philanthropy_418

Tax Reform and Charitable Estate Planning: Glass Half Empty or Half Full?

Robert F. Sharpe, Jr. explains the effect of changes in the federal estate and gift tax laws on philanthropic estate planning.

Last month, I focused on the expected impact of the Tax Cuts and Jobs Act of 2017 (the Act) on charitable giving, with an emphasis on current gifts of cash and other property. In this column, I focus on how changes in federal estate and gift tax laws can be expected to influence the ways individuals incorporate philanthropy into their estate plans.

Prior Years

As of last year, an individual could leave his heirs up to $5.49 million free of federal estate and gift taxes. A couple could leave up to $10.98 million. This has been the level of exemption adjusted for inflation since 2011, when a $5 million and $10 million exemption was introduced.  

To put this in perspective, some 2.7 million people died in the United States in 2016.1 Just 11,200 died with estates worth more than $5 million.2 That means that 99.6 percent of Americans weren’t subject to federal estate tax under prior law. On top of that, more than 65 percent of Americans live in states such as California, Texas and Florida with no estate or inheritance tax.3  

For all practical purposes, there have thus been no federal and very limited state estate tax considerations associated with charitable giving for many years. The Act further underscores that reality. 

While initial tax reform proposals called for the complete elimination of federal gift, estate and generation-skipping taxes, the Act keeps these taxes in place but doubles the exemption levels to $11.18 million for individuals and $22.36 million for couples. The Treasury announced in Revenue Procedure 2018-18 that these would be the amounts for 2018 after adjusting the $5 million per individual and $10 million per couple exemptions introduced in 2011 for chain-weighted inflation.

According to the Internal Revenue Service, just 4,142 Americans died with estates worth more than $10 million in 2016.4 This means the federal estate tax will apparently not apply to 99.8 percent of estates under the new law.

Increase in Giving?

One may argue that many individuals who would have faced estate tax in the past may actually increase amounts left to charity absent this levy. Why might this be the case?

Consider the case of Thomas, 80, a widower with an estate valued at $12 million. In 2012, he included a $1 million bequest to fund a gift in memory of his late wife when he updated his estate plan after she passed away. He plans to leave the balance of his estate to his two children after payment of any estate tax due.  

Prior to the Act, his taxable estate would have been roughly $5.5 million ($12 million - $1 million bequest - $5.49 million exemption = $5.51 million). Assuming the tax due would be approximately $2.2 million, his children would have received about $4.4 million each.

Now suppose Thomas passes away in 2018 under the $11.18 exemption regime. After satisfying the $1 million charitable bequest, Thomas’ children would owe no tax on the remaining $11 million and would receive $5.5 million each.

Why would Thomas remove the bequest when his children will receive an additional $1.1 million each due to the estate tax reduction? This would be highly unlikely. In fact, Thomas could double his intended bequest to $2 million, and his children would each still receive $600,000 more.

Surveys of high-net-worth (HNW) individuals suggest that as many as 95 percent of them will keep their charitable commitments the same or actually increase them if their estates aren’t subject to tax.5 In a broadly circulated U.S. Trust 2016 survey of HNW individuals, 72 percent responded they would maintain their current level of giving through their estates, and 23 percent responded they would somewhat or dramatically increase their charitable bequests.6 

Those who’ve worked closely with HNW individuals know this response is in large part due to behavior of HNW clients given that they often first decide how much they would like their children or other heirs to receive, make provisions for payment of tax on that amount and then leave the rest to their charitable interests. If there’s no tax due on the amount left to heirs, that simply increases the amount available for charitable purposes.

In my opinion, changes to Social Security, Medicare and other entitlement programs, along with extended periods of low interest rates, may present more long-term threats to the amount left for charitable bequests from nontaxable estates, which are the source of 99 percent of bequests in terms of numbers and 40 percent to 50 percent in terms of amount.7 

Split-Interest Gifts?

Congress made no changes in the tax treatment of charitable remainder trusts (CRTs), charitable lead trusts (CLTs), gift annuities and other split-interest gifts.  

Millions of Baby Boomers are now entering retirement with unprecedented amounts of assets, and they’re concerned more now than ever about the long-term preservation and growth of their wealth. 

