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WILEYe BOOK WILEY JOSSEY-BASS PFEIFFER J.K.LASSER CAPSTONE WILEY-LISS WILEY-VCH WILEY-INTERSCIENCE
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Invest in Charity
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WILEY NONPROFIT LAW, FINANCE, AND MANAGEMENT SERIES The Art of Planned Giving: Understanding Donors and the Culture of Giving by Douglas E. White Beyond Fund Raising: New Strategies for Nonprofit Investment and Innovation by Kay Grace Budgeting for Not-for-Profit Organizations by David Maddox Charity, Advocacy, and the Law by Bruce R. Hopkins The Complete Guide to Fund Raising Management by Stanley Weinstein The Complete Guide to Nonprofit Management by Smith, Bucklin & Associates Critical Issues in Fund Raising edited by Dwight Burlingame Developing Affordable Housing: A Practical Guide for Nonprofit Organizations, Second Edition by Bennett L. Hecht Faith-Based Management: Leading Organizations that Are Based on More than Just Mission by Peter C. Brinckerhoff Financial and Accounting Guide for Not-for-Profit Organizations, Sixth Edition by Malvern J. Gross, Jr., Richard F. Larkin, Roger S. Bruttomesso, John J. McNally, PricewaterhouseCoopers LLP Financial Empowerment: More Money for More Mission by Peter C. Brinckerhoff Financial Management for Nonprofit Organizations by Jo Ann Hankin, Alan Seidner, and John Zietlow Financial Planning for Nonprofit Organizations by Jody Blazek The First Legal Answer Book for Fund-Raisers by Bruce R. Hopkins The Fund Raiser’s Guide to the Internet by Michael Johnston Fund-Raising: Evaluating and Managing the Fund Development Process, Second Edition by James M. Greenfield Fund-Raising Fundamentals: A Guide to Annual Giving for Professionals and Volunteers by James M. Greenfield Fundraising Cost Effectiveness: A Self-Assessment Workbook by James M. Greenfield Fund-Raising Regulation: A State-by-State Handbook of Registration Forms, Requirements, and Procedures by Seth Perlman and Betsy Hills Bush Grantseeker’s Budget Toolkit by James A. Quick and Cheryl S. New Grantseeker’s Toolkit: A Comprehensive Guide to Finding Funding by Cheryl S. New and James A. Quick Grant Winner’s Toolkit: Project Management and Evaluation by James A. Quick and Cheryl S. New High Impact Philanthropy: How Donors, Boards, and Nonprofit Organizations Can Transform Nonprofit Communities by Kay Sprinkel Grace and Alan L. Wendroff High Performance Nonprofit Organizations: Managing Upstream for Greater Impact by Christine Letts, William Ryan, and Allen Grossman Improving the Economy, Efficiency, and Effectiveness of Nonprofits: Conducting Operational Reviews by Rob Reider Intermediate Sanctions: Curbing Nonprofit Abuse by Bruce R. Hopkins and D. Benson Tesdahl International Fund Raising for Nonprofits by Thomas Harris International Guide to Nonprofit Law by Lester A. Salamon and Stefan Toepler & Associates Joint Ventures Involving Tax-Exempt Organizations, Second Edition by Michael I. Sanders The Law of Fund-Raising, Second Edition by Bruce R. Hopkins The Law of Tax-Exempt Healthcare Organizations, Second Edition by Thomas K. Hyatt and Bruce R. Hopkins The Law of Tax-Exempt Organizations, Seventh Edition by Bruce R. Hopkins The Legal Answer Book for Nonprofit Organizations by Bruce R. Hopkins A Legal Guide to Starting and Managing a Nonprofit Organization, Third Edition by Bruce R. Hopkins The Legislative Labyrinth: A Map for Not-for-Profits edited by Walter Pidgeon Managing Affordable Housing: A Practical Guide to Creating Stable Communities by Bennett L. Hecht, Local Initiatives Support Corporation, and James Stockard Managing Upstream: Creating High-Performance Nonprofit Organizations by Christine W. Letts, William P. Ryan, and Allan Grossman
