A Taxing Dilemma

Charity leaders are split on how estate-tax repeal would affect gifts — and whether to take a stand

As a senior fund raiser at Harvard University, Charles W. Collier makes it his business

to know why donors leave bequests. Some do it mainly because they are in love with the university’s mission. Others want to leave a legacy for future generations.

But for many affluent benefactors, Mr. Collier says, a key reason is that they want to shield assets from estate taxes, which can consume as much as 55 percent of their wealth after they die.

“The estate tax is an enormously positive charitable motivator,” Mr. Collier declares. “I can’t tell you the number of donors to Harvard and elsewhere I know who say that, if the estate tax gets repealed, I’m leaving much more to my kids and much less to charity.”

To the disappointment of Mr. Collier and many other fund raisers, however, Congress has voted to kill the estate tax and its deduction for charitable bequests. This summer, the House of Representatives and Senate both passed legislation aimed at phasing out the tax over the next decade. Despite President Clinton’s pledge to veto that measure, many observers think it is only a matter of time before the tax disappears.

If that happens, experts say, universities, hospitals, museums, and other non-profit groups could lose billions of dollars in bequests, and the number of new private foundations formed with bequests could decline.

Many non-profit officials say that if the tax is eliminated, they will press Congress to approve other giving incentives in its place. Among the ideas: letting people who don’t itemize their returns deduct charitable gifts from their income taxes, and allowing older people to shift assets from individual retirement accounts to charity tax-free.

But non-profit officials are divided over whether saving the estate tax should be a priority. Some argue that too little is known about the tax’s effect on giving to take a stand. Others say that donors will continue to make bequests, or some other form of charitable gift, even without the incentive of the estate-tax deduction. Many non-profit advocacy groups, including Independent Sector, a national coalition of charities and grant makers, and the Council on Foundations, have taken no official position on the estate tax.

Critics, however, charge that organized philanthropy, including large charities, are afraid to alienate wealthy donors by supporting a tax that falls only on the rich.

“There are times when principled positions need to be taken,” says Mark Rosenman, vice president for social responsibility at the Union Institute, an educational institution. “The function of the non-profit sector is to be sure that basic needs are met. An action which needlessly accelerates the rich getting richer while the poor are getting poorer needs to be opposed.”

Indeed, only the wealthiest 2 percent of Americans are touched by the estate tax, which currently is levied on estates valued at $675,000 or more — a threshold that is set to increase gradually to $1-million by 2006.

And the wealthiest estates make the biggest charitable bequests. According to estate-tax returns filed in 1998, only 595 estates — each of which was valued at $10-million or more — produced nearly 50 percent of bequests that qualified for estate-tax deductions. Bequests from those mega-estates averaged more than $8-million apiece.

No one knows how many wealthy people would continue to make bequests without the threat of a huge estate-tax bill. But one thing is clear: Leaving a bequest gives donors a chance to be philanthropic at a bargain price.

At the top tax rate of 55 percent, for instance, a $1-million bequest to charity would cost the donor’s estate just that — $1-million. But to leave $1-million to an heir, an estate subject to the 55-percent rate would actually need to pay out $2.22-million. The tax would cost the estate $1.22-million — 55 percent of $2.22-million — and the remaining $1-million would go to the heir.

Losses Could Exceed $5-Billion a Year

In vowing to preserve the estate tax, President Clinton said that repeal could cost charities $5-billion to $6-billion a year.

That estimate is in line with other analyses of how repeal of the estate tax could affect the total amount of charitable giving by wealthy people.

A study of estate-tax returns for people who died in 1992, by David Joulfaian, a U.S. Treasury Department analyst, suggested that abolishing the estate tax would reduce bequests by about 12 percent among people who are affluent enough to be subject to the estate tax. At that rate, I.R.S. data show that charities would have lost about $1.7-billion in bequests in 1997 and $1.3-billion in 1998.

But that figure does not reflect the full impact of an estate-tax repeal, because wealthy people often make charitable contributions while they are alive to reduce the size of their assets on which estate taxes will be levied. Research by Mr. Joulfaian and his colleague Gerald Auten suggests that if the estate tax were repealed, the amount such wealthy donors would give in their lifetimes would drop by a total of 12 percent. That loss could easily add up to several billion dollars a year.

