California nonprofit leaders have endorsed a maneuver in the state legislature that would allow the state’s taxpayers to offset the loss of state and local tax deductions on their federal tax bills by earning state tax credits for donations to a state charitable fund.
The legislation could help keep the federal charitable deduction within reach for at least some middle- and upper-middle-income earners in California otherwise expected to take the newly doubled standard deduction, now $24,000 for couples and $12,000 for individuals.
“We actually think it gets around some of the complaints about the federal bill, which is that by doubling the standard deduction, fewer people will be able to itemize and therefore won’t be motivated to continue their charitable giving at the same level,” said Nancy Berlin, policy director at the California Association of Nonprofits, which is calling on lawmakers to vote “yes” on the measure.
Determined Response
In rewriting the tax code — President Trump signed the bill into law in December — congressional Republicans capped the amount of state and local taxes that taxpayers can deduct at $10,000. That was a blow for high-tax states such as New York and New Jersey, where the average amount of that deduction claimed by taxpayers is $22,169 and $17,850, respectively. Leaders in those places have vowed to find ways to work around that part of the new federal law.
In California, where the average deduction claimed for state and local taxes is $18,438, that pledge has taken the form of two complementary bills. One would establish the nonprofit California Excellence Fund. The other would allow taxpayers to obtain a credit against their state income taxes equal to 85 percent of the amount contributed to the fund; the donation could also be deducted from federal taxes.
Take a hypothetical taxpayer with a 40 percent marginal federal tax rate paying $100 in state taxes, said Manoj Viswanathan, an associate professor at UC Hastings College of the Law in San Francisco. Previously, the cost of that $100 state tax payment was only $60 for the taxpayer, because he or she was able to reclaim $40 through the federal tax deduction. With the federal tax deduction gone, the cost to the taxpayer would be $100.
“California turns around and says, OK, if you give us $100 via this special charitable contribution, we will give you an 85 percent credit,” Viswanathan said.
That means that the state effectively reduces the taxpayer’s $100 in state taxes by $85, leaving $15. But because the gift to the fund qualifies as a charitable donation, it is now deductible on federal taxes.
“So you’re out of pocket $15,” Viswanathan said. “But you’re getting a $40 dollar charitable contribution value or savings. You are better off by $25.”
The State of California, meanwhile, is better off by $15.
“The federal government is the one left holding the bag,” Viswanathan said. “They are the ones paying for the $40 that they didn’t expect to be paying.”
(Note that the top marginal rate under the new tax law is 37 percent. Viswanathan used 40 percent in his example to simplify the math.)
Where does the money contributed to the California Excellence Fund end up? Mostly in the California general fund — 85 percent of each contribution, or the value of the tax credit, would be swept into state coffers to be spent through the state’s standard appropriations process. When it comes to the spending of the remaining 15 percent, though, the donor taxpayer would get to choose from a list of options benefiting the public, such as state parks or community colleges.
Incentives to Give
The California measure would increase the number of taxpayers with itemized deductions in excess of the standard deduction, therefore giving them access to the charitable deduction, said Kirk Stark, a tax law professor at the UCLA Law School.
“It sort of newly places those individuals at the threshold of having a marginal incentive to give to charity in a way they wouldn’t if they were just claiming the standard deduction,” he said.
Stark, who helped craft the legislation, explained it this way: Take a California couple whose total deductions fall several thousand dollars short of the newly established $24,000 standard-deduction threshold. Looking to earn that 85 percent tax credit from the state, they make a gift of $10,000 to the California Excellence Fund.
“That gift would then put them into the itemizing range, because their total itemized deductions would go over $24,000, and therefore any additional charitable giving would draw in the federal subsidy of the deduction,” Stark said.
Berlin of the California Association of Nonprofits said that no one knows precisely how the law would play out because there are a unique set of deductions and other mathematical variables at play for each taxpayer. Still, she said, analyses show that the legislation would likely have the biggest impact on people with incomes in the low six figures.
