|Substantiation and Valuation. Under long-standing regulations,105 a charitable contributions deduction is only available if proper substantiation is maintained by the donor. In some cases, this includes obtaining a “qualified appraisal” of the value of property donated.106 In 1993, Congress added two further requirements.107 The first mandates donors to obtain a “contemporaneous written acknowledgment”108 from the charitable donee for gifts of $250 or more.109 The second imposes burdens on donees, not donors, to provide written notice of the existence and amount of any quid pro quo provided to a donor of more than $75.110
Because a charitable contributions deduction is often allowed for the fair market value of donated property, disputes arise about how to fix that value. The standard definition for this purpose reads:
“The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”111
The determination of fair market value is very fact specific. Thus, despite a large number of litigated cases, controversies continue to emerge regularly. The Internal Revenue Service publishes a helpful valuation guide for its appeals officers.112 Special procedures apply to gifts of art,113 and an I.R.S. Art Advisory Panel meets in closed session, several times each year, in order to determine the authenticity and fair market value of works of art. The meetings are closed in order to protect the confidentiality of taxpayer information presented to the Panel.114
Non-Itemizers. Taxpayers may elect either to itemize their deductions or to take a “standard deduction” instead.115 Most — more than 70 percent — choose the standard deduction.116 As a result (1) they cannot claim an itemized charitable contributions deduction and (2) they are entitled instead to the simpler, and at least sometimes more generous, standard deduction.117 Because the amount of the standard deduction does not vary with actual charitable donations, and is in lieu of certain other deductions as well, it provides no incentive to make charitable gifts, and it treats equally those nonitemizers who donate to charity and those who do not. There is an unavoidable policy tension here: between simplification of taxpayer compliance burdens, on the one hand, and a desire for improved incentives and horizontal equity among taxpayers, on the other.118
From 1982 to 1986, a nonitemizer charitable contributions deduction was allowed, phasing in during the earlier years until fully effective in 1986.119 It terminated after 1986120 and later was completely repealed.121 Restoration of the nonitemizer charitable contributions deduction has since been a favorite goal of charitable organizations. The design of any such deduction should respond to the various policy considerations and tensions among them; some of these will be discussed below.122
Cross-border issues. No income tax charitable contributions deduction is allowed unless the charitable donee is organized within the United States.123 This limitation is subject to two important qualifications. First, eligible U.S. charitable donees may use their funds abroad for charitable purposes.124 Second, a donor may donate to a U.S. charity that, in turn, donates to a foreign charity.125 However, the Service has denied deductions, in such a case, if the intermediate U.S. charity is a mere conduit, i.e., if “the domestic organization is only nominally the donee” but “the real donee is the ultimate foreign recipient.”126 The deduction nevertheless may be allowed even if the intermediate U.S. donee gives funds only to a particular named foreign entity;127 such U.S. intermediate entities are sometimes called “friends of” organizations because they are frequently so named.128 The intermediate donee must not be bound, by any charter or by-law provision, to deliver the funds to the foreign charity; gifts by the intermediate donee to the foreign charity must be within the charitable mission and purpose of the U.S. intermediate entity; and the U.S. intermediate charity must exercise some appropriate level of scrutiny over the foreign donee to make sure that it qualifies as an eligible charity.129
The above place-of-organization limitation does not apply for purposes of the gift tax or estate tax.130 The Internal Revenue Code, however, generally requires charities (other than certain religious groups or very small organizations) to notify the Service, and to apply for a determination letter confirming their charitable status, within 27 months of their organization.131 This requirement applies to foreign charities unless they derive less than 15 percent of their “support”132 from U.S. sources.133 A foreign charity that is not excused from this requirement but that fails to comply with it is not “treated as an organization described in section 501(c)(3)”134 and donors to it may be denied gift tax and estate tax charitable contributions deductions for their gifts.135
Because they are generally exempt from taxation, neither U.S. private foundations nor U.S. public charities need a charitable contributions deduction. They are, therefore, untouched by the place-of-formation rule136 that affects individual and corporate donors. They do, however, have other concerns when making grants to foreign charities. Domestic private foundations making grants to foreign organizations may deal with those concerns either by making a so-called “foreign equivalency” determination or by exercising expenditure responsibility. Either course of action can address the three particular issues such private foundations confront:
Grants to non-operating private foundations generally are not “qualifying distributions,”137
A grant to a private foundation (unlike one to a public charity) may be a taxable expenditure;138 and
A grant may be a taxable expenditure if it is used by the donee for non-charitable purposes.139
If a U.S. private foundation so chooses, it may cope with each of these by analyzing whether its foreign donee is a properly qualified organization. This path requires testing how the foreign recipient is categorized under U.S. standards. To avoid the first two problems, the U.S. private foundation must conclude that its foreign donee is a public charity rather than a private foundation.140 If the foreign donee has not received an I.R.S. determination of its public-charity status, the regulations permit the U.S. foundation to make a good-faith judgment141 based either on an affidavit of the foreign donee or an opinion of counsel.142 To avoid the third problem, the U.S. private foundation must determine that the foreign donee is described in I.R.C. § 501(c)(3).143
