[xxxiv] to claim a deduction in respect of such contribution of an amount up to 100 percent of the taxpayer’s 2020 contribution base;[xxxv] thus, the TCJA’s 60 percent limitation is suspended for 2020, and the taxpayer-donor may use a cash contribution to offset their entire 2020 income.
Consistent with the above-stated intent, contributions to a private foundation, to a supporting organization, or to a public charity for the establishment of a new (or for the maintenance of an existing) donor-advised fund,[xxxvi] will not qualify for the enhanced deduction under the Act because such funds will not necessarily be immediately employed in charitable activities. For example, there are no minimum distribution requirements for a donor-advised fund;[xxxvii] a private foundation can get away with distributing only 5 percent of the aggregate fair market value of its assets;[xxxviii] supporting organizations may perform a number of functions on behalf of a public charity, not all of which result in immediate liquidity for use by the supported charity.[xxxix]
In the case of a corporation, such a cash contribution to a public charity during 2020 will be allowed as a deduction in an amount up to 25 percent of the corporation’s taxable income (rather than the otherwise applicable 10 percent).[xl]
Any amounts in excess of the taxpayer’s applicable contribution base may be carried forward by the taxpayer for up to five years.[xli]
Most of the country has been on lockdown since early-to-mid-March; in the case of New York, the lockdown is scheduled to continue at least through mid-May.
The CARES Act became law on March 27. At that time, the Congress was necessarily working with less than adequate data and making a number of semi-educated assumptions.[xlii]
A lot has happened since then. For example, we have discovered that the $349 billion that had been set aside to fund SBA-guaranteed loans to small businesses and nonprofits under the Paycheck Protection Program was woefully inadequate, having been fully expended by mid-April.[xliii] Many business groups have been clamoring for Congress to provide a massive amount of additional funding for the program, and Congress is certain to comply in fairly short order.[xliv]
We have seen the number of jobless claims exceed 22 million over just a four-week period of coronavirus-related shutdowns.
Many state and local governments are reporting that they are nearly financially broke.
Despite these developments, most states remain wary of re-opening their economies in the near-term for fear of allowing a second wave of coronavirus infections to spread.
Finally, and most relevant to this post, many nonprofit organizations[xlv] are already urging Congress to further expand the tax breaks for charitable contributions by individuals[xlvi] – in other words, to go beyond the mere one-year suspension of the income-based percentage limitation for cash gifts to public charities – only three weeks after the enactment of the CARES Act.
Where does that leave us insofar as charitable giving and nonprofits are concerned? Intuitively, it is unreasonable to expect that any tax-based incentive would cause the general public to even consider increasing their charitable giving under the circumstances in which we find ourselves; businesses are even less likely to do so.
It is unfortunate, but for the same reason that many businesses will fail, so will many nonprofits – it is likely that not all of them can be saved. At this point, only those nonprofits that are deemed “essential” should be the beneficiaries of additional governmental support. Others should adapt as best they can to their changed circumstances, both today and after the health crisis passes; in some cases, that may require a reduction in activities, or a redirection of efforts; in others, it may require some degree of collaboration with other organizations, both nonprofit and for profit.
At the same time, perhaps we should encourage nonprofits to establish reserves, or to otherwise modify their behavior or structure so as to build or develop their resilience.[xlvii] We’re in a strange new world. This may be the time to experiment with new models of behavior for nonprofits and their supporters. The Code can be a very effective tool in this process.
[i] IRC Sec. 170.
[ii] P.L. 116-136.
[iv] Section 2205 of the CARES Act.
[v][v] IRC Sec. 170(c).
[vi] Reg. Sec. 1.170A-1(e).
[vii] IRC Sec. 170(f)(3).
[viii] Reg. Sec. 1.170A-1(g).
[ix] IRC Sec. 170(f)(8); Reg. Sec. 1.170A-13, 1.170A-15, 1.170A-16 and 1.170A-17.
[x] IRC Sec. 63(d).
[xi] IRC Sec. 63(c).
[xii] IRC Sec. 170(b).
[xiii] IRC Sec. 170(e).
[xiv] IRC Sec. 509(a).
[xv] IRC Sec. 170(b)(1)(A).
[xvi] IRC Sec. 170(b)(1)(B).
[xvii] IRC Sec. 170(b)(1)(C).
[xviii] IRC Sec. 170(b)(1)(D).
[xix] IRC Sec. 170(b)(2).
[xx] IRC Sec. 170(d).
[xxi] IRC Sec. 170(e).
[xxii] IRC Sec. 170(e)(1)(A).
[xxiii] IRC Sec. 170(e)(1)(B).
[xxiv] IRC Sec. 170(e)(5).
[xxv] If you ask me, “apparently wholesome” is in the eye of the beholder. What can appear more wholesome-looking than a double quarter pounder with cheese, I ask you? Alas, Congress is presumptuous enough to define “apparently wholesome food” by reference to the Bill Emerson Good Samaritan Food Donation Act. Seriously?
[xxvi] IRC Sec. 170(e)(3)(C).
[xxvii] IRC Sec. 170(f)(8).
[xxviii] Reg. Sec. 1.170A-13, 1.170A-15, 1.170A-16 and 1.170A-17.
[xxix] P.L. 115-97.
[xxx] IRC Sec. 170(b)(1)(G).
[xxxi] IRC Sec. 170(b)(1)(G)(i).
[xxxii] Section 2205(c) of the CARES Act.
[xxxiii] Section 2205(a)(3)(A) of the CARES Act.
[xxxiv] Section 2205(a)(3)(A)(ii) of the CARES Act. The application of the relaxed income-based limitation is elective with the taxpayer. In the case of a contribution by a partnership or an S corporation, the election is made separately by each partner or shareholder. Section 2205(a)(3)(C) of the CARES Act.
[xxxv] Section 2205(a)(1) and Section 2205(a)(2)(A) of the CARES Act.
[xxxvi] Section 2205(a)(3)(B) of the CARES Act.
[xxxvii] IRC Sec. 4966.
It should be noted that a public charity which sponsors a donor-advised fund may itself be engaged in a number of direct charitable activities, contributions to which would qualify for the enhanced charitable deduction.
[xxxviii] IRC Sec. 4942.
[xxxix] Their public charity status is derived from that of the public charities which they support. IRC Sec. 509(a)(3); Reg. Sec. 1.509(a)-4.
[xl] Section 2205(a)(1) and Section 2205(a)(2)(B) of the CARES Act.
[xli] Section 2205(a)(2)(A)(ii) and Section 2205(a)(2)(B)(ii) of the CARES Act.
[xlii] One might say, with less than a full deck . . . of information.
[xliii] It was originally intended that loans would be available through the end of June.
[xliv] But only after the parties have walked around the proverbial ring a bit, holding each other up like a couple of punch-drunk boxers.
[xlv] Who may also qualify for the forgivable, unsecured loans under the Paycheck Protection Program.
[xlvi] The greatest part of charitable giving comes from individuals, not from corporations or foundations. The so-called “1 percent” account for approximately one-third of all charitable giving.