Incentives and Disincentives for Contributions

By Laura Kalick, JD, LLM in Tax

When a gift is made to a 501(c)(3) organization, the donor is allowed a charitable contribution deduction. The charitable contribution deduction is a major incentive for charitable giving and is a significant source of funding for charitable organizations.

In fact, the Congressional Budget Office (CBO) recently issued a report called Options for Changing the Tax Treatment of Charitable Giving which compared various options including deductions and credits for all taxpayers with and without floors. The study found that if the current deduction was converted to a 15 percent nonrefundable credit for all filers with a two percent of Adjusted Gross Income floor, that contributions to charities (measured in 2006 dollars) would be reduced by $10 billion and at the same time, the tax subsidy by the Federal government would be reduced by $24.6 billion, a significant impact.

Other nonprofit organizations do not have the benefit of the charitable contribution deduction in building up their coffers. And although trade associations that are exempt from tax under IRC Section 501(c)(6) may benefit by the business expense deduction their members may take for paying dues that are considered ordinary and necessary business expenses, the portion of dues expended for lobbying or political activities cannot be deducted. An organization can either notify its members as to the portion of dues that is spent on lobbying or political activity or pay a “proxy tax” on that amount.

IRC 501(c)(4) organizations can lobby to an unlimited degree and can engage in political activities as long as that is not their primary purpose. It may be hard to make the case that a social welfare organization that is exempt under IRC 501(c)(4) is engaging in activities that would allow a donor to deduct a contribution or dues to the organization as an ordinary and necessary business expense. And clearly, a contribution to such an organization does not qualify for the charitable contribution deduction. Not only that, contributors to social welfare organizations may have to pay a gift tax on those contributions.

The IRS has a gift tax noncompliance project where they are reviewing donations to 501(c)(4) organizations. Although donors have annual gift tax exclusions and a lifetime exemption amount, in order to qualify for the exclusion or exemption, the individual must file a gift tax return.

In a separate initiative, the IRS is reviewing the activities of 501(c)(4) organizations in order to determine if those organizations are primarily involved in political activities and/or engaged in prohibited private benefit, both of which could cause the organizations to lose their tax-exempt status.

We will have to watch these IRS initiatives to see their future impact on nonprofit organizations.

This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Summer 2011). Copyright © 2011 BDO USA, LLP. All rights reserved.  www.bdo.com