Tax Incentives for Charity: An Overview of Legislative Proposals

Tax Incentives for Charity:
An Overview of Legislative Proposals
Jane G. Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
Summary
This reports briefly discusses the development of proposals for tax incentives for^th^th
charity embodied in H.R. 7 and S. 476 in the 108 Congress and S. 6 in the 109; the
revisions in the Pension Protection Act (P.L. 109-280), and prospects for future
legislation. Proposed changes initially included charitable deductions for non-itemizers,
rollovers of IRAs into charitable uses, a reduction in the excise tax on private foundation
income, an increase in the deductions cap for corporate contributions, and several
narrower provisions relating to business contributions of property and charitable
remainder trusts. P.L. 109-280 included some of these changes, along with some
revenue offsets.
Legislation involving tax incentives for charity began in the 107^th Congress with the
Community Solutions Act of 2001 (H.R. 7). This bill, adopted in 2001 by the House, had
eight new tax provisions designed to benefit charitable giving including a capped
deduction for non-itemizers. The President had proposed three of these tax provisions in
his original 2001 tax proposal, but these provisions were not included in the 2001 tax cut
(P.L. 107-16). Senate consideration also began in the 107^th Congress with S. 1924,
introduced by Senators Lieberman and Santorum, which would have provided a
temporary non-itemizers deduction with a higher cap along with other provisions. The
Senate Finance Committee reported this bill, the CARE Act of 2002, with a temporary
non-itemizers deduction with both a floor and ceiling, but it was not considered on the
floor, containing some other provisions of H.R. 7. A similar bill, S. 476 estimated to cost
$11 billion over 10 years, was passed by the Senate on April 9, 2003. A new version of
H.R. 7 passed the House in 2003. This report summarizes the tax provisions affecting
charitable contributions and briefly reviews the issues in most cases. The discussion
begins with H.R. 7 and continues with the provisions in the Senate alternative. A 109^th
Congress bill, S. 7, included charitable provisions as well, and the Senate continued to
propose some of these charitable provisions along with revenue raisers, which were
enacted in 2006 in P.L. 109-280. The President’s advisory panel on tax reform also
proposed extending the deduction to non-itemizers and introducing a floor.

Deduction for Non-Itemizers
Under current law a taxpayer can either itemize deductions (the major deductions are
charitable contributions, excess medical expenses, mortgage interest, and state and local
income and property taxes) or choose the standard deduction. The standard deduction
is advantageous if that amount is larger than total itemized deductions. H.R. 7 would
have allowed someone who takes the standard deduction to deduct charitable
contributions. Singles could deduct amounts in excess of $250 but not over $500; joint
returns may deduct the excess of $500 not to exceed $1000.¹ This provision was to be
effective for the years 2004-2006. While in effect, this deduction is the largest provision
accounting for $1.4 billion of the $2.2 billion cost in the first full year (FY2005). Over
all 10 years (2004-2013) it accounted for $2.9 billion out of $12.7 billion (22%). This
provision has not been adopted.
While the deduction for non-itemizers may increase giving, its effects would be
limited because of the cap although increased in effectiveness per dollar of revenue by the
floor. Even without a cap, the deduction is unlikely to induce additional giving as large
as the revenue loss because evidence suggests that the responsiveness of taxpayers,
particularly lower and moderate income taxpayers, to incentives is small.² The provision
would also increase complexity of tax filing by including another line item. (A limited
deduction for non-itemizers was formerly available for 1981-1986, enacted as part of the
Economic Recovery Tax Act of 1981 (P.L. 97-34).)
IRA Rollover Provision
The largest permanent tax provision in H.R. 7 allowed tax free distributions from
individual retirement accounts to charities by individuals aged 70 and1/2 and over, which
originally cost $204 million in the first year (9% of the cost), $470 in the last year (33%
of the cost, in FY2013), and 22% of the ten year cost. While this treatment may appear
no different from simply including the amounts in adjusted gross income and then
deducting them as itemized deductions, it can provide several types of benefits even to
those who itemize. (In the absence of a general deduction for non-itemizers, it also
permits such a deduction for eligible non-itemizers, or permits the avoidance of caps or
floors). Apparently an important motivation was to reduce adjusted gross income which
can trigger a variety of phase-outs and phase-ins, including the phase-in of taxation of
Social Security benefits. There are also income limits on charitable contributions. Since
IRAs tend to be held by higher income individuals, the taxpayers might be somewhat
more sensitive to the incentive to give; however, it is not clear why this particular group
of taxpayers is targeted. This provision was adopted in P.L. 109-280 with a $100,000
annual limit.

¹ This provision differs from the 107^th Congress version which allowed a permanent provision
with a cap beginning $25 for singles ($50 for joint returns) for 2002-2003,with the cap rising over
time ($50/$100 for 2004-2006, $75/50 for 2007-2009, and $100/$200 thereafter. The President’s
original proposal and his FY2003 proposal have no cap.
² See CRS Report RL31108, Economic Analysis of the Charitable Contribution Deduction for
Non-Itemizers.