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Mission-Based Management: Leading Your Not-for-Profit In the 21st Century, Second Edition by Peter C. Brinckerhoff Mission-Based Management: Leading Your Not-for-Profit In the 21st Century, Second Edition, Workbook by Peter C. Brinckerhoff Mission-Based Marketing: How Your Not-for-Profit Can Succeed in a More Competitive World by Peter C. Brinckerhoff Nonprofit Boards: Roles, Responsibilities, and Performance by Diane J. Duca Nonprofit Compensation and Benefits Practices by Applied Research and Development Institute International, Inc. The Nonprofit Counsel by Bruce R. Hopkins The Nonprofit Guide to the Internet, Second Edition by Michael Johnston Nonprofit Investment Policies: A Practical Guide to Creation and Implementation by Robert Fry, Jr. The Nonprofit Law Dictionary by Bruce R. Hopkins Nonprofit Compensation, Benefits, and Employment Law by David G. Samuels and Howard Pianko Nonprofit Litigation: A Practical Guide with Forms and Checklists by Steve Bachmann The Nonprofit Handbook, Third Edition: Management by Tracy Daniel Connors The Nonprofit Handbook, Third Edition: Fund Raising by James M. Greenfield The Nonprofit Manager’s Resource Dictionary by Ronald A. Landskroner Nonprofit Organizations’ Business Forms: Disk Edition by John Wiley & Sons, Inc. Planned Giving: Management, Marketing, and Law, Second Edition by Ronald R. Jordan and Katelyn L. Quynn Private Foundations: Tax Law and Compliance by Bruce R. Hopkins and Jody Blazek Program Related Investments: A Technical Manual for Foundations by Christie I. Baxter Reengineering Your Nonprofit Organization: A Guide to Strategic Transformation by Alceste T. Pappas Reinventing the University: Managing and Financing Institutions of Higher Education by Sandra L. Johnson and Sean C. Rush, PricewaterhouseCoopers LLP The Second Legal Answer Book for Nonprofit Organizations by Bruce R. Hopkins The Second Legal Answer Book for Fund Raisers by Bruce R. Hopkins Social Entrepreneurship: The Art of Mission-Based Venture Development by Peter Brinckerhoff Special Events: Proven Strategies for Nonprofit Fund Raising by Alan Wendroff Starting and Managing a Nonprofit Organization: A Legal Guide, Third Edition by Bruce R. Hopkins Strategic Communications for Nonprofit Organizations: Seven Steps to Creating a Successful Plan by Janel Radtke Strategic Planning for Nonprofit Organizations: A Practical Guide and Workbook by Michael Allison and Jude Kaye, Support Center for Nonprofit Management Streetsmart Financial Basics for Nonprofit Managers by Thomas A. McLaughlin A Streetsmart Guide to Nonprofit Mergers and Networks by Thomas A. McLaughlin Successful Corporate Fund Raising: Effective Strategies for Today’s Nonprofits by Scott Sheldon Successful Marketing Strategies for Nonprofit Organizations by Barry J. McLeish The Tax Law of Charitable Giving, Second Edition by Bruce R. Hopkins The Tax Law of Colleges and Universities by Bertrand M. Harding Tax Planning and Compliance for Tax-Exempt Organizations: Forms, Checklists, Procedures, Third Edition by Jody Blazek The Universal Benefits of Volunteering: A Practical Workbook for Nonprofit Organizations, Volunteers and Corporations by Walter P. Pidgeon, Jr. The Volunteer Management Handbook by Tracy Daniel Connors Trade Secrets for Every Nonprofit Manager by Thomas A. McLaughlin Values-Based Estate Planning: A Step-by-Step Approach to Wealth Transfers for Professional Advisors by Scott Fithian
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Invest in Charity A DONOR’S GUIDE TO CHARITABLE GIVING
Ron Jordan Katelyn L. Quynn
Legal Advisors Carolyn M. Osteen Martin Hall Ropes & Gray Boston, Massachusetts
John Wiley & Sons, Inc. New York • Chichester • Weinheim • Brisbane • Singapore • Toronto
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ABOUT THE AUTHORS
Ron Jordan, J.D., is Director of Planned Giving at New Mexico State University, Las Cruces, New Mexico. He has been admitted to the practice of law since 1975 and is a graduate of New England School of Law, Boston, Massachusetts, and Salem State College, Salem, Masschusetts. An assistant professor at New Mexico State University, he teaches courses in financial planning, consumer economics, and writing. Previously, he taught courses in federal income taxation and estate planning. He is also a consultant to nonprofit organizations. Katelyn L. Quynn, J.D., is the Director of Planned and Major Gifts for the Massachusetts General Hospital and the Partners HealthCare System, Inc., in Boston, Massachusetts. She is a former board member of the National Committee on Planned Giving and a past president of the Planned Giving Group of New England. In 1996 she was named Planned Giving Professional of the Year by Planned Giving Today. She serves as a board member of Charitable Accord and is a graduate of Tufts University and the Boston University School of Law.
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This book is dedicated to the donors who support charities worldwide.
