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Chapter 15: Giving to charity.

SHARING THE WEALTH

By virtually any standard, Americans live in an affluent country. In 2008, disposable personal income per person in the United States was $35,464. (1) However, despite this affluence, in 2008 there were 39,108,000 individuals, and 7,252,000 families, who were living below the poverty level. (2) According to the Worldwatch Institute, an independent nonpartisan research organization, of all high-income nations "the United States has the most unequal distribution of income, with over 30% of income in the hands of the richest 10% and only 1.8% going to the poorest 10%." (3)

But there is good news! Americans are generous givers. According to the Giving USA Foundation, American individuals, estates, foundations, and corporations, gave an estimated $303.75 billion to charitable causes in 2009. (4) The reasons we give are many and complex, ranging from a true sense of stewardship, to the desire to secure an income tax deduction. (5) Financial planning should include a consideration of not only the current income tax consequences of charitable gifts, but an evaluation of how current and deferred gifts impact the donor's financial situation and estate plan. Planned tax-efficient giving makes sense, both from the donor's and the charity's perspective.

A variety of assets can be given to charity, including cash, stocks, bonds, real estate, artwork, and life insurance. Gifts can be made outright, they can be deferred, and they can be made in a way that benefits the donor and members of his or her family (e.g., the "retained interest" in a charitable remainder trust, page 338). Individuals who itemize may deduct (within limits) contributions they make to, or for the use of, qualified organizations. But not all types of contributions are deductible. For example, gifts of less than the donor's entire interest in property, referred to as a "partial" interest, are generally deductible only under very limited circumstances, and then only when very specific rules are followed (see overview of charitable trusts, page 336-337). Nor can a deduction be taken for the value of the donor's services, the donor's personal expenses, or the part of a contribution for which the donor receives a benefit (e.g., contributions to a lobbyist for influencing legislation, a retirement home for room and board, or for raffles tickets).

Generally, the most tax-efficient gifts include:

* Otherwise taxable income--such as IRAs (see page 342) and IRD (see page 478).

* Long-term capital gain property containing substantial appreciation (see page 334).

* "Related use" gifts of tangible personal property to 50%-type organizations (see page 335).

* Life insurance with subsequent gift of premiums directly to charity (see page 342).

THE CONCEPT OF PLANNED GIVING

The term "planned giving" can be defined in terms of the sources of funds that donors use to make charitable gifts. In contrast to the annual gifts made from the donor's disposable income in support of the operational needs of a charitable or religious organization, the concept of planned giving involves gifts of the donor's accumulated assets to ensure the organization's long-term financial viability. The process often requires that donors make decisions regarding the distribution of significant portions of their estates. In recognizing that planned gifts must be coordinated with the donor's overall financial and estate plans, one commentator has simply defined planned giving as involving: "any charitable gift that requires assistance by a qualified professional to complete." The terms "deferred giving" and "gift planning" are also used.

Digging Deeper

A wealth of information about planned giving can be found at: www.pgdc.com.

Planned giving can also be defined in terms of the techniques and products used when making charitable gifts. In addition to providing for a substantial charitable gift, the donor and his or her family also often enjoy both income and estate tax benefits and an ongoing income. These techniques and products include:

(1) Wills that transfer assets by outright bequests of named assets (e.g., cash or real estate), residuary bequests of property remaining after payment of debts, estate costs, devises, bequests, and legacies, and contingent bequests (e.g., "I direct payment of $100,000 to XYZ Charity provided my spouse dies before me").

(2) Retirement plan assets transferred from both qualified retirement plans and IRAs--see page 342.

(3) Pooled income funds providing income from co-mingled investments and charitable gift annuities providing income as a general obligation of the charity--see pages 337 and 340.

(4) Charitable trusts, including:

(a) Charitable remainder annuity trust paying a fixed amount annually to the donor or other beneficiary--see page 337.

(b) Charitable remainder unitrust paying a fixed percentage of the trust's value, as determined yearly--see page 337. Variations of the unitrust include net income with makeup unitrusts (NIMCRUT), net income unitrusts (NICRUT), FLIP unitrusts, and charitable lead trusts (CLT)--see pages 337 and 339-340.

(5) Life insurance by transferring ownership directly or by irrevocably designating the charity as owner and beneficiary--see page 342.

(6) Private foundations and donor-advised funds allowing for different degrees of donor influence over fund disbursements--see pages 345-346.

LIMITS ON DEDUCTIONS

The amount of income tax deduction allowed individuals for charitable contributions typically depends upon the following four factors:

* The type of charitable organization to which the gift is made.

