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Charitable Planning Where Federal Estate Tax Is Not a Concern

A member of Congress once remarked that, with a $3.5 million federal estate tax credit shelter, a person would have to attend 200 funerals before finding one where the deceased had a taxable estate.  What effect will this new tax reality have on estate planning for middle America?  What tax strategies are still available?  Are inter vivos contributions now more attractive than testamentary transfers?  What other rewards may be available for philanthropic individuals who are part of the 99.5% who don’t have to worry about estate taxes?

Inheritance/state estate tax savings.  Elimination of the credit estate tax (calculated under the now-repealed state death tax credit against federal estate taxes) has triggered increases in stand-alone state death taxes in some parts of the country and stymied repeal of state estate taxes in some.  Deductions or exemptions generally are available for charitable bequests in states that have inheritance or estate taxes.  A total of 24 states and the District of Columbia impose estate taxes or inheritance taxes.  The rest do not impose “death taxes,” although real estate that clients own in a different state may be taxable under local law, and states may claim that part-year residents are liable for inheritance or estate taxes on intangibles and other assets. 

Tax-burdened assets.  Income in respect of a decedent will continue to be a problem for heirs.  Donors should be encouraged to leave IRAs, savings bonds and others items of IRD outright to charity. Charitable remainder trusts funded with IRAs or savings bonds could provide lifetime income to family beneficiaries without erosion from income taxes.

Nontax considerations.  Donors who wish to benefit charities and family members using the same assets may be attracted to charitable remainder trusts or charitable gift annuities because of the money management or trusteeship services these vehicles provide to beneficiaries (see the previous discussions).  If gift arrangements are established during life, they also avoid probate. 

Lifetime gift arrangements become more important.  Under the federal estate tax, married persons receive no estate tax savings from charitable bequests because the first spouse to die already has the protection of the 100% estate tax marital deduction.  Spouses, accordingly, may be better advised to make lifetime contributions where feasible – including charitable remainder trusts – and enjoy income tax savings, capital gains tax avoidance and current recognition from charitable organizations.  With higher credits amounting to virtual repeal of the estate tax for 99.5% of individuals, most unmarried persons now are in the same position as married couples and might be better served to establish inter vivos charitable gift annuities and charitable remainder trusts that reduce current taxes and provide lifetime income.

Federal Income Tax Proposals and 2010 Charitable Gift Planning

Currently, taxpayers earning more than $200,000 annually and families earning more than $250,000 annually can take itemized deductions at a rate equal to their marginal tax bracket, 33% or 35%, respectively.   President Obama has proposed limiting itemized deductions for these taxpayers at a 28% rate beginning in 2011. In effect, if a donor had a charitable deduction of $1,000, instead of deducting it against her full 39.6% rate, she could deduct it only against 28%.   If she gives away the $1,000, she would still owe tax on it at 11.6%.  The 28% cap apparently has not gained much traction, but a modified proposal has also been suggested that would limit itemized deductions to 33% or 35% for taxpayers whose income tax brackets would increase to 36% or 39.6%, respectively, in 2011. 

The House of Representatives recently passed a health care reform measure that includes a 5.4% surtax on taxpayers whose adjusted gross income exceeds $500,000 ($1 million AGI for joint returns).  The tax would be on excess AGI over $500,000/$1 million, meaning that itemized deductions (including charitable contributions) would not help.

The President’s proposals also would reinstate the 3% “haircut” on certain itemized deductions (including charitable deductions) for individuals whose adjusted gross incomes exceed a threshold amount (IRC §68).  Such taxpayers could lose up to 80% of affected deductions (not including expenses already subject to a threshold or ceiling).  The deduction “haircut” was to have ended in 2010.  Reinstatement of the §68 cutbacks would reduce incentives for contributions or, in many cases, create at least the perception that tax incentives for giving will be reduced.  If some or all of these tax proposals become law, high income clients may need to revise their charitable giving strategies. 

• IRA “rollover gifts” (for donors over age 70½) will be more attractive starting in 2010, assuming Congress reinstates required minimum distributions.  Gifts would reduce AGI up to required minimum distribution amounts, avoiding tax rate caps on charitable deductions and 3% haircut reductions;
• Interest-free loans that divert investment income to charities (maximum $250,000 loan per charity) would reduce both taxable income and AGI;
• Since most changes apparently would begin in 2011, 2010 would become the best year for giving.  Clients should consider bunching future annual gifts into 2010, or making donor advised fund gifts and “advising” distributions to charities after 2010.

Keeping Peace in the Family When Leaving IRAs to Charity

Income in respect of a decedent – especially traditional IRAs – can be the ideal subject for charitable bequests, avoiding state and federal income taxes and estate taxes.  But clients may be concerned about the reaction of family members who may object to charitable distributions. 

Heirs may not need the shrunken amount that would be left from retirement assets after taxes.  However, donors could make charitable bequests of retirement accounts and purchase life insurance to replace what a family member would have kept.  Or they could arrange for retirement death benefits to pass to a charitable remainder trust that would pay income for 15 or 20 years to family beneficiaries, with eventual benefit to charity.  The trust should greatly reduce federal estate taxes, and absolutely no income taxes – state or federal – would be triggered upon death.

Note that a charitable remainder trust is generally not feasible if the trust is to last for the lifetimes of very young beneficiaries, due to the 10% minimum charitable remainder requirement [IRC §§664(d)(1)(D) and 664(d)(2)(D), 664(d)(4)].  If the 10% test is a problem, planners should consider leaving charity a portion of the IRA outright with the remaining portion passing to an eligible “look-through” trust to benefit grandchildren or other young beneficiaries.  A term-of-years charitable remainder trust would work for beneficiaries of young ages if the donor is content to have distributions continue for a maximum of 20 years.

Where the donor wishes to use an IRA to benefit both family and charity, one commentator has questioned whether an account owner should ever establish a testamentary charitable remainder trust, funded with an IRA.  The point was that everyone would be happier with a partial outright distribution to charity from the IRA, with the rest passing under a beneficiary designation or through a family trust.  One answer is that the CRT could receive other assets from the estate, including IRD such as U.S. savings bonds, and provide inexpensive trusteeship if the charity is willing to serve as trustee.  A term-of-years CRT might be preferable where the donor wants to use an IRA to benefit family members with a wide range of ages – overcoming the rule that any stretch-out must be figured over the age of the oldest person. 
  
A disadvantage for the CRT is that if the estate is subject to federal estate tax, the IRC §691(c) income tax deduction for estate taxes attributable to a decedent’s retirement account is essentially unavailable if part or all of the account passes to a CRT (PLR 199901023).  Again, a solution would be to forego the charitable remainder trust and instead make an outright bequest from the IRA of an amount equal to the anticipated charitable remainder interest.  The rest of the IRA would be subject to estate tax, but could be configured as a stretch IRA that would entitle the beneficiary to an income tax deduction for any estate tax attributed to the IRA.

Rest in Peace, Series H and E Bonds

Starting in 2010, all Series H savings bonds will have reached “final maturity” and will no longer pay interest to owners.  Additionally, all Series E bonds will have stopped earning interest after June of 2010. 

It’s worth investigating whether clients have H or E savings bonds that they have forgotten about.  Expired savings bonds should be cashed in and the proceeds put to other use.  Cashing savings bonds generally results in having to report taxable interest that has accumulated over the years.  Philanthropic clients can reduce or eliminate tax by using bond proceeds for charitable contributions – especially gift annuities that provide large deductions, plus payments for life that will be partly tax free during the recipient’s life expectancy.

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