Chapter 28: Charitable uses of life insurance.
Atransfer of cash or other property to certain charitable, religious, scientific, educational, or other organizations may result in favorable income, gift, and estate tax results for the donor. (1) Income taxes can be reduced and estate taxes can be saved. More importantly, a gift to charity serves to reward the donor in significant psychological and moral ways. Charitable giving is one of the most important of all estate and financial planning considerations.
Life insurance is an important vehicle for accomplishing these tax and non-tax objectives. It is used in one of two ways:
1. as a direct means of benefiting the charity; or
2. as a way to allow the donor to give other assets during lifetime or at death to charity without denying or reducing the financial security of his family. It may even serve as a form of wealth enhancement.
Life insurance can be used both during the client's lifetime and at death to make meaningful gifts to charity. Some of the strategies used to provide direct gifts of life insurance to charity include:
* Donation of existing insurance policies on the life of a client to a qualified charity.
* Purchase and donation to a charity of new insurance on the life of the client, the client's spouse, or both.
* Disposition by will of a policy on another's life to a charity. The value of the policy at the policy owner's death will be includable in his estate, but an equal and offsetting deduction will be allowed for the gift to the charity by will.
* Contribution of cash directly to a charity, which in turn uses that cash to purchase a new (or existing) policy on the life of the donor (or other supporter).
* Naming the charity revocable or irrevocable beneficiary of one or more life insurance contracts (individual or group).
* Contribution of an asset other than life insurance in order to generate an income tax deduction, which in turn can save the client money otherwise payable in tax. This tax savings can then be gifted to the client's children or other beneficiary (or to an irrevocable trust for their benefit) who could use that cash to purchase life insurance on the client's life, or on the life of the client's spouse. The charity receives an immediate and certain gift and the client's beneficiary receives what he would have received (or, in many cases, even more) after taxes had there been no charitable gift. This use of life insurance is often called "wealth replacement."
WHEN IS THE USE OF SUCH A DEVICE INDICATED?
1. When the client would like to benefit one or more charities for reasons other than tax savings.
2. When the client would like to benefit himself and/ or his family through tax savings and create more income and capital at the same time a charity is benefited.
3. When a client would like to achieve the first and second objectives and is willing to incur expense to accomplish both. Planners and clients should both be aware that tax advantages do not mean a charitable gift is without cost. Charitable tax incentives may reduce the overall cost of the gift, and the achievement of noncharitable financial security goals may be facilitated through charitable giving techniques. But charitable giving should be considered as a planning tool only if the client has genuine charitable motives and has examined more direct alternatives for the accomplishment of noncharitable objectives.
WHAT ARE THE REQUIREMENTS?
1. The gift of the policy or other property must be made to a qualified charity such as a nonprofit school or hospital, a church or synagogue, or a local or civic organization such as the Boy Scouts or Girl Scouts of America. "Qualified" means that the charity meets three conditions:
(a) the organization is operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition, or to prevent cruelty to children or animals;
(b) no part of the earnings of the organization can be used to benefit any private shareholder or similar individual; and
(c) the organization cannot be one disqualified for tax exemption because it attempts to influence legislation or participates in, publishes, or distributes statements for, or intervenes in, any political campaign on behalf of any candidate seeking public office.
2. The gift of the policy or other property must be made before the end of the taxable year, even if the client is an accrual basis taxpayer. (Corporations reporting income on the accrual basis are subject to a less stringent standard. (2))
3. The gift must be of the donor's entire interest; generally, no deduction will be allowed for a gift of a "partial interest" (unless strict and narrow rules are met). So in most cases where a policy will be co-owned, or the death proceeds, cash values, or dividends will be split between noncharitable and charitable beneficiaries, no deduction will be allowed. (3)
4. Records must be kept, preferably in the form of canceled checks payable to the charity and/or a receipt from the charity showing the date, amount, and identity of the donor and donee.
5. The gift must exceed any benefit the client receives from the charity. If the client receives a benefit from the charity in conjunction with his gift, the deduction will be limited to the excess of the amount donated over the value of the benefit received from the charity.
HOW IS IT DONE--AN EXAMPLE
Life insurance creates an instant "expanded estate," and in many cases the proceeds can be transferred free of estate tax. If arranged properly, all parties could end up with a greater economic benefit than if life insurance were not used. Below is a more detailed explanation of some of the strategies used to provide for charity through indirect uses of life insurance:
1. A charity can be named as the annual recipient of any dividends received from life insurance. As dividends are paid to the charity, the client receives a current income tax deduction.
2. Dividends from an existing policy can be used to purchase a new policy. The client can name the charity as the owner and beneficiary of the new policy. An income tax deduction is allowed for the premiums paid by the client.
3. A charity can be named as contingent (backup) beneficiary or final beneficiary under a life insurance policy protecting dependents of a client. Should a primary beneficiary predecease the client, the charity will receive the proceeds, assuming the client does not have the opportunity or desire to change the beneficiary. Because the policy itself is never transferred to charity the proceeds are subject to estate tax. However, the proceeds will qualify for the unlimited federal estate tax charitable deduction and will offset the estate tax liability.
4. A charity can be named as the beneficiary of a currently owned or a newly acquired life insurance policy. Although this strategy will not yield a current income tax deduction and the proceeds will be included in the client's gross estate, it will result in a federal estate tax deduction for the full amount of the proceeds payable to charity, regardless of how large the policy.
5. An absolute assignment (gift) of a currently owned life insurance policy can be made to a charity. Alternatively, a new life insurance policy can be purchased and immediately transferred to the charity. Either strategy will yield a current income tax deduction.
6. Group term life insurance can be used to meet charitable objectives. By naming a charity as the (revocable) beneficiary of group term life insurance for coverage over $50,000, a client can make a significant gift to charity while avoiding any income tax on the economic benefit. For example, a 66-year-old executive with an average top tax bracket of 40% who had $1,050,000 of coverage would save $6,096 each year, 40% of the $15,240 annual "Table I cost" (the amount reportable as income). The advantage of this technique was significantly enhanced by the introduction of higher group term rates for individuals over age 65 who receive group term insurance. So the client saves income taxes every year the charity is named as beneficiary. In a later year if the client changes his mind, he can change the beneficiary designation and name a new charity or even a personal beneficiary. Note that the charity must be the sole beneficiary for the entire tax year.
7. Property can be donated directly to a charity and life insurance can be used to replace the wealth that might otherwise have been received by the client's children. For instance, the client, a widow in a 40% combined state and federal income tax bracket, contributes property worth $100,000 to a tax-exempt charitable entity such as Temple University. Assuming the client is entitled to a deduction on the full value of the gift, the $40,000 that she otherwise would have paid in income taxes is instead still available to her. She can choose to give the tax savings from the charitable gift to her child or grandchild who can, in turn, purchase and maintain insurance on her life.
Assume the amount of the insurance is at least enough to make up for the property the heirs would have received had no gift been made to charity. Life insurance takes the place of the net after-tax (and other cost) assets the heirs would have received had no planning been accomplished and had no gift to charity been made. In some cases the heirs will be able to take the tax savings realized by the client and purchase insurance to cover the value of the assets they would have received (after federal and state death taxes) had no gift been made. Here, life insurance is used to guarantee wealth replacement. Alternatively, they could purchase enough insurance to receive what they would have been left by the client had there been no estate tax on the property that was given to charity. In this case, life insurance provides wealth enhancement.
"Wealth Replacement" or "wealth enhancement" are concepts that can be realized in many ways, either during lifetime or at death, and either directly or coupled with a transfer to a charitable trust as illustrated below.
WHAT ARE THE TAX IMPLICATIONS?
The tax implications of using life insurance to benefit a charity include the following:
1. A current income tax deduction is allowed for the transfer of a cash value life insurance policy to a qualified charity. The client will save an amount equal to the value of the deductible gift multiplied by the client's effective tax bracket. For example, a $10,000 gift by a client in a 40% combined federal and state income tax bracket will yield a $4,000 tax savings. This means the cost of the gift is lowered to the amount contributed less the tax savings. In this example, the gift cost $6,000 ($10,000-$4,000).
