Congress Can Save Giving if Estate Tax Dies

By EDWARD J. MCCAFFERYand DON R. WEIGANDT

The federal estate tax is scheduled to die in 2010 — for a year, at least — but giving by the wealthy need not die with it. It is up to Congress to take action to keep planned giving alive. We believe that Congress should change the income-tax system to support wealthy donors and the charities they want to include in their estate plans, even without a separate estate tax. Help should come in two broad directions.

Congress should simplify and improve the existing laws on charitable giving. These laws are simply so complex that, in many instances, it is difficult for even the most generous soul to leave money and other assets to charity. The complexities of charitable giving under the tax laws are a relic from former times, when high tax rates allowed some donors to come out ahead by giving to charity. It is time to simplify the system, at the root.

Congress should also consider changing the tax code in ways designed specifically to keep planned giving alive in the absence of an estate tax. After all, without such a tax, many wealthy people will shun the kind of long-term planned giving on which many large nonprofit organizations have come to depend. Changing the tax laws in appropriate ways can ensure that an incentive to sit down and make planned gifts remains even if the “death tax” dies.

Here are eight ideas that we hope will get Congress thinking:

• Make assets in individual retirement accounts, 401(k) plans, and other qualified retirement accounts, which hold an estimated $2.7-trillion, readily transferable tax-free to charity, at any time and in any amount. Why should people have to wait until they die to donate money held in a retirement plan?
• Allow tax-free contributions of stock options used to compensate highly paid executives. Under current law, when a charity exercises donated options, the donor gets stuck with a tax bill. What’s more, donors of options rarely get an offsetting charitable deduction to take some of the sting out of their tax liability. Oddly, neither problem applies to options that are left to charity on the donor’s death. Congress should change the law so that the exercise of donated options is the charity’s, not the donor’s, income, whether the contribution is made during life or at death.
• Change the law so that charitable contributions are not subject to the so-called phaseout rule, which reduces or eliminates personal exemptions and itemized deductions and so increases a person’s taxes as income rises. Charitable deductions should have equal standing with two other deductions that already are out of the phaseout rule’s pernicious clutches: those for investment interest, and those for loss of property due to fire, storm, or other catastrophe.
• Repeal the ceilings on the amount of charitable income-tax deductions a donor can take in a particular year, or at least make the ceilings more generous and uniform. Right now, the ceilings vary from 20 percent to 50 percent of adjusted gross income. Congress should repeal the different levels, or at least make them all 50 percent. Lawmakers also should consider extending the period in which donors can roll forward their deductions for later use. The current five-year limit on carrying forward write-offs is too stingy. It should be at least 20 years, the same period over which corporations may deduct net operating losses. Better yet, the time limit on charitable deductions should be dropped altogether.
• Simplify and relax the rules on private foundations so that creating a private philanthropic trust or other charitable organization is not so painfully complex. The private-foundation rules are perhaps the leading instance of the tax laws making it too hard to give. Why, for example, should private foundations be subject to the antiquated rules on so-called jeopardy investments, which seek to discourage foundations from undertaking certain investments? These rules say that investments in public companies that carry high risk but high long-term-profit potential are improper. In the age of modern portfolio theory, which encourages a mix of risky and safe investments that, to some degree, balance each other out, these jeopardy rules for foundations are practically laughable.
• Institute a uniform flat tax on charitable-annuity payments — say, 20 percent. A major source of confusion for donors and their advisers is the byzantine set of rules on income that charities give back to donors under remainder trusts, gift annuities, and other annuity arrangements. Some of the income is taxed at capital-gains rates, some at higher ordinary-income rates, and some not at all. Making this bad situation worse is the fact that with fairly basic planning, wealthy people can eliminate taxes on income generated by their assets not given to charity. Thus, perversely, turning wealth management over to a charity can both complicate tax planning and raise the amount donors pay in taxes over their lives.
• Change the rule on donations of assets, such as stock, that are worth less than what the donor paid for them. Under current law, it makes more sense for a donor to sell such assets for cash and get a tax break for the loss than to donate the assets to charity. Congress could eliminate the need for this mechanical step by allowing the donor to get a loss as well as a charitable-contribution deduction.
• Finally, and most sweepingly, allow a tax credit, rather than a deduction, for large gifts to charity. Congress could create a system in which donors of more than $100,000 would receive a 40-percent tax credit, while those giving more than $1-million would qualify for a 50-percent credit, and donors of more than $10-million would get a 60-percent credit. This sort of plan is similar to the inducements for giving that exist with the current estate tax in place, but in a more efficient, and simple, way.

These are the kinds of ideas that Congress should be considering, and now is the time to be doing so. We are not so naive as to think that such proposals will be enacted automatically along with any permanent repeal of the estate tax. We realize that some of the ideas are more feasible than others, and some are more costly to the Treasury than others. Still, we hope our ideas can help guide the early steps toward overhauling the tax code in ways that lead to more giving.

Congress could and should consider a wide range of moves to clean up and improve the tax landscape of philanthropy and to deal with any potential shortfall in planned giving as a result of repeal of the estate tax. At this point, the questions are more important than the answers. It is time to start asking them.

Edward J. McCaffery is the Maurice Jones Jr. Professor of Law and Political Science at the University of Southern California Law School. Don R. Weigandt is managing director of J.P. Morgan Private Bank, in Los Angeles.