2017 Federal Tax Act; Estate Planning Update

Client Alerts Wealth Management

The significant increase in the estate tax exemption in 2010, and its doubling late last year, eliminated the threat of estate tax for almost all taxpayers. As a consequence, almost no taxpayer needs an estate tax charitable deduction. More to the point, for almost all donors a charitable bequest at death won’t gain a meaningful tax deduction for anyone.

Consider these two alternative approaches to charitable donations at death, assuming the donor’s estate faces no threat of estate tax. Assume also for an easy example that donor’s general intent is to make charitable donations at death and to leave all remaining assets equally to donor’s children.

1.  Donor directs all assets to children. Donor doesn’t direct anything to charity. But, donor has a conversation with children, and confirms it in a letter, asking them to make certain charitable donations in donor’s memory following donor’s death.

A.  This first approach risks that the children won’t make the donations donor intends. Indeed, this first approach turns entirely on the children’s legal right not to make the requested donations.
B.  But, if the children do make the donations, the donations will qualify for the income tax charitable deduction.
C.  A child’s ability to take advantage of a charitable income tax deduction in a given year will depend on the child’s other income, deductions and credits that year. Generally, the child will be able to carry forward any unused charitable income tax deduction for up to five years.

2.  Donor directs intended charitable donations from donor’s traditional IRA following donor’s death. Donor directs all remaining assets to children.

A.  This second approach eliminates the risk that the intended donations never get made.
B.  It funds those donations with dollars that would be fully income taxable if directed to donor’s children. In many circumstances, keeping traditional IRA proceeds out of a child’s taxable income is equivalent to gaining an income tax charitable deduction for the child as indicated in the first approach above.
C.  In other circumstances, this second approach might not be as tax-advantageous as the first approach.

i.    In the first approach, children will be the beneficiaries of donor’s IRA.
ii.   Depending on a child’s age, among other things, the child might be able to defer income taxes on most of the child’s inherited IRA for decades. The value of that deferral might exceed the value of keeping IRA proceeds out of the child’s taxable income.
iii.  The only way to determine the relative value of that income tax deferral is to run examples based on the child’s age, assumptions about investment returns inside the IRA, assumptions about future tax rates and other factors.

D.  Unless donor directs 100% of a given IRA to charity, this approach will also require careful planning to assure that donor’s children will be able to defer income taxes on their remaining portion of that IRA.