The deduction for a charitable gift of a life insurance policy is subject to the same limitations as other charitable gifts. (4) One such limitation relates to the amount of a current deduction allowed based on a percentage of the donor's adjusted gross income in that year. (5)
A second limitation is that to be deductible the gift must be total and absolute. An outright gift of all of the incidents of ownership and all rights and benefits in a life insurance policy will be deductible up to the allowable percentage of the donor's income. A gift of less than the client's entire interest in a life insurance policy (or any other asset) will be deductible only if it constitutes one of the following interests: (6)
(a) a remainder interest in a qualified charitable remainder unitrust or annuity trust;
(b) a remainder interest in a pooled income fund;
(c) a charitable gift annuity;
(d) a remainder interest in a personal residence or farm;
(e) a qualified conservation easement;
(f) an undivided portion of the taxpayer's entire interest in property; or
(g) a guaranteed annuity interest or unitrust interest in a charitable lead trust.
In other words, a client can usually deduct the value (as defined below) of a life insurance policy given to charity (or to an irrevocable charitable trust). Furthermore, after a complete and irrevocable gift of the policy, the client can deduct any premiums paid after the transfer of the policy to the charity (or to an irrevocable charitable trust). (7) However, no deduction will be allowed for any portion of the gift unless the client donates to the charity either his entire interest or an undivided portion of his entire interest in the policy. A gift of an "undivided portion" of a policy would include a fraction or percentage of each and every substantial right in the policy. Alternatively, a deduction for a gift of a partial interest in property will be permitted if the partial interest is the client's entire interest in the property. (8)
A gift of the cash value will be considered a transfer of less than the client's entire interest regardless of whether the client (a) retains a continuing right to name some other party as the recipient of the "net amount at risk" (i.e., the pure death benefit), or (b) irrevocably designated the recipient of the death benefit before making the gift of the cash value to charity. (9)
If a client creates a "split-dollar" plan with a qualified charity, under which he contributes to the charity the policy's cash surrender value but designates a noncharitable beneficiary as owner of the death benefit, the IRS will not allow an income tax deduction. (10)
Some flexibility is allowed where the client retains a very limited right that cannot be used for the client's personal benefit. For instance, it appears a client can make a gift of a life insurance policy and reserve the right, exercisable only in conjunction with the donee charity, to add another qualified charity as beneficiary, change the portion of the proceeds one or more qualified charities will receive, or even shift all of the proceeds to another qualified charity. Technically, the IRS has reasoned in such situations that even though the donor shares with the charitable owner of the insurance policy the right to designate other qualified charitable recipients, the donor has still made a charitable gift of any rights he held in the policy and, therefore, the gift is not considered a gift of a partial interest. (11)
Merely naming a charity as the beneficiary of a life insurance policy will not result in an income tax deduction, even if the designation is irrevocable. This follows the rule discussed above that the charity must be given the client's entire interest in the policy. If the charity is named only as beneficiary, regardless of whether that designation is revocable or irrevocable, the policy proceeds will be includable in the client's gross estate. But when the death benefit is paid to the charity, the client's estate will be allowed an offsetting charitable deduction.
There is an important exception to this "all or nothing" rule: an employee who names a charity as the beneficiary of the total death benefit (or at least the entire amount in excess of the first $50,000) under a group term life insurance policy on his life for the entire tax year can exclude from income the value of the otherwise taxable coverage attributable to the charitable portion of the proceeds. (12) This charitable technique can shield considerable amounts from income tax; yet, the client can retain the flexibility to change his mind the following year and name a personal beneficiary. The cost of this exclusion from income taxation is that the term coverage will remain in the client's estate and, unless actually paid at death to the designated charity, will generate federal estate tax.
2. When all incidents of ownership in an existing life insurance policy are donated to charity, the transfer is treated as a gift of "ordinary income" property in the year it is assigned absolutely to the charity. This means the donor must reduce his contribution amount by the gain that would have been realized had he cashed in the policy or sold it. (13) The policy owner will be entitled to a current income tax deduction.
The amount of the deduction for a charitable gift of a life insurance policy is generally the lower of (a) the fair market value of the policy, or (b) the donor's cost basis. (14) Stated another way, where the policy's value at the date of the gift is greater than the net premiums the client has paid, the deduction will be limited to the client's net premiums so in most cases, the donor's deduction will be limited to basis.
Fair market value is dependent on the "replacement cost" of the policy. This depends on which of the following is involved:
Newly Issued Policy--Typically, the deduction for a policy transferred immediately after its issue or within its first year is based on the net (gross premium less dividends, if any) premium payments made by the date of the transfer.
Premium Paying Policy--The deduction value is for the sum of the "interpolated terminal reserve" plus any unearned premium at the date of the gift. The term "unearned premium" is defined as the unexpired payment to the insurer between the date of the gift and the premium due date after the gift. Dividends accrued to the date of the gift are also added. Any loans against the policy are subtracted.
Paid-up or Single Premium Policy--The deduction is based on the single premium the same insurer would charge for a policy of the same amount at the insured's attained age. (15)
If the insured is in impaired health, it could be argued (by both the taxpayer in charitable giving cases and the IRS in non-charitable situations) that adverse health increases the value of the gift to charity. This argument is logical since impaired health to some extent must affect life expectancy. To this point, however, there are no rulings, nor is there a formal IRS position on the subject.
3. Premiums are generally deductible on policies contributed to or owned by charity. Once a policy is donated to or purchased on the donor's life by the charity, subsequent premiums are deductible if (a) paid in cash to the charity or (b) paid directly to the insurer. Cash payments made directly "to" a qualified charity will qualify for a current deduction of up to 50% of the donor's adjusted gross income. The current deduction for premium payments made to the insurer (but "for the use of" charity) may be limited to 30% of the donor's adjusted gross income. The charity could, of course, use other money to pay premiums if the client decided to discontinue contributions.
It makes no difference whether premiums are paid all at once (such as in a single premium policy) or over just a few years (such as in a "vanishing payment" arrangement). The deduction will, nevertheless, be allowed in the year the donor parts with dominion and control over the cash. Note that if the client merely collaterally assigns the policy to the charity as security for a note, premiums he pays on the policy will not be deductible. This makes sense because the charity is not the absolute owner of the policy and the policy could easily end up in the client's hands if he pays off the note.
4. Regardless of the size of the gift of life insurance, no federal gift taxes are payable on transfers to qualified charities, but there is an important qualification, especially where life insurance policies are involved. A gift tax charitable deduction is allowed without limit for an outright transfer of a new or existing life insurance contract but, except in certain defined situations, any deduction will be denied if the transfer is "of less than an entire interest" in the policy. (16)
For instance, your client would not be allowed a gift tax charitable deduction for a gift of a "split-dollar" policy between an individual and a charity. In such situations, the insured's gift of the right to the cash surrender value of the policy is a gift of a "partial interest," less than the donor's entire interest in the property and, consequently, does not meet one of the exceptions that will qualify the gift for a charitable deduction. Note that this disallowance cannot be avoided by having the client make an irrevocable designation of a personal beneficiary before making the gift to the charity.
In addition, if a policy is donated to a charity in a state where the charity has no insurable interest in the insured's life, and the lack of such an interest is deemed to give the insured's estate some rights to control the ultimate disposition of the proceeds, the IRS will disallow the deduction on the grounds that the insured retained an incident of ownership. (17) It would seem that if the charity was the original policy purchaser, even where statutory law gives the insured's estate some right over the ultimate disposition of the proceeds, it could not be said that the insured retained some right since he never had it. But smart planners will avoid the issue and check state law to be sure that insurable interest in the life of the insured is not a problem.
