Charitable Contributions and Estate Planning

When some people die, they want the proceeds of their estate to impact as many lives as possible. Not surprisingly, very few individuals consider allowing their estate to be heavily taxed by the government as a means to that end. As Fairfax, VA estate planning attorneys, we occasionally have clients who are interested in leaving money to a favorite charity as well as to a few loved ones. This is certainly a worthy aim, and it can be a way to keep their assets from being absorbed in taxes.

One of the ways that an estate planning attorney might try to achieve certain goals for his or her clients, is to first use deferred tax retirement accounts to fund the postmortem charitable contribution. If you've been employed at any time in the last four decades, chances are excellent that some of your money has been placed in a Roth IRA, a 401k, or some other type of deferred tax retirement account. However, many people die before the money in these accounts is depleted. If the remainder of a fund is transferred to a non-charitable beneficiary, he or she will likely have to pay taxes upon its transfer. However, a tax-exempt charity can receive the funds without their being subject to taxation. So, if you are planning to leave a sum of money to a charity, it may be wise to start by designating that any of the assets in tax-deferred retirement accounts are used first.

Consider the following example:

An Alexandria doctor has an estate worth $5,000,000. It consists of a $3,000,000 residential home, a $1,000,000 IRA, investment real estate worth $500,000, and $500,000 in securities. The doctor wishes to leave $500,000 to the Fairfax chapter of the Salvation Army and the remainder to his daughter. For the sake of this example, the daughter is in a 33% federal income tax bracket and pays 7% state income tax.

If the IRA is liquidated before funding the charity, then $1,000,000 IRA is taxed, leaving $600,000. This means that after the $500,000 is paid to the charity, only $100,000 in cash remains for the daughter to use to pay the estate taxes. She will have to liquidate another asset to cover the estate taxes unless she has the cash on hand.

However, if the $500,000 to the Fairfax chapter of the Salvation Army is paid directly from the $1,000,000 IRA (before it is liquidated and taxed), then only $500,000 is subject to taxation, leaving the daughter $300,000 in cash to apply toward the estate taxes.

It's important to note that in both scenarios the taxes owed on the estate are the same—the balance of the estate is $4,500,000 regardless of how the charity is funded. The main difference is that the testator's arrangement to directly fund the charity from the IRA leaves the daughter with more liquidity.

This is just one of the ways that estate planning attorneys will use charitable contributions to achieve optimal results. The laws regarding charitable contributions change from year to year. If you are planning on leaving money to a charity in your will, contact your Virginia estate planning attorney to discuss the impact.