This book is also available in print as ISBN 0-471-41439-5 For more information about Wiley products, visit our web site at www.wiley.com Copyright © 2001 by John Wiley & Sons, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4744. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, (212) 850-6011, fax (212) 850-6008, E-Mail: PERMREQ @ WILEY.COM. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.
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CONTENTS
Preface
xix
Acknowledgments
xxi
Chapter 1
Chapter 2
Chapter 3
Engaging in Philanthropy
1
Philanthropy in the United States
1
Who Are the Nation’s Past and Future Donors and Where Do You Fit In?
2
Donor Motivations: Why Make a Gift?
4
Getting Started
6
The Donor’s Action Plan
8
Selecting a Charity to Benefit from Your Philanthropy
15
501(c)(3) Charities
17
You and Charity
17
What Does Philanthropy Mean to You?
18
Charities A to Z
18
Charities
19
Due Diligence
21
Visit the Charity
22
Web Resources
23
About the Charity
25
Frequently Asked Questions
25
The Process
26
President /CEO/Chancellor
26
Vice President for Development (Advancement)
28
Board of Trustees (Directors)
28
Development Office
30
Annual Giving
30 xi
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Chapter 4
Chapter 5
Contents
Major Gifts
31
Planned Giving
32
Stewardship
32
Gift Accounting and Processing
33
Computer Services
33
The Charity’s Gift Review Committee
33
The Charity’s Investment Policies
34
The Charity’s Portfolio
34
Separately Invested Endowed Funds
35
Spending Provisions
36
Management Fees and Expenses
36
Conclusion
37
Professional Advisors, Family Members, and Your Philanthropy
39
Professional Advisors
39
Attorney
40
Financial Advisor
41
Stockbroker/Mutual Fund Companies
41
Certified Public Accountant
41
Trust Officer
42
Insurance Agent
42
Development/Planned Giving Professional
42
What to Ask When Selecting an Advisor
43
Charitable Giving and Family Dynamics
45
Working with Friends and Mentors
45
Conclusion
46
How Will the Gift Be Used? Endowed Funds
47
Frequently Asked Questions
47
Unrestricted Gifts
48
Restricted Gifts
49
Current Use Awards
49
Endowed Funds
50
Creating an Endowed Fund
52
Financing Your Endowed Fund
55
Fund Description
55
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Contents
Chapter 6
Chapter 7
Chapter 8
Mechanics of a Fund Description
56
Conclusion
59
Types of Charitable Gifts
61
Frequently Asked Questions
61
Annual Gifts
62
Pledges
63
Major Gifts
63
Planned Gifts
63
Gifts in Kind
65
Structured Gifts
66
Negotiating Gifts
66
Making the Right Decision
68
Conclusion
69
Basic Income Gifts: Charitable Gift Annuities, Deferred Gift Annuities, and Pooled Income Funds
71
Frequently Asked Questions
71
Charitable Gift Annuities
72
Deferred Gift Annuities
77
Pooled Income Funds
80
Conclusion
84
Trusts
87
Frequently Asked Questions
87
Parties to a Trust
87
Trust Powers
88
Gifts to a Minor and the Uniform Transfer to Minors Act
89
Gifts to a Minor and a Minor’s Trust
90
Revocable Inter Vivos Trust (Living Trust)
90
Charitable Remainder Trusts
92
Qualified Terminable Interest Property (QTIP) with Remainder to a Nonprofit
103
Charitable Lead Trusts
104
Nongrantor Charitable Lead Trusts
104
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Chapter 9
Chapter 10
Chapter 11
Contents
Nongrantor Charitable Lead Annuity Trusts
105
Nongrantor Charitable Lead Unitrust
106
Conclusion
106
Gifts Through Your Estate
109
Frequently Asked Questions
109
Tax Law and Charitable Gift Planning
110
The Will
111
Parts of a Will
112
Suggested Language for Charitable Bequests
113
Legally Binding Documents for Bequests
116
Probate
116
Property Held Out of State — Ancillary Administration
117
Medicaid
118
Conclusion
119
Incorporating Charitable Giving and Retirement
121
Frequently Asked Questions
121
Using Planned Giving Vehicles to Assist in Retirement Planning
122
Retirement Vehicles for Charitable Giving
125
Tax Consequences of Charitable Gifts of Retirement Accounts at Death
126
Types of Retirement Plans
126
Ways to Transfer Retirement Assets to a Charity
127
In Summary
129
Conclusion
131
Private Foundations, Supporting Organizations, and Donor-Advised Funds
133
Frequently Asked Questions
133
Private Foundations
134
Supporting Organizations
138
Donor-Advised Funds
142
Conclusion
145
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Contents
Chapter 12
Chapter 13
Gifts of Securities
149
Frequently Asked Questions