Reduce the Excise Tax on Foundation
Investment Income
Under current law, there is a 1% tax on investment income of foundations, and an
additional 1% if the foundation does not make a certain minimum distribution (based on
distributions made in the previous five years), or has been subject to a tax for failure to
distribute in the previous five years. H.R. 7 would have eliminated the extra 1% tax. This
provision accounted for $196 million (9%) in the first year, $270 million (19%) in the last
year, and $2,273 (18%) for the 10-year period.
Private foundations, whose contributors (or their families) retain the right to direct
the distribution of funds, have always been subject to greater scrutiny, in part because of
the possibility of the donor (or family ) obtaining a private benefit. Foundations are
required to distribute 5% of their assets each year (or pay a penalty), but the tax is credited
against that distribution.
If the foundation is just making the minimum distribution, every dollar of tax
reduction should be funneled into distributions. Moreover, the moving average
discourages a large contribution in a particular year. The reduction in the investment tax
would also make private foundations more attractive in general, although that increased
attractiveness might in part induce more contributions, and in part replace contributions
that might have gone to other charities. The effects should be small, however, because
the tax is small.
Proponents of reducing the tax also argue that it should be reduced because it brings
in revenue that is in excess of IRS audit costs, which they indicate was the original
purpose of the tax (which was introduced in 1969). The revenue stream from this tax has,
however, been quite variable recently because it is heavily affected by the stock market.
In any case, a reading of the legislative history indicates that while the Senate
characterized the tax as an audit fee, the House referred more generally to the notion that
private foundations should bear part of the cost of government generally because of their
ability to pay (as well as viewing it in part as a user fee), and both objectives were cited
in the final explanation of the bill. It was reduced twice (in 1978 and 1984) based on the
argument regarding costs of audit versus revenue.
Another argument made for eliminating the additional tax is the additional
complication arising from it. Of course, one could as easily simplify by converting the
entire tax to a flat fee; simplification does not require reduction.
H.R. 7 added a new provision that limits the counting of administrative costs as part
of a foundation’s minimum distribution requirement. Foundations are required to make
a minimum distribution of 5%, but that 5% can currently include administrative costs
(which currently have only to be “reasonable”). As originally introduced earlier in 2003,
the provision would have disallowed any administrative costs, but the proposal as
reported allows deductions for most administrative costs, with some exceptions. This
proposal was not adopted. (See CRS Report RS21603, Minimum Distribution
Requirement for Private Foundations: Proposal to Disallow Administrative Costs, for an
analysis.) This provision has not been adopted.

Raising the Cap on Charitable Deductions
of Corporations
Under current law corporations can deduct charitable contributions of up to 10% of
income; H.R. 7 would have gradually raised the cap to 20% (by one percentage point
each year beginning in 2004, reaching 15% in 2008-11, and 20% thereafter).³ This
provision accounted for 4% of the first year cost, 19% of the final cost and 12% of the 10-
year cost. Most corporate giving already falls well under the cap; the average giving is
less than 2% of income.
There has been dispute over corporate charity, since shareholders could make their
own decisions about charitable giving. In some views, charitable giving by corporations
is another management perk that might be excessive because of monitoring problems by
shareholders (this problem is also called an agency cost problem). Others argue that
corporations should be encouraged to give to charity and to be socially responsible.
Economists have studied models in which charitable giving is part of the firm’s profit
maximizing behavior (e.g., by gaining the firm good will). Evidence on the effectiveness
of the deduction is mixed, with time series studies showing a positive effect and cross
section results not finding an effect.⁴ This provision has not been adopted.
Extend Present Law Section 170(e) Deduction for Food
Inventory to all Businesses; Extend Research Benefit
Corporations that donate inventory to charity in general get a deduction for the cost
(not the market value). A special rule allows businesses paying the corporate tax to also
exclude half the appreciation (half the difference between market value and cost of
production, if the inventory is given to an organization that directly passes it on to the ill,
the needy, or infants, as long as the total deduction is no more than twice the cost. An
important category of donations is that of food and there have been disputes between
taxpayers and the IRS about how to measure the fair market value of food. H.R. 7 would
have allowed unincorporated businesses (or businesses that are incorporated but do not
pay the corporate tax) the additional deduction, and the fair market value of wholesome
food would be considered the price at which the firm is currently selling the item (or sold
it in the past), although this deduction would be limited to the corporate percentage cap
on deduction in general. This provision accounted for 3% of the first year cost, and 6%
of the last year cost.
The objective was to create more equity among types of taxpayers and resolve
disputes (largely in the taxpayer’s favor). However, one important concern about donated
inventory is whether firms might be profiting from charitable contributions for items that
they could not otherwise sell. P.L. 109-280 extended the provision to unincorporated

³ This provision is more generous than the 107^th Congress version which would have raised the
cap to 15%.
⁴ See James R. Boatsman and Sanjay Gupta, “Taxes and Corporate Charity: Empirical Evidence
from Micro-Level Panel Data, “ National Tax Journal, Vol. 49, June 1996, pp. 193-213.

