Nonprofits May Find Themselves Paying Dearly for 2010's Last-Minute Tax Deal

In their rush to gain an end-of-the-year tax deal, federal elected leaders postponed hard choices, and in the process, they denied the government the revenue it needs to respond to unforeseen crises and to deliver on promises made.

At the same time, wary corporate decision makers reported that uncertainty over tax and fiscal policy had discouraged them from creating jobs or making investments in research and development essential to prosperity.

As self-imposed constraints limit the agility of government and business, the nonprofit sector worries that the tax deal-formally known as the 2010 Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act-may have a cascading effect, further impoverishing state and local governments and shifting the burden of providing social services from government to nonprofits. Moreover, nonprofit leaders fear that the estate-tax provisions contained in the new law may reduce incentives for wealthy people to make the no-strings-attached donations and bequests that free nonprofits from the constraints of politics and markets.

Our tax structure has long reflected the value we place on nonprofits' ability to take risks and try out new ideas without fear of political or market reprisals. Income and inheritance taxes have encouraged donations and bequests as well as the creation of philanthropic foundations.

As a result, our nation has a diverse set of nonprofits and grant makers that can tackle issues at home and across the globe.

Free from the need to garner votes or generate profits, they needn't test the political winds before offering services to the most marginalized Americans. Their reach extends to the developing world, where they have created or supported "social enterprises" with for-profit business models for providing off-the-grid communities with renewable sources of energy.

And globally they have even entered into public-private partnerships to effect high policy, as Warren Buffett did last month in making his $50-million gift to the U.N.'s politically hampered and resource-strapped International Atomic Energy Agency. That grant will help to create a "nuclear fuel bank" upon which countries committed to nonproliferation can draw to meet their energy needs.

Whether the tax deal will limit the freedom of nonprofits to achieve such salutary outcomes is a matter of intense debate. But it is up to nonprofit leaders to ask and answer that question before the law's review in 2012. An election year is a particularly poor time for political risk taking. Policy makers will need to be armed with the facts and buttressed by a clear and unswerving sense of the nonprofit world's purpose.

First the facts: The law extends several provisions that can affect charitable giving-and provides time to gather data on their effects. It extends Bush-era tax cuts at all income levels and continues favorable treatment of capital gains and dividends. It delays a requirement that high-income taxpayers reduce their itemized deductions, including for charitable gifts. It exempts older taxpayers from treating up to $100,000 donated to charities from their individual retirement accounts as taxable income.

But what worries some nonprofits is the 35-percent cap it places on inheritance taxes, while exempting estates of $5-million or less. Many analysts argue that these estate-tax provisions will remove incentives for bequests as well as gifts wealthy people make during their lifetimes to reduce the size of their taxable estates. Others contend that estate-tax considerations play a negligible role in the decision to give but can influence the size of the gifts made. They draw on the 2004 predictions of the Congressional Budget Office, which anticipated a drop-off in the number and size of bequests. Indeed fewer dollars were donated in this way during the phaseout of the estate tax from 2008 to 2009. But that year's economic contraction is likely to have had far greater effect. More time in an improved economic climate can yield more data on which policy makers can base future choices.

As we undertake that analysis, it is essential that we come to a shared view of the reasons for charitable organizations and their tax-exempt status in the first place.

Americans value nonprofits because they can take actions and generate ideas that may be unwelcome, unpopular, and unprofitable in the short run but that produce societal benefits over time. In the process, they can engage communities in identifying and tackling hard problems when others cannot.

Among those problems is the need to get our country on a financially sustainable course. Nonprofits have already contributed by sounding the alarm, providing analysis, and offering policy options.

The deficit dilemma has helped to highlight the hurdles political and business decision makers face when it comes to calling for sacrifice. Elected officials must respond to caricatures of their views repeated in 24-hour news cycles. Business leaders are required to produce shareholder value as measured in quarterly returns. Nonprofit executives may be the only ones who can afford to ask tough questions, test novel solutions, and build consensus.

In considering our tax laws in 2012, our goals should be straightforward: to regain our ability to solve problems as a nation, to rebuild societal resilience, and-in the case of nonprofits-to preserve the freedom to help tackle society's next hard problems.