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Nonprofits nervous about proposed Minnesota tax change on charitable contributions

A potentially bitter pill in the omnibus tax bill would change tax treatment of donations from a deduction to a credit.

Rep. Ann Lenczewski previews the House omnibus tax bill April 24 with House Majority Leader Erin Murphy and House Speaker Paul Thissen.
Photo by Paul Battaglia

Minnesota nonprofits are watching nervously to see if a potentially bitter pill ends up in the omnibus tax bill that eventually lands on the desk of Gov. Mark Dayton.

Their concern centers on a proposed change in the tax benefits Minnesotans get when they make charitable contributions.

The current House bill calls for replacing the current state “tax deduction” with a “tax credit.” 

More importantly, they worry the change could mean that Minnesotans might be less motivated to donate because the current state tax break would be substantially cut.

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Those fears, though, might not come true even if the change becomes law, given that taxpayers would still find it financially advantageous to deduct charitable contributions on federal returns when itemizing.

In a year in which DFL legislators are looking everywhere for revenue, the House plan would bring in an extra $44 million in the next biennium just from the change in how deductions for donations would be calculated.

House alone on change

At this point, the change does not appear in either the Senate’s tax bill or the governor’s proposal.

But strange things happen in the final weeks of the legislative process. What doesn’t appear today can suddenly sprout tomorrow.

Uncertainty rules this session over what a final tax bill will look like, given that the Senate, House and governor all have different plans.

Senate Majority Leader Tom Bakk addressed that uncertainty — which looks like chaos to many — in a statement earlier this week.

“Like any negotiations, even negotiations back in your family, they work best when everybody gets a little something they want, and I think that will be the final outcome of this session, too,” Bakk said.

That means something like the change in calculating charitable deductions could end up in the final bill. 

Disclaimer: MinnPost, like other nonprofits that rely on donations, could be affected if the House version prevails.

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Deduction vs. credit

What the House is proposing seems simple: A “deduction” reduces taxable income. A “credit” reduces taxes owed.

The House plan, however, also seems to make a relatively simple deduction system far more complex. Currently, when taxpayers itemize, any donated amount is deductible on state and federal returns. That would change in the House proposal.

Proponents of the change say that people shouldn’t need to be motivated with tax breaks to be charitable.

Supporters — including Rep. Ann Lenczewski, the chair of the House Taxes Committee and bill sponsor — also argue that the proposal levels the playing field between those who itemize and those who don’t.

About 60 percent of state taxpayers do not itemize.

Additionally, proponents say that the current system is not progressive. People in the highest income tax brackets receive a higher percentage benefit than those in lower brackets.

With the new system, however, taxpayers in all brackets would take hits.

Some examples

This can be eye-glazing stuff, but try some examples:

• The current system: What happens now when an itemizing joint filer in the lowest income bracket donates $1,000.

There’s a 5.35 percent rate for the lowest bracket, which includes married couples with a taxable income of less than $35,480. The filers in that bracket receive a tax benefit of $53.50 for their donation simply by multiplying their bracket, 5.35 per cent, times their donation, $1,000.

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If a couple from the highest bracket – 7.85 percent on a taxable income of more than $140,960 – donates $1,000, they receive a tax benefit of $78.50.

The new system: Things would become more complex and less beneficial to the taxpayer. 

It becomes a system that includes multipliers and thresholds, a system in which adjusted gross income, not taxable income, becomes a factor.

Take that low-bracket couple in the first case, the couple that received a $53.50 benefit under the old system. In the new system, they’d only get an $8 benefit.

Meanwhile, the couple in the highest bracket that received a $78.50 benefit in the current system would get nothing in the new.

How all that happen gets heavy, unless you love tax talk.

Start with the low-income filers. Now we have to figure that couple’s adjusted gross income. For the sake of the example, say that their adjusted income was $45,000 before deductions dropped them into the lowest bracket.

Under the proposed formula, they would receive an 8 percent credit for contributions made in excess of the greater of $400 ($800 for joint filers) or 2 percent of adjusted gross income.

In this case for our low bracket, 2 percent of the filer’s adjusted gross income is $900. The couple then would subtract that $900 from the $1,000, which amounts to $100. They then would get 8 percent of that figure, or an $8 tax credit.

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Some lose out

In our first example, the high-income filers who donated $1,000 would get no credit because of that 2 percent threshold.

So, given that high-end donors are a key to the survival for many nonprofits, try one more example in which a benefit does kick in.

Take a couple, itemizing and filing jointly, with a gross income of $175,000.

Even with deductions, that couple might remain in the current top bracket. If that couple donated $5,000, the formula would work out like this: 2 percent of the $175,000 would amount to $3,500. Subtract that figure from the $5,000 contribution, leaving $1,500. The couple now gets a tax credit of 8 percent of the $1,500, which amounts to $120, as opposed to $392.50 deduction under the current system.

Non-itemizers, who currently get a charitable deduction benefit for 50 percent of contributions in excess of $500, would lose a tax benefit under the proposed system.

This proposal has been floated before.

Four years ago, the House Taxes Committee came up with a massive tax reform package, including this plan for donations. But in that case, there was a large crowd of special interests howling in unison.

This time, House reforms are not nearly so broad, meaning the nonprofits have fewer allies to oppose the plan.

The approach of the nonprofits appears to be one of diplomatic resistance.

In a notice to its members, the Minnesota Council of Nonprofits tried to both praise the DFL while raising concerns.

The praise: “After years of budget cuts, the Minnesota Council of Nonprofits and the Minnesota Budget Project and many nonprofit organizations are pleased to see there will be revenue raised, progressively, to solve this year’s deficit and start to get the state back on track in spending priorities.’’

The concern: “We are concerned that this change [in the benefit for charitable giving] would result in some Minnesota donors who currently receive a tax benefit not being eligible for the new credit with an unknown and potentially risky reduction in charitable giving.”