* The kind of property donated (e.g., cash, stocks, or artwork).

* The value of the property and the donor's tax basis.

* The donor's adjusted gross income.

Qualified organizations. For contributions to be deductible, they must be made to or for the use of a "qualified organization." (6) Generally, this includes the five following types of organizations:

* Those created and operated exclusively for religious, charitable, educational, scientific, and literary purposes, or for the prevention of cruelty to children or animals, or to foster national or international amateur sports competition.

* Fraternal organizations operating under the lodge system, provided the contributions are to be used for the same religious, charitable, and other purposes as listed above.

* Veterans' organizations.

* Non-profit cemetery companies.

* The United States, a state, or U.S. possession, or any political subdivision, if the contributions are made exclusively for public purposes.

Note that this list does not include contributions to specific individuals, political organizations, homeowners' associations, labor unions, chambers of commerce, and social clubs.

For purposes of determining limits on charitable deductions, charities are generally divided into two categories, those considered "public" in nature, and those considered "private" in nature.

(1) 50%-type organizations--include public charities such as churches, schools, hospitals, medical research organizations, federal, state, and local governments, private operating foundations, and conduit foundations that generally direct their support to public charities.

(2) 30%-type organizations--include private charities such as veterans' organizations, fraternal societies, nonprofit cemeteries, and private family foundations (referred to by the IRS as "private non-operating foundations," see page 335).

Contributions to 50%-type organizations. Generally, an individual is allowed a charitable deduction of up to 50% of adjusted gross income for gifts to 50%-type organizations. Such gifts include outright gifts of cash, ordinary income property (e.g., deferred annuities and business inventory), and short-term capital gain property (e.g., stock held less than one year). However, special rules apply in the case of gifts of long-term capital gain property, gifts made for the use of the charity, and gifts of tangible personal property:

(1) Long-term capital gain property. The deduction for these gifts is limited to 30% of adjusted gross income. These are gifts of appreciated property that have been held for more than one year and would produce long-term capital gains if sold (e.g., stocks and real estate). However, this limit can be avoided if the donor makes a special election, referred to as a "step-down election," to have all contributions of long-term capital gain property valued at the lesser of fair market value or adjusted cost basis (i.e., gifts valued at cost could be deducted up to 50% of adjusted gross income, rather then the lower 30% of adjusted gross income). This election applies to all long-term capital gain property in the tax year. No carryover is allowed for such reduced long-term capital gains.

(2) Gifts "for the use of." The deduction for these gifts is limited to 30% of adjusted gross income. These are gifts of an income interest in property, but not the property itself (e.g., a charitable lead trust, see page 337).

(3) Tangible personal property. The deduction for these gifts, such as automobiles, clothing, furniture, and art, depends upon whether the property is "related" or "unrelated" to the charity's exempt purpose:

(a) Related use gifts--can be deducted at full fair market value, but are limited to 30% of adjusted gross income (e.g., the gift of a painting to a museum would be a related use gift). However, this limit can be avoided if the donor makes the special election described in paragraph (1) above.

(b) Unrelated use gifts--can be deducted at the lesser of fair market value or cost basis, and are limited to 50% of adjusted gross income (e.g., the gift of a painting to a hospital would be an unrelated use gift). This reduction requirement is meaningless when used clothing is contributed to a rummage sale (i.e., donated clothing has typically depreciated to less than cost). However, this reduction can result in loss of a substantial deduction if the contribution is a valuable antique (i.e., the antique has appreciated above cost). It would be best to donate the antique to a local museum.

Contributions to 30%-type organizations. An individual is allowed a charitable deduction of up to 30% of adjusted gross income for gifts to or for the use of 30%-type organizations. Such gifts include gifts of cash, ordinary income property, and short-term capital gain property (i.e., a capital asset such as real estate, held by a donor for one year or less, that if sold would produce short-term capital gain or loss). However, the following special rules apply in the case of gifts to 30%-type organizations of long-term capital gain property, qualified appreciated stock, and tangible personal property:

(1) Long-term capital gain property. The deduction for these gifts is limited to 20% of adjusted gross income.

(2) Qualified appreciated stock. The deduction for these gifts is limited to 20% of adjusted gross income. This is generally publicly traded stock that, if sold on the date of contribution at its fair market value, would result in a long-term capital gain (but the gift must represent 10% or less of all outstanding stock of the corporation and family attribution rules apply). Note that this is an exception to the general rule that contributions of appreciated property (tangible or intangible), to or for the use of private foundations, are limited to the donor's adjusted basis (i.e., the donor cannot deduct the full appreciated fair market value).