5. If a client holds any incident of ownership in the policy at death, regardless of whether the charity owns the policy or whether a charity has been irrevocably named as the beneficiary of the proceeds, the entire amount of the payment made by the insurer at the insured's death will be subject to federal estate tax in the insured's gross estate. (18) (See Chapter 23 for a discussion of what constitutes an incident of ownership.)
Gifts of life insurance made at death to a qualified charity (as well as those made prior to death to charity that for some reason were brought back into the client's gross estate) are includable in a client's estate, but will receive a federal estate tax charitable deduction. This deduction is unlimited. The policy proceeds could amount to millions of dollars or more and, regardless of how large, could be left to a qualified charity and the estate tax charitable deduction would eliminate the federal estate tax the proceeds would otherwise have generated. (19)
However, even though the estate tax on the insurance paid to charity may be entirely eliminated, there may be a cost. The inclusion of the life insurance may adversely affect the estate's ability to qualify for the benefits of: IRC Section 303 (partial stock redemptions); IRC Section 6166 (installment payments of estate tax); and before 2004, IRC Section 2057 (deduction for qualified family-owned business interest, "QFOBI").
Once again, however, there is an important qualification. As is the case with both the income and gift tax laws, for estate tax purposes the deduction will be disallowed if the entire interest in property is not transferred to the charity. This is due to the fact that if the insured has not given up each and every incident of ownership he owns, he continues to hold a property interest in the policy. This is sufficient to cause estate tax inclusion of the entire proceeds no matter how seemingly small that incident is.
6. If a client assigns all incidents of ownership in a life insurance contract to a charity, and survives for more than three years after the transfer, the policy should be excludable from the donor's estate for federal estate tax purposes.
7. No tax is paid by the charity upon receipt of either a lifetime gift of a life insurance policy or a bequest of a policy at death. Likewise, the payment of premiums by a charity on a policy it owns and is the beneficiary of will not generate a gift tax to the original donor of the policy.
8. Income earned by a charity on assets it owns generally will not be subject to income tax. But as noted below, if a charity borrows policy cash values to finance the purchase of income producing investments, the income produced by these investments may be considered unrelated business taxable income and result in a tax to the otherwise tax-exempt charity. (20)
QUESTIONS AND ANSWERS
Question--What are the advantages of using life insurance as a means of charitable giving?
Answer--There are a number of reasons for using life insurance for charitable giving. These reasons include:
1. The death benefit of a life insurance contract owned by or payable to a charity is a guaranteed, self-completing gift; as long as the insurance is maintained in force by the payment of premiums the charity is assured of the gift. If the client lives, cash values can be used as soon as they are available by the charity for an emergency or opportunity. These cash values will grow constantly year after year. If the client becomes disabled, the policy will remain in full force through the "Waiver of Premium" feature. This guarantees the ultimate death benefit to the charity, as well as the same cash values and dividend buildup that would have been earned had the client not become disabled. Even if the client were to die after only one premium payment, the charity is assured of the full intended gift. This distinguishes life insurance from other intended gifts through which the charity may or may not be the beneficiary, or may or may not receive what has been promised. So, the life insurance gift to the charity provides an immediate certainty rather than a mere expectation.
2. The life insurance gift is fixed in value and is not subject to the risks and price variations of the securities or real estate markets.
3. Aclient who might not otherwise be able to afford a significant gift can magnify the utility of a given number of dollars by leveraging them through life insurance. Through a relatively small fixed and budgetable annual cost (the premium), a significant benefit can be provided for the charity of the client's choice. Furthermore, premiums can be spread out over the client's lifetime, making the payment of the gift less burdensome.
4. Life insurance makes it possible to create a sizable gift without impairing or diluting a family's control over its other investments. Other assets earmarked for the client's family can be kept intact. The charity is benefited while the family's financial security is maintained and, perhaps, enhanced.
5. Life insurance is a cost effective means of making large charitable gifts. Life insurance is transferred free of probate, administrative fees, delays, or any other transfer costs. It is not subject to the claims of present or former spouses, or creditors. The charity, therefore, receives 100% of the money and is more certain of that receipt. This prompt and certain payment should be compared with the payment of a gift to the same charity by will.
6. A gift to charity through life insurance can be completely confidential. Conversely, if publicity is desired, it can be arranged very effectively. The amplified gift can lead to public recognition, if desired. For instance, a charitable organization could establish a Millionaires Club consisting of individuals who donated a policy amounting to $1,000,000 or more.
7. Because of the contractual nature of the life insurance contract, large gifts to charity are seldom subjected to attack by disgruntled heirs.
Question--What are the disadvantages or costs of using life insurance in charitable giving?
Answer--There are certain costs involved in using life insurance for charitable giving. These include:
1. Life insurance requires the payment of a stream of dollars in the form of premiums. Fortunately, if unrestricted cash is given to a charity, which then uses those dollars to pay premiums on a policy insuring the donor (or some other individual), the client will receive a current income tax deduction.
2. Life insurance is typically a gift that will not benefit the charity until some future date. This is particularly true if the policy has not been assigned to or purchased and owned by the charity. Life insurance is not, therefore, the indicated means of providing for a charity that is desperate for cash to meet current operating expenses. (However, any charity that seeks to grow must eventually think of its long-term needs, and the use of life insurance in an effective planned giving program will help to insure the long-term financial stability of the organization.)
Question--Why is the existence of insurable interest important when a client makes a gift of life insurance to a charity?
Answer--Assume your client purchases a policy on her life and donates it to a charity in a state in which the charity has no insurable interest in the client's life. The IRS could argue that under state law the decedent's estate (and therefore her heirs) could claim the policy proceeds in spite of the charity's ownership because the charity has no insurable interest. The IRS could then argue that the client's ostensible transfer of all her rights really gave the charity less than her entire interest in the policy. The IRS would state that even though the donor clearly thought she gave all the interest she actually had, because her estate could claim an interest in the proceeds, she was actually in control of the proceeds. The IRS would then seek to disallow income, gift, and estate tax deductions and include the proceeds in the insured's estate, which would be the worst of all possible tax consequences. (21)
Practitioners must carefully read the precise wording of applicable state law. Under New York law, for example, a charity has an insurable interest only if the insured is the policy purchaser and transferor. (22) The statute does not appear to apply to a transfer where one spouse purchases a contract on the other spouse's life and then assigns it to the charity, nor where the charity itself is the purchaser. Other states (Georgia, for example) provide that any institution that meets the Internal Revenue Code definition of a qualified charity has an insurable interest in the life of any donor.
Question--What is the difference between a gift of a policy directly "to" a charity and a gift of a policy "for the use of" a charity?
Answer--The mechanics of a gift of life insurance to a charity can determine how much is deductible by a client in a given year. Gifts of life insurance are more valuable when they are made directly "to" rather than "for the use of" a charity. For instance, if a client pays premiums to the insurance company on a policy owned by a charity on his life, it is true that he is indirectly helping the charity, but this form of payment of the premiums is deductible as a gift "for the use of" the charity and the deduction in a given year, maximum, will thus be limited to only 30% of the client's adjusted gross income. If the client makes a direct cash gift to the charity, the gift will certainly be deductible up to 50% of his adjusted gross income (assuming the gift is to a public charity). (23)
Direct cash gifts to charity in the form of checks also make it easier for the client to substantiate (a) the fact of the gift, (b) the identity of the charitable donee, (c) the timing of the gift, and (d) that the donee did in fact receive the gift. Direct gifts are therefore less likely to cause an audit or generate litigation, and are the recommended way to secure a deduction for gifts to be used to pay premiums.
Question--What are the advantages of using life insurance as a wealth replacement tool?
Answer--Life insurance used as a wealth replacement tool enables a client to meet both charitable and personal objectives by assuring an immediate and certain gift to charity while also assuring his family that they will receive as much, if not more, than they would have received had no gift been made to charity. Since a qualified charity can sell assets contributed to it without an income tax liability on any gain, a client who lacks liquid assets can make a charitable gift of illiquid assets, while still affording the charity a source of cash through the sale of the assets.
