Repeal of the Estate Tax: Impact on Nonprofits

An overview of the estate tax and the impact repeal would have on the ability of nonprofits to serve their communities. Congress will likely consider legislation to repeal the gift and estate tax. Republicans are proposing complete repeal of the tax; Democrats are interested in modifying the tax so that its impact is clearly on the super-rich. While concentration of wealth and power is central to the debate, there is also a direct and significant impact on nonprofit organizations, resulting from legislative changes made to allow charitable deductions two years after the estate tax was enacted in 1916. Repeal of the tax will mean less money in the form of gifts and bequests; it will mean a large drop in revenue sources for private foundations; and it will mean a large loss in federal revenue, much of which goes to human services programs, including those dealing with low-income families. Shortly after enactment, the estate tax was challenged on constitutional grounds, arguing that it was an infringement of States' rights to regulate the transfer of property upon death. But the Supreme Court upheld its constitutionality and, as a result, it has been a part of the tax code for the last 84 years. There have been a number of amendments to the estate tax over the years. For a good summary see Johnson, B.W. and Eller, M.B., "Federal Taxation of Inheritance and Wealth Transfers," in R.K. Miller and S.J. McNamee (eds.), Inheritance and Wealth in America, NY: Plenum Press, 1998, pg. 61-90. HOW THE ESTATE TAX WORKS
  • Taxpayers are allowed to pass on $675,000 over their lifetime without their estate being taxed. They can actually pass on more money through use of a $10,000 per year gift tax to multiple individuals, which is not counted in the $675,000 exclusion threshold. The exclusion threshold is scheduled to rise to $1 million in 2006 (see table on next page). Actually, it is slightly more complex for those really interested:
    • Because the gift and estate tax were made unified in 1976, the first $675,000 that is given away before (i.e., the gift tax) or after death (i.e., the estate tax) is exempt from the tax (e.g., a family member can inherit that amount without facing estate taxes).
    • Unlike income tax which is calculated based on annual earnings, the estate tax is calculated on life-long transfers. Like income tax, there are credits and exclusions; but the gift and estate taxes are based on credits and exclusions over the taxpayer's life.
    • First, all gifts of up to $10,000 ($20,000 if married) each year are exempt from the tax. There is no limit on the number of people to whom the taxpayer can give this money. Only amounts above $10,000 could be subject to the gift and estate tax.
    • Second, there is a unified tax credit given to each estate. Between 1987 and 1997 there was a tax credit of $192,800, which can be achieved by giving away $600,000 over the entire lifetime. (The tax on a $600,000 estate is equal to $192,800. So giving away $600,000 equates with a tax credit of $192,800.) The $600,000 exclusion is separate from the $10,000 exempt gifts described above. The unified credit was increased in 1997 to allow the credit to increase as high as $345,800. This translates into $1 million that can be given away without being taxed. (The exclusion threshold listed below is double for couples.)
    Estate Tax Exemptions Year Credit Exclusion Threshold 2000 220,550 675,000 2001 220,550 675,000 2002 229,800 700,000 2003 229,800 700,000 2004 287,300 850,000 2005 326,300 950,000 2006 345,800 1,000,000
  • The amount taxed is the value remaining above the exclusion threshold after subtracting funeral and administrative expenses, claims against the estate, losses and other casualties, and several other deductions, including charitable contributions. (There is an unlimited deduction for property bequeathed to a surviving spouse.) There is no limit on the amount of money that can be given to charities. Thus, charitable contributions can lower the value of the estate and thereby lower the tax that is levied.
  • The marginal tax rates range from 18% for small estates – taxable amounts less than $10,000 – rising to 55% for estates valued over $3 million. (For decedents dying between 1987 and 1997, the reduction in taxes due to graduated tax rates and the unified credit were phased out for taxable estates between $10 million and $21 million, effectively creating 60% bracket.) Given the tax credit (or exclusion thresholds), it is very unlikely that the lower marginal tax rates would be applied.