Under these circumstances, irrevocable charitable gifts completed today that feature immediate income tax benefits, additional income, a tax-free growth environment and other financial benefits may be more appealing when compared to gifts through estates that no longer offer tax benefits.

Let’s consider the case of a retired couple who doesn’t have enough deductible expenses to itemize gifts under the new standard deduction of $25,600 for couples over 65. If they periodically created charitable gift annuities or made additions over time to a charitable remainder unitrust (CRUT), such gifts could serve largely or completely to satisfy their standard deduction requirement in those years and make it possible to itemize other deductible expenditures.

The bad news when an individual funds a CRUT or other irrevocable charitable gift vehicle, however, is he can no longer access the corpus at will. The good news is that no one else can either. The irrevocability required to enjoy income and capital gains tax benefits of such gifts also results in fencing off assets from creditors and those who might take advantage of the elderly in later years. This tangential benefit of a CRT will hold special appeal for the estimated 30 percent of Baby Boomers who’ll be childless in their retirement years.8 Note that this group tends to be disproportionately charitable in terms of their estates.

CRTs can also be structured in ways that result in a portion of annual payments being used to make immediate gifts directly from the trust. For those whose ability to itemize gifts has been reduced, this structure offers another way to achieve the equivalent of full deductibility, much as in the case of those who are making use of the individual retirement account rollover provision. This income isn’t reportable by the donor and is thus comparable to being received and donated on a fully deductible basis.

CLTs also offer a way for those who don’t itemize (due to higher standard deductions or adjusted gross income limits) to make significant gifts over an extended period in a way that’s essentially the same as making fully deductible gifts. Again, this is due to not receiving funds that are directed for charitable use from the CLT. 

While gift and estate tax considerations may no longer be as important when considering the use of lead trusts, the ability to make tax-free current gifts, combined with the desire to delay inheritances and make wise use of gift and estate tax exemption amounts, will continue to make CLTs very attractive to certain donors.

Bottom Line

It’s time to step back, take a deep breath and move forward with the knowledge that the charitable estate-planning world isn’t coming to an end. In fact, for many clients, especially those with a lifelong history of philanthropic involvement, the recent changes in the law may result in more discretionary assets in their estates that can be divided between heirs and charitable interests.  

Others may find that accelerating bequests may result in immediate tax benefits and increased economic security in their later years.   

In any event, advisors may find opportunities to better serve their clients by looking at the philanthropic aspects of their estate and financial plans through a different and more broadly focused lens.

Endnotes

1. Centers for Disease Control and Prevention, “Mortality in the United States 2016,” www.cdc.gov/nchs/products/databriefs/db293.htm.

2. Tax Policy Center, www.taxpolicycenter.org/briefing-book/how-many-people-pay-estate-tax.

3. As of now, 17 states and Washington, D.C. have an estate and/or inheritance tax, and those jurisdictions are home to 35 percent of the U.S. population. Thus, 65 percent of the U.S. population live in jurisdictions that aren’t affected by federal estate tax. Several of those jurisdictions, such as California, Texas and Florida, are home to wealthy individuals.

4. See supra note 2.

5. “The 2016 U.S. Trust Study of High Net Worth Philanthropy” (October 2016), www.ustrust.com/publish/content/application/pdf/GWMOL/USTp_ARMCGDN7_oct_2017.pdf, at p. 81.

6. Ibid.

7. The conclusion that 99 percent of charitable bequests come from nontaxable estates is derived at by making the following calculation: In 2016, Giving USA reported that $30 billion of charitable bequests came from nontaxable estates. The Internal Revenue Service reported that $16 billion came from 1,207 taxable estates (defined as $10 million or above), and other studies estimate that 8 percent of decedents (216,000) made charitable bequests. See generally www.philanthropy.com/article/New-Research-Sheds-Light-on/162667. Because the number of taxable estates that made bequests (1,207) is .6 percent of 216,000, 99.4 percent of bequests thus come from nontaxable estates. 

8. See generally www.pewsocialtrends.org/2015/05/07/childlessness/ and https://newoldage.blogs.nytimes.com/2011/03/25/aging-without-children/.

 

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