Consider this technique as a way to enable a business owner to harvest the fruits of a lifetime of labor without the penalty and loss of heavy income tax on any gain. Compare, for instance, the retirement income derived, net after taxes, from the sale of a family business with the income derived if the business is donated to a charitable remainder trust. The trustee of the trust could sell the business and pay the donor client an income for life or a term of years with 100% of the sales proceeds since the trust would pay no income tax on any appreciation inherent in the gift. Likewise, consider this technique as a way to enable a highly successful investor to convert taxable gain on an investment portfolio into retirement income without the income tax "slippage" inevitable upon a direct sale.
There are many ways the wealth replacement technique can be employed. One way is to create a charitable remainder trust funded with highly appreciated property that generates a low income yield. The client receives an annuity from the trust (a fixed annuity if the remainder trust is an annuity trust, or a variable annuity if the trust is a unitrust), with the remaining principal going to the qualified charity upon termination of the trust. (24) The advantages of this technique are:
1. The present value of the charity's right to receive the property when the noncharitable beneficiary's interest ends is currently deductible by the client.
2. Even if the property contributed to the trust has built-in gain, no tax on that appreciation is imposed on the client.
3. If, and when, the trustee sells the property, neither the client nor the trust must report any capital gains. However, part of the noncharitable beneficiary's distributions from the trust may be treated as a distribution of capital gain and taxed at the time of distribution.
4. In many cases the client's income from the donated property will be significantly increased because the trustee will have been able to sell the property (at no tax to the trust) and use the net proceeds to invest in higher yielding securities. Had the client sold the property, his net investable amount would have been reduced by the tax on the gain. So, the tax savings as well as the higher return from the new investment enhance the yield from the trust.
A portion of the cash generated by both the client's immediate income tax deduction and from the increased return from the property can be given to the client's intended heirs. The heirs can choose to use that money to purchase insurance on the life of the client (and/or the client's spouse) so that, at the client's death, the wealth passing to charity through the trust is replaced. Note that replacement requires only the net amount that the intended heirs would have received had the client retained the asset, and had that property been subjected to state and federal death taxes and other transfer costs.
Question--How can life insurance combined with gifts of stock to charity help a client keep a family business in the family?
Answer--Life insurance can be used creatively to combine business continuity objectives and charitable goals in a number of ways. For instance, suppose your client wants to benefit charity, provide liquidity for her own estate, and guarantee that no one but her son can obtain the stock. One possible solution is for her to transfer stock to the charity directly. She could make a gift to her son of the income tax savings that the donation of stock generates. He could use those tax savings to purchase insurance on his mother's life and enter into a buy-sell agreement to assure him that at her death he will have the money to buy her out. At some time in the future, the corporation could purchase the stock from the charity after an arm'slength valuation. This provides the charity with cash and returns the stock to the corporation.
Question--Suppose a client has a very large estate and believes that if he gives his children too much when he dies, he will limit their personal growth incentives. Also, he is charitably inclined. If he leaves his entire estate to his children, his charitable objectives will not have been met and estate taxes will consume a large portion of his estate. He also knows that if he leaves his entire estate to charity, his children will have no financial security. How can life insurance be used to solve this problem?
Answer--Life insurance can serve as a partial wealth replacement vehicle to accomplish many or even all of the client's planning goals. Suppose, for example, that the client is in his middle fifties and is extremely wealthy, but has a spouse with a relatively small estate. He would like to leave most of his estate to a charity, but would also like to provide his wife with income for life and to provide each of his four children with roughly $1,000,000 after taxes to help them build their own fortunes.
Here's one way the client can accomplish his objectives using life insurance:
Step 1: The client and his spouse can give as much as $2,000,000 ($1,000,000 gift tax unified credit equivalent for each spouse) away immediately in the form of $500,000 cash gifts to each of their four children. No gift tax is payable on the transfers, assuming the couple has made no taxable gifts in the past. This money is used by each child to purchase a large policy either on the client's life, his spouse's life, on the survivor of the two, or a combination of these. The children own and are beneficiaries of the insurance, none of which will be in the client's estate, and none of which is subject to the claims of the client's (or his spouse's) creditors.
Step 2: Simultaneous with the large cash gifts, the client establishes a testamentary charitable remainder trust that provides that at the client's death prior to his wife, she will receive all the income from the trust for as long as she lives. At her death, all the assets in the trust will pass to her alma mater. The entire estate remaining at the client's death passes into this trust, which entirely eliminates the federal estate tax at his death and provides his wife with significant income for as long as she lives. This technique provides a substantial benefit to the charity as well.
The wealth replacement concept is supported by two factors. First, the four children purchase life insurance for pennies on the dollar. Second, some or all of the premiums are financed by money that otherwise would have been paid in taxes or by income that would not have been enjoyed by the client had he done nothing. In the case of a testamentary charitable gift such as the one in the example directly above, the income of the client's spouse is enhanced by income earned on money that otherwise would have been paid in death taxes.
Question--Why do some professionals refer to the combination of life insurance and a charitable remainder trust as a "Wealth Enhancement Trust"?
Answer--Through a combination of charitable trust planning and life insurance replacement of wealth, beneficiaries may receive more wealth than if no charitable gift were made. This is sometimes referred to as "wealth enhancement" rather than mere "wealth replacement."
Charitable remainder trusts are generally exempt from income taxes. This enables a client to convert highly appreciated property such as stock, real estate, or even a business interest into income-producing assets without the amount of capital being used to produce income being reduced by any capital gains taxes. Thus, the entire value of the property, undiminished by federal or state taxes, is available for investment. The increased income produced (over that which would have been produced had the contributed asset been sold and the after-tax proceeds reinvested) can then be used to pay for wealth replacement life insurance.
For instance, suppose a client is a 60-year-old widow with five children. Assume she is in the 40% combined state and federal income tax bracket and in a 45% estate tax bracket. One of her assets is a $1,000,000 parcel of undeveloped land she bought for $100,000 many years ago. She wants to perpetuate the memory of her late father. However, she needs additional income for retirement and wants to be sure her children, one of whom is handicapped, have sufficient financial security at her death.
If she does nothing, the client's five children will receive only $550,000 of her $1,000,000 parcel of land. Federal death taxes alone will consume the other $450,000 of the asset. Under this scenario, the charity will receive nothing. Alternatively, the client could transfer the land to a charitable remainder annuity trust or unitrust (a CRAT or CRUT). Assume she retains an annuity or unitrust interest for life with an annual percentage payout of 5.3%. In the case of a CRAT, she will receive a fixed annuity of $53,000 per year (.053 x $1,000,000) for life. In the case of a CRUT, she will be paid $53,000 in the first year and a future annuity of 5.3% of the value of the trust funds as revalued at the beginning of each year, with payments continuing for as long as she lives.
Assume that the most favorable IRC Section 7520 rate allowable is 5.0%. (25) If she sets up a CRAT, she will receive a $370,620 income tax charitable deduction. See Figure 28.1. If she sets up a CRUT, she will receive a $371,520 deduction. See Figure 28.2.
The charitable gift to the CRAT would result in an income tax savings of $148,248 (0.40 x $370,620). This is about 14.8% of the transfer to trust ($148,248 +- $1,000,000). The charitable gift to a CRUT would result in an income tax savings of $148,608 (0.40 x $371,520). This is about 14.9% of the transfer to trust ($148,608 ?*? $1,000,000).
Note that the client's return in either case is based on the entire value of the capital contributed to the charitable trust ($1,000,000), rather than what it would have been if she sold the land for $1,000,000, paid income taxes of $135,000 [15% capital gain tax rate on the $900,000 ($1,000,000 amount realized - $100,000 basis)] of gain on the land], and invested the $865,000 ($1,000,000 sales proceeds--$135,000 tax) difference. The result can be a significantly higher return.
The client then transfers (a) income tax deduction generated savings (26) and/or (b) a portion of the income retained from the charitable remainder trust as a gift to one or more individuals. They, in turn, could use that money to purchase insurance on her life to replace the wealth transferred to the charitable trust and enhance the net after-tax wealth they would have received.
