When Congress allowed the estate tax to expire at the end of 2009, it may not have realized that it was setting up a social experiment that could test the values of high-net-worth individuals.
Most estate planners in the second half of the decade never imagined the government would allow the estate tax to be repealed. Instead, the expectation was merely for some reform. That means planners never asked their clients to make a crucial decision — whether to give one dollar to their children, or the same dollar to charity — said Carol Kroch, vice president, managing director and head of wealth and financial planning at Wilmington Trust Corp.
Under the tax, which amounted to 45% on individual estates exceeding $3.5 million, or $7 million per couple, a client who did not give to charity was able to give their children only 55 cents for every dollar, Kroch said. "Now we're saying, as long as the repeal lasts, I'm really putting my values on the table. I can give my children the whole dollar versus giving the whole dollar to charity."
Whether the repeal will stay in place long enough to actually affect charitable giving is another question. Most tax experts believe that at some point in 2010 Congress will retroactively reinstate the 2009 tax rate of 45%, with a $3.5 million exemption for individuals, back to Jan. 1.
Ben Harris, senior research associate at the Brookings Institution and the Urban-Brookings Tax Policy Center, said a 2003 Congressional Budget Office report on the estate tax and charitable giving revealed in even starker terms the impact of an estate tax repeal. The CBO report showed that the repeal of the estate tax significantly affects both charitable contributions made during life and charitable bequests made after death, Harris said. "People will give less in life if they expect there to be repeal, and they will also give less after they die," he said. "With repeal, the price of charitable giving is more expensive."
Research has shown that individuals respond to tax incentives, not only for estate taxes but for taxes in general. When people are given tax deductions on mortgages, for example, they respond to the incentive by taking out larger mortgages, Harris said. "To say that repeal has no effect on charitable giving turns your back on the broader incentives of tax policy. This is a monumental change in the estate tax rate. We're not talking about going from a 45% estate tax, to a 35% tax. We are talking about from 45%, down to zero. Does this mean people won't give to charity anymore? No. Of course they'll give to charity; just less."
Martin Shenkman, an estate tax lawyer, said charitable giving has dropped markedly as the estate tax exemption moved from $1 million, to $3.5 million in 2009. Charities have been hit with a "double whammy," Shenkman said. The decline in philanthropy as a result of the higher exemption has been coupled with the recession, which has hit charities hard.
"I'd like to think we're all altruistic," said Sanford J. Schlesinger of Schlesinger Gannon & Lazetera LLP, a law firm specializing in trusts and estates law. "But especially in a dreadful economy, repeal will have a devastating effect on charity."
Doug Freeman of the law firm Freeman, Freeman & Smiley disagrees. He said the relationship between the estate tax and philanthropy is highly misunderstood and that the elimination of the estate tax will not affect most people's approach. "I think the biggest risk to philanthropy, frankly, is that advisers think the giving is connected to the tax," Freeman said. "Where you'll see the impact is when advisers say to their clients that they don't have to give to charity anymore and should give to their children instead. Tax advisers who believe that estate planning is based on tax motivation are not likely to recognize that philanthropy, though affected and shaped by tax, is not driven by tax."