In the early 19th century, the noted French historian and political philosopher, Alexis de Tocqueville, published his classic treatise, “Democracy in America.” In one of the earliest studies of the American experiment in democracy, he marveled at the role voluntary action and philanthropy had played in building and sustaining education, religion and other vital components of the fledgling society.

Over the nearly 200 years since de Tocqueville’s commentaries, the United States has continued to rely in large part on the voluntary redistribution of income and wealth in tandem with taxation and government spending to meet societal needs.

The historical record reveals that philanthropy in the United States has remained steady or increased over time in spite of periodic recessions and fluctuations in asset values, interest rates and tax codes. Even in the midst of the Great Depression, charitable giving overall dropped for a relatively brief period of time before recovering to pre-Depression levels by 1937. (See “Short-Lived Dip,” p. 10.)

In June 2012, Giving USA 2012 released a report1  showing that inflation-adjusted giving in the United States increased by an anemic 0.9 percent in 2011 after increasing just 1.3 percent in 2010. These increases in the percent range follow on the heels of a 12 percent drop in charitable giving between 2007 and 2009, the worst decline since the Depression. It’s been estimated by those responsible for the Giving USA report that giving in the United States may not return to 2007 levels until 2022.2

It Starts at the Top

Conventional wisdom suggests that reduced giving be primarily concentrated in the masses of middle income Americans who were hardest hit by increased unemployment, stagnant wages and reductions in the value of savings. However, this is demonstrably not the case.

A number of reports that have recently surfaced make it very clear that the declines in giving were actually at the top of the income and asset scale. This is important to know for those who advise wealthier individuals. 

IRS Reports Shed Light

The Internal Revenue Service has released in-depth summaries of income reported and deductions claimed on federal income tax returns filed in 2008 and 2009. Those reports include the breakdown of charitable income tax deductions claimed over that time period, broken out by taxpayers’ income range.3

Surprisingly, those with incomes under $200,000 only reduced their giving by 3 percent in 2008 and 2 percent in 2009. The total reduction comprised just $4.5 billion of the $35.5 billion in total decline in itemized deductions during that period.

Taxpayers with income in the $100,000 to $200,000 range actually increased their deductible giving from $40.5 billion in 2007 to $40.6 billion in 2008. After accounting for a $300 million reduction in 2009, the difference in giving for that income range between 2007 and 2009 was less than one half of 1 percent.

On the other hand, taxpayers with incomes over $200,000 reduced their itemized gifts by 20 percent in 2008 and another 18 percent in 2009, for a total reduction of 34 percent between 2007 and 2009. In terms of dollar volume, the reduction was $31.1 billion. This accounts for nearly the entire $32.4 billion drop in giving by individuals reported by Giving USA for that calamitous period.

Reports of publicly announced gifts over $1 million also indicate that declines in giving have been concentrated among the wealthiest Americans. The Chronicle of Philanthropy reports that gifts at this level declined some 86 percent from $32.2 billion in 2007 to $4.4 billion in 2009.4 The difference of $27.8 billion, once again, seems to parallel the total drop in giving by individuals, as reported by Giving USA and the IRS.

Taking Stock 

Finally, the IRS has also reported on giving by type of property contributed for 2008 and 2009. While cash donations dropped by 9 percent over that period, the amount of securities and other non-cash gifts declined by 46 percent from $58.7 billion in 2007 to
$31.8 billion—a difference of $26.9 billion.5 Once again, the decline in non-cash giving nearly equals the entire decline in individual giving reported by Giving USA.

The picture that’s just now emerging is one in which the painful declines in charitable giving in the United States between 2007 and 2009 were concentrated in $1 million-and-up gifts by individuals with incomes over $200,000, giving appreciated securities and other non-cash property.

What does this information portend for the future of philanthropy in the United States? On the tax policy front, it’s interesting to note that both sides of the aisle have put forth proposals that would limit the amount and value of federal income tax deductions for charitable gifts.  

It’s now clear these limits would fall most heavily on the higher income individuals, whose giving levels have already been impacted by declines in asset values and, in some cases, lower incomes. In the case of an administration proposal, the only limits on charitable deductions would fall on those with incomes over $200,000, where the most damage in giving occurred.

Reductions in tax deductibility of gifts amount to a partial tax on donated amounts. In this case, elasticity of demand may portend further declines in giving by the wealthy if the after-tax cost of this activity is higher as a result of proposed tax increases targeted at the most philanthropic among the ranks of the wealthy.

