We folks who deal with high net worth clients have wondered for years what will happen with estate taxes when the current plan sunsets in 2011. Let me make a guarantee here (which is something I don’t often do). I guarantee that estate taxes will be addressed before 2010 which is when they are set to return to zero and return to 2001 levels when 2011 begins. Already, congress is abuzz with talk about what to do about it. Frankly the estate tax has been the running joke in the planning community for years when congress said that the estate tax would disappear in 2010. People said that they would start to write special instructions for “pulling my plug”, but only if it were advantageous from an estate tax planning perspective. All kidding aside, regarldless of what gets decided, I guarantee that there will be implications. As The NY Times reported in 2005, the last time there was talk about eliminating the estate tax, charities remained shockingly silent for fear that any attempts to block the measure would be donor suicide. I mean really, would you give to a charity that intentionally lobied for higher estate taxes? Are you crazy? Make no mistake, this time, I guarantee there will be legislation being passed and it will have a major impact on both the wealty, and nonprofits.
While many in the nonprofit community have been quite vocal against Obama’s plan to lower the charitable tax deduction, if history is any guide, I don’t think they will be speaking up now. Perhaps they should. I believe that the changes to the estate tax will have a much bigger impact on charities than the income tax deduction. Charities felt that they had nothing to lose by speaking up on the proposed change to the deduction because the change would be bad for BOTH the wealthy, AND the charities. By lowering the deduction, the wealthy would be losing a tax incentive to give to charity (perceived as bad for the wealthy), and the charities would be hurt by that. Nobody had a problem speaking up to say this was a bad idea. The estate tax is a completely different animal and I would argue, will hurt charities much more than the income tax deduction. Have you heard anyone talking about this? Nope. This will be a silent walk to the grave for the nonprofits. Here’s how it will happen.
Year/ Exclusion Amount /Max Top tax rate:
2001 $675,000 55%
2002 $1 million 50%
2003 $1 million 49%
2004 $1.5 million 48%
2005 $1.5 million 47%
2006 $2 million 46%
2007 $2 million 45%
2008 $2 million 45%
2009 $3.5 million 45%
2010 repealed 0%
2011 $1 million 55%
In the above chart, notice that the estate tax exemption amounts have been going up since 2001. From 2001 until 2008, the exemption amounts didn’t go up that much; essentially from $1-2 million. The period from 2001 to 2002, up until recently, was the worst period of time for the markets since the great depression. While the exemption amounts did go up slightly from $675,000 to $1 million dollars, that was not a big increase in real dollars for the wealthy. From 2003 up until 2008, the stock market experienced a bull market while the exemption amounts only increased from $1 million to $2 million. This year however, the exemption amounts went to $3.5 million. That means that a husband and wife can leave $7 million dollars free from federal estate taxes. Compare that to only $2 Million total in 2002 ($1 million for each individual), and that’s a lot of extra millions. Let’s add somthing else here. Portfolios are down much more than the last recession. This means that exemption amounts are much higher, and people have less money. Well that’s great for the wealthy right? How about for the nonprofits? They are still talking about how the drop in the income tax chariable deduction is going to impact them. Folks, wake up, you have a new problem. It’s called the estate tax. While nonprofits have had lots of other things to deal with lately, I fear that what’s being discussed with the estate tax is going to be yet another blow to their ability to continue to operate as they had been.
Before the wealthy shoot me here, let me point out that there’s a fine balancing act that needs to take place here. Nonprofits play an essential role in society and they perform many responsibilities for society that the government isn’t good at and has no place in. If charities are not fundamentally strong, society is worse off and someone else needs to pick up the slack. If the government needs to do more, guess what, that means we all will wind up paying higher taxes anyway. It’s in our nation’s interest to make sure they remain financially healthy.
At present, the latest word on the street is that the Democrats support leaving the estate tax at the current level of $3.5 million. The exemption amount has never been this high before and only time will tell how much of an impact that will have on charities and donations. In my business, avoiding paying estate taxes is one of the primary functions that a wealth manager helps clients peform. While emotion has been the primary driver of charitable contributions, not taxes, I fear there’s a perfect storm that is lining up. For many in the wealth managent community, charity is only a means of avoiding taxes for their clients. Unless an adviser can use charity as a way to save taxes for their clients, they generally don’t bring it up. Doing so means less under management for the adviser and that translates directly to less fees. I assure you, right now, many advisers are just struggling to keep their doors open and discussing charity with their client is the last thing on their mind. The big question is, how many potential donors were lost by dropping investment portfolio values, raising the estate credit amounts from $2 million to $3.5 million, and cutting the charitable income tax deduction?
Just to be clear, I would be in favor of freezing the estate exemption limits. I feel people pay enough in taxes and they shouldn’t have to pay again when they die. Make no mistake though, this will be another blow for charities. Don’t drop the charitable tax deduction, raise it, by a lot. I’d also be in favor of paying higher income taxes to pay for things like universal health care, education, and alternative energy. I realize you can’t have your cake and eat it too, I just worry that the cake recipe is looking like pie and we’re all going to get some in the face if we don’t think these things through more clearly.