IRC 2055: How to Claim a Charitable Estate Tax Deduction

When a person leaves property to a charitable cause in their will, the federal government allows their estate to take a deduction for the value of that gift. This provision, found in Internal Revenue Code (IRC) Section 2055, is known as the estate tax charitable deduction. Its purpose is to encourage philanthropic giving by reducing the overall value of an estate that is subject to federal estate tax. For estates large enough to owe this tax, a charitable bequest can significantly lower the final tax bill. The estate’s executor is responsible for ensuring that both the recipient organization and the nature of the gift meet the specific requirements set by the IRS to qualify for the deduction.

Qualifying Recipients and Transfers

For a charitable gift from an estate to be deductible, it must be made to a specific type of recipient. The most common qualifying recipients are organizations operated exclusively for religious, charitable, scientific, literary, or educational purposes. This category includes most public charities recognized by the IRS as tax-exempt under IRC Section 501(c)(3). The organization must be a qualified entity at the time of the decedent’s death.

Bequests made to or for the use of government entities also qualify. This includes transfers to the United States government, any state, or any local political subdivision, provided the gift is for public purposes. Additionally, certain veterans’ organizations and fraternal societies operating under a lodge system can be qualifying recipients if the gift is used for charitable purposes. Gifts to some foreign charities can also qualify under certain tax treaty provisions.

The structure of the gift, or the type of transfer, is also a factor. The most straightforward qualifying transfer is an outright bequest, where cash or property is given directly to the charity through the decedent’s will or trust, with no strings attached.

A more complex method involves split-interest transfers, where both a charity and a non-charitable beneficiary receive an interest in the same asset. These are typically structured through specific types of trusts:

• A Charitable Remainder Trust (CRT) makes payments to a non-charitable beneficiary for a set term or for life, after which the remaining assets pass to a designated charity. The two main forms are the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT).
• A Charitable Lead Trust (CLT) makes payments to a charity for a specified period. At the end of that term, the remaining assets are transferred to a non-charitable beneficiary.
• A Pooled Income Fund operates like a mutual fund managed by a charity. A donor’s beneficiary receives a share of the fund’s income for life, with the principal passing to the charity upon the beneficiary’s death.

Calculating the Deduction Amount

The method for calculating the value of the estate tax charitable deduction depends on how the gift is structured. For an outright, direct bequest, the deduction is equal to the fair market value of the property or the amount of cash transferred to the charity at the time of the decedent’s death. If an estate leaves $100,000 in cash or stock to a university, the estate can claim a $100,000 charitable deduction.

The calculation becomes more intricate for split-interest transfers like Charitable Remainder Trusts (CRTs) or Charitable Lead Trusts (CLTs). In these cases, the estate cannot deduct the full value of the asset because a non-charitable beneficiary also has an interest. The deduction is based on the present value of the interest that the charity will eventually receive. Present value is an actuarial calculation that determines what a future sum of money is worth in today’s dollars.

This calculation relies on the term of the trust, the payout rate specified in the trust document, and the section 7520 interest rate, which is published monthly by the IRS. Using IRS actuarial tables, these elements are combined to determine the portion of the trust’s value that can be attributed to the charity’s future interest. For a CRT, this is the present value of the remainder interest; for a CLT, it is the present value of the lead interest.

A final consideration that can affect the deduction amount is the burden of taxes and other expenses. If the decedent’s will or state law requires that federal estate taxes or state inheritance taxes be paid from the funds designated for the charitable gift, the deduction must be reduced. For example, if a $1 million bequest to a hospital is required to pay $50,000 in estate taxes, the charitable deduction is limited to $950,000. This ensures the deduction only applies to the net amount the charity actually receives.

Information Needed to Claim the Deduction

To claim the estate tax charitable deduction, the executor must gather specific documents and information. The foundational documents required are certified copies of the decedent’s will and any relevant trust instruments that authorize the charitable transfers. If a beneficiary formally disclaims an inheritance, causing that property to pass to a charity, a copy of the written disclaimer is also necessary.

The executor must also collect detailed information about each charitable recipient. This includes the organization’s full legal name, its complete address, and its Employer Identification Number (EIN). This information is used to properly identify the beneficiary on the tax return and allows the IRS to verify its status. It is the executor’s responsibility to confirm that each recipient is a qualified organization.

Verifying an organization’s status can be done using the IRS’s online Tax Exempt Organization Search tool, which confirms if a charity is a 501(c)(3) organization in good standing. This due diligence protects the estate from having a deduction disallowed due to an ineligible recipient.

All of this gathered information is compiled to complete Schedule O (Charitable, Public, and Similar Gifts and Bequests) of Form 706. On this schedule, the executor must list each charitable beneficiary, provide a description of the property each is receiving, and state the value of the gift. The schedule also asks whether any litigation affects the charitable bequests.

How to Claim the Deduction on the Estate Tax Return

The executor must attach the fully completed Schedule O to the primary Form 706. All supporting documentation gathered previously, such as certified copies of the will, relevant trust agreements, and any qualified disclaimers, must be included with the return package.

The entire estate tax return, including Form 706, Schedule O, and all attachments, must be filed with the IRS. The return can be filed electronically or mailed to the address found in the form’s official instructions.

After the return is submitted, the executor should be prepared for potential follow-up from the IRS. The agency may review the charitable deduction and issue a request for further information or clarification to validate the amount claimed or the recipient’s qualifications. Responding promptly to any such inquiries is required to finalize the acceptance of the deduction.