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CHARITABLE GIVING WITHOUT AN ESTATE TAX
May 2011
There are many concerns expressed by individuals and charities regarding the impact to charities if there is no federal estate tax or if the available exemption (now $5 million) is at such a level that effectively few people of means have an estate tax. Even assuming the estate tax exemption drops to $2.5 - $3.5 million at January 1, 2013, will people be motivated to make charitable donations from their estate if there is no estate tax benefit?
Studies throughout the years have shown that charitable donations in the United States are motivated more by a desire to give to a charitable cause than by the income tax deduction or estate tax deduction associated with it. I do not believe this will change. Tax-advantaged methods of giving should, and will continue. Certainly in the very large estates where individuals establish private foundations, charitable giving will not be impacted because those individuals will continue to transfer the substantial portion of their estate (the amount beyond which they choose to give to their family) to their own foundation, obtain the charitable deduction to avoid estate tax, and leave the ultimate gift giving decisions to family members. Hopefully, they will educate their family members well in advance so that they can carry on the tradition of giving.
Income tax planning has always been appropriate for lifetime gifts; there is no reason not to make charitable donations in a tax advantaged manner. The simplest method of doing this is giving away appreciated securities to the charity rather than selling them, paying the short-term or long -term capital gain tax and giving the net proceeds to the charity. A direct gift of appreciated stock is a fairly common approach.
Many families, in reviewing their estate plans recognize, the possibility – hopefully remote or nonexistent – that their children or grandchildren may not survive them. In this case, prudent planning calls for alternative conditional gifts. This can include other family members (brothers, sisters, nephews, nieces) good friends, and, quite often, favorite charitable causes.
I have counseled people for years to consider accelerating their level of charitable giving through their estate plans to include charities even if the children and grandchildren survive. If we are looking at a $3.5 million exemption, where a husband and wife collectively can exclude $7 million from estate tax, it means – in many cases – that the entire estate will pass free of estate tax. People who have been supporting charities during their lifetime and claiming deductions for income taxes, should certainly consider making gifts to those charities as part of their bequest even if there is no estate tax advantage. I will address later in this article a method to preserve an income advantage.
Let's say we have a $5 million estate. That estate may consist of a $2 million home, a $2 million portfolio of stock and savings, and a $1 million retirement account. These are significant amounts, but in the Bay Area this is not unusual. Assuming we have a $5 million estate, and assuming further that it is the typical family of two or three children and maybe four or six grandchildren, wouldn't it be beneficial to use some of the great appreciation that has occurred in the value of the family residence to make a charitable gift? If the $2 million residence has no mortgage, even a 10% portion of that value could be given to charities and provide a significant benefit to them. Would the family members of the $5 million estate truly miss $200,000? If the entire estate were left to the children and nothing to the grandchildren, this would mean each child would receive $2.4 million rather than $2.5 million. This seems worth considering if you have been supporting a charity or charities on a regular basis and desire to support the continuing the work of that organization with your bequest.
There are two relatively easy ways to gain a tax benefit from that gift even if there is no estate tax. Many articles have been written over the past decade of the advantages of giving the retirement account to the charity. In my example of a $1 million retirement account, that amount is fully income taxable to the beneficiaries. Relatively recent legislation has allowed us to "stretch" the withdrawal from the account over the lifetime of the beneficiary. "Lifetime" is defined by the IRS tables but generally it is the lifetime that is anticipated to extend to as long as the age 116. Thus, the deferral can be significant and the vast amount retained in the retirement account for future tax deferred growth. That is a true benefit although it will be subject to income tax upon withdrawal.
If the $200,000 gift to charity comes from the retirement account, that gift is totally exempt from income tax. If the estate is subject to estate tax, that charitable gift is free of income and estate tax. This is truly tax efficient. The net consequence to the beneficiary is a loss of approximately 20% of the value, with the 80% difference going for estate and income taxes. An outright gift of the portion of the retirement account to charity will avoid the income tax that the children would otherwise pay if it were distributed to them. True, it removes 100% that the children might receive, but it is very tax efficient.
Another way of making a gift to charity with income tax benefits would be to make a gift to the children and allow the children to make the gift to your charity of choice. This would be a non-contractual direction to the child It is often used by a surviving spouse when there is no estate tax at the death of the first spouse. An example would be to leave the $2.5 million to each child with the written wish that they contribute $100,000 to your desired charity. The child would then be entitled to the $100,000 charitable income tax deduction. This could not be a legally enforceable direction, but a good discussion with the children about your estate plan and your wishes will usually go a long way. If the situation were such that you believed your children would not follow your wish, then you have the option to make the gift during your lifetime or ignore the income tax aspects of the gift.
Charitable giving is a national trait of Americans. I cannot quote precisely the charitable giving in dollars or per capita by Americans as opposed to other countries, but it is a well deserved and well known reputation that Americans are unusually generous.
I have had the pleasure of serving on Planned Giving Committees of several national and local organizations. It is quite gratifying to assist these organizations and see the results of people who are willing to share their estate with charities of their choice.
Next month we will discuss Charitable Gift Annuities, another form of charitable giving for mutual benefit.
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