Charitable Bequest Planning for Clients Who Won't Face Estate Taxes April 2012

Most estate planners expect Congress will reenact large transfer tax exemptions after the current $5.12 million exclusion sunsets on 12/31/2012. Tax-sheltered amounts are scheduled to drop to just $1 million in 2013, but the only uncertainty seems to be whether the new exemptions will continue in the $5 million range, $3.5 million (as desired by President Obama) or at some other level. Whatever happens, transfer taxes likely won't be a concern for 99% of the population.

The estate tax charitable deduction historically has played a role in encouraging individuals to make bequests to organizations they supported during life, which invites the question: What estate planning strategies remain for philanthropic individuals who won't have to worry about estate taxes?

Inheritance/state estate tax savings: A total of 22 states (CT, DE, IL, IN, HI, IA, KY, ME, MD, MA, MN, NE, NJ, NY, NC, OH, OR, PA, RI, TN, VT, WA). and the District of Columbia currently impose estate taxes or inheritance taxes. Real estate and tangible personal property that clients own outside their home states may be taxable under various rules and rates (vacation homes and their contents may be a concern). All states provide exemptions or deductions for transfers to qualified charitable organizations, including charitable remainder trusts. Note, however, that transfers to nonqualified charitable remainder trusts arranged as QTIP trusts under IRC §2056(b)(7) (all income to the surviving spouse, remainder to charity) may have poor tax results in states with stand-alone death taxes that do not provide for a QTIP election. No QTIP election is required, however, for testamentary transfers to qualified charitable remainder trusts, where marital deductions are available as a matter of law under IRC §2056(b)(8).

Tax-burdened assets. Income in respect of a decedent will continue to be a problem for estates and beneficiaries. Donors should be encouraged to choose IRAs, savings bonds and others items of IRD when making charitable bequests. Charitable remainder trusts funded with IRAs or savings bonds could provide lifetime income to family beneficiaries without erosion from income taxes. It's important, from a drafting standpoint, for a donor's will to make specific bequests of items of IRD to charity, or to have IRD assets pass to charity as a residuary bequest. A donor can change the death beneficiary of a qualified retirement plan or IRA to a qualified charity, which is the preferred way to ensure favorable tax treatment. Satisfying pecuniary bequests to charity out of IRD items will generate an estate tax charitable deduction but the estate will have to include the IRD in its income [Treas. Reg. §1.691(a)-4(a)].

Nontax considerations. Donors who wish to benefit charities and family members with 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. If gift arrangements are established during life, they also avoid probate.

Bequest acceleration. Clients who don't need estate tax charitable deductions may be better advised to make lifetime contributions where feasible – including charitable remainder trusts and charitable gift annuities – and enjoy income tax savings, capital gains tax avoidance, reduction of future probate costs and current recognition from charitable organizations. Individuals who have considered leaving personal residences or farm property to charity via wills or living trusts can accomplish similar results with intervivos gifts of remainder interests that also produce hefty charitable deductions under the current historically-low §7520 rates.