(3) Tangible personal property. The deduction for these gifts (whether related use or unrelated use) is limited to 20% of adjusted gross income, but the deduction is limited to the lesser of fair market value or cost basis.

Application of the limits and carryovers. Contributions in any year that cannot be deducted because they exceed the adjusted gross income limits may be carried over for five years. Contributions to 50%-type organizations that exceed 50% of adjusted gross income cannot be deducted currently, but may be carried forward. The current deduction of contributions to 30%-type organizations may be limited by contributions to 50%-type organizations (i.e., when applying the 30% limitation, contributions to 50%-type organizations, whether subject to either the 50% limitation or the 30% limitation, are considered first to determine whether any amount is available under the overall 50% limitation). However, each year's current contributions must be considered before any carryover contributions. Application of these limits can be complex.

For example, assume a donor with adjusted gross income of $50,000 gives $2,000 in cash to his or her church, land with a fair market value of $28,000 to his or her college (basis of $22,000), and $5,000 in cash to a private foundation. The overall 50[degrees]% limitation is $25,000 (.50 x 50,000 = 25,000). The $2,000 cash donated to the church is considered first and is fully deductible. The $5,000 cash donated to the private foundation is not deductible currently because contributions to 50%-type organizations (2,000 + 28,000 = 30,000) are more than his or her overall 50% limitation of $25,000. The current year's deduction for the gift of land is limited to $15,000 because of the 30% limit on gifts of long-term capital gain property (.30 x 50,000 = 15,000). See the discussion of long-term capital gain property on page 334. However, the $13,000 unused part of the gift of land can be carried over (28,000 - 15,000 = 13,000). For the current year, the donor's deduction is limited to $17,000 (2,000 + 15,000 = 17,000). Needless to say, these rules are both complex and interrelated, and a donor would be well advised to seek competent tax advice before making substantial gifts.

Gift tax deduction. Lifetime gifts must comply with both the income tax and gift tax charitable deduction provisions of the tax law. Fortunately, outright gifts typically meet these dual requirements. Unlike the income tax charitable deduction, where annual limits apply, the amount of the gift tax charitable deduction is unlimited. Although the gift tax charitable deduction is unlimited, with deferred giving a charity will often receive less than the entire asset. In these situations, qualification for the full gift tax deduction cannot be assumed (e.g., only the present value of the charity's interest in a gift annuity is eligible for the gift tax charitable deduction; see page 340-341).

Estate tax deduction. In general, those organizations that qualify gifts of property for an income tax deduction are the same as those that will provide an estate tax deduction. But there are several major distinctions between the estate tax deduction and the income tax deduction. First of all, the charitable deduction for the estate tax is not limited by the percentages that are applied in taking an income tax deduction (i.e., there is no distinction between 50%-type organizations and 30%-type organizations). As with the gift tax, the charitable estate tax deduction is unlimited, and the contribution is deductible in full on the estate tax return. Nor are there any reductions applied to the amount of the charitable transfer, depending upon whether the property is "ordinary income" property or "capital gain" property (see page 334).

OVERVIEW OF CHARITABLE TRUSTS

Charitable trusts can be established for both individual and charitable beneficiaries. The requirements for charitable remainder trusts are specific and detailed in order to assure that an accurate determination can be made of the benefit the charity will eventually receive. Such trusts can offer both income and estate tax benefits, and include:

(1) Charitable Remainder Annuity Trusts (CRATs) are trusts under which a fixed amount of at least 5% and no more than 50% of the initial net fair market value of trust assets is paid annually to a noncharitable beneficiary. Payments to the noncharitable beneficiary may be for a set term not exceeding 20 years or for the life of the beneficiary. The amount of the grantor's tax deduction is measured by the present value of the charity's remainder interest at the time property is given to the trust. The value of the remainder interest must be at least 10% of the initial net fair market value of all property placed in the trust. If the trust income is insufficient to make the required payments to the noncharitable beneficiary, then capital gains or trust principal must be used. If the trust income is more than required to make the payments, the excess is reinvested in the trust. See the expanded discussion of charitable remainder trusts on page 338-339.

(2) Charitable Remainder UniTrusts (CRUTs) are trusts under which a fixed percentage of the net fair market value of the trust (valued annually) is paid at least annually to a noncharitable beneficiary. This percentage cannot be less than 5% and must be no more than 50%. Payments to the noncharitable beneficiary may be for a term not exceeding 20 years or for life. The amount of the grantor's tax deduction is the present value of the charity's remainder interest. The value of the remainder interest must be at least 10% of the net fair market value of each contribution as of the date the property is contributed to the trust. Payments to a survivor would further reduce the donor's charitable deduction. See the expanded discussion of charitable remainder trusts below, and the discussion of Net Income with Makeup Charitable Remainder Unitrusts (NIMCRUTs) on page 339-340.

