A wealthy American with an estate valued in the millions could not pick a better year to shuffle off this mortal coil. A one-year repeal of the estate tax — a tax applied when an estate passes to an heir — means that estates can be directly transferred from the deceased to the recipient without losing any assets.
The repeal loophole, dating back to a clause in the tax cut laws signed by President George W. Bush in 2001, likely saved former Yankees owner George Steinbrenner's heirs over $500 million of his $1.1 billion estate after he passed away this year, according to the New York Times.
But while the wealthy stand to benefit, a University such as Brown could actually stand to lose donations in the absence of the tax, according to a 2004 Congressional Budget Office study.
Short-term shortfall?
The estate tax may incentivize estate owners to increase tax-exempt charitable donations since the donations reduce the amount of the estate that can be taxed, according to the CBO study. In the absence of a tax for only one year, would the motivation to donate drop?
Executive Director of Planned Giving David Coon doesn't think so. He said the effects of a short-term repeal would be virtually non-existent, partly because people plan their estate division and charitable bequests far in advance. Pundits always expected the Democratic Congress to reinstate the tax, said Professor of Economics David Weil, so this repeal — the first since the estate tax was enacted in 1916 — was not foreseen.
Weil also said "people take care of their families first," so planned charitable donations would be decided only after estate owners already made sure they left enough to their families.
"I don't see them cutting their bequest to Brown because now ‘I can leave even more to little Johnny,' " he added.
Moreover, both Weil and Coon said it is not conclusive that estate owners actually donate more with the estate tax in place.
"There are two ways in which the estate tax affects charitable donations," Weil said. "The tax may induce me to give more to a charitable cause because it is tax-exempt, or I may give less to charity because there is less money left over. A priori, it's not clear which way that affects you."
Seeing into the future
Uncertainties about the future applicability of the tax have made big gift donors to the University cautious about establishing their long-term plans, Coon said. "They want to see how the estate tax is going forward."
The tax is scheduled to return to pre-Bush era rates next year. In 2011, 55 percent of an individual estate worth more than $1 million will be taxed, up from 45 percent on estates over $3.5 million in 2009, according to the Times.
Other changes in tax policy can trigger concerns for big-gift donors. For example, proposed increases to the income tax affect donation plans, Coon said, although the real effect of these changes — either increasing or decreasing donation trends — is also unclear.
The University is more affected by broader economic conditions than by specific changes in tax laws, Weil said. "From Brown's point of view, the far more salient fact is the financial chaos," he said. "Donors legitimately feel less secure about their financial futures."
An impossible repeal
It's also unclear what would happen to charitable donations if the estate tax repeal were permanent, giving donors time to factor the repeal into their planned estate division. The 2004 CBO study predicted a 6 to 12 percent drop in charitable donations if Congress permanently repealed the estate tax "because repealing the estate tax reduces the incentive to contribute."
But both Weil and Coon said they do not believe the situation is that cut-and-dry.
"There's a lot of fear that people would donate less because there is no tax benefit," Coon said, but he believes charitable donations could trend either way. While the financial incentive of charity would be lifted, there would also be more funds left over, meaning there would be more in total to give.
Coon added that "people are tremendously giving" so a donor's motivation does not only derive from a potential tax break, but from a desire to give back to the University. It is the distinction between these motivations that could drive charitable donations either up or down if an estate tax were repealed permanently.
Not that such a repeal is even in the realm of possibility at this point. "No one believes that the estate tax repeal is permanent," Weil said. Most experts even thought there would be a retroactive tax established for this year, but now "no one has a clue if you even can."
It remains unclear if a retroactive tax for 2010 would be legal, and estate inheritors would likely challenge the constitutionality of such a tax in court, according to the Times. Should such a need to retain legal counsel arise, these heirs would just so happen to have a little extra money on their hands