 

Investment Markets

On the positive side of the ledger, much of the decline in giving of non-cash gifts from 2007 to 2009 followed the precipitous decline in stock values of over 50 percent by the time the Dow bottomed out at 6,500 in March of 2009. As of early August 2012, the Dow had increased over 100 percent since the 2009 lows. Many of these gains have now been held for more than 12 months and qualify for deductibility at full fair market value.

These asset value recoveries mean those advising philanthropically minded clients have a special opportunity this fall to provide counsel on ways to complete gifts more cost effectively than may be possible in the future.  

Let’s summarize these opportunities, a number of which have been explored in greater detail in this column in previous months.

Clients may want to realize capital gains against the 15 percent rate that’s guaranteed until the end of 2012. To further minimize the tax on those gains, it could be wise to make gifts using the most highly appreciated assets that can be deducted in amounts up to 30 percent of adjusted gross income (AGI) and serve to offset tax on ordinary income and capital gains, while bypassing capital gain on the donated assets. 

Another approach is to sell securities in a loss position and use the resulting cash to pay off pledges or make new gift commitments subject to the 50 percent of AGI limit for gifts of cash. This strategy takes advantage of any deductibility of losses, combined with the full charitable gift deductions guaranteed through the end of 2012.

As noted at the outset, economic conditions from 2007 to 2009 and the less than robust period of recovery haven’t been the most conducive to making large outright charitable gifts.

On the other hand, charitable remainder trusts (CRTs) and other split-interest gift planning vehicles can be particularly attractive in this environment.

In August, the applicable federal midterm rate (AFMR) was a record low 1 percent. For gift vehicles that benefit from lower interest rates, this was indeed good news. For example, a charitable lead annuity trust (CLAT) making fixed payments to charity of just 5.3 percent for 21 years will result in a 100 percent gift tax charitable deduction.  

This means a grandparent could place any sum desired in a CLAT, fund charitable obligations for 21 years, remove the assets from the grandparent’s estate and have grandchildren receive the funds completely  free of federal transfer taxes at the age of 21.

The CLAT can also be an attractive way to make a sizeable charitable gift over a period of time, while leveraging the $5.12 million gift and estate tax exemption equivalent amount that’s set to expire at the end of 2012.

Suppose a donor would like to fund a $5 million pledge to a campaign that allows commitments to be funded over as long as an 8-year time period.

The donor could place $10 million in a CLAT paying 6.3 percent, or $630,000 per year for eight years, resulting in total payments of $5.04 million before transferring the trust corpus to his heirs. The gift tax deduction for this gift using the August 1 percent AFMR is $4,820,600, leaving a taxable gift of $5,179,400. The donor’s exemption equivalent amount of $5.12 million would be more than sufficient to offset any gift tax that would otherwise be incurred at the time the CLAT is funded.  

The result is to fund a $5 million charitable gift commitment while transferring $10 million (more or less depending on the performance of the trust) to heirs at the cost of the $5.12 million exemption equivalent amount. 

CRTs and gift annuities funded with appreciated, low-yield properties can also be attractive in today’s low-interest environment.  

Older clients with assets that are invested conservatively for fixed income might find gift annuities and charitable remainder annuity trusts (CRATs) attractive. Consider a 75-year-old individual who funds a CRAT paying 5 percent for life, using $1 million in appreciated securities that had been paying dividends of less than 1 percent. This will result in this individual bypassing capital gains tax at the time of the gift and increasing income to $50,000 per year (much of which may be taxed at lower than ordinary income rates under the tier structure of income reporting), while at the same time generating a charitable income tax deduction of $496,000.  

In this situation, a donor might want to fund such a gift before the end of 2012 when favorable tax treatment is assured. He might also want to use the income tax deduction to offset tax on gains from diversifying other investments while investment market values remain high.

 

Challenges Ahead

If current conditions persist at a time when the U. S. donor population continues to grow older, it may be increasingly challenging for philanthropically inclined individuals to make large outright gift commitments.

Fortunately, however, extremely flexible gift planning tools have been developed that serve to meet a donor’s needs while also resulting in vital support for the United States’ non-profit community.

 

Endnotes

1. www.givingusareports.org.

2. http://philanthropy.com/article/Donations-Barely-Grew-at-All/132367/

3. www.irs.gov/taxstats/indtaxstats/article/0,,id=133414,00.html.

4. See Chronicle of Philanthropy, http://philanthropy.com/stats/topdonors/.

5. Supra, note 3.