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CHARITABLE GIVING PART ONE In this and the next article we will be taking a look at the estate planning ramifications of gifts to charity - hopefully in sufficient depth to give at least a nodding acquaintance with the income-, gift- and estate-tax rules as viewed primarily from the standpoint of the donor. There is also a substantial body of law, beyond the scope of our present discussion, which governs the conduct of charities and the organization and operation criteria with which they must comply if they are to be tax-favored recipients of donations - tax-favored both in terms of their supporters' tax deductions and of their own exemptions from income taxation. So-called "charitable deductions" are available for gratuitous transfers by individuals, trusts, estates and corporations in the computation of their "taxable income"; in figuring an individual's "taxable gifts"; and in arriving at an estate's "taxable estate". Unfortunately, there are definitional differences between the charitable deductions for the three taxes, as the following discussion is intended to demonstrate. Individuals' income tax. For income-tax purposes the primary statutory rules are found in Section 170 of the Internal Revenue Code, one of its longer provisions, which describes a discouragingly complex set of hoops through which many would-be philanthropists must pass before claiming their deductions. Space does not permit a comprehensive description of the obstacle course; but its main provisions may be summarized as follows. There must be
The donor who meets these three criteria may claim a deduction in arriving at his taxable income for the year of the gift up to but not in excess of a certain percentage of his "contribution base" (gross income less certain deductions) and may carry forward for the next five years any excess contribution and take a corresponding deduction in each year that any part of the gift remains undeducted.
The deduction percentages of the contribution base are 50% and 30%, depending upon the classification of the donee. More specifically, it must be determined whether the organization is a "private foundation", on the one hand, or a "publicly supported charity" or an "operating foundation" on the other. In the case of a publicly supported organization (a college, hospital or church would be a typical example), or an "operating" private foundation, the general rule is that the donor may deduct the gift up to 50% of his contribution base for the year in which it was made and may carry the excess forward as Mortimer was required to do. In the case of a "private foundation" (negatively defined by law in terms of what it is not rather than what it is - but basically an organization whose support is derived from a single donor or a small group of donors), the applicable limitation is 30%. There is also an excess carryover provision in the law for gifts to 30% organizations. A charitable income tax deduction which has not been totally used up during a donor's lifetime, whether to a "30%" or a "50%" donee, evaporates at his death. For a gift to qualify for
an income tax deduction, the recipient must be "a
corporation, trust, or community chest fund, or
foundation" which was created or organized in this
country. This is sometimes referred to as the
"domestic organization" rule of the statute. 1. Charitable remainder trusts. Under the old dispensation, a person could generally transfer money or property to a trustee to administer under a trust agreement which reserved all of the income from the trust to the donor or some other individual for life or a fixed term of years and then gave whatever remained at the death of the noncharitable beneficiary to the charity or charities which the donor had designated. This relatively straightforward arrangement gave the donor an income tax deduction based upon the actuarially determined present value (i.e., value when the trust was set up) of the charity's postponed right to receive the trust principal at the death of the income beneficiary. In 1969 Congress changed the rules and provided that if a transfer to a "split-interest" trust was to give an income tax deduction for the value of the charitable remainder interest - i.e., the right to take the trust property on the income beneficiary's death or at the end of the term of years - it must comply with the very specific requirements of another Code provision, Section 664. This new provision created two tax-exempt entities: the charitable remainder annuity trust, or "CRAT"; and the charitable remainder unitrust, or "CRUT". Be it a CRAT or be it a CRUT, there are several common characteristics; there are also two major differences. The CRAT is a trust from which a fixed payment is to be made at least annually to one or more noncharitable beneficiaries for a term of not more than 20 years or, in the case of individuals, for the life or lives of the individuals who in either case (term of years or life estate) must be alive when the trust is established. The payment must be made annually and must either be stated as a dollar amount or as a percentage of the initial value of the property placed in trust. In either case it must be at least 5% and not more than 50% of that value. No additions may be made to the trust. The remainder interest, determined at the outset must be worth at least 10% of the initial (and only) contribution.
The CRUT is a little more complex than the CRAT and comes in two slightly differing forms. In the plain vanilla version a fixed percentage (not less than 5% and not more than 50%, as in the case of the CRAT) of the annually determined value of the trust property is required to be paid out each year. The payee criteria are the same as for the CRAT; there is a similar 10% value-of-remainder rule. Additions to a CRUT are permissible.
A more involved version of the CRUT is the income-with-make-up provision. Instead of the straight percentage payout, the trust provides that if the trust's income in any given year is less than the percentage amount, the trust pays only that year's income unless there have been one or more prior years in which the income exceeded the percentage amount. In that event, the annual income for all of the prior years is aggregated, as is the percentage amount for all such years. The latter is deducted from the former, and from the excess there is distributed to the noncharitable payee the amount by which the percentage amount for the current year exceeds that year's income.
As noted, the CRAT or CRUT, as the case may be, enjoys an exemption from federal income tax. This means for example, that it may sell low-basis assets which it is given without being taxed on the gain it realizes upon the sale of those assets. Therein, of course, lies one of the CRT's major attractions. Taxpayers holding valuable non-income producing assets with very low cost bases may have them made productive of a cash flow where none was formerly available. Recognizing that it may take time for a trustee to convert donated non-income producing property into income-producing property, the IRS has indicated that if the trust instrument so provides and if certain conditions are met, it plans to allow the trustee of a CRUT (but not of a CRAT) a distribution-free period in which it may make the conversion. This will occur when final regulations are issued. During this period no distributions need be made to the noncharitable beneficiary; after the period has ended, the regular distribution requirements kick in. This type of arrangement is known familiarly as a "flip" provision. No discussion of the charitable remainder trust would be complete without a word or two about the taxation of the trust's noncharitable beneficiary or beneficiaries to whom the CRT makes its annual or more frequent distributions. As one might expect, those distributions are at least partially taxable. Here's how it works. The distribution is treated, first, as "ordinary income" to the beneficiary - and therefore fully taxable - to the extent that at the time of the distribution the CRT had ordinary income for the current year or accumulated and not yet distributed ordinary income from a prior year or years. If the distribution exceeds current and ordinary income, it is deemed to be made up of current and then accumulated capital gain income. Only after these two categories (ordinary income and capital gain income) have been exhausted is the distribution deemed to consist of tax-free income, current or accumulated; and in the unlikely event that all three categories of income have been "cleaned out", the distribution is regarded as a nonreportable return of principal.
2. Gift annuities. Another popular form of charitable gift is the gift annuity. The donor-annuitant and the charity enter into an agreement under which the donor transfers cash or property to the charity in exchange for the charity's promise to pay him a specified annuity (or to pay the annuity to another person) for the donor's or the other person's life or for a term of years. At the end of the annuity period the charity receives whatever remains. The annuity rate is less than the annuity rate which would be obtainable in the marketplace, hence the gift element.
A gift annuity may also be funded with the transfer of property rather than cash, in which case there will probably be an element of capital gain in the transaction on which the annuitant will be required to pay tax ratably over his or his and his wife's life expectancies. The gift annuity is notably different from its CRT counterpart in that it constitutes a contract on the part of the charity which is therefore required to make the contracted annuity payments regardless of the value or even the continued existence of the money or property placed in the annuity. GO TO PART TWO OF THIS ARTICLE The complete list of Christopher Stoneman articles is:
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