Planned Charitable Giving
David K. Walser, CPA
The tax code provides a number of incentives for supporting charitable causes. Some of these incentives allow a current income or transfer tax deduction for gifts that may not fully benefit charity until some time in the future. This article examines some of these deferred charitable giving techniques.
Charity begins at home.
Before the advent of § 401(k) plans, most of the typical middle-class taxpayers’ wealth was tied up in their homes. Having such a large portion of their net worth tied up in an illiquid asset, such as a home, made it difficult for charitably minded taxpayers to act on their charitable intentions. Congress came to the rescue with § 170(f)(3)(B)(i), which allows a deduction for a contribution of a remainder interest in a personal residence or farm. The value of the deduction is computed using standard IRS tables for income and remainder interest factors.
Example: Bob and Betty Lou live close to the local university where Betty Lou taught before retiring a few years ago. The couple does not have any children and they would like to leave their “excess” assets to charity upon their deaths. Their home is currently worth $400,000. The couple gives the university a remainder interest in their home. Using the appropriate § 7520 rate (currently 5%) and Bob and Betty Lou’s ages (both are 70), Bob and Betty Lou would receive a current deduction of $171,824 on their income tax return. After both Bob and Betty Lou have died, the university will take possession of the home and may use it or sell it.
Note: The remainder interest cannot be made in trust. This can make it difficult for Bob and Betty Lou to move into a new house.
Promising not to do what you don’t plan to do anyway.
As a general rule, taxpayers must give away their entire interest in an asset in order to claim a charitable contribution deduction. One of the exceptions to this rule, for remainder interests in personal residences and farms, is discussed above. Another exception, for “qualified conservation contributions”, is discussed here: A qualified conservation contribution is a contribution of a “qualified interest in real property” made to a “qualified charity” exclusively for “conservation purposes” that restricts the ability to use the property for some purposes or to make certain changes to the property. (See § 170(f)(3)(B)(iii) and the regulations there under.)
Example: For several years, Joaquin and Rosalinda have been farming land Rosalinda inherited from her grandfather. The land is outside a major metropolitan area that is slowly growing toward them. The couple would like to keep the farm in their family, as a farm. Joaquin and Rosalinda grant a conservation easement (a qualified interest in real property) to a local agricultural preservation trust (a qualified charity). The easement prohibits future development of the farm land into home sites or into anything other than a farm. The trust will enforce the easement’s restrictions and the trust has the wherewithal to do so. Assume that the value of the farm land is $1.5 million without the restrictions on development and $1 million with the restrictions. Joaquin and Rosalinda would receive a $500,000 charitable contribution deduction on their income tax return.
Note: This is an area of the tax law that is receiving increased scrutiny from the IRS and Congress. Reportedly some are claiming large deductions for “restrictions” that have no practical effect and should have little impact on the real estate’s value. (For example, an easement restricting the modification of a home’s façade, may have no effect on value if the home is in a historical district that ALREADY imposes restriction’s on modifying the home’s appearance.) In other cases, the IRS alleges that the claimed values of the deductions are excessive. Congress is exploring ways of combating these perceived abuses.
Halving your assets and using them too.
Many older taxpayers have been disappointed with the yield their investments have produced in today’s low interest rate environment. Consuming a portion of their investment principal, to compensate for these low yields, runs the risk they will run out of assets before they run out of breath. An alternative is to buy an annuity from an insurance company. Charitably minded taxpayers should consider a “charitable gift annuity” in addition to commercial annuities.
Charitable gift annuities are annuities “sold” by charities. In exchange for the taxpayer’s “contribution” the charity promises to pay the taxpayer a fixed amount for the rest of the taxpayer’s life. Many charities set their annuity rates based on tables published by The American Council on Gift Annuities (www.acga-web.org). The ACGA’s tables produce an annuity that has a present value (computed using the IRS’s annuity tables and the current § 7520 rate) that is substantially less than the value of the taxpayer’s contribution. The taxpayers receive a charitable contribution deduction for the difference. The annuity payments are taxed under the rules of § 72 (the same rules used for commercial annuities).
Example: Eliza, age 79, gives her local hospital $20,000 in exchange for a charitable gift annuity. The hospital uses the ACGA’s table to set the annuity rate at 7.8%. Using the IRS tables current § 7520 rate of 5%, the present value of the annuity is $10,200 and the value of the deduction is $9,800. Each year, for the rest of her life, Eliza will receive an annuity payment of $1,560 ($20,000 x 7.8%).
Note: Not all charities follow the ACGA’s guidelines, so it pays to shop around for the best charitable annuity rate. Also, it should go without saying, the charitable gift annuity rates are likely to be substantially lower than rates available from commercial annuities.
Charity is where the remainder is.
A more complex version of charitable gift annuities are charitable remainder trusts. Charitable remainder trusts allow taxpayers a current deduction of the actuarial value of the remainder interest that will pass to charity at the end of the trust’s term. During the trust’s term, the taxpayer (or someone else named by the taxpayer) will receive a payment from the trust. Such trusts allow taxpayers to increase the cash flow from their assets while earning a current income tax deduction.
Charitable remainder trusts come in two basic flavors: Charitable Remainder Annuity Trusts (CRAT) and Charitable Remainder Unitrusts (CRUT). CRATs pay the non-charitable beneficiary a fixed amount each year. CRUTs pay an amount based on a fixed percentage of the value of the trust’s assets measured each year.
Example 1: Jose and Julie, both age 70, establish a CRAT paying 7.8% for the rest of their lives. They fund the CRAT with $1 million. Jose and Julie would receive a $78,000 annuity payment from the CRAT each year and a charitable contribution deduction of $110,114.
Example 2: Jose and Julie also form a CRUT paying a unitrust percentage of 7.8% with $1 million. Each year Jose and Julie will receive 7.8% of the value of the trust’s assets. If the value of the assets is $1.1 million in year two, they will receive $85,800 from the trust. If, in three the value of the assets is $900,000, they will receive $70,200. Jose and Julie will receive a deduction of $260,060.
The CRAT and CRUT payments are taxed under rules described in § 664(b). These rules are too complex to describe in the room permitted here.
The tax code provides numerous opportunities for deferred charitable giving. These opportunities are not for all taxpayers. For the charitably-minded, the rules allow some current tax benefit for values a charity may not receive for many years in the future.
David K. Walser, CPA, is Director of Tax Services for Inlign Wealth Managment, LLC. He can be reached at (602) 385-7559 or dwalser@inlign wealth.com.
This content has not yet been Rated.
To Rate content, please Login.
