By Shannon McNulty
Special to the Legal
The United States is the most charitable country in the world, according to a study by the Charity Aid Foundation. Our high levels of charitable giving are driven not just by the value we place on charitable activities but also by federal policies that reinforce those values in the form of valuable tax incentives. Against the numerous public policies that support charitable giving, the Pennsylvania realty transfer tax (RTT) stands as an unfortunate outlier as a policy that penalizes individuals when they make gifts of real estate to charitable organizations.
The Pennsylvania RTT is triggered when real property is transferred from one owner to another. The tax ranges from 2 percent to 4 percent of the fair market value of the property transferred. The rate is based on a state rate of 1 percent, and most municipalities impose an additional 1 percent. Philadelphia and Pittsburgh impose an additional 3 percent, yielding a total transfer tax rate of 4 percent in those counties. The RTT is one of the highest real estate transfer taxes in the country, rivaled only by the combined rate imposed by New York state and New York City.
There are a number of exceptions to the Pennsylvania RTT, including transfers to certain family members or transfers to trusts for the benefit of those family members. However, unlike most other states that impose this type of tax, Pennsylvania provides no exception for transfers to charitable organizations. Moreover, even including a charity as a beneficiary of an otherwise exempt trust renders the transfer to the trust fully taxable.
The Pennsylvania law stands in stark contrast to federal tax laws that provide special incentives for taxpayers to make charitable gifts of real estate and other capital assets. Taxpayers who donate a capital asset held for more than one year may claim a federal income tax deduction in the amount of the fair market value of asset. The taxpayer not only benefits from the tax deduction but also avoids paying tax on his or her capital gain on the property. For this reason, gifts of capital assets are a popular strategy for charitable giving.
Fortunately, the federal tax benefits from gifting real estate often more than offset the donor’s RTT liability, such that the ultimate effect of the RTT is to reduce the donor’s federal income tax benefit. In certain cases, however, the RTT surpasses any benefit provided by the federal deduction, resulting in a net tax liability to the donor for making the charitable gift. Furthermore, the RTT is due within 30 days of the date on which the property is transferred. Any income tax benefit is only received the following year, after the taxpayer files his or her tax return.
The impact of the RTT has grown in recent years as a result of dramatic increases in the value of land located in Marcellus Shale drilling areas. In addition to providing much-needed revenue to the state, the wealth generated by natural gas development has the potential to provide significant benefits to local charities. The role of such charities in preserving community bonds and helping the less fortunate is perhaps more important than ever during a gas boom that has presented environmental challenges and resulted in dramatic economic changes, leaving some residents with vast amounts of wealth and others with rising housing costs and environmental pollution.
Because the RTT applies to the transfer of gas rights as well as surface rights, it has the potential to stymie charitable giving among landowners in drilling communities. I recently advised a client in connection with establishing a trust for the benefit of his two children and their descendants, funding it with gas rights worth approximately $1 million. The client wished to name his church as a contingent beneficiary so that any remaining trust property would be transferred to the church if at some point no living descendants remained. While such a trust is exempt from the RTT if all the beneficiaries of the trust are the settlor’s lineal descendants, the exemption is nullified if any of the beneficiaries is a charitable organization. Unfortunately, I had to advise the client that naming his church as a beneficiary would trigger a tax of $20,000 when he transferred the gas rights into the trust – a steep price to pay for his generosity.
As residents and lawyers of Pennsylvania, we should be embarrassed that our state penalizes individuals for acts of kindness and work toward amending the RTT to exempt transfers to charitable organizations. Creating an exception to the RTT for charitable gifts would provide significant benefits for the state’s charities and provide important state recognition of the importance of our state’s charitable organizations and the generosity of its residents.
Shannon McNulty is an estate-planning and tax attorney in Philadelphia. She is a frequent author on personal and corporate tax issues.