business (not to exceed 10% of business income), making permanent a change adopted
in the Katrina Emergency relief Act of 2005, but no other change was made.
Modify the Basis of S Corporation Stock for
Certain Charitable Contributions
Under current law, a shareholder in a Subchapter S corporation (a corporation treated
as a partnership) was allowed to deduct his or her pro rata share of any corporate
contribution. At the same time, the taxpayer must decrease the basis of stock by that
amount (which is a way of reflecting the effect on the shareholder’s asset position). The
bill provides that the taxpayer will not have to reduce basis in the stock to the extent a
deduction is taken in excess of adjusted basis of the donated property (e.g., cost). This
provision appears to be consistent with allowing a deduction for the market value of
appreciated property without including the appreciation in income (a special benefit
generally available to taxpayers). This provision would have cost 1% of loss in the first
year, and about 5% in the last year. It has not been adopted.
Modify Tax on Unrelated Business Taxable
Income of Charitable Remainder Trusts
Current law provides tax deductions for some portion of a trust and income tax
exemption on the earnings, if a remainder of the assets is left to charity (while paying
income to a non-charitable donee, usually a spouse or other relative during an interim
period). The trust’s income is, however, no longer exempt from tax if the trust has
unrelated business income. This provision liberalizes the rule by providing for a 100%
excise tax on any unrelated business income rather than loss of all tax exemption. This
provision accounts for a negligible share of the cost. This provision has not been adopted.
Contributions of Scientific and Computer Property
Certain special treatment (similar to that for food inventory) is allowed for certain
scientific property used for research and for contributions of computer technology and
equipment, provided the property is constructed by the taxpayer. In concrete terms, this
rule requires that no more than 50% of the cost is due to parts purchased elsewhere. This
provision expired in 2003. The bill would allow property assembled, as well as
constructed, to be eligible and make the provision permanent. This provision would
account for 6% of the first year cost and 14% of the last year cost. It has not been
adopted.
There are a number of other provisions in the 108^th Congress version of H.R. 7 which
are minor or were not addressed in the 107^th Congress version. The most important one
would exclude certain items (such as rent) received by a subsidiary from a tax on
unrelated business income except for the excess over an arms-length price. This provision
was adopted in P.L. 109-280.

Modifications in the Senate Proposal; Final Changes
In the 107^th Congress, the Lieberman-Santorum plan, S. 1924, would have provided
non-itemizers deductions with a cap of $400 ($800 for joint returns); the Senate Finance
Committee reported a version of S. 1924 (as a substitute for H.R. 7) with a temporary
non-itemizers deduction with floor and a ceiling ($250/$500 for singles and $500/$1000^th
for joint returns) as in H.R. 7. A similar bill was introduced as S. 476 in the 108
Congress, with charitable provisions costing $11 billion from 2003-2013, with $2.8
trillion due to a two year non-itemizers deduction. This bill was passed by the Senate on
April 9, 2003. The proposal included the IRA rollover provision but not the foundation
excise tax reduction or the increase in corporate contributions cap. The remaining
provisions of H.R. 7 discussed above were included although the provision for research
and computer contributions was a temporary extension through 2005. There were also
a number of additional provisions, although some of them relatively small. Another
important set of provisions related to benefits for contributions for conservation purposes
including a 25% exclusion from capital gains on the sale or exchange of property to the
government for conservation purposes ($766 million) and lifting contribution caps for
contributions for conservation purposes ($332 million). A third provision allowed the
food inventory treatment for book inventories as well ($283 million). There are a number
of minor provisions as well. The bill also included increases in grants, as well as revenue
offsets relating to tax shelters and user fees.
A Senate floor amendment allowing up to 10 years to eliminate excess holdings of
stock to avoid a heavy tax on excess business holdings was adopted. This provision
would cost $129 million over 10 years. Some indications were made at the time that Wal-
Mart might especially benefit from this change. In the 107^th Congress consideration of
the bill, this provision substituted for an amendment proposed, but then withdrawn,
during committee consideration which would have raised the limit on holdings in one firm
from 2% to 5%. Another amendment passed on the Senate floor extended the 25% capital
gains exclusion for land sold to any charity regardless of the purpose.
A similar bill, S. 6, sponsored by Senators Santorum, Frist, Hutchinson, and^th
McConnell, was introduced in the 109 Congress. The administration included
provisions in their budget of FY2006, but did not include the non-itemizers’ deduction.
The Pension Protection Act (P.L. 109-280) included certain provisions of H.R. 7 as
noted above, along with lifting contribution caps for conservation and the book inventory
provision. It included some other minor benefits along with a number of revenue raising
provisions including increased accountability and restrictions for donor advised funds
and supporting organizations, arrangements that, like private foundations, permit
individuals to direct future charitable distributions from a fund.
While there is no current legislation relating to a deduction for non-itemizers, the
President’s advisory panel on tax reform has proposed such a deduction along with a 1%
floor, which would only allow charitable deductions in excess of 1% of income.