Not a Catastrophe

Despite such potential effects, many philanthropy leaders say that it would be an exaggeration to call abolition of the estate tax a catastrophe for charities.

They contend that instead of leaving bequests, a significant number of wealthy donors would shift their tax-planning strategies and use other charitable techniques to shelter assets.

Craig Wruck, chairman of the government-relations committee of the National Committee on Planned Giving, points out, for example, that the repeal measure passed by Congress included a provision that could make charitable remainder trusts more popular.

The provision, he says, would effectively raise capital-gains taxes on assets that are sold by heirs at a premium over their original cost. Many people may try to eliminate their heirs’ capital-gains liability by shifting such assets to charitable remainder trusts, Mr. Wruck says. Such trusts could give the donors an immediate income-tax deduction and pay the heirs a stream of income for life.

Heirs, too, could have a motivation to form charitable remainder trusts, Mr. Wruck says. They could avoid capital-gains taxes on appreciated assets by donating the assets to such trusts. What’s more, they would get an income-tax deduction for the donation, he notes.

Besides adjusting rather than canceling their giving plans, a significant number of donors could decide to leave large bequests even without the threat of estate taxes, many fund raisers say.

Frank H. McGrory, a senior fund raiser at the Massachusetts Institute of Technology, in Cambridge, which in fiscal 2000 received $29-million in bequests, says the donors he has encountered leave bequests because they want to support an institution’s mission or “because they want to establish some memorial for an individual.”

He tells of a U.S. Army officer who graduated from Boston University but who nonetheless left nearly his entire $4-million estate to M.I.T. recently to memorialize a sibling, an M.I.T. graduate who was killed in World War II. “There was no tax motive there,” Mr. McGrory says of the gift. “It was clearly to honor his brother.”

Effects on Foundations

Many philanthropy experts are not as sanguine as Mr. McGrory, however. They say that repealing the estate tax would significantly affect a variety of non-profit organizations.

Private foundations could be especially vulnerable. Tax returns filed for people who died in 1995 show that such funds received almost a third of all bequests generated by estate-tax deductions.

John A. Edie, senior vice president of the Council on Foundations, says, however, that “it’s very hard to be certain” that an elimination of the estate tax would lead to a significant decline in the number of new foundations.

“My gut feel is that initially, in the short run, it may have some impact, but whether it would in the long term, I don’t know,” Mr. Edie says. “A lot of people are forming foundations long before they die, and they’re doing it for reasons that aren’t primarily stimulated by tax reduction.”

Land Donations

Another potential casualty of estate-tax repeal, some observers say, could be donations of conservation easements to land trusts. Under certain conditions, such donations can qualify not only for the standard break on estate taxes but for an additional deduction.

However, Jean Hocker, president of the Land Trust Alliance, an umbrella group for 1,200 land-conservation groups, says that, for a variety of reasons, elimination of the estate tax “could be a plus and a minus” for land preservation.

For example, Ms. Hocker says, while some wealthy people might conserve land to take advantage of the estate tax’s charitable-deduction provision, in other cases family members may be forced to sell land for development so that they can pay a huge estate-tax bill.

The Land Trust Alliance has not taken an official position on repeal of the estate tax. Ms. Hocker cites the complexity of the issue, as do many other non-profit officials.

Too little is known, some groups say, about how the estate tax influences giving decisions and about whether abolishing the tax would actually make more money available for giving.

But Mr. Edie of the Council on Foundations acknowledges that the estate tax is a hot potato for philanthropy. Publicly supporting the estate tax or some other tax-rate issue could alienate donors and put the non-profit world “in a bad public light,” he concedes.

The council has not taken a position on tax rates “for the last 20 years at least,” Mr. Edie says. Doing so “immediately puts you in the position of saying, ‘American people should be taxed more so that the price of giving will go down and therefore we as charities will get more money,’” says Mr. Edie.

“If next year they want to reduce the tax rates 10 percent across the board, should we oppose it?” he asks. “Why are we only picking and choosing? If you want to be consistent, you would have to oppose every tax cut and support every tax increase.”