  • Here is the marginal tax rate and the effective tax rates for certain estates above the exclusion thresholds: Taxable Estate Marginal Tax Rate Total Tax Amount Effective Tax Rate 675,000(*) 37% 220,550 32.7% 700,000(*) 37% 229,800 32.8% 850,000(*) 39% 287,3000 33.8% 950,000(*) 39% 345,800 34.3% 1,000,000(*) 39% 850,000 34.6% 1,500,000 43% 555,800 37.1% 2,000,000 45% 780,800 39.0% 3,000,000 53% 1,290,800 43.0% 4,000,000 55% 1,840,800 46.0% (*)The tax credit means these marginal and effective tax rates will not be applied as follows: in 2001 there is a $220,550 credit allowing no tax on estates valued at $675,000; in 2002 and 2003 there is a $229,800 credit; in 2004, a credit of $287,300; in 2005, a credit of $326,300; and in 2006, a credit of $345,800. The effective tax rate is much lower once credits for state inheritance taxes and other deductions are included. In 1995, the IRS calculated the effective tax rate at follows. The decline in the effective tax rate for estates worth more than $20 million is mainly because of the large amount given to charities which is deductible. 1995 Effective Estate Tax Rates Gross Estate Effective Rate $600K - $1 mil 3.0% $1-$2.5 mill 12.5% $2.5-$5 mill 24.3% $5.5-$10 mill 29.0% $10-$20 mill 31.2% > $20 mill 22.5%
WHO PAYS THE TAX?
  • Only the very rich pay the estate tax. In 1993, for example, only 60,000 estate tax returns were filed. But these estates were valued at over $103 billion. 1997, there were 90,000 returns with estates valued at $162.3 billion. The IRS estimates the number of filers will increase to 133,000 filers by 2006.
  • Not everyone who files pays a tax. For example, in 1997, only 42,900 (47.7%) of the 90,000 returns that were filed had to pay a tax. Among those paying the tax, the bulk is paid by the very, very rich. Of those paying the estate tax, 36,612 (85.3%) had estates valued at under $2.5 million. But these estates paid $5.1 billion or only 31% of total revenue collected through the estate tax.
  • Put another way, less than 2% of individual taxpayers pay the estate tax. And two-thirds of the tax that is collected is paid by the richest 0.2% of taxpayers. Thus, most of the tax is really paid by the super-rich.
  • The estate tax generates significant revenue for the federal government. In FY 1998, roughly 110,000 returns were filed and the government collected $24.6 billion. In 1999, the government collected $28.4 billion from the estate and gift tax.
  • Some have argued that the growth of the stock market and the increased value of property will subject many more people to the estate tax than should be. This is very unlikely given the credits, exemptions, and deductions that are allowed. Nonetheless, even if the exclusion threshold were raised from the planned $1 million to $2.5 million, it would reduce federal revenues from the estate tax by only one-third and would have even less impact on charitable contributions. This is because it is the largest estates that are paying the major part of the tax and providing the greatest amount of charitable contributions.
IMPACT ON CHARITABLE GIVING Andrew Carnegie argued in 1891 in his book The Gospel of Wealth that giving to charity was very important. Carnegie felt that the wealthy could produce "an ideal state in which the surplus wealth of the few will become, in the best sense, the property of many." (Carnegie, Andrew, The Gospel of Wealth and Other Timely Essays, Belknap Press of Harvard University Press: Cambridge, MA, 1962.) Without doubt, the gift and estate tax have helped to create this type of redistributive effect.
  • There are no limits on the percentage of an estate that can be left to charities – and bequests to private foundations are treated the same as those to public charities.
  • The second largest deduction for estates has been the deduction for charitable contributions. The largest deduction is the unlimited amount that can be given to a surviving spouse. Nonetheless, for taxable estates of $20 million or more – the largest estates – the amount given to charity nearly equaled the amount given to the surviving spouse ($7.47 billion vs. $7.53 billion).
