Is It Time to Revisit Formula Clause Charitable Gifts?

As professional advisors and their clients continue to digest the Tax Cuts and Jobs Act signed into law in late 2017, one unanticipated effect may be on planned and estate gifts to charities. In particular, it may be time to revisit formula clauses used in donors’ estate planning documents.

In very simplistic terms, formula clauses in estate plans operate to give an amount to family or friends up to whatever the applicable lifetime exemption from federal gift and estate taxes is at the time of the decedent’s death, with any excess going to charity.

Under the Tax Cuts and Jobs Act, the lifetime exemption from federal gift and estate taxes increases to $10 million per person—so those with formula clauses in their estate plans may now have a drastically different outcome.

The use of formula clauses is not prolific, but there are a number of affluent individuals and couples who use formula clauses to pass wealth to individual beneficiaries and charity. Formula clauses may be especially desirable when an estate includes a significant amount of hard-to-value assets, such as business or partnership interests, and the decedent’s estate wishes to avoid paying estate taxes.

Why should formula clauses get a second look now? Under the Tax Cuts and Jobs Act, the lifetime exemption from federal gift and estate taxes increases to $10 million per person, adjusted for inflation (estimated to be $11.18 million in 2018). Philanthropic individuals with formula clauses in their estate plans may now have a drastically different outcome under the new tax law. Consider this example:

Barbara, a Florida resident, dies in 2018 with an estate valued at $9 million.

Her estate plan includes a formula gift that transfers an amount equal to her unused lifetime exemption from federal gift and estate taxes to her three nephews, with the balance going to The Chicago Community Trust to fund programs focused on homelessness prevention.

When she executed her estate plan in 2016, the lifetime exemption from federal estate tax was $5.45 million, of which Barbara had $4.5 million of unused exemption. Barbara always assumed her estate would provide a significant bequest to the Trust to fund the programs she cared about; Barbara’s philanthropic legacy was always very important to her.

Under the new tax law passed in 2017, all of Barbara’s estate will go to her nephews, and nothing will go to fund homelessness prevention through The Chicago Community Trust.

Further adding to the planning challenge is the anticipated expiration of the increase exemption amounts beginning in 2026, when the lifetime exemption amounts are expected to revert to pre-2018 levels.

If your estate plan includes a planned charitable gift using a formula clause, or if you are an estate planning attorney with clients who have formula clauses in their estate plans, now may be a prime time to revisit those plans to ensure that they continue to align with long-term charitable planning goals.