In 1996, the council and Independent Sector commissioned a study of various tax proposals. The study found that eliminating the estate tax would have cut charitable bequests by roughly $3-billion that year.

Even though “bequests currently are a small fraction of total charitable giving,” a report on the study noted, “the estate tax has the potential to stimulate much larger charitable giving in the future,” because succeeding generations are expected to inherit trillions of dollars in coming decades.

But the report’s conclusions did not prompt the council or Independent Sector to follow up with a recommendation to Congress.

John Thomas, a spokesman for Independent Sector, says it is possible that the organization will take a position in the future on repeal of the estate tax. “We’re going to rethink this whole thing down the road,” he says. But Independent Sector has “no position at this time” on the issue, he adds.

Policy Stance

Critics say it is inappropriate for philanthropy leaders to refrain from taking a position on the estate tax, because of what is at stake. Killing the tax, they contend, would benefit the rich at the expense of people whom the non-profit world is supposed to be helping.

“At a time of growing disparity in the distribution of wealth, to cut taxes rather than increase investments in dealing with public problems is wrong-minded public policy and works against the interests that non-profits and philanthropy ostensibly serve,” says Mr. Rosenman of the Union Institute.

Jon Pratt, executive director of the Minnesota Council of Nonprofits, in St. Paul, also says he wishes that the big umbrella groups would step forward and actively support keeping the estate tax in place. But he acknowledges the sensitive spot that they find themselves in. They “feel torn” between responding to the interests of donors and responding to the long-term interests of the non-profit world, he says.

Mr. Pratt says that the reluctance of philanthropy leaders to articulate a firm position on the estate tax is a sign that the non-profit world is still working on developing a “mature set of theories” about tax policy. Eventually it will do so, Mr. Pratt predicts.

But for now, he says, “lacking a general theory about the role of taxation in society, the non-profit sector is unlikely to have a position on a particular tax” — especially one like the estate tax “where you can create enemies.”

Mr. Pratt says the estate tax should remain in place not only because it is an incentive for charitable giving but also because it is “one of the few correctives that aims to say, ‘No, we will not have unbridled inequality.’” As such, Mr. Pratt says, the estate tax “is exactly the kind of public policy that non-profits should be supporting.”

Trillion-Dollar Windfalls

But not everyone who studies philanthropic trends agrees.

Some people argue that abolishing the estate tax could generate more giving, not less, because additional wealth would flow to heirs, who in turn would have more money to give to charity.

In addition, some analysts contend that money that now goes to government would instead be pumped into the economy, where it would help to expand productivity, jobs, and income — and the capacity of people to donate more to charity.

Among those who subscribe to that theory is Paul G. Schervish, director of the Social Welfare Research Institute at Boston College.

Last year, Mr. Schervish and his colleague John J. Havens estimated that between $6-trillion and $25-trillion could flow to charities in the next 50 years as older people pass their wealth to heirs in the so-called intergenerational transfer of wealth. At the time, Mr. Schervish and Mr. Havens suggested that the more conservative figure of $6-trillion was most credible.

But now, Mr. Schervish says that ending the estate tax could make the upper limit of the projection — $25-trillion — a “more likely” scenario because more money would be available to help the economy grow.

Mr. Schervish also points to other data that he says make him inclined to support elimination of the estate tax.

For example, he says, in recent years the wealthiest Americans have been shifting a greater proportion of their estates to charities and away from heirs. From 1992 to 1997, among estates of $20-million or more in which there was no surviving spouse, the total value of the estates rose 65 percent, estate-tax revenue rose 67 percent, bequests to heirs increased 57 percent, and charitable bequests rose 110 percent, he says.

Based on surveys that he has conducted of wealthy donors, Mr. Schervish says, he believes that even if the estate tax were repealed, the very wealthy would continue to increase the proportion of assets that they leave to charity.

Mr. Collier of Harvard isn’t so sure.

“I’m working with a guy with a net worth of $150-million,” he says. “He hasn’t made substantial gifts to his two children, but he wants to get as much as possible to them. I’m trying to get him and his wife to do a lot of charitable giving and to think through an appropriate inheritance for their two sons.

“But he said to me on the phone, ‘If this estate-tax repeal goes through, all bets are off.’”