The major advantage is that the client receives an immediate income tax deduction for the present value of what the charity will someday receive. The tax savings is then given to a personal beneficiary who purchases life insurance on the life of the client, the client's spouse, or the survivor of the two, in order to replace the wealth provided to charity. Because the insurance is not in the client's estate, it is not subject to state and federal death taxes and is exempt from the claims of the client's creditors.
Question--How high a payout can be taken from a CRAT or CRUT?
Answer--The annual payout to the noncharitable beneficiary must be at least 5% and not exceed 50% of (a) the initial fair market value of the property contributed to the trust (in the case of a charitable remainder annuity trust), or (b) the net fair market value of the trust's assets determined at least annually (in the case of a charitable remainder unitrust).
In addition, the value of the remainder interest in a charitable remainder trust must be a least 10% of the value of assets contributed in the trust. In the case of a CRAT, the value of the remainder interest must be at least 10% of the initial fair market value of all property placed in the trust; in the case of a CRUT, the 10% requirement applies to each contribution of property to the trust. The value of the remainder interest in either event is calculated using the IRC Section 7520 interest rate, which is published monthly by the IRS.
In the event that an additional contribution is made to an existing CRUT that does not meet the 10% remainder interest requirement, it will not cause the trust to cease being treated as a CRUT, but it will be treated as a transfer to a separate trust that is not a CRUT. (27)
Question--How can a "last-to-die" policy be used in conjunction with a joint and survivor charitable remainder trust?
Answer--In many cases the client will be married and will wish to provide financial security beyond his death for his surviving spouse's life. Here, planners should consider a joint and survivor charitable remainder trust that provides an annuity or unitrust amount to the client and his spouse for life. After the death of one spouse, the annuity or unitrust amount will continue to be paid to the surviving spouse. Upon the death of the surviving spouse, the trust assets will then be paid to the charity. Because of the federal estate tax marital deduction, at the first spouse's death, there should be no federal estate tax imposed on the present value of the annuity that continues for the surviving spouse's life. Using the same annuity trust and unitrust examples as presented above, and assuming the client is 60-years-old and has a 58-year-old spouse, the calculations would be as shown in Figure 28.3 for a CRAT and Figure 28.4 for a CRUT.
Note that the charitable deduction for the remainder interest is reduced when the value of the noncharitable payout is increased by making payouts for two lives, rather than just for one life. In the case of a CRAT, the deduction is reduced from $370,620 (one life) to $240,266 (two lives). In the case of a CRUT, the deduction is reduced from $371,520 (one life) to $247,450 (two lives).
Since the client's federal estate tax liability on assets not in the charitable remainder trust will not be triggered until the second spouse's death, insurance placement can be more flexible. A policy can be purchased on the client's life, his spouse's life, or a last-to-die policy can be purchased on the lives of the couple since it will not be until the proceeds are payable under this latter policy that estate taxes will be due and the income from the charitable remainder trust will stop.
Question--What are the income tax consequences of a charitable gift of an annuity?
Answer--A charitable gift of an annuity issued after April 22, 1987, whether the gift occurs in the year of maturity or before it matures, will result in the immediate recognition of gain. When the donor gives the contract to charity, it is treated for income tax purposes as if he surrendered it. Reportable gain is equal to the excess of (a) the cash surrender value at the time of the gift over (b) the client's investment in the contract. But in return, since the client must currently recognize the gain as ordinary income, that amount becomes part of the client's basis and so the entire value of the annuity given to charity is fully deductible. (28)
Question--If a policy subject to a loan is donated to a charity, what problems arise as a result of the contribution?
Answer--A gift of a life insurance policy subject to a loan may, in certain circumstances, cause significant tax problems including: (1) generating taxable income to the donor under the bargain sale rules; (2) generating taxable income to the charity under rules relating to charitable unrelated business taxable income; and (3) imposing excise tax penalties under the charitable prohibited transaction rules.
1. Bargain Sale Problem--When encumbered property is contributed to a charity, the donor is treated as if he cashed in the policy, received an amount equal to the loan as reportable income, and made a gift of the difference. (29) Technically, bargain sale rules apply and treat the contribution as two separate transactions: (a) the client is treated as if he sold part of the policy to the charity with the charity paying him an amount equal to the loan; and (b) the client is then treated as if he made a gift of the net value of the policy to the charity.
2. Unrelated Business Taxable Income (UBTI) Problem--All tax-exempt organizations, including charities, are treated as if they are taxable to the extent they receive UBTI. Essentially, UBTI is income received by the tax-exempt organization or entity that is unrelated to its tax-exempt purpose. (30) However, the definition of UBTI also includes debt-financed income. This is income generated through borrowing on a charity owned asset to finance the purchase of another income-producing asset. (31) If a charity borrows against the cash values of a life insurance policy in order to buy income producing assets, the IRS may classify the income produced by the new investment as debt-financed income. The income produced by the new investment may be considered unrelated business taxable income and taxed to the charity at corporate tax rates.
For instance, assume a private foundation owned and was the beneficiary of life insurance policies with cash values in excess of $2,000,000. Assume further that the foundation borrows against the cash surrender at about 5% and finds a way to invest the borrowed funds in marketable government securities yielding more than 10%. The IRS, in such a situation, would argue that the income from the newly purchased marketable securities was passive income generated from debt-financed property and, thus, UBTI.
The solution is simple: charities should borrow against the cash surrender values of life insurance policies only for cash needs of the charity, and not to invest in other income-producing assets. For instance, there should be no problem if the charity in the example above borrowed $2,000,000 from policies it owned to finance the purchase of a new building to provide care for disabled children.
With the advent of interest sensitive, variable, and universal life contracts, borrowing from a life insurance policy by a charity to achieve current rates of return is no longer necessary. Most importantly, life insurance owned on many lives by a charity can serve as a "money pump" to deliver millions of dollars to an important charity.
3. Prohibited Transaction Problem--This problem relates only to transfers of encumbered policies to private foundations (organizations that receive a significant part of their support from one or more specific sources, rather than from the general public). Gifts to private foundations are subject to harsh and complex "prohibited transaction" rules intended to prevent the abuse of their tax-exempt status by related parties.
These abuses include:
(a) self-dealing between the entity and certain disqualified persons (including the donor); (32)
(b) holding more control of a closely held corporation or unincorporated business than a Code specified maximum; (33) and
(c) the purchase and maintenance of investments that jeopardize the exempt purpose of the charity (so-called "jeopardy" investments). (34) (Unfortunately, many of these same rules may also apply to transactions between related parties and charitable lead trusts or charitable remainder trusts.)
Certain gifts to a private foundation of life insurance subject to a policy loan have been held to violate the prohibitions against self-dealing and jeopardy investments. Prohibitions against self-dealing, particularly where the client who sets up the foundation gains an unfair advantage from his dealing with the trust at taxpayers' (federal treasury) expense, can result in severe tax consequences. Any lending of money from the foundation to the donor, and most sales or exchanges of property as well as transfers of mortgaged property, could trigger a self-dealing excise tax penalty.
Where does a life insurance policy subject to a loan fit into this set of rules? Assume the client gives a life insurance policy on his life to a private foundation. Assume further that the policy was subject to a loan. The client, as a donor, would be considered a "disqualified person" by the IRS. This means he is prohibited from engaging in certain related-party transactions with the foundation. According to the IRS, a private foundation commits a prohibited act of self-dealing if it takes an asset subject to a mortgage or similar lien that a disqualified person placed on the property within the 10-year period ending on the date of the transfer. So in the example, the IRS could treat the policy loan as a mortgage or similar lien for purposes of applying the excise tax on acts of self-dealing in private foundations. The IRS might characterize the client's relief from the loan by the foundation as an act of self-dealing and impose prohibited transaction penalty taxes.