(3) Pooled income funds are trusts created by public charities, rather than by private donors. The donors, or other income beneficiaries, receive from the commingled funds in the trust an income for life that is based upon the earnings of the trust. The amount of the grantor's tax deduction is the present value of the charity's remainder interest.

(4) Charitable lead trusts allow a grantor to place funds in trust with an annuity or unitrust interest going to a charitable beneficiary and the remainder interest returning to the grantor or some other noncharitable beneficiaries. Although the grantor continues to be taxed on trust income under the grantor trust rules, he or she is also entitled to an income tax deduction at the time of the gift equal to the present value of the charity's annuity or unitrust interest.

CHARITABLE REMAINDER TRUST

The charitable remainder trust enables an individual to make a substantial deferred gift to a favored charity while retaining a right to payments from the trust. Under the right circumstances, use of such a trust offers multiple tax and nontax advantages, particularly to the individual who owns substantially appreciated property. These advantages include: a charitable deduction resulting in reduced taxes; an increase in current cash flow; avoidance of capital gains upon a sale of the appreciated property; the eventual reduction or elimination of estate taxes; and the satisfaction of knowing that property placed in the trust will eventually pass to charity.

[ILLUSTRATION OMITTED]

After establishing a charitable remainder trust, the grantor gives property to the trust while retaining a right to payments from the trust. (The term "grantor" is used to describe a person who establishes a trust, whereas the term "donor" is used to describe a person who makes a gift. For simplicity, only the term "grantor" is used in describing the charitable remainder trust.)

At the time the property is given to the trust, the grantor can claim a current income tax deduction equal to the present value of the charity's remainder interest. Upon receipt of the gift, the trustee will often sell the appreciated property and reinvest the proceeds in order to better provide the cash flow required to make the payments to the grantor. This sale by the trust is usually free of any capital gains tax to the trust, but may be taxable to a beneficiary upon distribution. Upon the grantor's death, the property placed in the charitable remainder trust passes to the designated charity.

The tax savings and increased cash flow offered by the use of a charitable remainder trust often enable the grantor to use some or all of these savings to fund a wealth replacement trust for the benefit of his or her heirs, thereby providing for the tax-effective replacement of property that has been transferred to the charitable remainder trust. (7) If the wealth replacement trust is established as an irrevocable life insurance trust, it is often possible to gain gift tax advantages during the grantor's lifetime, while at death entirely avoiding inclusion of the life insurance proceeds in the estates of the grantor and his or her spouse.

A unitrust can provide for the grantor to receive annually a fixed percentage of the trust value (valued annually), whereas an annuity trust can provide for the grantor to receive annually a fixed amount. Either type of trust can require that payments be made for the joint lives of the grantor and another person, such as the grantor's spouse. Characteristics common to both unitrusts and annuity trusts are: (1) payments must be made at least annually and may not be less than 5%, nor more than 50%, of the net fair market value of the trust assets (determined when trust is created with an annuity; determined annually with a unitrust); (2) value of charity's remainder must be at least 10% of trust assets; (3) the trustee cannot be required to invest in specific assets (e.g., stock in a corporation or life insurance); and (4) payments may be for a term not greater than 20 years, or for the life or lives of the beneficiary(ies). Any individual beneficiary must be living when the trust is created.

Payout rate. Selection of a payout rate can have a substantial impact upon the current income tax deduction (i.e., the present value of the charitable remainder interest). If the deduction is to be meaningful, the payout rate is usually limited to 7% or less. For example, assuming a $100,000 gift to a charitable remainder unitrust to be paid for the beneficiary's life, the following table illustrates the interrelationship of the beneficiary's age and the selected payment percentage:
Age of        Payout   Deduction
Beneficiary

50               5%     $25,943
                10%      $9,413

60               5%     $37,656
                10%     $17,530

70               5%     $51,905
                10%     $30,197


NIMCRUT

The term "NIMCRUT" stands for Net Income with Makeup Charitable Remainder UniTrust. As a form of charitable remainder unitrust (CRUT), the trust assets are valued annually creating a unitrust amount (variable annuity payment) made at least annually to one or more trust beneficiaries. Distributions consist of the lesser of a fixed percentage (not less than 5% nor more than 50%) of the value of the trust assets (valued annually), or the net income of the trust for the current year. Unlike the CRUT, a makeup account is created in any year that income earned is less than the fixed percentage allowed. The makeup account is then paid out in any future year in which the income earned exceeds the fixed percentage payout for that specific year (i.e., the NIMCRUT provides for "makeup" distributions). No adjustment for the time value of money is allowed for makeup distributions. Pre-contribution capital gains are generally not available for distribution. Post-contribution capital gains may be classified as income, provided this does not conflict with state law. (8)

