One change from the recent tax reform law is that the number of tax payers who itemize deductions on their tax returns will fall from about 37 million to an estimated 16 million. This is because the “standard” deduction was increased for 2018. For single individuals the increase was from $6,500 to $12,000 and for married filers from $13,000 to $24,000. However, the personal exemption was eliminated so the overall impact is less than it may seem at first glance.
The cost of tracking the various transactions that are allowed to be deducted from a tax payer’s gross income is costly. It takes time by the taxpayer (saving receipts, organizing them) and by the tax preparer who must evaluate them and correctly report them. It is also more costly for the IRS to review and possibly audit returns with itemized deductions. These activities do not add to overall economic productivity.
The standard deduction is a simple dollar amount based on your filing status (single, married, etc.). No receipts and no record keeping required. This results in a simpler tax return and an easier task by the IRS to verify the validity of the return. Revisions to the tax code that avoid this expensive record keeping is a good thing from an efficiency point of view.
Why do Charities care?
The tax code has long rewarded taxpayers for donating funds to eligible non-profit (charitable) organizations by allowing donors to reduce their taxable income by the amount of their donation if they itemize deductions. A donor who gives $1,000 to a charity will be able to reduce their taxable income by $1,000. This lowers their tax bill by $1,000 multiplied by their marginal tax rate. If we assume a 25% tax rate, then this donor would receive a $250 tax benefit for donating $1,000 thus the actual cost of the gift is $750. Donors that do not itemize deductions receive no tax benefit. Since less tax payers will be itemizing their returns there will be more donors that do not receive the tax benefit for donations than in previous years. Tax rates were also decreased for some taxpayers, also reducing the value of the tax benefits for charitable donations. Both of these changes will reduce the benefits of donating to a charity for many tax payers.
What will be the impact?
It is hard to know how individual donors will respond to these changes but the Tax Policy Center estimated that the value of the tax subsidy (the benefits donors receive) from the government will decrease from $63 billion to $42 billion per year. Different charities have different types of donors and some charities may feel the impact of this in a greater or lesser way than another charity. However, it is likely that this change will reduce donations to charities as a whole. Time will tell how much of an impact this has on Montana charities.