How Do Estate Donations and Tax Deductions Work?
Understand how a planned charitable gift functions within an estate, from its legal establishment to its ultimate effect on the estate's tax obligations.
An estate donation, also known as a charitable bequest, is a gift made to a charitable organization after an individual’s death. This type of donation is directed by the person’s estate plan and fulfilled by an estate representative, such as an executor or trustee. The process involves transferring assets, which can range from cash and securities to real estate, from the deceased’s estate to a designated nonprofit. These gifts are planned during an individual’s life but are only activated upon their death, allowing a person’s legacy to include support for causes they valued.
Methods for Making an Estate Donation
A charitable bequest can be included in a last will and testament. This legal document can specify a gift as a certain dollar amount, a particular asset, or a percentage of the estate’s value. Another option is a residuary bequest, which donates all or a portion of the estate that remains after debts, expenses, and other gifts are settled.
A revocable living trust can also direct a posthumous charitable gift. The creator of the trust, or grantor, maintains control over the assets during their life. Upon the grantor’s death, a successor trustee distributes the assets according to the trust’s terms, which can include a donation to charity. This method allows the assets within the trust to avoid the probate court process.
Individuals can also name a charitable organization as a direct beneficiary of financial accounts like IRAs, 401(k)s, and life insurance policies. By completing a beneficiary designation form with the financial institution, the asset passes directly to the charity upon the owner’s death. This transfer bypasses probate and can offer tax advantages, as the charity does not pay income tax on the distribution.
Valuing Donated Assets
The value of donated assets is determined as of the individual’s date of death. An executor can elect to use an alternate valuation date, which is six months after death. For cash donations, the value is the amount given, while publicly traded securities are valued at their fair market value on the chosen date, calculated by averaging the highest and lowest selling prices on that day.
When the donation involves tangible personal property or real estate, a formal appraisal is required to establish its value. The estate’s executor must hire a qualified appraiser to prepare a report on the property’s fair market value. This appraisal provides the official valuation that the Internal Revenue Service (IRS) will recognize.
Valuing an interest in a closely held business is more complex because the assets are not publicly traded. A specialized business valuation expert must be hired to conduct a thorough analysis of the company. This process results in a valuation report that substantiates the worth of the donated business interest.
The Charitable Estate Tax Deduction
An estate can claim a deduction for donations made to a qualified charitable organization, which is an entity the IRS recognizes as eligible, such as a 501(c)(3). This deduction is governed by Internal Revenue Code Section 2055. The value of the gift is subtracted from the gross estate, reducing the total value subject to taxation.
The federal estate tax charitable deduction is unlimited, meaning the entire value of the donation can be deducted. This can significantly lower the estate’s tax liability. For example, if a taxable estate valued at $15 million donates $1 million to charity, the deduction reduces the taxable estate to $14 million, resulting in substantial tax savings, especially for larger estates that exceed the federal estate tax exemption amount.
Post-Mortem Procedures and Substantiation
The executor of the estate or trustee of a trust is legally responsible for fulfilling the charitable bequest. This involves the formal transfer of the designated assets to the charity. The specific action depends on the asset and could mean writing a check from the estate’s account, re-titling real property, or transferring securities.
The executor must obtain proper documentation from the recipient charity. The IRS requires a “contemporaneous written acknowledgment” to substantiate the donation. This document must be received before the estate tax return is filed and include the charity’s name, donation date, a description of the property, and a statement on whether any goods or services were provided in exchange.
The gift is formally reported on Schedule O, “Charitable, Public, and Similar Gifts and Bequests,” of Form 706, the U.S. Estate Tax Return. The written acknowledgment from the charity must be attached to the return as proof of the donation. This is where the details of the donation are listed and the deduction is claimed.