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CHARITABLE GIVING
WITH UNCLE SAM AS YOUR PARTNER

PART TWO

by Christopher G. Stoneman

In the last article we focused on the complex income-tax treatment of charitable gifts. This time we will briefly consider the estate- and gift-tax ramifications of such transfers.

1. Estate tax. A decedent's estate is allowed an unlimited deduction for charitable gifts provided that they come within the far less complicated requirements of the estate tax statute, Section 2055 of the Internal Revenue Code.

In summary the basic rule is that the gift must be a gift of property included in the donor's gross estate and must also constitute a transfer for "public, charitable, and religious uses" (the caption given to the section). In distinction from the income tax provision, there is no "domestic organization" requirement (see Article XI).

Example—Teresa, a United States resident, is a graduate of a Dutch university to which she makes a lifetime gift. She uses the charitable remainder annuity trust (CRAT) mode, reserving a 7% interest in the trust for life, with her alma mater to receive the trust property at her death. Teresa will not be entitled to an income tax deduction for her gift, since the charitable beneficiary is a foreign organization. Her estate, however, will be entitled to deduct the value of the property passing to the university when she dies. If someone else had established the trust there would be no deduction at Teresa's death because the trust (from which the charitable gift is made) would not have been included in Teresa's gross estate.

For estate tax purposes a charitable gift may take a variety of forms, notably the following:

  • An outright bequest or cash or other property

Examples

  • I give to THE SOUTH WOODSTOCK MUSEUM the sum of $5,000

  • I give my collection of first editions to THE HILLSDALE LIBRARY, Hillsdale, New York

  • I give all Windsor County real property owned by me at my death to VERMONT LAND TRUST

  • From a trust established during the decedent's lifetime

Example

At the Grantor's death the Trustee shall pay the sum of $10,000 to each of the following organizations: AMERICAN RED CROSS, AMERICAN CANCER SOCIETY, UPPER VALLEY COMMUNITY FOUNDATION

  • Through the exercise of a power of appointment

Example—Simon establishes a trust for his son's benefit and gives the son a general power of appointment over the trust at his, the son's, death. Simon's son dies and exercises the power to appoint the trust among his three favorite charities, all of which meet the 2055 definition. Since the general power of appointment causes the trust to be included in Simon's son's estate, his exercise of the power as indicated generates an estate tax deduction. Note that the same result would have followed if Simon had gone on to specify that if his son did not exercise the power of appointment, the property would pass "by default", as the saying goes, to a charity named by Simon. Note also, however, that if Simon had given his son a limited or "special" power of appointment (e.g., the power to appoint the property amongst family members and charities) and the son exercised the power in favor of the same three charities, there would no estate-tax deduction in the son's estate since the "appointive" property (i.e., the property subject to the power) was not includible in the son's gross estate.

The designation of a charity as beneficiary under a life insurance policy

Example—Julio insures his life for $100,000. As owner of the policy he names his nephew as beneficiary or, if the nephew dies first, the local church. Julio retains the right to change the beneficiary, which means that the insurance proceeds will be part of his gross estate. The nephew predeceases his uncle. The insurance is includible in Julio's gross (but not his probate) estate but will be fully deductible.

In addition to the foregoing, an estate-tax deduction may be claimed for a split-interest gift provided that it satisfies the statutory conditions. In this context a "split-interest" gift is one which is partially for a noncharitable beneficiary and partially for a charity. The charitable remainder trusts which were discussed in the preceding article are examples of split-interests:

Example—Leo leaves the residue of his will to his trustee in trust for an old army buddy for life and then, at his buddy's death, to Catholic Charities. Leo's friend is to receive 9% of the value of the trust determined annually. The trust, in other words, is a charitable remainder unitrust, or CRUT. This meets the statutory requirement and entitles Leo's estate to a charitable estate-tax deduction in an amount equal to the value of the charitable interest determined as of the time of Leo's death. If the noncharitable interest had been fixed at 9% of the initial value of the trust, it would have qualified as a charitable remainder annuity trust, or CRAT.

In addition to the CRAT and CRUT there is a class of eligible split-interest trusts where the order of the interests is reversed and the charity comes first. In this situation the law requires that the charity receive an interest analogous to the noncharitable beneficiary's interest in a CRAT or the CRUT, as the case may be, and the noncharitable beneficiary receives the remainder. Trusts of this kind are known as "charitable lead trusts", or CLTs.

Example—Pierre has five children, all of whom he considers to be well provided for from other sources. In his will he places the residue of his substantial estate in a CLT for 20 years. An amount equal to 9% of the trust's initial value is to be paid annually to the local hospital of whose board of trustees Pierre is the chairman. At the end of the 20-year period, the trust ends and is then distributed to Pierre's then living descendants per stirpes (see Article VI). Pierre's estate receives an estate-tax charitable deduction based on the value of the 20-year interest.

The charitable lead trust is not anywhere near as commonly used a device as the charitable remainder trust. Although it generates a deduction "up front", so to speak, it requires the noncharitable beneficiaries to wait out the trust term before they receive their inheritance. If the initial trust fund comprises the residue of an estate and, as is commonly done, estate taxes are made payable out of the residue, the use of a CLT will of course increase the size of the after-tax residue, thereby partially compensating for the delay in payment of the noncharitable beneficiaries' remainder interests. Thus, the CLT may be especially attractive in cases such as Pierre's where it will not cause undue hardships for his descendants to await the arrival of the silver spoon.

It is interesting to note that unlike the income-tax charitable deduction the estate-tax deduction does not distinguish between gifts to publicly supported charities and those to so-called private foundations (see Article XII). All that matters is that the organization be organized and operated exclusively for charitable, etc. purposes and, accordingly, does not carry on political activities or devote any substantial part of its energy to attempting to influence legislation.

2. Gift tax. Much of what has been said about the estate tax is equally applicable to the gift tax charitable deduction (Section 2522). Split-interest gifts must conform with the charitable remainder or lead trust rules. There is, however, a "domestic organization" requirement in the gift tax in the case of gifts by nonresidents to charitable corporations (as distinguished from charitable trusts, funds, community chests or foundations whose domicile is apparently of no consequence to the tax collector). More than one commentator has deplored this inconsistency among the various definitions and asked why there should not be a single definition of charity for all of the various tax deductions with which the law is concerned.

Christopher Stoneman

The complete list of Christopher Stoneman articles is: