Estate Tax and Charity Deductions

Estate Tax

The estate tax applies to wealthy taxpayers at rates that increase as the value of the estate increases. It is assessed against the value of the estate at the time of the taxpayer's death. It is subject to a generous exclusion that varies from year to year but is typically in the seven-figure range. For taxpayers dying in 2010, President Bush's temporary tax cuts completely eliminated the estate tax. Nevertheless, the estate tax may be reimposed in the future.

To deduct charitable donations from the value of your estate, the recipient must be an organization that qualifies under Section 501(c) of the Internal Revenue Code. In most cases, such an organization must have applied for 501(c) status and received approval. Eligible organizations are generally established for religious, charitable, educational, scientific or literary purposes. Churches, hospitals, universities, public charities and organizations dedicated to the prevention of cruelty to animals often qualify.

Donations can be used to your advantage in two ways. First, you can use donations to reduce the value of your estate below the estate tax threshold. If your estate is worth $1,100,000, for example, and the estate tax threshold is $1,000,000, a donation of $100,000 will reduce the taxable value of the estate to zero. Second, if your estate is so large that you will remain liable for the estate tax even after donations are excluded, deducting charitable donations decreases the cost of your donation -- for example, if your estate tax rate is 45 percent, every dollar you donate will reduce your estate tax liability by 45 cents, thereby reducing the amount available to bequest to other beneficiaries by only 55 cents, rather than by a dollar.

Your estate will be taxed on the income it earns after your death even if your estate is small enough to fall within the estate tax exclusion. For example, if you hold investments worth $100,000 that earn 10 percent in the year after your death (during which time your estate may be in probate), your estate executor must file an estate tax return and report income of $10,000. If you leave instructions in your will to donate income from your estate to 501(c) organizations, the amount of these donations can be deducted from your estate's taxable income.