- Specify how the donation will be used.
- For long term gifts (e.g., a fund that will continue for decades, or an agreement to donate a set amount each year for many years) what investment management or other fees might the charity charge the fund? Will the charity allocate a portion of the initial gift or each year’s withdrawals to general charitable administrative expenses? Can that fee be negotiated so that more of the donation is applied to the objectives the client is hoping to achieve?
- Reach an agreement as to how a gift/bequest will be named, what prominence will be given, how it will be displayed, what happens if the facility moves. Should the client/donor’s name be on a plaque inside the building, prominently on the outside of the building? What is agreeable?
- What happens if the purpose of the gift is no longer relevant?
- Address other issues to assure client’s objectives are met.
Charitable Planning Tips
► Remainder Interest in Residence and Farms: Generally, a charitable deduction is not permitted for charitable gifts of less than a donor’s entire interest in property. IRC Sec. 170(a)(3). Donations of a remainder interest in a farm or residence is subject to special and favorable rules. A client can donate a remainder interest in a residence, live there for the rest his or her life, yet gain a current income tax deduction. Home sale prices have recently fully recovered since the recession. The current low interest rates, combined with high home prices, make this a particularly valuable technique now.
► Help Clients Plan Donations to Enhance Personal Objectives? There are many ways, depending on the client’s particular interest and goals, who is affected, and with what, to tailor a donation to meet client personal objectives. A key step in many cases is to structure a donor agreement between the donor and the charity in advance of the charitable gift. Consider the following:
► Example of Donation Coordinated with Personal Goals. For prostate cancer the overall 5-year relative survival for 2003-2009 from 18 SEER geographic areas was 99.2%. The median age at diagnosis for cancer of the prostate was 66 years of age. Purchasing a charitable gift annuity that will benefit the American Cancer Society and provide an annuity for life, for these older clients, may be a simple and ideal planning step to address cash flow needs in retirement, charitable intent and more for this group of clients.
For pancreatic cancer the overall 5-year relative survival for 2003-2009 from 18 SEER geographic areas was only 6.0%. For a client diagnosed with pancreatic cancer, creating a QTIP trust with a remainder to the American Cancer Society may provide the personal goal of ultimately benefiting the American Cancer Society, but assuring no matter what, maximum protection for a surviving spouse.
► Charitable Pledges: It is not uncommon for clients to make commitments to charity. While this can be noble, if it is not preceded by rationale financial planning and forecasts, a client might find themselves in an awkward financial position where they may not feel comfortable carrying out the pledge. Children, or other heirs, when they become aware of the pledge might also try to convince the parent/donor to cancel the pledge in order to enhance their future inheritance. The enforceability of a charitable pledge will depend on state law and the facts involved. Some states will permit a charity to enforce a pledge even if there was no consideration given and even if the charity did not take steps to rely on that pledge (e.g., begin construction of a building based on a large pledge). Some courts will enforce a charitable pledge simply because of the social desirability of assuring that donors meet pledges. More Game Birds in America, Inc. v. Boettger, 125 NJL 97, 101 (1942).
► Simple Bequest: A very common charitable gift is a bequest under the client’s will. Even though there may be no estate tax benefit, bequests will remain common as many clients for personal reason wish to make a last bequest to charity. These gifts can also be used to create a powerful message for heirs. Estate planning is not only about the transmission of wealth, but about the transmission of values. A simple bequest to a charity in a will can demonstrate commitment, values and more. A personal letter of instruction can help.
Example: Dear children, I wanted to explain to you that after my father’s miraculous struggle with pancreatic cancer, I have made a bequest in my will to the Charity Name to fund research that will hopefully [describe objective]. I also hope by this bequest to encourage you to each find ways to give back to charity to demonstrate gratitude.
Example: Add phrase to the testamentary bequest, “I have made this bequest to charity to demonstrate the importance to my heirs of making a contribution back to society,” or whatever drives home the client’s point.
► Charitable Gift Annuities Help Meet Personal Goals and Charitable Goals: A gift annuity is a contract between the donor and his or her favorite charity in which the client gives the charity a one-time payment and receives a contractual commitment for a periodic payment, an annuity, for life. The amount of the annuity is determined at inception, without modification (worries) about investment performance/volatility. If your client, or a loved one, is facing the challenges of aging generally, or a specific health challenge, committing some component of his/her investments and expenses to a charitable gift annuity can put some of their finances on auto-pilot, can provide certainty and simplicity.
