Dateline, April 26, 2007, Chicago
After every major tragedy there is an apparent desire on the part of complete strangers to provide some aid to the victims. The more intense the media coverage, the more intense the desire to provide aid. Often politicians encourage the outpouring, as Stephanie Strom of the New York Times reported this past weekend in Katrina Tax Break Spurs $11 Billion in Donations, April 21, 2007. You may recall that following Hurricane Katrina, Congress enacted legislation that lifted the 50% limit on charitable contributions of cash made to most charities during 2005. One Treasury official put the cost of that provision at $3 billion, according to Strom. Congress had originally estimated the cost at $819 million. As we reported earlier, one of the legislation's prime beneficiaries was Vice-President...
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Dick Cheney.
This was not first time that special tax legislation was enacted in the wake of a major tragedy. Following the South Asia tsunamis in late 2004, Congress enacted H.R. 241, permitting taxpayers to deduct charitable contributions to aid the victims in 2004 as long as the contributions were made by January 31, 2005.
Congress has also been asked to address issues posed by the longstanding tax law concept of "charitable class." This issue comes up every time there is a house fire or a police officer or fire fighter die in the line of duty. Prospective donors who want to help the victims and their survivors can do so on a taxable-deductible basis, but only if the donors make their contributions to a qualified charitable organization. Tax-exempt organizations can only disburse funds to the victims and their survivors if the recipients are members of a charitable class, which generally means the recipients must be members of a broad and indefinite class of people. Moreover, the act of making a payment must be viewed as benefiting the community at large—which means the recipients must have a financial need which is being met by the distribution. Donors cannot earmark funds for the benefit of specific individuals.
The charities that collected funds for the victims and survivors of 9/11 ran into problems when it came to disbursing the funds because many of the victims and survivors were well-provided for by life and disability insurance policies, pensions, and personal assets. Although the charities could certainly sympathize with these folks, as we all could, many of these individuals were not traditionally thought of as members of a charitable class because they did not have an economic need. Congress enacted legislation that permitted charities to make payments to these individuals without fear of losing tax-exempt status. See the Victims of Terrorism Tax Relief Act of 2001. IRS Publication 3833.
More recently, Congress enacted legislation intended to cure a similar charitable class problem. This followed the tragic events of October 26, 2006, when five firefighters were killed by a sudden burst of flames from a brush fire that had been set by an arsonist. The United Way of Central County, California raised over $1 million to aid the survivors, and then realized that it could jeopardize its tax-exempt status by distributing the funds to the survivors because the survivors might not be considered a charitable class. See H.R. 6429, the Fallen Fighters Assitance Tax Clarification Tax Act of 2006, as discussed by us in an earlier post.
All of this ad hoc legislation creates two major problems. First, it makes the IRS's job impossible. Take the January 2005 legislation involving contributions to aid the victims of the tsunamis. Taxpayers claimed contributions made in 2005 for purposes of calculating 2004 taxable income. How many of these folks inadvertently claimed a deduction for the same contribution when computing their 2005 taxable income? More pertinent, is it a good use of IRS resources to develop an audit plan to attempt to detect double deductions for a piece of legislation that is effective for one year? We would argue not.
Second, it implicitly carries the message, "You are a more worthy victim if you are injured along with 10,000 other people, but you are not a worthy victim if your house burns down or your spouse is a police officer who is killed in the line of duty."
We were reminded of this issue just last week following the shootings at Virginia Tech. Holly Hall of the Chronicle of Philanthropy reported on the fundraising efforts already underway in her article, More Than $1-Million Raised for Charities Created After Virginia Tech's Tragedy, Apr. 24, 2007. Undoubtedly, the vast majority of the contributions described in her article will benefit a charitable class and will be deductible. But we couldn't help but wonder whether charitable class might become an issue for some of the organizations raising funds.
Congress would do the tax system, charities, and legitimate victims a huge favor if it would address these issues systematically. We would like to see Congress develop and then enact legislation that deals once and for all with the questions of earmarking and charitable class. All too often when a police officer is killed in the line duty, somebody establishes a scholarship fund at a local bank or community foundation for the officer's children. In many cases, the contributed amounts are not deductible as charitable contributions, but some people undoubtedly deduct them. Why not adopt a formalized procedure for dealing with these funds so that people can legitimately claim a charitable deduction, the fund administrator need not worry about tax-exemption or other tax issues, and state charity regulators need not worry about fraud? Possibly, there could be an automatic exemption for these funds, if a short-form notice were filed with the IRS and the fund filed under state charitable solicitation laws. In the absence of a specific regime to sanction and regulate these funds, Congress should require those creating these funds to affirmatively provide a notice to donors that contributions are not-deductible for tax purposes.
In our view, special legislation to encourage charitable contributions following disasters is unnecessary. At the margin it might make a difference, but we suspect that for most people, the contribution would be made with or without the special legislation. The Strom article points out that much of the giving that took place following the Hurricane Katrina special legislation was to colleges, universities, and other charities that had nothing to do with providing Katrina-related relief. An earlier Strom article pointed out that some charities suggested that donors prepay pledges--commitments they had made long before Hurricane Katrina, to take advantage of the tax break. In a Hurricane Tax Package, a Boom for Wealth Donors, N.Y. Times, Oct. 27, 2005. Strom's earlier article also suggests at least one fundraising consultant thought the legislation might permit some taxpayers to utilize charitable contribution carryovers of cash contributions that had been subject to the 50% limit in prior years. This consulant told Strom that Congress intended this, but might not have realized the cost. Keep in mind that charitable contribution deductions can be carried forward for five years. Unused carryovers then expire.
If Congress wants to provide this sort of tax relief, it should consider doing so on a more rational basis. For example, Congress might consider enacting legislation lifting the 50% limitation in the case of contributions to disaster relief organizations if the contributions are targeted to help the victims of a disaster in a presidentially designated disaster area, and permit such contributions to be claimed for a particular tax year if made before the April 15 deadline. Obviously, that idea needs some work, but the need and concept are clear enough. Were Congress to do that, the IRS could make a permanent modification to the Form 1040 and Schedule A and the special tax break would be permanent and targeted. Tax subsidies would be made on a far more consistent and rational basis. We should note that we aren't the first to think about April 15th, as opposed to December 31, as the date to tie the deduction for charitable contributons to. See Eugene C. Steurele and Martin Sullivan, Toward More Simple and Effective Giving: Reforming the Tax Rules for Charitable Contributions and Charitable Organizations, 12 Am. J. Tax Pol'y 399 (1995).
We should also note the IRS receives a flood of exemption applications for new charities following many highly publicized tragedies. In the wake of Virginia Tech, we assume that the IRS has already received applications for charities designed to address gun violence, gun education, adolescent mental illness, bullying, and many of the other issues that became part of the Virginia Tech story. We hope that state secretaries of state are discouraging people from creating these new organizations. Experience has shown that these knee-jerk reactionary efforts often produce no results while wasting money and administrative resources. The well-intentioned folks behind these startups should be encouraged to donate their time or money to existing charities. We already have too many charities.
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