In recent months the Obama administration has proposed changes in the tax code, including some that could impact the charitable community. One proposal-a plan to reduce the maximum allowable tax deduction for charitable contributions from 35% to 28% for families making $250,000 or more-has become a virtual lightning rod in the financial and philanthropic communities.
The projected impact this would have on charitable giving is still unclear and subject to debate. Predictions range from a 1% or 2% decline in charitable donations to the virtual devastation of gifting and the nonprofit community. Whichever way the pendulum swings, however, philanthropy will remain an important area of opportunity for financial advisors.
To gauge how the changes could impact clients, let's look at a couple in the 35% tax bracket that gives $100,000 to charity. Assuming they can deduct the entire donation in the year of transfer, they will reduce their income taxes by $35,000 under current law, resulting in a net cost of $65,000 in making the gift. Under the proposed legislation, the couple will only be able to deduct their gift at the 28% tax rate, reducing their taxes by $28,000. They will pay an additional $7,000 in taxes for the privilege of making their gift, increasing the after-tax cost of the gift by 10.8%, to $72,000.
The Impact On Nonprofits
Unfortunately, the recent financial collapse and evaporation of wealth have decimated direct charitable donations at a time when the need for nonprofit help is skyrocketing. This perfect storm of financial and economic crisis, uncertain tax legislation and increasing demands upon nonprofit organizations by the communities they serve is happening while we're experiencing increased interest in philanthropy and a heightened awareness by Americans of the overall impact they can have through their charitable gifts.
The importance of the nonprofit sector, it should be noted, cannot be understated. With 9.4 million employees and 4.7 million full-time volunteers nationwide, nonprofits constitute 11% of the American workforce and 5% of the gross domestic product. The nonprofit sector would be the seventh-largest economy in the world if it were its own country, greater than the auto and financial industries combined.
Given the volume of assets dedicated to charitable goals, advisors should see this as a time to be actively engaged in discussions with clients about charitable giving and philanthropy. Based on a recent study by the Center on Philanthropy at Indiana University, it seems the door to that opportunity is more open than ever. According to the 2008 Study of High-Net-Worth Philanthropy, the majority of today's wealthy or affluent donors wouldn't stop their charitable gifting even if tax deductibility were reduced to zero. This coincides with the view that tax policy has little to do with the high level of donations in the U.S. Studies indicate, for example, that 70% to 80% of Americans donate each year, but only one-third itemize deductions.
Why should advisors care about the impact of the Obama tax proposals on their clients' family philanthropy? Perhaps because clients expect advisors to be involved in their philanthropic planning. The Center on Philanthropy Study found that affluent donors have dramatically expanded their use of financial and legal advisors over the last two years and have been making those shifts at the expense of traditional relationships with nonprofit personnel, such as development officers and planned giving staff, or peer-to-peer discussions (See Figure 1).
The increased interest in philanthropy highlights the significant opportunity advisors have to deepen their client relationships across multiple generations. Donors are engaging more directly with their advisors and the opportunities are expanding for advisors who embrace a comprehensive discussion of holistic wealth strategies with clients and their families. The trend is also consistent with a secondary finding from the study that points to a parallel growth in the use of charitable instruments such as split interest trusts and donor-advised funds, which typically require the involvement of an advisor. Donor-advised funds in particular have become the fastest growing charitable instrument in the country with annualized adoption rates exceeding 20% over the last few years.
Assessing The Landscape
So where does this take us? We have a global economic crisis that is threatening to undermine the viability of a key segment of the American economy-the nonprofit community. We have individual donors no longer simply looking for better philanthropic advice and comprehensive solutions, but actively seeking advisors who can deliver a more holistic wealth planning solution. Advisors, meanwhile, are looking for ways to respond to difficult market conditions and to client desires to continue supporting the causes they care about in the most cost-effective and efficient manner possible. All this is happening with the prospect of a changing tax environment.
It's important to remember that the proposed federal tax changes would be phased in starting in 2011, giving advisors and their clients time to manage the impact. Also, tax deductions for many high-income donors are already capped at 28% as a result of the alternative minimum tax, so the net tax impact in 2011 may be moot.