A NIMCRUT provides a great deal of flexibility for the donor who wishes to defer income for retirement. Trust income can be deferred by having the trustee make appropriate investment selections (e.g., a deferred annuity), or by donating to the trust low-income or non-income producing assets (e.g., growth stocks, closely held stock, or real estate). Unlike the CRUT, to the extent there is inadequate trust income, the trustee has no obligation to pay out the unitrust amount and the donor can be positioned to receive larger makeup payments after retirement. Also, as with the CRUT, a donor may make multiple gifts to the same NIMCRUT. However, before making gifts to any NIMCRUT, it is essential that the donor fully understand that payments are contingent upon the trust earning income.

FLIP unitrust. For the donor who desires greater flexibility, a FLIP unitrust might be considered. This technique begins with a NIMCRUT, or a NICRUT (similar to a NIMCRUT but without the makeup provisions), that is converted to a standard CRUT upon the occurrence of an approved triggering event. Approved triggering events cannot be controlled by the donor, unitrust beneficiary, trustee, or any other person. For example, the beneficiary's 65th birthday is an approved triggering event, but not the beneficiary's retirement, as that event is controlled by the beneficiary. Unfortunately, when a NIMCRUT "flips" to a standard CRUT, any outstanding makeup amounts are forfeited.

CHARITABLE GIFT ANNUITY

A charitable gift annuity is received pursuant to a contractual obligation by a charity to make annuity payments to a donor in exchange for the transfer of property to the charity. In comparison to charitable trusts they are less costly and relatively simple to adopt, typically requiring only an application and a one or two page agreement. The donor's tax-deductible gift is measured by the difference between the market value of the gift and the value of the retained life annuity. The annuity can be immediate or deferred, and for a single life or the joint lives of two annuitants.

The actual rates used to calculate the annuity payout are typically based upon those published by the American Council of Gift Annuities. The council meets periodically in order to review interest rates and mortality assumptions and update the annuity rates. Although these rates are published in an attempt to avoid "rate bidding wars" between charities, the council has no enforcement authority. However, charities using the rates need not retain their own actuaries and have the assurance that the underlying actuarial assumptions will likely produce an ultimate charitable benefit.

The contractual obligation to the annuitant is solely the charity's and the annuity payments are dependent upon the continuing financial stability of the charity. If desired, the charity can insure its obligation to the donor by purchasing a commercial annuity. This relieves the charity of the burden of investing the proceeds to assure that all payments will be made to the annuitant. To the extent that the cost of a commercial annuity is less than the amount realized from the gift, the excess funds become immediately available to the charity.

Tax treatment. The annuity receives favorable tax treatment. A portion of each payment is received tax-free as a return of principal (but excludable only until the investment has been recovered, thereafter taxed as ordinary income). The remaining portion is taxed as ordinary income. However, if the donor has transferred appreciated property to the charity, he or she has a gain (either capital gain or ordinary income depending on the property) to the extent the fair market value exceeds his or her adjusted basis. His or her basis in the property must then be allocated between the charitable gift and the investment in the annuity contract. As a result, the return of principal element of each annuity payment is divided into two parts, one representing a return of gain (taxed as capital or ordinary gain) and the other representing a return of basis (excluded from income).

QUALIFIED CONSERVATION EASEMENT

A "qualified conservation contribution" requires that the donor convey a qualified real property interest to a qualified organization exclusively for conservation purposes. Granting a conservation easement during lifetime can provide the property owner with an income tax deduction plus a potential estate tax savings attributable to both the easement's depressing the value of the property and to the partial exclusion of that reduced value from the gross estate. This is an exception to the rule that bars deductions for charitable contributions of partial interests in property.

Income tax deduction. A taxpayer who makes such a contribution may take a charitable income tax deduction equal to the difference in the value of the land immediately before and after the easement is placed on the property (i.e., the loss of value due to the placement of the easement).

Estate tax exclusion. The executor may elect on the estate tax return to exclude from the decedent's taxable estate up to 40% of the value of any land subject to a "qualified conservation easement." In addition to meeting the requirements of a "qualified conservation contribution," the land must be located within the United States or its possessions and must have been owned by the decedent or a member of his or her family for three years. The exclusion is generally not available when the property is debt-financed or the donor has retained development rights (i.e., the donor cannot retain the right to develop property for general recreational use by the public, such as a ski resort). The granting of the easement can be made by the decedent before death or by the decedent's executor.

