It says in the curriculum that charitable gifts are not subject to estate tax in some jurisdictions. However, the second term in the formula contains (1-Te). Why is the estate tax reducing the charitable gift if it is not subject to it?
FVcharitable gift= (1 + rg)n + Toi[1 + re(1-tie)]n(1-Te)
Shouldn’t it just be: FVcharitable gift= (1 + rg)n + Toi[1 + re(1-tie)]n ?
We must see the components of this formula:
(FV after tax to the receiver if gifted now) / (FV after tax to the receiver if bequeathed at death)
as opportunity costs of one to each other.
This means that, in order to decide correctly, both options (gifting now vs at death) must be comparable. Therefore, we calculate the FV of each option and compare.
In the case of charitable gifts where the receiver is exempt of taxes (to income and estate), then the receiver will be able to get:
(1 + rg)n
So the formula would be:
(1 + rg)n / [1 + re(1-te)]n(1-Te)
However, we are forgetting to consider the tax advantage to the donor of making such a gift now (a gift to a charity). The donor will deduct the gift now and save taxes at the tax rate of Toi. Those savings (for the donor) compounded to the final year will be:
Toi[1 + re (1-tie)]n(1-Te)
Therefore, the correct comparison of both opportunities would be:
(1 + rg)n + Toi[1 + re (1-tie)]n(1-Te)
__________________________________ = X
[1 + re(1-te)]n(1-Te)
Hope this helps
Thanks, I get it now. I didn’t realize that the savings would also be transferred at death, hence the (1-Te) on the savings.
More than be transferred at death, I would see this tax savings as a benefit of the strategy “gift now”. However, your point of view is valid too.