August 31, 2011
Charitable Deduction - Estate Tax
Americans in general are a charitable lot. Millions of Americans annually donate to community, religious, civic and athletic organizations that operate as charitable organizations. There is an immediate tax benefit to this, the charitable deduction the donor can take on their annual tax return during one's lifetime. Conversely, even at one’s passing, there is a tax benefit to donating to charity, namely a deduction on their estate tax. The following are some questions that provide a broad overview of the topic.
1. What is the charitable deduction in the context of the estate tax?
Federal law allows a U.S. citizen or resident of the United State to leave some or all of their estate to a qualified charitable organization which will reduce their estate tax liability. IRC §2055(a).
For example Danny Decedent was a resident of Campbell, CA. At the time of his passing in 2011, Danny had earned a vast fortune because he was an early investor in Google, namely $12M. Danny was concerned about paying Uncle Sam millions of dollars in estate taxes at his death, as the tax rate for estates larger than $5M was 35%. IRC §2010(c). Danny had engaged in philanthropic endeavors during his life and wanted to benefit these charities rather than have his money be sent to Washington D.C. Therefore, Danny decided to leave his entire estate to two California-based charities, HealthCare Volunteer and CACS Government Research, via his will.
Editor’s Note: The person is fictionialized while the charities are authentic.
2. What types of charities are eligible beneficiaries?
Federal law says the following charities are eligible: (1) The United States, any state, any political subdivision thereof, or the District of Columbia, but only if the contribution is used for exclusively public purposes, (2) IRC §501(c)(3) organizations established in nonprofit corporation form, (3) IRC §501(c)(3) organizations established in charitable trust form, (4) various veterans' organizations or (5) employee stock ownership plans subject to certain conditions. IRC §2055(a).
(2) and (3) are the most common beneficiaries for reference. For example, thousands of people have left money to their university or graduate school which falls under the category of (2) and (3).
3. What happens if a donor receives something in return for the donation?
When a donor receives something in exchange for their donation, a quid pro quo basically, the value of the goods or services generally offsets the value of the contribution for tax purposes. Treas Reg §1.170A. For instance, assume a late donor gives $100,000 to their beloved alma mater, San Diego State University for example, and SDSU replies by giving the late donor’s grand niece an athletic scholarship worth $40,000. Generally speaking, the donor’s estate could only claim a $60,000 charitable deduction on the estate tax return. (IRS Form 706 for those curious).
4. Is there a limit on the charitable deduction for estate tax purposes?
Federal law does not limit the estate tax charitable contribution deduction that can be claimed. IRC §2055. Thus, a person is free to leave their estate to a charity to avoid paying any estate tax. For instance, noted multi-billionaire Bill Gates may leave his entire estate, something in the range of $56B, to a charitable organization to avoid the estate tax.
5. Is it common to leave an estate to charity?
From my experience, few clients leave their estate to charity. In particular, the select few who do leave money to charity usually allocate a small fraction of their estate to charity rather than their entire estate. Individuals who leave vast amounts to charities are often the very wealthy who face an estate tax issue. This should by no means dissuade anybody from thinking about giving to charity. It is just that many parents have a sense of obligation to provide for their children. In contrast, the very wealthy do not really have that concern because their children are taken care of already. Hence, the former often leaves their estate to their spouse and children whereas the latter leaves it charity typically.
6. Are there trusts for this?
Yes, there are trusts specifically designed to achieve a charitable estate tax deduction. Examples of these include a charitable lead trust and a charitable remainder trust.