Example: Client was diagnosed with breast cancer and her physician has recommended a treatment plan to include surgery followed by chemo-therapy. While the overall 5-year relative survival for 2003-2009 from 18 SEER geographic areas was 89.2%, the challenges for a number of years will be significant. The difficulty dealing with financial matters has increased. Sufficient gift annuities are purchased so that the monthly payment covers her recurring expenses. Funds are deposited automatically into her bank account and mortgage, utilities and tax bills are all on auto-pay. On your client’s death the American Cancer Society will receive the funds that remain for its charitable purposes.
► Refund of Pledge: If a charity makes a commitment to a client/donor to use the funds donated for a specific purpose but reneges on that application of the donated funds, the donor might be able to receive a refund of the donation. In one particular case the charity committed to build a modern animal welfare facility designed to serve a particular geographic region and to name seal rooms to be located in the new building for the donors. Instead, the charity unilaterally opted to build a smaller building without the separate rooms thereby negating the naming opportunity. The donors sued and received a refund of their donation. Adler v. SAVE, 432 N.J. Super. 101, 74 A.3d 41 App.Div. (2013).
►Qualified Appraisal: Practitioners should exercise care to assure that when a client submits an appraisal to support a contribution that the appraisal meets all the criteria for a qualified appraisal if required or the donation may be denied. No charitable contribution deduction is permitted for donations exceeding $5,000 (excluding cash or marketable securities) unless the donor obtains a “qualified appraisal” by the due date of the return. Treasury Regulations Sec. 1.170A-13(c)-13 list the details of these requirements. In one case the taxpayers donated residential property but the appraisal report submitted with the return neglected to include several required items necessary to a qualified appraisal: the expected date of the property being contributed to the city, the terms of the agreement between taxpayers and the city as to the use/demolition of the property, the appraiser’s qualifications, and the required statement that the appraisal was prepared for income tax reporting purposes. JAMES HENDRIX, ET AL., Plaintiffs, v. UNITED STATES OF AMERICA, Defendant Case No. 2:09-cv-132. The strict rules for what constitutes a qualified appraisal prohibit a party to the transaction from giving the appraisal. This can present a challenge when life insurance is donated because the insurance company who issued the policy, and likely would provide the Form 712 that is used to determine value, may not be able to be a qualified appraiser under these rules.
► Charitable Remainder Trust: A charitable remainder trust (“CRT”) can be more advantageous post ATRA. The new Medicare tax on passive income does that became effective 1/1/13 does not apply to charitable remainder trusts (“CRTs”) instead as payments are made to your client/donor are taxable subject to the CRT tier system. Using CRTs might shift net investment income (“NII”) to the trust and thereby defer the new 3.8% Medicare tax, generate an income tax deduction of some benefit, and defer the new higher capital gains tax. Better tax results might, however, be achieved. The CRT can defer income over many future years and thereby facilitate keeping the client’s marginal taxable income below the threshold for application of the NII tax. Therefore, making a gift to a CRT could effectively avoid any application of the NII tax to the client. While interest rates are quite low it is difficult for clients who are not sufficiently old to meet the requirements for a CRT. However, as interest rates rise CRTs will continue to grow in popularity to address client charitable goals, the desire for regular cash flow in retirement, and to minimize higher income and capital gain taxes.