Generally, the problems described in this question will rarely occur when competent counsel is present and the policy in question is financially sound. Note also that it is not life insurance, per se, which causes the problem, but rather the acceptance and payment by the foundation or trust of the donor's debt and obligation to pay interest and principal on the policy loan. If there is no policy loan and the insurer is financially sound, there should be no problem with life insurance.
Question--What is a DAG?
Answer--DAGs (Directors' Amplified Gifts) are a way that a responsible, charitable-minded corporation can meet multiple objectives with a single estate planning technique. Suppose a client owns the Financial Data Center (FDC), a highly successful firm marketing financial and estate planning software and brochures. The FDC is in a combined federal and state tax bracket of 40%. Assume that the FDC has actively sought out some of the brightest and most creative minds in the country to serve on its board of directors. Their insight and guidance has helped the FDC grow even faster and more soundly than its competitors. The client would like to solve a recruiting problem with respect to new board members. There are several problems the client has discussed with you and asked you to consider:
(a) Small cash payments to directors are almost meaningless after taxes are considered.
(b) Large cash payments may be frowned upon by shareholders.
A potential solution, the DAG, works like this:
(a) The FDC corporation sets up a DAG. Each director, in addition to normal director's fees and perks, is allowed to select the charity of his choice as the recipient of between $250,000 and $1,000,000 to be paid to a designated charity in honor of the director at death.
(b) To finance the employer's obligation under the plan, the corporation becomes owner and beneficiary of life insurance on the life of each covered director. The policy could be regular whole life or a second-to-die policy in order to lower outlay or cover unhealthy directors more easily. Premiums are designed to vanish before the director's term of service expires.
(c) At a director's death, the corporation receives the proceeds free of income tax (except for any possible corporate level AMT).
(d) The corporation then leverages the cash by making a deductible corporate contribution to the charity of the director's choice. A corporation in a 30% combined federal and state income tax bracket, for example, could take in $100,000 and pay out $142,857 using the formula below
BEFORE DEDUCTION PROCEEDS / (1-Combined Tax Bracket)
If the FDC is in a combined state and federal income tax bracket of 40%, and if it receives a net of $100,000 of life insurance proceeds, it could afford to pay out about $166,667 to charity. ($100,000/(1-.40)). This $66,667 amount in excess of the $100,000 of insurance proceeds is the amplified portion of the DAG. Alternatively, the proceeds could be used to reimburse the corporation for an accelerated charitable contribution made on a prior date.
There are a number of advantages to the DAG:
1. The size of the amplified gift is so large that it has appeal even to the most successful and well-paid directors. It makes possible a truly significant statement and carries a large psychological benefit.
2. Despite the size of the gift to charity and the great honor and memorial it will provide after death, as well as the continuing psychological benefit during lifetime, the director so honored is at no time taxable on the corporation's payment of premiums, nor is the director's estate taxable on the actual payment.
3. There is no out-of-pocket cost to the director.
4. The director has great flexibility and can change the charitable recommendation at any time since the charity is given no direct interest in the corporate-owned insurance, or in any other assets the employer may use to support the plan.
5. The corporation can deduct (up to the corporate limits for charitable contributions) payments it makes to the charity. This can be used to lower the cost of the plan or increase the amount going to charity. If corporate tax rates rise in later years, the leverage of the plan increases.
6. In the authors' opinion, the program does not require disclosure under current SEC regulations.
7. A DAG tremendously enhances the corporation's charitable image and multiplies the utility of corporate dollars. It receives a large return in the form of favorable public relations, even before it makes the first payment to charity, through the charity's anticipation of the gift.
8. This technique may be more cost efficient in recruiting and retaining top-level directors than a less affordable pay increase to directors. Under a DAG, if a director leaves before the expiration of his term, no payment need be made and the corporation can retain the insurance coverage and apply it against future charitable contributions on behalf of other directors.
9. A DAG can be used not only by a large public corporation but, because it is simple and inexpensive to establish and maintain, even small firms can use the concept to achieve the same goals as corporate giants.
Life insurance financing is so essential because it is not possible to accurately predict the timing of the donations (i.e., date of deaths of directors), and a nonfinanced plan could have a significant negative impact on earnings if more than one director died in a single year. Life insurance enables a corporation to favorably describe the arrangement in the firm's financial (and/or proxy) statement and plan for payment through predictable and relatively small corporate outflows in the form of premium payments.
Question--Is it appropriate to contribute a life insurance policy to a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT) rather than directly to a charity?
Answer--In the opinion of the authors, generally, neither a CRAT nor a CRUT should be the transferee of a life insurance policy. One reason that a client should not contribute life insurance to such a trust is that both trusts are required to make steady payouts of annuities to the client (and/or some other party in many cases). Adding life insurance to the trust will further drain the trust's cash flow and leave less money for the required annuity payouts.
It is clear that a charitable remainder trust can be named recipient of a life insurance policy's proceeds if the trust is a unitrust created during either the client's lifetime or under the client's will. But because charitable remainder annuity trust rules do not allow contributions after the date the trust is originally created and funded, a CRAT cannot be named as recipient of life insurance proceeds.
Question--What is the alternative minimum tax (AMT) and how does it impact on charitable giving?
Answer--The AMT is a tax designed to assure that individuals who pay little or no regular income tax, because they have taken advantage of certain exclusion, deduction, and credit obtaining techniques called "preferences," will pay at least this minimum tax. Ironically, many of these preferences are in reality tax incentives designed to encourage taxpayers to take certain risks or make certain investments or contributions that are deemed to be in the public interest. So, on the one hand, Congress encourages the action and, on the other hand, it seeks to discourage the same pattern of behavior by diminishing the tax benefits for the same action.
For tax years beginning before 1993, the major preference item in terms of charitable giving was a contribution of appreciated property. Specifically, the unrealized gain inherent in a gift of long-term capital gain property was considered a preference item for purposes of the AMT. However, for taxable years beginning after 1992, a charitable contribution of appreciated property is no longer treated as a tax preference. As a result, if a taxpayer makes a gift to charity of long-term capital gain property that is real property, intangible property, or tangible personal property, the use of which is related to the donee's tax-exempt purpose, the taxpayer is allowed to claim a deduction for both regular tax and AMT purposes in the amount of the property's fair market value (subject to applicable percentage limitations). (35)
Since life insurance is an ordinary income type asset and a donation of life insurance is not considered a preference item, and since the receipt of insurance proceeds will not be taxable in any way to the charity, it does not present AMT problems in and of itself.
Question--What is charitable split dollar (and charitable reverse split dollar)? (36)
Answer--In both of these arrangements, donors use a charity as a conduit to purchase large amounts of life insurance on a tax-deductible basis. The plans mimicked a similar corporate split dollar technique and while the strategy may or may not have worked under insurance law, it violated several aspects of charity law, in particular private benefit rules.
The IRS effectively shut down this technique with IRS Notice 99-36, and Congress imposed harsh penalties for becoming involved in such plans by enacting legislation in December, 1999 that makes it clear that no deduction is (or was) allowed for the donation of a personal benefit contract. (37) Current law defines a "personal benefit contract" as "any life insurance, annuity, or endowment contract if any direct or indirect beneficiary under such contract is the transferor, any member of the transferor's family, or any other person (other than [certain charitable organizations]) designated by the transferor." Charities that continue to pay premiums on personal benefit contracts must report all payments made after February 8, 1999 to the IRS on Form 8870 and must pay a 100% excise tax on all premiums paid after December 17, 1999.
Because the legislation that was passed in December 1999 made it clear that charitable split dollar and charitable reverse split dollar never did give rise to an income tax deduction, it is possible that some of the charities involved will face legal suits and may even lose their tax-exempt status as a result of their participation in promoting or agreeing to implement these programs.
