Want to keep some of your hard-earned money from going to the tax man when you die, and accomplish some good at the same time?
You can accomplish both goals as a part of your estate planning by making gifts of money or other assets to your church, your alma mater, or your favorite charities.
“There are ways to combine charitable deductions and estate tax exemptions to limit, or in some cases even eliminate, money going to the government,” says Willis Hobson, senior vice president of Hilliard Lyons Trust Company LLC, who spoke at the annual meeting of the Mississippi Farm Bureau Federation.
While tax laws can be “really bizarre,” he says, the government actually encourages post-death charitable giving by eliminating restrictions imposed on charitable deductions against income taxes.
There are no limits based on the type of recipient or the type of gift, and there is no need for a five-year carry forward for such gifts.
“The result — basically a limitless charitable deduction,” Hobson says. “The creative combination of the estate tax exemption and the limitless charitable deduction may result in large estates passing to family members and charities totally tax free.”
For example, with the $5 million exemption in effect for 2011, a $6 million estate could escape any federal estate taxes by giving $1 million to charity, with heirs receiving the remaining $5 million.
In 2010, when there was no estate tax, the heirs could have received the entire $6 million. Under 2009 law, heirs would’ve received only $3.5 million, charity $2.5 million. Unless changes are made before then, the estate tax exemption is set to revert to $1 million in 2013.
One tool that may be used for giving, Hobson says, is the charitable remainder trust, which can give the creator(s) an immediate income tax deduction, shelter assets from capital gains taxation, and pay an income to them for life.
At the death of the creator(s), the remainder of the trust passes to charity.
An example of how such a trust could be used: John and Helen Jones, both 75 years old, have a farm with an estimated value of $3 million. Most of the acreage was acquired by gift or inheritance over 40 years ago and the farm has a basically negligible basis of $500,000. They clear roughly $60,000 a year from the farm and now want to retire.
If they were to sell the farm for $3 million and reinvest the proceeds, using the $500,000 cost basis, they would have a capital gain of $2.5 million. This would be taxable at 15 percent, or $375,000, leaving them $2.625 million to reinvest. At 4 percent, this would provide an annual income of $105,000, versus the $60,000 they are clearing while farming.
If they give the farm to a charitable remainder trust, they could save $260,528 in income tax, which could then be invested along with the $3 million from the farm. This could produce an annual income of $310,421, compared to the $105,000 in the previous example and only $60,000 from their present farming operation.
After the 14-year life expectancy of the two 75-year olds, assuming an average annual appreciation rate of 4 percent and income of 2 percent, at their death there would still be $1,640,042 in trust principal to pass to charity.
Caveats to such a trust, Hobson notes, is that it is irrevocable, cannot be amended, and heirs are left out. However, he points out, the additional income generated by the trust would allow the couple to build an estate outside the trust for their heirs, or to buy insurance to provide for heirs. The increased income flow also enables lifetime gift giving.
Retirement savings, such as IRAs, can also be included in estate planning to benefit charity and reduce or eliminate tax liablities, Chris Cole, financial consultant with JJB Hilliard, WL Lyons LLC, explained.
“Retirement savings held at death are hit with a double whammy: estate tax based on the value at date of death and income tax on assets as they are consumed. Instead, these savings can be an ideal post-death charitable gift.”
An example: Farmer Jones died and left an estate of $1 million. Of that, $100,000 was an IRA with his children as designated beneficiaries. Of the remaining $900,000, he left 10 percent, $90,000, to charity.
With the estate tax exclusion, no tax would be levied on the $900,000, but the $100,000 would be subject to income tax at the 34 percent rate, or $34,000, which the children would have to pay.
If, on the other hand, the beneficiary of the $100,000 was a designated charity, there would be no tax due on the gift. The charity would get $10,000 more, the heirs would get $34,000 more, and the government would get zero.
“Donating an IRA to a charity can also reduce taxes, increase the amount going to heirs, and help a good cause in the process,” Cole says.
Stocks, land, and other assets that have attained a substantial increase in value can also be donated directly to a charity, he notes, thus avoiding capital gains taxes and taking a full deduction of the value of the assets.
“This has potential for significant savings,” he says.
Cole emphasized that IRAs, life insurance, or other assets with beneficiary designations need to be reviewed frequently, and updated as life situations change, in order to insure that they are distributed according to one’s wishes after death.
“This is something you have to be proactive about,” he says.