Planned Giving and Fundraising World in State of Confusion Over Estate Tax Repeal

We have finally made it to the day everyone said would never come. For nine years – since the passage of EGTRRA in 2001 (whatever that stands for) – every speaker, writer, expert in the area of estate planning told us that Congress would never let this happen.

What day? What’s so dreaded about the estate tax repeal?

Truth be told: it is not the lack of estate taxes in 2010 that is so dreaded. It is the feared return of the Carryover Basis and what that would mean to planning and estates in 2010.

Let’s start over again. Planned giving professionals should always be on the lookout for new tax planning opportunities to encourage giving – during life or in one’s estate.

Are there any opportunities here – with the estate tax repeal of 2010 – for gift planners?

Not an easy question to answer.

Firstly, the repeal is only for one year. Even if there are some charitable planning advantages in 2010’s law, they will be gone before we know it.

Secondly, contrary to the rantings of the so-called Anti-Death Tax lobby, the repealed estate tax is not good for charitable giving. It may not be so bad, especially if bequest donors don’t get to their attorneys in time to change their wills. But, it is definitely not a law that would encourage more charitable bequests. More likely the opposite since it may encourage people to drop charities from their wills.

Thirdly, and the point of this article, charitable tax planning opportunities generally exist when there are tax savings reasons for giving to charity. Are there tax savings opportunities in 2010 as a result of the estate tax repeal?

This takes us back to the beginning of the article: Carryover Basis.

When Congress passed the so-called Estate Tax Repeal, they had to make up the projected loss in revenue from somewhere. So, sneaky Bush administration officials came up with a great idea: Let’s tax capital gains at death in the year of the estate tax repeal to make up for some of the lost revenue on paper from the repeal. Hocus pocus if you ask me.

Up until 2010, the U.S. had not seen in modern times (maybe ever) a tax on capital gains at death except for one year – 1976 – and it was repealed because of the confusion and challenges it caused. The first quote I found on the internet summed it: Legal scholar Lawrence Zelenak called the short unhappy life of carryover basis "one of the greatest legislative fiascoes in the history of the income tax."

Before 2010, all capital gains property in one’s estate would receive a “step-up in basis.” In other words, the code essentially wiped clean any capital gains at death – no surprise since the same asset was facing upwards of a 55% estate tax.

In 2010, there is a step-up in basis for up to $1.3 million in each estate for appreciation on capital assets. Additionally, surviving spouses receive an extra $3 million exemption on appreciation of capital assets, before having to start paying capital gains taxes.

Before 2010, surviving spouses generally never paid any estate tax – there was what we called the marital estate tax exemption. Either the government figured it wouldn’t look good to force widows to sell their mansions to pay estate taxes, or it is just easier to go after an estate when the surviving spouse is dead – less trouble.

Now, surviving spouses might be in for a big surprise once their $3 million of stepped up basis is exceeded. Time for widows to pay some taxes!

There are a lot of potential twists to the 2010 estate tax system. How is the $1.3 million of free capital gains allocated among appreciated assets? How does the surviving spouse allocate his or her $3 million of free capital gains?

My question is: how will people prove that the asset they inherited received some of the free step-up in basis? Will surrogate courts issue certificates indicating how much step up in basis certain properties receive?

Questions for executors of estates: what if we can’t prove the cost basis for this stock that has split and/or merged umpteen times? Ask the IRS and they will tell you that without proof of basis, it is assumed to be zero (i.e. pay capital gains on 100% of the value).

What about estate plans that didn’t anticipate the estate tax repeal? Unintended consequences such as surviving spouses effectively being cut out of their late spouses’ estates because the will or trust called for all assets not affected by estate tax to pass to children or others?

What about Credit Shelter Trusts? These are designed to lock away the federal estate tax exemption amount in a trust, typically income to surviving spouse with limited right of principal invasion, remainder to children. This year, there might be no need for this type of trust – maybe the kids should get the money outright?

The questions go on and on. Congress claims that they want to retroactively undo the estate tax repeal – before the 9 month filing deadline for decedents’ estate tax returns. Watch Congress push off until September 1, 2010, for a last minute attempt at fixing this mess before the estates that pulled the plugs on January 1, 2010 have a chance at zero estate tax. My prediction: 2011 will come and federal estate taxes will return to 2001 levels of $1 million exemption and highest federal estate tax bracket of 55% - and they can blame George Bush for that one.

Charitable Planning

The short answer to my original question (Are there any charitable planning opportunities in the estate tax repeal?) is no. Even if many people will be paying more in taxes via the carryover capital gains tax, I can’t see any logical way to promote gifting to avoid a one year tax – one at a relatively low rate of 15%.

You could try to make the case that Charitable Remainder Trusts should become very popular as devices for avoiding this one year carryover basis capital gains tax. I wouldn’t bother.

Attorneys might tell their clients to designate highly appreciated items in their estate to charities. The challenge would be whether the estate can sell the asset on behalf of the charity or would the charity be forced to accept the item for the capital gains tax to be avoided? This could make for some interesting questions in dealing with valuable tangible property or art – not so fun for nonprofits not equipped for owning these types of things.

What should we be doing?

Educating is the key. Any time we, planned giving professionals, have the opportunity to educate our donors about estate planning; it’s an opportunity to provide a needed service and a soft sell of bequests and other planned gift options.

Plan a seminar with a top estate planning attorney. My guess is that these types of presentations will draw standing room only crowds.

Find an article that is informative about the challenges of estate planning under the current scheme. Include it in your planned giving newsletter. Just make sure you send it out before Congress changes its mind and retroactively changes the 2010 law.

Most planned giving dollars are from bequests – period. So why do we planned giving people spend so much time promoting various complex giving arrangements? The answer is that we need something interesting to put out there – get people’s attention, get their minds thinking. Even if at the end of the day most planned giving prospects will only include you in their will (and probably not tell you), planned giving marketing would go stale quickly if all we ever speak about is bequests.

That’s the business. We market all of the fancy stuff, give people something to think about, and most go with the simple, least challenging option.

And, this new world of estate tax repeal certainly gives us interesting, thought provoking material to communicate with our donors. Even if we don’t have any exciting new charitable tax savings to announce.