The next eight months promise to be an important time for practitioners who advise clients on effective ways to make charitable gifts. While there’s a great deal of uncertainty concerning the economy’s health, the future of the federal income and estate tax and other matters, there are islands of certainty from which efficient philanthropic planning can proceed between now and the end of the year.
Let’s take a look at factors that will come into play and what steps donors may wish to take to make charitable gifts in the most economic way.
Giving on the Rise
In March 2012, the Internal Revenue Service issued estimates of the amount of itemized gifts given to charity in 2010. After drops in giving by higher income donors in 2008 and 2009, which were the largest since the Great Depression, estimated itemized gifts rose by 6 percent from $148 billion to $158 billion. “Trend in Itemized Deductions,” this page, shows the amount of itemized deductible gifts from 1998 through 2010.
If this rate of increase continues for 2011 and 2012, itemized deductions should return this year to the 2007 estimated level of $174 billion, the previous high point in charitable giving.
This increase indicates that the negative impact on giving caused by the crash of 2008 ended in 2010, and high-net-worth individuals may have, in many cases, regained the confidence necessary to make larger gifts.
Areas of Certainty
While no one knows what the federal tax structure will look like in the future, there are areas of certainty in that realm that should motivate planning in the coming months.
Unless Congress acts to avert the automatic sunset of the Bush tax cuts of 2001, there will be dramatic changes in the nation’s income, estate and gift tax law beginning in January 2013. As noted in previous columns,1 the gift and estate tax credit amount of $5.12 million is scheduled to return to $1 million on Jan. 1, 2013. While few believe this will actually occur, the possibility is becoming increasingly real in light of Congressional gridlock.
With continued low applicable federal midterm rates, charitable lead trusts (CLTs) continue to be a popular way to leverage the $5.12 million exemption while it’s still in place.2 Not surprisingly, the IRS recently released a report indicating that CLTs have been the fastest growing type of charitable trust over the past decade, and CLTs are now providing more dollars each year for charitable use than charitable remainder trusts (CRTs) or pooled income funds.3
On the income tax front, the Obama administration continues to propose limiting the charitable income tax deduction to the 28 percent tax bracket. If that occurs, along with repeal of the Bush tax cuts, there will be a significant increase in the after-tax cost of charitable gifts in 2013. Individuals in the 35 percent tax bracket (or 39.6 percent bracket if the Bush tax cuts expire), may have to pay taxes of up to 11.6 percent on income used to make charitable gifts.
The rule requiring a reduction in charitable and other itemized deductions by 3 percent of income above a threshold level (the Pease Amendment) is also scheduled to return on Jan. 1. It may, therefore, be prudent for those with outstanding gift commitments to fulfill them, to the extent possible, this year.
A positive sign on the tax planning front is the fact that the charitable deduction would apparently have been the only adjustment to income allowed under the recently defeated Buffett Rule, which would have required individuals with income over $1 million to pay a flat tax rate of 30 percent. This is good news, because taxpayers who would have been subject to a Buffett Rule with no charitable deduction available would have to earn $144,000 to make an after-tax gift of $100,000. To maintain the income required for a gift at $100,000, the gift would have to be reduced to $77,000, with $23,000 held back to pay tax on the $77,000 donated. If a variation on the Buffett Rule eventually becomes law in its current form, it appears that charitable gifts will be excepted from the tax axe and charitable income tax planning would remain a central focus for the highest income Americans.
Research shows that much of the drop in giving in 2008 and 2009 was due to large reductions in gifts of securities. As of early 2012, the Dow had doubled in value since its low point in April 2009. The return of giving to 2007 levels will, no doubt, be largely driven by a comeback in gifts of appreciated securities. As these gifts may be negatively impacted by a reduction in the value of charitable contributions next year, gifts of securities and other appreciated property currently provide an attractive alternative to cash gifts.
Making gifts of appreciated securities and immediately repurchasing them using cash that might otherwise have been donated can be an excellent way for investors to make gifts while upping their cost basis to current market levels. A future sale then results in less gain, while a decline from current values would generate losses for tax purposes.
We can also expect contributions of appreciated, low yielding securities to increase during 2012. Making gifts of such assets through CRTs can be an excellent way to diversify an overly concentrated investment position on a tax-free basis, while providing immediate income tax savings and a significant future gift.
For these reasons and others, charitable giving for this year shouldn’t be paralyzed by uncertainty. Real benefits exist for those who act in 2012 to take advantage of significant windows of opportunity.
1. See, e.g., Robert F. Sharpe, Jr., “A Year of Speculation,” Trusts & Estates (January 2012) at p. 28.
3. “Split Interest Trusts—Filing Year 2010,” Internal Revenue Service Winter 2012 Statistics of Income Bulletin, www.irs.gov/pub/irs-soi/12eowinbulsplitinterest.pdf.