► Evaluate Existing CRTs for New Donation Opportunities: Your client may have created a CRT in the past and may no longer need the cash flow from the annuity provided, or perhaps the client would like to benefit the named charitable beneficiary now. The client can terminate the CRT so that the charity will receive the current value of its remainder interest. If a CRT is terminated early, the client, as the non-charitable beneficiary, will report capital gain based on the value of the assets distributed to him or her as a taxable exchange under IRC Sec. 1001. PLR 200314021 and 200733014. When a CRT is terminated early the client would be treated as selling his or her interest in the CRT to the charity as remainder beneficiary. Practitioners should coordinate such a termination, if feasible, in a tax year when the client is in a lower tax brack
► CRT as a Retirement Plan: The most common CRT is structured as an annuity trust called a “CRAT.” If the initial gift to the CRT was $200,000 and the payout rate was 5% then the CRT would pay $10,000/year to the donor/annuitant for its term. A charitable remainder trust can also be structured as an uni-trust called a “CRUT.” If $200,000 were given to a CRT paying 5% it too would payout $10,000 in the first year. If the value of the assets increased to $220,000 by the second year the payout would be based on the payout rate of 5% of the then value of the assets or $11,000. Thus, a CRUT can provide an inflation hedge on its payments to the to the client/donor. This can be incredibly important in planning a CRT for cash flow for a long duration. Additional variations on the CRT theme can further help practitioners tailor charitable planning to not only achieve the income tax benefits a CRT can afford, but to better achehive client economic goals. If a CRUT is created it can be specified that the unitrust payments will only be made from income. NI-CRUT “net income-only arrangement” Using this type of CRUT the client/donor, as income beneficiary, will only receive the actual trust income if the income is less than the fixed percentage payment required. This NI-CRUT technique can be applied in a manner to facilitate a CRT being used to provide a result analogous to a “retirement plan.” IRC Sec. 664(d)(3)(A); Treas. Reg. § 1.664-3(a)(1)(i)(b)(1). One additional step might be advantageous in structuring a CRT to achieve retirement plan-like results. A NIM-CRUT is a spin on the NI-CRUT. The “M” is for “make-up.” Example: Assume your client has a non-income producing asset, such as raw land, that she wants to donate to charity. The CRT will not produce income until the charity sells the property. In a NIMCRUT, if the income in any year is less than the unitrust amount for that year, the shortfall is made up in future years in which trust income exceeds the unitrust amount. It is as if the payments due to the client/donor are accrued and will be paid in a future year. The maximum payout in later years is the sum of the CRUT amount due to the client/donor in each of the prior years, plus the amount necessary to make up for any shortfalls in prior lean years. A NIMCRUT may be the ideal CRT for a client/donor planning for retirement because it addresses the risks to cash flow of future inflation.
► Is it Deductible? When? If a charity solicits donations to fund a particular projection, e.g., building a school, and if the condition of the solicitations is that the donations will be returned if the minimum funds are not received sufficient to fund the designated project, the client/donor cannot deduct the donated funds until it is assured that the condition will be met. Rev. Rul. 77-148, 1977-1 CB 63.
► Naming Rights: Donors will often negotiate as a condition of their donation that a building be named after them. This presents a house of issues that practitioners are likely to become more involved with over time. First, there must be a donor agreement that clearly addresses all aspects of the naming in writing. While counsel is likely to be involved in the drafting, CPA practitioners should still play an active role. Be certain that the client concerns as well as practical issues are addressed. How long does the charity agree to use the client/donor’s name for? What if the building is renovated? Demolished? Repurposed? How will the donor’s name be displayed? There is another issue that could raise potentially significant tax issues. If a wealthy retired donor negotiates to have a town theater named for her, there may be no income tax implications and the full amount of the donation may be deductible (subject to the usual charitable giving limitations). But what if the client/donor is currently involved in and owns a family business that operates real estate in the same locale that the theater that is being named will be located. Will the value of that naming right provide economic benefit to the local family business? Depending on the circumstances it might well provide a significant benefit. Does the value of that economic benefit have to be applied to reduce the potential charitable gift for income tax deduction purposes? The law is not clear and these situations could be very fact sensitive. The donor agreement counsel negotiates to confirm the naming right itself might be the primary document the IRS uses to challenge the deduction.
► Charitable Lead Trust and Personal Goals: Charitable lead trusts (“CLTs”) are the opposite of CRTs with the charity receiving the payments from the trust during the trust term and the designated heirs, typically a client/donor’s children, receiving the remainder interest. While CLTs have typically been used to minimize gift or estate taxes (A CLT is not income tax exempt like a CRT)) the technique can be adapted to meet personal goals. Assume that a client has an adult child with a health challenge that will limit the child’s work expectancy. The client could establish a CLT with term that concludes at the ill-child’s anticipated retirement date. The back end of the CLT would be a trust for that particular child that would name trustees and include dispositive provisions that were consistent with the financial concerns facing that child. Example: Daughter, is a single mother with two children. At age 40 she was diagnosed with cervical cancer. The overall 5-year relative survival for 2003-2009 for Localized (confined to primary site) cancer of the cervix is over 90%. While the prognosis is positive, daughter is very worried about supporting her children, in the event the outcome is negative. Parents establish a 15 year CLUT for $1 million. The CLUT pays out 6% for the 15 year period which the Daughter will direct to meet various charitable projects supporting cancer research. The payment to the charity for 15 years will reduce the gift tax value of the transfer from $1 million to $397,213. If the invested funds earn 7.5% over the 15 year period Daughter’s children will receive a nest egg of $1.2 million when the CLT ends. The CLT plan empowers Daughter to be proactive to fight cancer while giving her assurance of her children’s security.