For estate tax purposes the exclusion amount is limited to $500,000. The 40% exclusion percentage is reduced by 2% for each percentage point by which the value of the qualified conservation is less than 30% of the value of the land. For example, assume that property with a basis of $500,000 has a value of $1,000,000 before an easement is granted and the easement reduces the value of the property to $750,000, a reduction of 25%. This is 5% less than the minimum 30% threshold. Therefore, the 40% exclusion must be reduced by 10% to 30% (40 - (5 x 2)). The property is included in the estate at a reduced value of $525,000 ($750,000 x .30 = $225,000 reduction; $750,000 - $225,000 = $525,000 reduced value). The value of the property excluded from the decedent's estate under this provision does not receive a step-up in basis. This means the new basis is $675,000 ($525,000 stepped-up basis plus $150,000 carryover basis attributable to the fact that 30% of the property was excluded from the gross estate; $500,000 x .30 = $150,000).

CHARITABLE IRA ROLLOVERS

Charitable IRA rollovers to public charities are limited to donors who are 70^ years of age or older and are available only for the years 2010 through 2012 (distributions made in January of 2011 can be treated as having been in the 2010 taxable year). The amount is limited to $100,000 in total each year from all of the donor's IRAs (both traditional IRAs and Roth IRAs). The rollover must be made directly in a trustee-to-charity transfer (e.g., it cannot be made to a charitable remainder trust, lead trust, gift annuity, or pooled income fund). The charitable IRA rollover counts towards any required IRA minimum distributions in the year of the gift. The percentage-of-income limitations described on pages 333-336 do not apply. Since the rollover is excluded from the donor's taxable income, this gives donors who take the standard deduction (i.e., did not itemize) an opportunity to give without incurring taxable income.

CHARITABLE GIFTS OF LIFE INSURANCE

Gifts of life insurance policies and premiums have become a popular way of providing substantial gifts to a donor's favored charity. When properly implemented, the donor should receive charitable deductions for the value of the insurance contract and for all future premium payments.

In order to obtain the anticipated income, gift, and estate tax deductions, the donor must make a gift of his or her entire interest in the policy. The donor will not qualify for these deductions if he or she retains the right to name or change the beneficiary, or gives less than his or her entire interest (e.g., assignment of death benefit, but retention of cash values).

Although virtually all states have passed legislation that specifically provides that charities have an insurable interest in the lives of their donors, the variety of state laws and likely changes to these laws make it imperative that specific state statutes be consulted prior to making gifts of life insurance and premiums, or having a charitable organization apply for life insurance.

Do not confuse charitable gifts of life insurance with "charitable split-dollar," a highly aggressive planning technique that provided the donor with an improper financial benefit in exchange for his or her charitable contributions. Charitable split-dollar is no longer viable due to legislation passed in December of 1999. Likewise, do not confuse charitable gifts of life insurance with "stranger-originated life insurance (STOLI)" involving the questionable use of a charity's insurable interest to promote a speculative life insurance arrangement. (9)

CHARITY AS DESIGNATED BENEFICIARY OF RETIREMENT PLAN

Naming a charity as beneficiary of some or all of a retirement plan can be a simple and tax-efficient way to make a charitable bequest. The benefits include the following: (1) charities are exempt from state and federal income taxes and can receive retirement funds without any reduction for income taxes paid, whereas payments to individual beneficiaries are considered "income in respect of a decedent" and would be taxed as ordinary income (see page 478); (2) satisfying charitable objectives with retirement account assets makes it possible to pass other property to non-charitable beneficiaries, which can then be sold at fair market value without paying income taxes, (unlike retirement account assets, this property is entitled to a "stepped-up basis" at death, see page 479); and (3) payments made to a charity are deductible from the gross estate and are not subject to estate taxes (with larger estates this can save estate taxes).

Before making a charity a beneficiary, it should be determined if: (1) the plan contains any restrictions against naming a charity as beneficiary; and (2) the account holder is married (retirement plans other than IRAs require that the spouse waive his or her rights under the retirement plan). The mere naming of a charity as beneficiary will not adversely impact the calculations of the owner's required minimum distributions (RMDs) during his or her lifetime (prior rules would have prevented using the joint life expectancy of the owner and another person if a charity was a named beneficiary).

A "designated beneficiary" must be determined for the purpose of calculating the required post-death distributions from a retirement account. Designated beneficiaries are living persons for whom a life expectancy can be calculated. (An exception to this rule allows some trusts to qualify as designated beneficiaries provided they meet specific requirements.) A charity is considered to be a "non-designated beneficiary" since it has no life expectancy.

