Charity at bargain prices.

Everybody likes a bargain. IRS Letter Ruling 200002011 now expands the opportunity for bequests to charity at a "discount."

Sec. 691(a)(1) requires that items of gross income not properly includible in a decedent's income tax return during his life be reported as taxable income by the recipient. This type of income is known as income in respect of a decedent (IRD). IRD--qualified plans, various forms of deferred compensation and stock options--is making up an increasingly large part of clients' estates.

IRD can be very expensive to collect. If a marital deduction is not available, the estate tax must be paid on the full value. That amount is then subject to income tax when collected; a deduction for Federal estate tax is allowed, but the resulting tax is still substantial.

Example: The following calculation shows that almost 80% of income can be lost to taxes:

Estate tax:
IRD                       $1,000,000
  Federal and state
  estate tax (55%)        $  550,000

Net after taxes           $  450,000

Income tax:

Gross amount              $1,000,000

Deduction for
  federal estate taxes
  (net of state credit)   $  390,000

Taxable income            $  610,000

Tax (40%)                 $  244,000

Total taxes:

Estate tax                $  550,000

Income tax                $  244,000

Total taxes               $  794,000

Many clients provide for charitable bequests under their wills. The opportunity has long existed to designate a charity as the beneficiary of a qualified plan. Rather than giving the charity cash or marketable securities (which receive a new basis at date of death), clients gave the charity the right to receive all or a part of the proceeds of a qualified plan. The taxable beneficiaries would receive the "untainted" assets; the charity would receive the items that would otherwise be subject to income tax. It did not really matter to the charity, because it is not subject to income tax.

Letter Ruling 200002011 expands the opportunity further. It allows for deferred compensation and nonqualified stock options to pass to charity as well.

The opportunity presented is substantial. Certainly, any client who has a charitable bequest in his will, and items that will constitute IRD at death, should structure the estate plan so as to use the income items that would be IRD to fulfill his charitable bequest. The opportunity can be expanded further. Once clients realize that these income items will be subject to tax rates approximating 80% if left to relatives, they may very well decide to leave more items to charity.

FROM DAVID S. RHINE, CPA, MBA, NEW YORK, NY