“This is an extraordinary time to [make large gifts], but most people aren’t doing anything,” says Conrad S. Ciccotello, associate professor in the Department of Risk Management and Insurance in the J. Mack Robinson College of Business. Ciccotello is a sought-after expert on the subject of charitable giving and other expenditures that impact personal financial planning and tax exposure. He is also director of Graduate Wealth Management Programs at Robinson, where he instructs and learns from major industry players.
Two different areas in the tax code can affect gifts to charity: income tax structure and transfer (estate) tax structure. There is a “trade-off between the two regimes,” Ciccotello says. Both income and estate taxes could rise in 2013, but “no one knows what those rates will be.
“On the transfer tax side, there is an extraordinary cliff from the $5.12 million an individual can move through their estate, or gift, in a lifetime. This is called the exclusion amount. It will revert to 2001’s level of $1 million,” he says, adding “this is a dangerous scenario for anyone with a net worth in excess of $1 million.” Charitable gifts do not count against the exclusion amount. So a decline in the exclusion amount in 2013 may favor charitable gifts in the new year. For the rest of 2012, however, with the exclusion at $5.12 million, making non-charitable gifts is a good strategy.
One popular way of giving – a contribution of up to $100,000 directly from the IRA of an individual 70.5 years or older – expires in 2012, unless Congress extends the provision. “This can help a person older than 70.5 years meet the minimum required distribution but not have it included at all in their income,” says Ciccotello. This privilege does not apply to gift annuities or donor funds, he adds. “It has to be a direct gift from that person.”
It’s a good time for financial planners to get creative. “The wedges we are talking about now, in terms of the current rates and what the rates could be are extraordinarily large. Think about dividends.” They are currently taxed at 15 percent, but next year there is potential for taxation at ordinary income tax rates (as high as 39.6 percent). The changes in dividend tax rates could impact the charitable giving of those that rely heavily on dividend income, often senior citizens.
Among the ideas policymakers are mulling is placing a cap on charitable contributions. “I’ve read about various proposals where annual charitable contributions are capped at levels around $30,000. If you made donations of five times that, you would only be able to write off $30,000. . . . One of the end games of a ‘grand tax bargain’ is a flatter rate scheme with reduced deductions. That’s a lot to get done by December 2012. . . . It will be a monster lift. But it could happen in 2013. . . if someone has enough clarity on charity to want to make a big gift, it’s a nice time to do it now.”
“The charitable aspect of the transfer tax is a little different. Charitable gifts do not count against the exclusion amount, and the exclusion amount has never been this high or portable between spouses before.” he continues. “The exclusion amount for an individual is $5.12 million, but the law in 2010 made the exclusion portable. If you only used $1 million of your $5 million, the other $4 million went away.” Any unspent allowance can be transferred to the spouse. Whether portability will be a part of the transfer tax law in 2013 is uncertain.
The future of the exclusion amount is in the hands of elected officials. “There is a lot of talk about compromising to have an exclusion of $3.5 million. If the exclusion reverts to $1 million dollars for any length of time, that is going to be an incredible event in this country. Lots of people will need to see an estate tax expert.”
Ciccotello won’t make any predictions for the grand bargain. “One day it looks better for a deal; the next day it looks worse. Given the political environment, I think there is incentive on both the left and the right to have this go ‘over the cliff.’ Politically, the issue is whether there is enough pragmatism to get a deal done before we get into 2013. There is precedent for changing the tax rules after the fact; in 2010, the estate tax disappeared, and then it returned. So individuals may enter 2013 with one set of tax rules that change dramatically during the year. This is a difficult environment for basic household budgeting, as well as charitable giving.