  • The estate tax proves to be an incentive to give to charity. Estates that have tax liability give between two to three times as much to charity as estates without tax liability. The latest available data, 1997, shows that taxable estates gave to charities 2.1 times the amount non-taxable estates did.
  • In 1997, estates provided $14.3 billion to charities. Estates under $2.5 million gave $2.6 billion or 18%. Estates of $5 million or more gave $10.3 billion to charity or 72% of what all estates gave. The largest share of this came from estates valued at $20 million or more: $8.3 billion or 58%.
  • Estates with a net worth of more than $10 million gave more than one-third (36%) of their net worth to charity.
  • The Treasury Department estimates that between $5 billion and $6 billion in charitable gifts would be lost if the estate tax is repealed. (In a study for the Council on Foundation and Independent Sector, Price Waterhouse and Caplin & Drysdale concluded there would be an even greater impact on giving – $7.3 billion -- if extrapolated to from their 1996 estimates.)
  • Using the more conservative Treasury Department figures, total giving in the United States would have dropped in 1999 by more than 3%.
WHAT CHARITIES WOULD BE AFFECTED? It is difficult to be precise because of lack of data. Nonetheless, IRS provides data on charitable bequests from 1995 (see Publication 1136 (9-99) which is from the Statistics of Income Bulletin).
  • The largest number of charitable bequests went to religious institutions (58.8%), but the Charitable Bequest Recipients: 1995 largest amounts went to educational, medical, or scientific institutions and private foundations. (See figure below.) SOURCE: IRS, Statistics of Income Bulletin, Summer 1999, Publication 1136 (9-99).
  • Nearly the largest amount went to private foundations – $3.1 billion in 1995. Roughly one-third of foundation assets come from estate revenues, particularly from larger estates. Thus, it can be expected that repeal of the estate would have a significant impact on foundations. This would mainly affect the creation of new foundations or enlarging existing foundation, but would inevitably have an impact on yearly giving by foundations.
  • The "Other" category includes a range of social service organizations and other charities that are not covered by the remaining categories. In 1995, estates provided $2.5 billion to "other" charities. Repeal of the estate tax would likely have a significant impact on many human service charities that rely on gifts and bequests from wealthy donors.
  • Like private foundations and human services organizations, educational, medical or scientific institutions would be greatly affected by repeal of the estate tax. In 1995, these institutions received $3.2 billion.
  • It appears that "social welfare" groups – those promoting civil rights, community development, social science research, or government effectiveness – would be the least affected by repeal of the estate tax. However, these groups are often heavily dependent on private foundations for support. Given the repeal of the estate tax would dramatically impact private foundations, these types of charities would also be significantly affected by repeal of the tax.
OTHER IMPACTS ON CHARITY In FY 1999, the gift and estate tax provided $27.7 billion in revenue to the federal government. This is expected to exceed $30 billion in FY 2000. Discretionary spending in FY 2001 was $617 billion. Thus, repeal of the gift and estate tax could mean a 4.6% cut in discretionary spending. Traditionally, cuts in discretionary spending are seldom made in military spending. Given the Bush administration's commitment to increases for defense spending, these cuts will need to be made in domestic discretionary programs, which accounted for $322 billion in FY 2000. It is not uncommon for such cuts to be made in programs with constituents who have less political clout. Usually this means human services, primarily targeted to low-income families. It is possible that the loss of revenue from the estate tax could come from the budget surplus. If so, this would mean little opportunity to increase domestic discretionary spending. In the end, it will mean that the super-rich get a tax break while the less fortunate get nothing – and possibly could suffer. Since nearly one-third of charity revenue comes from government support, the repeal of the estate tax would have a triple-whammy on charities. It would mean less money in through charitable contributions, reduced grants from private foundations, and less money in government support.
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