Question--What is "financed" charitable life insurance? (38)
Answer--This is a technique that is also growing in popularity in the non-charitable marketplace. To summarize, the charity takes out a loan from a bank to pay premiums on a pool of insurance contracts. The death benefits, or in some cases other assets of the charity, are used as collateral for the cumulative loan. This planning is problematic in several ways. Depending on the circumstances, it may trigger unrelated business taxable income, and if the policy does not perform as well as projected, the underlying contract could lapse and the charity would be forced to repay a substantial cumulative loan plus interest with nothing to show in return. Such planning should be considered highly speculative and be scrutinized carefully by legal counsel.
Practitioners are cautioned to carefully evaluate the actual performance of the policies and the economic viability of the overall strategies. The more money borrowed, the greater the risk the client is taking and the higher the cost--because the ultimate loan balance must be paid either out-of-pocket during the insured's lifetime or from death proceeds. If the intent is to pay the loan off at death, then sufficient additional death proceeds must be purchased to satisfy the obligation and still have enough proceeds to accomplish the objective of the insurance. If premium financing is used to support a large life insurance contract, it is suggested that advisors borrow as little as possible, keep the duration of the loan relatively short, consider worst case scenarios, and develop an "exit strategy"' before implementing the plan. Constant monitoring of policy performance and disclosure of the cost and risk to the client are essential. (39)
Question--What are the substantiation rules for a charitable gift of life insurance?
Answer--The rules are explained as follows:
Value and Form of Gift
Deduction Disallowed Unless
$250 or greater:
The charity provides the donor with a contemporaneous written acknowledgement of the contribution stating the amount of cash or non-cash property received and the value of any consideration provided by the charity to the donor in return for the gift.
More than $250, but less than $5,000:
Same as above, plus the donor must complete IRS Form 8323, which provides the charity's name, address, description of property, how and when the donor acquired the property, basis, FMV, and method by which the property was valued.
$5,000 or more
A "qualified appraisal" must be obtained (under IRC Section 170(f)(11)(E)). Neither the donor nor the insurance agent (or insurer who issued the policy) can perform this appraisal.
Question What are IOLI, CHOLI, FOLI, and SOLI?
Answer--"In the context of charitable planning, these are all variations of the same plan. In Investor Owned Life Insurance (IOLI), a group of policies are established on the lives of the charity's wealthier donors. The charity (or a trust controlled by the charity) purchases the policies and pays the premiums, sometimes using a financing or bond program arranged for by the plan promoter, for a minimum of two years. At the end of that period, the charity sells the policies to an investor or investor group. Since the investors could not otherwise purchase these policies directly, the charity effectively is renting out their insurable interest to benefit this investor group. CHOLI stands for Charity Owned Life Insurance, FOLI is Foundation Owned Life Insurance, and SOLI is Stranger Owned Life Insurance.
Many of these plans vary in how they are established--the source of the premiums, the arrangement for the charity to keep or sell the policies at the end of the contestability period, and so on--but in the long run, the result will be the same. The Senate Finance Committee has proposed a 100% excise tax on all costs involved in these transactions, and while this legislation has not yet passed into law, restrictive legislation in some form is almost certainly to be passed in the near future.
To gather information to better form this future legislation, the Pension Protection Act of 2006 imposed a two-year reporting requirement on all charities that have entered into arrangements where life insurance interests are in anyway split between the charity and private investors. Furthermore, the Treasury Department has been charged with assembling a report to Congress detailing whether these plans are suitable for a charity's tax exempt purpose." (40)
(1.) See Stephan R. Leimberg, Tools & Techniques of Charitable Planning (The National Underwriter Company, 2001), Ch. 2.; Stephan R. Leimberg, Tools & Techniques of Estate Planning (The National Underwriter Company, 14th ed. 2006), Ch. 32.
(2.) A corporate charitable contribution paid on or before March 15 will be treated as paid in the prior taxable year if the corporation's board authorizes the contribution in that prior year and makes an appropriate election. IRC Sec. 170(a)(2).
(3.) IRC Sec. 170(f)(10); Tax Relief ExtensionAct of 1999 (P.L. 106-170); Notice 99-36, 1999-1 CB 1284. See also Addis v. Comm., No. 02-73628 (9th Cir. 2004), aff'g, 118 TC 528 (2002), and Winer v. Comm., TC Memo 2002-153 (involving deductions taken in 1997 and 1998--before the enactment of IRC Sec. 170(f)(10) on December 17, 1999--and denying the charitable income tax deduction on the basis of failure to meet the substantiation requirements of IRC Section 170(f)(3)).
(4.) See IRC Sec. 170.
(5.) IRC Sec. 170(b). The amount of charitable contributions that can be deducted for federal income tax purposes in a given year is limited by the Code. Technically, there exist percentage limitations of 30% and 50% of the donor's "contribution base", essentially adjusted gross income without considering loss carrybacks. The 50% limit is reserved for cash type gifts to hospitals, schools, mosques, synagogues, and churches, and other publicly supported charities. Most gifts of property to public charities as well as contributions "for the use of" charity are subject to a 30% limit. A 20% limitation is imposed where the contribution consists of appreciated capital gain property donated to private foundations.
(6.) IRC Secs. 170(f)(2), 170(f)(3).
(7.) See Eppa Hunton IV v. Comm., 1 TC 821 (1943); Behrend v. Comm., 23 BTA 1037 (1931).
(8.) Treas. Regs. [section][section]1.170A-7(a)(2)(i); 1.170A-7(b)(1).
(9.) Rev. Rul. 76-143, 1976-1 CB 63.
(10.) IRC Sec. 170(f)(10); Tax Relief ExtensionAct of 1999 (P.L. 106-170); Notice 99-36, 1999-1 CB 1284. See also Addis v. Comm., No. 02-73628 (9th Cir. 2004), aff'g., 118 TC 528 (2002), and Weiner v. Comm., TC Memo 2002-153 (involving deductions taken in 1997 and 1998--before the enactment of IRC Sec. 170(f)(10) on December 17, 1999--and denying the charitable income tax deduction on the basis of failure to meet the substantiation requirements of IRC Section 170(f)(3)).
(11.) See Let. Rul. 8030043.
(12.) IRC Sec. 79(b)(2)(B).
(13.) IRC Sec. 170(e)(1)(A).
(14.) See Behrend v. Comm., 23 BTA 1037 (1931); Tuttle v. U.S., 305 F. Supp. 484 (1969), rev'd on other grounds, 436 F.2d 69 (2nd. Cir. 1970).
(15.) See Treas. Reg. [section]25.2512-6.
(16.) IRC Secs. 2522(a), 2522(c).
(17.) See Let. Rul. 9110016, which was revoked by Let. Rul. 9147040 because of a retroactive change in the statutory law of the taxpayer's state of residence.
(18.) IRC Sec. 2042.
(19.) IRC Sec. 2055.
(20.) See IRC Sec. 511(a).
(21.) See Let. Rul. 9110016 for a description of the adverse tax consequences associated with such gifts in states where charities do not have an insurable interest in donors' lives. Letter Ruling 9110016 was revoked by Let. Rul. 9147040 after legislation was passed granting charities insurable interests by the state in which the gift occurred.
(22.) Note that some states are currently considering modifying their insurable interest statues to permit charities to assign their insurable interest to outside investors. For more information, see the testimony of JJ McNab, CFP, CLU, QFP, before the Senate Finance Committee in the hearing, "Charity Oversight & Reform: Keeping Bad Things from Happening to Good Charities," held on June 22, 2004, at: http://finance.senate.gov/hearings/testimony/2004test/062204jmtest.pdf.
(23.) IRC Sec. 170(b)(1). There are cases that seem to imply that even payments made directly to the insurer on the charity's behalf will qualify for the larger current deduction. The authors suggest the more conservative and certain approach of the donor writing a check to the charity, and the charity writing its check to the insurer. This approach makes an IRS audit less likely, especially if the amount of the check is rounded upward (e.g., an $1,895 premium is rounded to $2,000), and makes compliance with an IRS audit a much easier process.
(24.) See Stephan R. Leimberg, Tools & Techniques of Estate Planning (The National Underwriter Company, 14th ed. 2006), Ch. 33.