The Service issued procedural guidance in 1992 that substantially reduced the compliance burdens of U.S. private foundations electing to follow the foreign-equivalency route.144 The revenue procedure in question applies when the foreign donee does not have a determination letter from the I.R.S.;145 it provides a simplified method for obtaining a “currently qualified” affidavit from the foreign donee. The exact language of an acceptable form for that affidavit is set forth in the revenue procedure.146 A proper affidavit generally will protect all U.S. private foundations relying on it so long as it remains “currently qualified”;147 it will remain so unless the underlying facts change or, if financial data are important, so long as they reflect the grantee’s “latest complete accounting year.”148
Because foreign equivalency determinations are often problematical,149 many U.S. private foundations instead elect to address the three issues, above, by exercising expenditure responsibility. Five steps are usually required: (1) a pre-grant inquiry to determine that the foreign grantee is able to fulfill the charitable purposes of the grant; (2) a written grant agreement; (3) annual reports from the foreign grantee; (4) notifications to the I.R.S.; and (5) ensuring that the granted funds are maintained in a segregated account.150 If the U.S. donor follows this path, it is no longer necessary to determine how its foreign donee would be characterized under U.S. law.151
A U.S. public charity, although free from the three burdens discussed above,152 may also elect to determine whether its foreign donees are charitable organizations. If they are, the U.S. donor public charity is protected in making those grants;153 if not, it must, at the risk of losing its tax-exempt status, verify that the foreign donees used the funds for charitable purposes.154 This verification often entails taking steps similar to those taken by a private foundation exercising formal expenditure responsibility. Thus, if the public charity exercises expenditure responsibility with respect to a grant to a foreign donee, it does not have to make a foreign equivalency determination.
Transfer taxes. Charitable contributions are deductible for purposes of both the estate tax and the gift tax.155 Although there are minor linguistic differences within and between the relevant sections,156 those do not portend significant legal differences for most purposes. Under both the estate and the gift tax regimes:
The deductions are unlimited,157 so there is no need for any carryover provisions;
The special reduction rules that apply for income tax purposes158 do not apply;
The deduction floor that applies for income tax purposes159 does not apply;
The special donation-substantiation rules that apply for income tax purposes160 do not apply (although general substantiation-of-deduction requirements are applicable);161 and
As in the case of the income tax, no deduction is permitted for charitable gifts of partial interests,162 except for: (i) donations in the form of charitable lead annuity trusts or unitrusts, charitable remainder annuity trusts or unitrusts, or pooled income funds;163 (ii) gifts of a undivided interest in the donor’s entire property,164 (iii) remainder interests in personal residences165 and farms,166 and (iv) certain qualified conservation interests.167
A Venn diagram of the income tax, gift tax, and estate tax charitable deduction provisions would show a considerable overlap, but also areas of each that differ from the others. It is often desirable to draft documents to focus on the intersection to ensure that the charitable donations qualify under each and all of the regimes. In almost all cases, inter vivos transfers should attempt to qualify for both income and gift tax purposes, lest an income tax deduction be allowed but a gift tax be imposed or vice-versa.
Recent legislation provides for the phase-down of both estate and gift tax rates168 and the eventual repeal of the estate (but not the gift) tax.169 The repeal, scheduled to be effective on January 1, 2010,170 is itself scheduled to lapse on January 1, 2011, thus fully restoring the estate tax to the Code.171 Because this risible state of affairs makes it very difficult to do sensible estate planning,172 it is very likely that Congress will revisit this and will revise either the estate tax repeal or its scheduled restoration.
Policy issues. The charitable contributions deduction may be viewed either as base-defining or as an incentive (or subsidy) for charitable giving. The most widely-accepted definition of the proper tax base for an income tax — the Haig-Simons definition — states that income for any period is the sum of (1) amounts spent by the taxpayer on personal consumption during the period and (2) the change in the taxpayer’s net worth during the period.173 Because amounts given to charity no longer appear in the taxpayer’s net worth, the question becomes whether such giving should be viewed as personal consumption. If not, the deduction for charitable gifts is an appropriate policy response for defining net income subject to tax, and should not be viewed as a subsidy.174
Even if the base-defining rationale is accepted, allowing a deduction for the appreciation in value of property donated to charity, without including that increase in the income of the donor, cannot be so justified.175 To that extent, it must be supported, if at all, on the grounds that it is an incentive or subsidy for giving. If it were thought desirable to preserve the deduction generally, but eliminate the harder-to-justify deduction for appreciation in value of property donated, three routes to achieve that could be followed:
The deduction could be limited to the adjusted basis of the property donated, i.e., the deduction for the unrealized appreciation in value could be denied, or
The deduction could be allowed for the full fair market value of the property donated, but the gain inherent in the property could be included in the donor’s income at the time of the gift, or
A deduction could be permitted for the full fair market value of the property donated, but the charitable donee could be required to pay tax on the unrealized appreciation in value at any later time when it sells or disposes of the property.176
The first route is similar to some already in the Code for charitable gifts;177 the second and third would be novel in that context.178 The second approach requires donors to pay tax even though they do not receive any cash or property in exchange for the donated property; this is sometimes deemed undesirable as a matter of tax policy. The third route not only defers, perhaps indefinitely, the imposition of any tax on the unrealized appreciation in value, but would subject it to tax, upon later disposition of the property, at the tax rates of the donee rather than those of the donor. Consideration might be given to making the first route the default rule, but allowing donors to elect to apply the second or (with the consent of the donee) the third route in lieu of the first.
