by Deborah L. Jacobs
Billionaires Gates, Buffett and Zuckerberg will still give big. But what about ordinary donors?
For donors, a crucial question has always been how much to give to charity while alive and what to leave as charitable bequests in their wills or trusts. The economic crisis has caused many people to cut back on current charitable giving, perhaps figuring they could always make up for it with bequests. But changes in the federal estate tax system signed into law by President Obama on Dec. 17 may well lead some of those who had postponed charitable giving to cut back on future bequests too.
The new tax law raises the exemption from federal estate tax to $5 million a person ($10 million per couple) for deaths in 2011 and 2012. As a result, fewer families will even come close to paying the tax. That means that, except for the super wealthy, the tax benefits of giving through an estate plan have been wiped out.
Previously, charities could point to the estate planning benefits of both lifetime gifts and charitable bequests. There’s an income tax deduction associated with gifts during life--adjusted gross income can be reduced up to 50% for cash gifts to public charities and by up to 30% for donations of appreciated assets, such as stock held longer than 12 months. But charities could also make another argument: If you’re not comfortable making a large gift now, remember your favorite cause or alma mater money in your will and you will be leaving less for Uncle Sam.
Of course that’s still a huge estate tax benefit for the nearly 60 U.S. billionaires who have now pledged to give away at least half their fortunes during life or at death. Facebook co-founders Mark Zuckerberg and Dustin Moskovitz are among those to have recently joined the philanthropic campaign led by Berkshire Hathaway ( BRK - news - people )'s Warren Buffett and Microsoft ( MSFT - news - people ) co-founder Bill Gates.
And certainly there are many others of lesser means committed to supporting charity regardless of the tax benefits. But without being too cynical or ignoring the power of altruism, studies do suggest that tax incentives are a positive influence on giving, and tough economic times are a negative one.
Had the Bush tax cuts been allowed to expire at the end of this year, the estate tax exemption amount would have returned to just $1 million, giving many affluent folks a tax reason to make both lifetime charitable gifts and charitable bequests. Now, with married couples able to pass up to $10 million tax-free, most people do not need to be concerned about pruning their net worth through lifetime gifts, whether to charity or to family.
Even for billionaires, who still have a tax incentive to make charitable bequests, the new law diminishes the tax savings. To compute what’s saved you multiply the amount donated by the estate tax levy--at the new rate, that’s 35 cents on every dollar donated; it would have been 55 cents if the tax rate had gone to 55% for most estates in 2011, as it was scheduled to do under the previous law.
At the same time, a special tax break that allows older folks to donate assets directly to charity directly from an IRA suddenly has less allure too. As a part of the just passed tax package, Congress extended retroactively the "charitable IRA rollover" that had expired on Dec. 31, 2009. This on-again, off-again provision, first introduced in 2006, allows people 70 1/2 and older to transfer as much as $100,000 per year directly from their traditional IRAs to charity. The donation can count against the "required minimum distributions" they would otherwise be required to take.
Note that there’s no income tax deduction for these contributions, but the sum going to charity is not included in the donor’s adjusted gross income. (The advantage of this is that the older donor isn’t subject to percentage limitations on charitable deductions and may be able to avoid certain penalties that come with a higher AGI, such as higher Medicare premiums.) The provision was only extended until the end of 2011, although donors can make 2010 contributions retroactively through January.
Certain limitations continue to apply: the IRA rollover money cannot be contributed to donor-advised funds, supporting organizations or private non-operating foundations. Whether or not you’re eligible to do a rollover, you can still donate IRA assets through an estate plan. And in doing so there’s more latitude about which charitable entity can receive the gift. To make these gifts, you must name the charity on the beneficiary designation form--for example, by making the charity a 100% beneficiary of the account or indicating that the charity is a beneficiary of a specific percentage of the funds and having the rest go to other beneficiaries.
Still, from a tax perspective, why would you want to donate IRA assets? Until recently, charities could make the case that these gifts, whether made during life or through an estate plan, were preferable to leaving retirement assets to heirs. In both cases the strategy avoided the possibility that together estate tax and income tax would eat into the inheritance. (Since charity is tax-exempt, it can draw the funds without paying income tax.)
But how the world has changed during the past year. With a higher exemption amount, the federal estate tax concerns fewer donors who might have otherwise donated IRA assets. And meanwhile, the possibility of converting a traditional IRA to a Roth IRA -- an option that became available in 2010 to all taxpayers, regardless of their income or filing status -- has given the charities some stiff competition for IRA nest eggs that account owners don’t expect to need.
Although you have to pay income tax on the amount converted from a traditional account, doing that eliminates the requirement for you or your heirs to pay tax on future distributions. And because you avoid the requirement to take yearly minimum distributions starting at age 70 1/2, that can leave more for beneficiaries if you don’t use the money yourself. The potential for growth inside this tax-free wrapper is substantial. So assuming you can afford to pay the tax with nonretirement assets--and can stomach the idea--you might now find this strategy preferable to giving an IRA to charity.
For all these reasons, it’s small wonder that charities mostly stood on the sidelines during the 2010 debate over reinstating the estate tax. The charities would have fared much better if, as scheduled, the tax-free amount reverted to $1 million in 2011 with the tax on the balance rising to 55% in most cases. But had they openly lobbied for this, they would have angered potential donors.
As always, gifts made during life, if you can afford them, have a lot more psychic appeal since you have the satisfaction of seeing for yourself how your money is put to use. Plus (with the exception of money donated through an IRA rollover) you get a current income tax deduction. Yet until the economy rebounds, questions like "Will I have enough to retire comfortably?" and "Do my spouse and children need a larger inheritance than I previously assumed?" are likely to keep distracting donors from philanthropy.
In an ideal world, wealthy families that stand to benefit from the estate tax cut will make provisions to give at least some of those tax savings back to charity--either during life or through an estate plan. Whether this will happen, remains to be seen.
Deborah L. Jacobs, a lawyer and journalist, is the author of Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide (DJWorking Unlimited, 2009).