When the charity is the only beneficiary, the RMD is determined as if there were no designated beneficiary and there is limited flexibility as to when distributions may be taken (see page 409). However, this is rarely a concern as most charities have no tax incentive to delay distribution and want to receive the funds as soon as they are available.

When there are multiple individual beneficiaries (i.e., multiple "designated beneficiaries"), the RMD calculation is based upon the oldest beneficiary, unless separate accounts are established before September 30th of the year following the owner's death, in which case each individual beneficiary should be able to calculate his or her own RMD (based upon their individual life expectancies).

When a charity is among the beneficiaries, the individual beneficiaries will be unable to use their life expectancies to calculate RMDs if the charity is included among the beneficiaries on September 30th of the calendar year following the year of the account owner's death (the deadline for determining the identity of account beneficiaries for the purpose of determining RMDs). The reason for this is that an account that has both designated and non-designated beneficiaries is treated as if it has no designated beneficiaries. However, the problem can be avoided and the individual beneficiaries can preserve their ability to stretch out annual withdrawals over the course of their lifetime by either: (1) establishing separate accounts for the charitable and the non-charitable beneficiaries after the death of the account owner, but not later than the September 30th deadline; or (2) paying out the charity's share prior to the September 30th deadline. Unlike individual beneficiaries, a charity has no incentive to stretch out distributions from the retirement account. The individual beneficiaries may then take minimum distributions over the life expectancy of the oldest remaining beneficiary or over their individual life expectancies if the account is divided into separate accounts for each remaining individual beneficiary.

A retired married couple might wish to make a charity a partial beneficiary of their retirement assets, but be reluctant to do so because of a need to provide for the surviving spouse and a desire to leave the bulk of the account to adult children. The following beneficiary designation addresses that concern and passes a 10% interest (a tithe) in the retirement account to a charity, with the remaining 90% to any surviving children, but only upon the death of the surviving spouse: "In the event of my death, transfer ownership of my Account to my spouse if he/she survives me. If my spouse predeceases me, transfer ownership of my Account to the following beneficiaries who survive me and make payment in the following proportions: Son A--30%; Son B--30%; Daughter C--30%; XYZ Charity--10%. If any of my Individual Beneficiaries predeceases me, his or her share shall be divided among the other individual beneficiary(ies) who survive me in the relative proportions assigned to each such surviving Individual Beneficiary. If there is no surviving Individual Beneficiary(ies) at the time of my death, transfer ownership of my Account to my estate (unless otherwise required by the laws of my state of residence)."

Should the account owner's spouse die first, then the charity would receive a 10% interest and the adult children would receive their 90% interest in the retirement account. Should the account owner die first, the spouse would either remain a beneficiary of the account or transfer the funds to the spouse's IRA. In this event, the spouse should consider using the same beneficiary designation as above, but with the underlined text deleted. In either case, if the individual beneficiaries desire to delay receipt of their distributions over the longest possible time, it is important to take the actions set forth in paragraphs 1 or 2 above.

PRIVATE FOUNDATIONS

A private foundation is a not-for-profit organization established by an individual charitable donor that operates as either a trust or a corporation. The foundation is controlled by the foundation's board or trustees, who may be selected by the founder. Private foundations are particularly suited to those individuals who wish to make substantial donations while providing a lasting legacy in the family name. Unlike outright gifts to public charities, the founder and his or her family are able to maintain limited control over assets given to the foundation and retain the flexibility to redirect charitable gifts with changing community needs. Active involvement of the founder's children and other family members as board members has the ancillary benefit of teaching others how to share the family wealth consistent with the founder's values and vision.

To assure that private foundations adequately serve a public purpose, there are very strict rules and regulations governing their operation. In particular, a prohibition against "self-dealing" prevents any transactions (with certain exceptions) between the foundation and "disqualified persons." Such disqualified persons include the founder, the founder's spouse, and lineal descendants, as well as the foundation managers and others involved in business relationships with a substantial contributor to the foundation. Compliance with these rules is essential and penalties for self-dealing are substantial. One exception to these rules allows disqualified persons to be paid by the foundation for reasonable and necessary work performed for the foundation, provided the compensation is reasonable.

Although the earnings on investments held by private foundations are not subject to income taxes, they are subject to an excise tax of 2% on investment income. Income on investments must be distributed to qualified charities each year. Regardless of income, approximately 5% of its "average net assets" are required to be distributed within 12 months of the close of the fiscal year. Specific steps must be taken to verify the tax-exempt status of grant recipients. Added to these requirements are annual information tax returns, corporate filings, documentation of gifts received, and requirements for public inspection and disclosure.