►Add Charity to Bypass Trust Beneficiaries: It has not been conventional to permit charitable gifts from a bypass trust, since the goal historically has been to maximize the assets outside the surviving spouse’s estate. Instead charitable bequests could be made by the surviving spouse or from the estate of the surviving spouse to garner an estate tax charitable deduction. However, the new tax paradigm might provide an incentive to rethink this traditional approach. If the family unit has charitable giving objectives, then selecting the optimal source from which to fund those charitable gifts could maximize the overall tax benefits of the contributions. The bypass trust might be in a higher income tax bracket than any family member so that distributions to charity may provide the biggest tax bang for the buck. Further, if the family unit will be making charitable donations in any event, using highly appreciated assets inside a bypass trust to fund charitable bequests may be a cost effective and simple means of avoiding future capital gains taxes without the risks associated with general powers or other approaches.
► Charitable Limitations:. Contributions, reported on Form 1040 are deducted on Schedule A (below-the-line deductions) and are subject to the 50%, 30%, or 20% of adjusted gross income (AGI) limitations. In contrast, however, on a Form 1041 for a complex (non-grantor) trust the charitable contribution deduction is reported above-the-line and there are no percentage limitations. This is because the trust is governed by IRC 642(c) instead of IRC 170. So charitable trusts can provide a significant income tax advantage over individuals making a comparable donation. The deduction, on a complex trust, might shift net investment income (NII) for purposes of the 3.8% surtax from the trust to the tax-exempt charitable beneficiary. Practitioners should consider recommending that when clients are planning trusts, when appropriate, charitable beneficiaries or the right to make contributions, be included.
► QTIP and Charitable Remainder: If a client’s spouse faces the challenges of aging or illness the well spouse could create an estate plan that provides protection for that spouse and an eventual charitable bequest. The client could establish inter-vivos (while alive) marital trust (“QTIP”) to protect ill spouse. A QTIP trust can protect the ill spouse by providing professional management of the assets in the trust, trustees who can his pay bills and handle other matters for spouse if/when necessary, protection from lawsuits and claims, and other benefits. The QTIP trustees can invade the principal of the trust and use it to pay any or all of it for the care of the spouse. No estate tax will be due on the well-spouse/transferor’s death. Following the death of surviving spouse, whatever assets remain in the QTIP trust can be contributed to charity, since the charity can be named as the remainder beneficiary of this trust.
►Bequest of Closely Held Business with Hedge Against IRS Challenge of Valuation Challenge: This technique involves a charity to backstop a defined value clause on the sale of assets to a grantor trust. President Obama has repeatedly proposed eliminating this technique by causing estate inclusion. The use of a defined value mechanism may dissuade the IRS from pursuing the challenge the value of closely held business, real estate or other hard to value interest transferred, especially if the excess is paid over to a charity. Prospective donor structuring substantial sale to a defective grantor dynasty trust (“IDIT”) or even just a gift using the current $5.25 (2013) million gift exemption. Concerned about possible valuation challenges in the event of an audit of hard to value assets, e.g. a closely held business. Transfer documents limit sale (gift) to the IDIT to a dollar value of the assets sold, keyed into the intended purchase price using defined value clause. The excess of the gift as valued by the IRS on audit, over the defined value of the gift (the intended gift amount) passes as a result of the defined value clause to charity. While IRS incentives to audit would be adversely effected, the charity’s interests should be protected by the state AG’s involvement and fiduciary duties of executor. The IRS has argued the rationale of the landmark decision in Commr. V. Procter, 4th Circuit 1944. Procter held that mechanisms that render an audit ineffectual won’t work if they create a condition subsequent. This creates a public policy problem since to enforce it renders the issue moot. McCord v. Comm’r, 120 TC 358 (2003), rev’d and rem’d, 461 F3d 614 (5th Cir. 2006). Taxpayers transferred partnership interests to children and charities using formula clause that transferred approximately $6.9 M to children and trusts for children, $134,000 value of partnership interests to one charity, and the balance to a second charity. Donees (children and two charities) required to determine the value of the partnership interests, and to allocate the gift among themselves, based on the price at which the assigned partnership interest would change hands as of