Keeping the charitable deduction within reach is important for taxpayers “in that middle bracket, who are people who are charitable givers and who have always itemized and depend on that as part of the way they manage their charitable giving,” she said.
Broader Movement
The California plan is not unique. More than 30 states offer tax credits for charitable donations to state-supported programs and activities including private-school tuition scholarship programs, natural-resource preservation, and shelters for domestic-violence victims. Tax lawyers cite these existing tax-credit programs as legal precedent for new, similar proposals in California and elsewhere.
And if multiple states implement similar workarounds, as they are signaling they will, there are big implications for federal tax revenue.
Stark of UCLA Law School noted that in its cost analysis of the new federal tax law last year, the Congressional Budget Office projected $668 billion in increased revenue from limits on deductions, including state and local tax deductions. That figure did not take into account the fact that states might adopt charitable tax-credit programs, “which would mean that Congress, by overlooking this feature of current law, may have materially underestimated how much the Tax Cuts and Jobs Act would add to the federal deficit,” Stark says.
Blurring the Lines
To be sure, not everyone is convinced the proposal is a good one. Dom Betro, chief executive of the nonprofit Family Service Association in California’s Riverside and San Bernardino counties, criticized the California legislation as a scheme to curry favor with voters in the name of charity. In an email, he questioned the proposed uses of the money to be collected in the California Excellence Fund.
“Are they the seeding, funding, and leveraging of nonprofit charitable causes, or is it to just fund the same old, same old state bureaucracy and budget?” Betro said.
Tax deductions and credits are important tools in promoting charitable giving as investments, Betro said, but what lawmakers in California are trying to pass is not that.
“It is more a ‘getaround’ than a ‘workaround’ and will further confuse and tarnish the public’s understanding of the purposes of the nonprofit sector and many cool reasons to donate to charitable causes,” Betro said.
David Thompson, vice president for public policy at the National Council of Nonprofits, said his organization has not come out with a stance on the measure in California or elsewhere even as his group follows the lawmaking closely. Enabling more people to take the charitable deduction is a good thing, Thompson said, but added that the measure could add to existing confusion about the structures, finances, and governances of charities.
“This blurs the lines between governments and nonprofits,” Thompson said. “This is a line we are fighting, especially at the state level, to make as bright as possible.”
In an op-ed in the Chronicle, nonprofit tax-law experts Leslie Lenkowsky and Suzanne Garment cautioned philanthropy leaders against the effort in California, what they deemed a “Dilot,” or a donation in lieu of taxes. Private control of money, they wrote, is important and should remain distinct from public control.
“The California plan would give state tax credits only for donations to the state’s fund, and the fund’s money will be spent for purposes ultimately determined by the State of California. That sounds an awful lot like — well, taxes,” they wrote.
Imperfect Solution
Berlin of the California Association of Nonprofits says that the legislation is not a perfect solution, “but we’re dealing with a federal bill that is terrible for California. This was a way to respond and try to help some of the taxpayers in California.”
Berlin noted that some national nonprofit leaders advocated for a “wait and see approach,” which she described as folly.
“Our feeling was that the nonprofit community just can’t sit out on the sidelines on this,” she said. “If we just stay on the sidelines and say, Let’s wait to see how this all works out, no one is going to take us seriously.”
She and her colleagues have considered, and discussed with lawmakers, whether the measure would confuse where the dividing lines are between government and public funds and nonprofits and private philanthropy. Nevertheless, they decided to support the bill.
“Frankly, that happens a lot already. There are lots of public-private partnerships, and those are generally thought to be good — government and nonprofits working together to get things done.”
She pointed to examples like the Mayor’s Fund for Los Angeles, a charitable foundation that takes private donations to pay for city programs.
Californians, especially who that fall within the relevant income levels and tax brackets, are smart enough to understand what the state legislature is trying to accomplish, she said.
“Those people will not be confused at all. There is going to be an accountant sitting there saying, ‘This is in your best interest.’ "