The deduction for charitable gifts can be viewed as a government matching program.179 For example, if a donor who itemizes deductions and whose top marginal tax bracket is 35 percent makes a $100 gift to charity, and deducts that amount from his income, the net cost or “price” of the gift is $65.180 The government, from this viewpoint, is making a $35 matching grant to the charity chosen by the donor. The size of the matching grant varies directly with the top tax bracket of the donor. Thus, the government offers a higher match to wealthier, higher-income taxpayers than to less-wealthy, lower-income taxpayers. This regressivity is objectionable to some on tax policy grounds; defenders support it as merely an appropriate base-defining rule.181
If it were thought desirable to eliminate this regressivity, a credit could be provided in lieu of the deduction.182 The amount of the credit could be calculated, at least approximately, so as to involve any chosen amount of revenue loss and to simulate an equivalent deduction at any selected target tax rate. While this would eliminate the regressivity (because the government’s “matching grant” would then be the same at all income levels), it would not be possible to justify a credit of this sort under a base-defining rationale.183
There is uncertainty about how much the income tax deduction for charitable giving affects amounts given to charity.184 Economists analyze this in terms of “price elasticity”: the extent (expressed as a decimal ratio) by which a reduction in the “price” of giving increases such giving.185 The price of a $1 donation for itemizers is one minus the donor’s top marginal tax rate.186 If the price declines by 10 percent (e.g., because of an increase in the donor’s top marginal tax rate), and if donations, as a result, increase by the same 10 percent, the price elasticity would be -1.0. If, however, a 10 percent reduction in price produces only an 8 percent increase in donations, the price elasticity would be -0.8. There is general agreement that the lower the price of giving, the more is given to charity, but quantifying the effect has proved to be extremely difficult.187 The more recent economic literature has produced estimates of price elasticity ranging from -0.5 to -1.75;188 the former number suggests that a 10 percent decline in the price of giving would increase long-run charitable giving by only 5 percent; the latter suggests that a price decline of 10 percent would increase long-run charitable giving by 17.5 percent.189 Analyzing prior writings, and taking into account other effects — particularly the so-called “crowding out” effect of tax-financed contributions — beyond price elasticities, one economist has concluded that tax incentives are treasury efficient if they exceed -0.99 (using low estimates for the amount of crowding out) or -0.56 (using high estimates).190
Using newly-available panel data,191 several leading scholars have found differing price elasticities for “transitory,” as opposed to “permanent,” tax rate changes,192 concluding that the former are significantly smaller in absolute terms than the latter, which fall in the range of -0.79 to -1.26.193 The authors concede that their research is only a “first step,” and that much further work has to be done with panel data “to address how changes in expectations of future tax policies . . . affect current individual [charitable] behavior.”194
Price elasticities may differ for large donors and small donors. Many believe that the price elasticity is lower for lower income donors, including those now generally electing to use the standard deduction in lieu of itemizing deductions.195 If so, in estimating the impact of providing a deduction for nonitemizers, it is more likely that the revenue foregone would be greater than the additional donations stimulated; however, not all observers agree.196
Designing a sound nonitemizer deduction197 requires confronting and balancing conflicting policies:
The standard deduction is intended to provide nonitemizers an implicit deduction in an amount sufficient to substitute for itemized deductions, including the charitable contributions deduction. Permitting nonitemizers to deduct charitable contributions thus raises two concerns: (1) would this erode the simplification of compliance burden fostered by the standard deduction, and (2) if a nonitemizer charitable deduction is permitted, should the amount of the standard deduction be reduced to take that into account and prevent “double dipping”?
Because the amounts covered by a nonitemizer deduction are relatively modest but the number of people claiming it would likely be large, the already-lean I.R.S. resources might not be able to audit those returns effectively, thus giving rise to the perception, if not the reality, of more tax fraud.198
These concerns could be ameliorated, albeit not eliminated, by permitting a nonitemizer deduction only above a certain floor amount.199