the date of this assignment between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant acts. The donees entered into a settlement agreement allocating the gift based on an independent appraisal. Some suggest that the case implies that no charitable beneficiary is necessary, but is relying on that the desired approach. In the Estate of Christiansen the Tax Court upheld a valuation adjustment clause structured as a form of disclaimer. The decedent’s will bequeathed her net estate to her daughter. If any assets were disclaimed, 25% would pass to a charitable foundation and 75 percent to a twenty-year charitable lead annuity trust (CLAT). The daughter was a remainder beneficiary of the charitable lead annuity trust. The daughter disclaimed a fractional share of the estate, equal to the excess of the estate over $6.35 million. The Tax Court found that the disclaimer passing to the lead trust was not a qualified disclaimer, because Christine had not disclaimed her interest in the lead trust. The court stated that revaluation clauses that depend for their effectiveness on a condition subsequent are ineffective. The Tax Court also rejected the IRS argument that the disclaimer’s adjustment clause was void on public policy grounds, because it would discourage the IRS from auditing estate tax returns. Estate of Christiansen v. Comm’r, 130 TC 1 (2008). Wandry v. Commissioner, T.C. Memo. 2012-88. In Christiansen, Petter and McCord the defined value clauses used all had a charitable component. The Wandry Court explained that in these cases, “This factor contributed to our conclusion, but it was not determinative“. In Wandry even though there was no charity involved the Court ruled in favor of the taxpayer, noting that the documents clearly indicated that the gift was of a fixed dollar amount and not of a percentage interest in the LLC. While some practitioners suggest that you no longer need a charity or a pay-over mechanism in a defined value clause, many practitioners prefer that approach.
► Bequest to Charitable Lead Trust (“CLT”) to Minimize Audit Risk on Large Estate: Using a testamentary CLT reduces audit incentive if audit adjustment won’t increase tax revenue but rather increase the amount going to charity using a defined value clause Example: “I bequeath $1M of the Family Widget Business to my daughter Jane. If the value as finally determined for federal estate tax purposes exceeds $1M, the excess shall be bequeathed to the Jane 15 year 6% Charitable Lead Trust.” Charitable “Lids” The above concepts are being expanded by some practitioners to use as caps or “lids” on the value of any type of estate planning transfer.
► Charitable Bail Out: The client could donate a portion of his or her business or the real estate to a charitable remainder trust (“CRT”). When the business is later sold, or the business redeems the equity held by the CRT, the CRT would invest the proceeds, which could pay the client a monthly annuity for life (or for the client’s life and the life of another beneficiary or beneficiaries). This annuity may cover a significant portion or all of your client’s living expenses. As with gift annuities, your client must be cautious about how much you commit to a CRT, because you cannot access the principal in the event of an emergency. Thus, in certain plans, a portion of the asset may be sold and a portion contributed to a CRT. On your client’s death, the money remaining in the CRT will be given to the charities named. Your client can also reserve the right in the CRT agreement to designate new charities in his or her will.
► Single Member LLCs: Real estate values have grown substantially in recent years so it is likely practitioners will see more clients considering donations of appreciated real estate. An issue many real estate donations raise is the done charity’s concern about potential environmental risks. In some cases appropriate due diligence can be done before the donation is contemplated, but this is not always feasible. What can be done? The donee charitable organization may accept the contribution of donated property in the name of a single member LLC. This will enable the charity to insulate itself from any potential environmental liability associated with the property by confining that risk inside the single member LLC. This will not jeopardize the donor’s income tax deduction. Notice 2012-52, 2012-35 IRB.
► Inventory: Charitable contributions of inventory are only deductible up to the income tax basis of property. Clients, especially those with informally run closely held businesses, not realizing this limitation may donate unneeded business property and simply list it as another non-cash contribution. IRC Sec. 170(e).
► Bequests: Many clients do not face an estate tax so a bequest to charity will provide no tax benefit. Consider having the bequest paid in advance of death so that an income tax deduction may be realized. Be certain to have the charity sign a written acknowledgement that the gift is an “advancement” of the bequest to avoid the client being held responsible twice.
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