The maximum amount a donor may deduct in one year for gifts to a private foundation is 30% of his or her "contribution base," generally equal to adjusted gross income. This is reduced to 20% for appreciated long-term capital gain property (see page 335). Private foundations cannot receive gifts of interests in a closely held or family-owned business stock under the rules governing "excess business holdings."

DONOR ADVISED FUNDS

A donor-advised fund is a type of charitable giving program that provides for the favorable tax benefits of charitable gifts, but with flexibility as to timing, management of assets, and selection of the ultimate charities. Contributions are made in either cash or assets to a public charity that sponsors and sets up the fund. These contributions are eligible for an immediate income tax deduction. Typically, the donor thereafter recommends which charitable organizations will receive grants, when these grants will be distributed, and their amounts. It is important to recognize that the sponsoring charity has the final approval regarding who receives grants (e.g., to assure grants are made to qualified nonprofit organizations). (10) Minimum contributions are usually $10,000, but can vary between sponsoring charities. In return for its services, the sponsoring charity receives annual fees and charges.

CROSS REFERENCES TO TAX FACTS ON INVESTMENTS (2011)

Q 7936. What general rules apply to charitable deductions?

Q 7937. How is fair market value of a gift of property determined?

Q 7938. What verification is required to substantiate a deduction for a charitable contribution?

Q 7941. What are the income percentage limits for deduction of a charitable contribution?

Q 7942. When is the deduction for charitable contributions taken?

Q 7943. Can an individual deduct the fair market value of appreciated real estate or intangible personal property such as stocks or bonds given to a charity?

Q 7944. May an individual deduct the fair market value of appreciated tangible personal property, such as art, stamps, coins, and gems given to a charitable organization?

Q 7945. May an individual take a deduction for charitable contributions to private foundations?

Q 7948. Can a deduction be taken for a charitable contribution of less than the donor's entire interest?

Q 7949. What is a charitable remainder trust? How are charitable remainder trusts used as planning tools?

Q 7950. Can a deduction be taken for a contribution to a charitable remainder trust or a pooled income fund?

Q 7951. What is a charitable remainder annuity trust?

Q 7952. What is a charitable remainder unitrust?

Q 7953. What is a pooled income fund?

Q 7954. What is a donor advised fund?

Q 7955. How much can be deducted for a gift to a charitable remainder annuity trust or unitrust? When is the deduction taken?

Q 7960. Is a gift of a "conservation easement" or a "facade easement" deductible?

Q 7962. What is a charitable IRA rollover or qualified charitable distribution?

(1) Disposable personal income is the annual income available to persons for spending or saving; it is calculated as personal income less personal tax and non-tax payments. Statistical Abstract of the United States, 2011, Table 681, Disposable Personal Income Per Capita in Current and Constant (2005) Dollars by State: 2000 to 2009.

(2) Statistical Abstract of the United States, 2011, Table 708, Individuals and Families Below Poverty Level--Number and Rate by State: 2000 and 2008.

(3) "Rich-Poor Gap Widening," Worldwatch Institute, November 12, 2003.

(4) "GivingUSA 2010," Giving USA Foundation. See www.givinginstitute.org.

(5) Under a chapter entitled "Selling The Dream," Tools & Techniques Charitable Planning lists no less than 20 varied reasons that people give to charitable organizations. See Stephan R. Leimberg, et al, The Tools & Techniques of Charitable Planning, 2nd ed. (Cincinnati: The National Underwriter Company, 2007), p. 1.

(6) IRS Publication 78, Cumulative List of Organizations, contains a listing of these approved organizations (charities can be searched online at: http://apps.irs.gov/app/pub78).

(7) The "wealth replacement trust" is often another name for an irrevocable life insurance trust; see page 474.

(8) Classification of capital gains as income involves a consideration of the prudent investor rule under the Uniform Prudent Investor Act. For a discussion of this act, see Donald F. Cady, Field Guide To Estate Planning, Business Planning & Employee Benefits (Cincinnati: The National Underwriter Company, 2011, revised annually), p. 485.

(9) For a discussion of stranger-originated life insurance (STOLI), see Cady, p. 532.

(10) For a table showing the relative advantages of donor advised funds and private foundations, see Leimberg et al, p. 181.
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Title Annotation:2011 FIELD GUIDE TO FINANCIAL PLANNING
Author:Cady, Donald F.
Publication:Field Guide to Financial Planning
Date:Jan 1, 2011
Words:7346
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