(25.) In the case of charitable deductions, the client can choose either the current month's IRC Section 7520 rate, or look back to either of the two prior months' rates and select the most favorable of the three. By waiting until the date the IRC Section 7520 rate is announced by the IRS (usually between the 18th and 21st of the month), the client can determine which of four months' rates is most favorable. The IRC Section 7520 interest rate is published at www.taxfactsonline.com as it becomes available.
(26.) An income and gift tax charitable deduction is allowed for the present value (measured actuarially) of the charity's right to someday receive what remains in the trust (i.e., the donor is given an immediate deduction for the value of the charity's remainder interest in the trust). That present value is computed using the monthly varying federal discount rates under IRC Section 7520.
(27.) IRC Sec. 664(d). More extensive information on charitable trusts can be found in Stephan R. Leimberg, Tools & Techniques of Charitable Planning (The National Underwriter Company, 2001).
(28.) See Treas. Reg. [section]1.170A-4(a).
(29.) See Treas. Reg. [section]1.1011-2(a)(3).
(30.) See IRC Secs. 511, 512.
(31.) See IRC Sec. 514.
(32.) See IRC Sec. 4941.
(33.) See IRC Sec. 4943.
(34.) See IRC Sec. 4944.
(35.) See, generally, IRC Sec. 57(a)(6).
(36.) Adapted from Stephan R. Leimberg, Tools & Techniques of Charitable Planning (The National Underwriter Company, 2001), p. 114.
(37.) IRC Sec. 170(f)(10); Tax Relief ExtensionAct of 1999 (P.L. 106-170); Notice 99-36, 1999-1 CB 1284. See also Addis v. Comm., No. 02-73628 (9th Cir. 2004), aff'g., 118 TC 528 (2002), and Weiner v. Comm., TC Memo 2002-153 (involving deductions taken in 1997 and 1998--before the enactment of IRC Sec. 170(f)(10) on December 17, 1999-and denying the charitable income tax deduction on the basis of failure to meet the substantiation requirements of IRC Section 170(f)(3)). For commentary on charitable split dollar, see www.leimbergservices.com.
(38.) Adapted from Stephan R. Leimberg, Tools & Techniques of Charitable Planning (The National Underwriter Company, 2001), pp. 114-115.
(39.) For more information, see Lawrence L. Bell, "Charities and Insurance: The Next Big Thing," Steve Leimberg's Estate Planning Newsletter No. 671) at: htpp://www.leimbergservices. com; Michel Nelson, "Insurance Interest Under Siege, Steve Leimberg's Estate Planning Newsletter No. 670 at: http://www.leimbergservices.com; Stephan Leimberg and Albert Gibbons, "TOLI, COLI, BOLI, and Insurable Interests--an Interview with Michel Nelson, Estate Planning (July 2001), p. 333; Stephan Leimberg and Albert Gibbons, "Premium Financing: The Last Choice--Not the First Choice," Estate Planning (January 2001), p. 35. See also the testimony of JJ McNab, CFP, CLU, QFP, before the Senate Finance Committee in the hearing, "Charity Oversight & Reform: Keeping Bad Things from Happening to Good Charities," held on June 22, 2004, at: http://finance.senate.gov/hearings/testimony/2004test/062204jmtest.pdf.
(40.) From Stephan R. Leimberg, Tools & Techniques of Charitable Planning, Chapter 13, Charitable Uses of Life Insurance, (The National Underwriter Company, 2nd edition to be released 2007). See also Leimberg, Stephan. "Stranger Owned Life Insurance (SOLI): Killing the Goose that Lays Golden Eggs," Estate Planning, January 2005.
Figure 28.1 CHARITABLE REMAINDER ANNUITY TRUST (One Life--Table 90CM) Transfer to Trust: $1,000,000 Age: 60 Payments: End of Period Check Possibility Charity Will Not Receive Interest Annuity Factor Exhaustion: 18.8679 Mortality L(119): 0 Possibility: 0.0% Check Exhaustion of Trust Fund Ann. Factor (50 years, 5.0%): 18.2559 Annuity Test Value: $967,563 Valuation Ann. Factor (Age 60, 5.0%): 11.8751 Annuity Value: $629,380 Annuity Payment: $53,000 Frequency of Payments: Annual Section 7520 Interest Rate: 5.0% Years to Exhaust Trust: 59 Mortality L(60): 85537 5% or Less Possibility Test Passed Adj. Factor (Annual, 5.0%): 1.0000 Special Factors: Not Required Adj. Factor (Annual, 5.0%): 1.0000 Charitable Contribution: $370,620 Source: Trust Calculator (part of The Ultimate Trust Resource, a National Underwriter Company publication) Figure 28.2 CHARITABLE REMAINDER UNITRUST (One Life - Table 90CM) Transfer to Trust: $1,000,000 Unitrust Payout 5.3% Rate: Age: 60 Frequency of Annual Payments: Months Until First Payment: 0 Section 7520 5.0% Interest Rate: Adjusted Payout Rate Factor (Annual, 0 months, 5.0%): 1.000000 Adjusted Payout Rate [5.3% x 1.000000]: 5.30% One Life Unitrust Remainder Factor (Age 60, 5.2%): 0.37761 One Life Unitrust Remainder Factor (Age 60, 5.4%): 0.36542 Difference [.37761-.36542]: 0.01219 Interpolation Adjustment (5.300%): 0.00609 Unitrust Remainder Factor [.37761-.00609]: 0.37152 Charitable Contribution [$1,000,000 x .37152]: $371,520 Unitrust Value [$1,000,000-$371,520]: $628,480 Figure 28.3 CHARITABLE REMAINDER ANNUITY TRUST (Two Lives--Table 90CM) Transfer to Trust: $1,000,000 First Age: 60 Frequency of Payments: Annual Section 7520 Interest Rate: 5.0% Check Possibility Charity Will Not Receive Interest Annuity Factor Exhaustion: 18.8679 Mortality L(119): 0 Mortality L(117): 0 Possibility: 0.0% Check Exhaustion of Trust Fund Ann. Factor (52 years, 5.0%): 18.4181 Annuity Test Value: $976,159 Valuation Ann. Factor (60, 58, 5.0%): 14.3346 Annuity Value: $759,734 Annuity Payment: $53,000 Second Age: 58 Payments: End of Period Years to Exhaust Trust: 59 Mortality L(60): 85537 Mortality L(58): 87397 5% Possibility Test Passed Adj. Factor (Annual, 5.0%): 1.0000 Special Factors: Not Required Adj. Factor (Annual, 5.0%): 1.0000 Charitable Contribution: $240,266 Source: Trust Calculator (part of The Ultimate Trust Resource, a National Underwriter Company publication) Figure 28.4 CHARITABLE REMAINDER UNITRUST (Two Lives--Table 90CM) Transfer to Trust: $1,000,000 Unitrust Payout Rate 5.3% First Age: 60 Second Age: 58 Frequency of Payments: Annual Months Until 0 First Payment: Section 7520 Interest Rate: 5.0% Adjusted Payout Rate Factor (Annual, 0 months, 5.0%): 1.000000 Adjusted Payout Rate [5.3% x 1.000000]: 5.30% Two Life Unitrust Remainder Factor (Age 60, Age 58, 5.2%): 0.25364 Two Life Unitrust Remainder Factor (Age 60, Age 58, 5.4%): 0.24125 Difference [.25364-.24125]: 0.01239 Interpolation Adjustment (5.300%): 0.00619 Unitrust Remainder Factor [.25364-.00619]: 0.24745 Charitable Contribution [$1,000,000 x .24745]: $247,450 Unitrust Value [$1,000,000-$247,450]: $752,550
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|Title Annotation:||PART II TECHNIQUES|
|Publication:||Tools & Techniques of Life Insurance Planning, 4th ed.|
|Date:||Jan 1, 2007|
|Previous Article:||Chapter 27: Buy-sell agreements.|
|Next Article:||Chapter 29: Death benefit only (DBO) plan.|