149
Securities Held by the Donor’s Stockbroker or Banker
150
Securities Gifted Via DTC
150
Securities Held in the Donor’s Possession
151
Donor Wishes to Give Part of a Stock Certificate
151
Value of the Gift
152
Date of the Gift
152
Your Charitable Income Tax Deduction
153
Gifts from Dividend Reinvestment Plans
154
Series EE and HH Bonds
155
Zero Coupon Bonds
156
Gifts of Shares of a Mutual Fund
156
Closely Held Stock
157
Valuation of Closely Held Stock
157
Restrictions on Transfer
157
Gift of Closely Held Stock— An Arm’s-Length Transaction
158
Closely Held Stock and Debt
158
Transfer to a Charitable Remainder Unitrust
158
S Corporation Stock
159
Preferred Stock— Section 306 Stock
160
Conclusion
160
Gifts of Real Estate
163
Frequently Asked Questions
163
Factors to Consider
164
Outright Gifts of Entire Property or Fractional Interest
165
Gift of a Personal Residence or Farm with a Retained Life Estate
166
Gifts of Real Estate to Fund Charitable Gift Annuities
167
Charitable Deferred Gift Annuity
167
Gift of Real Estate to a Charitable Remainder Unitrust
168
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Chapter 14
Chapter 15
Contents
Conservation Easements
171
Conclusion
174
Gifts of Noncash Assets: Tangible Personal Property, Intellectual Property, and Inventory
175
Frequently Asked Questions
175
Tangible Personal Property
175
Definition of Tangible Personal Property
176
Transfer of Personal Property
176
Related Use
177
Gift of a Future Interest in Tangible Personal Property
179
Unrelated Use
179
Intangible Assets
180
Inventory
182
Tax Considerations for Gifts of Noncash Assets
182
Substantiation Requirements
184
Appraisals
185
Gifts of Art Worth $25,000 or More
185
Tax Deductibility of Appraisal
185
Form 8282
186
Conclusion
186
Gifts of Life Insurance
187
Frequently Asked Questions
187
Ways to Use Life Insurance
188
Charitable Income Tax Deduction for an Outright Gift of a Paid-up Policy
189
Outright Gift of a Partially Paid-up Life Insurance Policy
189
Charitable Income Tax Deduction for a Partially Paid-up Policy
190
Charitable Income Tax Deduction When Donor Makes Premium Payments
190
Short-term Endowment Policies
190
Insurance Used in Asset Replacement Arrangements
191
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Contents
Chapter 16
Funding a Charitable Remainder Net Income Unitrust/Flip with Life Insurance
192
Reporting Requirements
192
Conclusion
192
Tax Consequences of Charitable Gifts
195
Frequently Asked Questions
195
Federal and State Income Taxes
196
Fair Market Value
198
Cost Basis
198
Deductibility of Tangible Personal Property
199
Acceleration of Deduction and Alternative Valuation
200
Deduction Reduction Provision
201
Pledge and Promissory Note
201
Benefits to Donors
201
Ordinary Income Reduction Rule
202
Income in Respect of a Decedent
203
Deductibility of Charitable Contributions for Business Organizations
204
Depreciation
206
Capital Gains Taxes
206
Federal Estate and Gift Taxes
207
Legislative Proposals
208
Gift Tax Annual Exclusion
208
Payments for Tuition and Medical Bills
208
Gifts by Husband and Wife/Unlimited Marital Deduction
209
Streams of Income and Gift Tax Consequences
209
Sale of a Personal Residence
211
Gifts of Real Estate Subject to a Mortgage
211
Tax Implications of a Bargain Sale
211
Substantiation Requirements
212
Appraisals
212
Partial Interests
213
Conclusion
214
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Contents
Consumer Issues and Charitable Giving
217
Philanthropy Protection Act of 1995
217
Truth in Philanthropy
218
Donor Rights: The Planned Gift Should Be Compatible with the Donor’s Goals
219
The Charity’s Responsibilities
221
Unfair and Deceptive Practices
222
Conclusion
223
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P R E F AC E
WHY YOU NEED THIS BOOK For most of our careers we have worked for nonprofit organizations advising donors on ways to make charitable gifts. We wrote Invest in Charity to teach donors how to select charities, make outright gifts, life income gifts, and gifts of assets other than cash such as stock, real estate, and tangible personal property. We hope this book will help donors, volunteers, professional advisors, and the charity’s development staff better understand the process of gift giving. This book will help you understand the world of philanthropy. You will learn the language of charitable giving and learn how best to make your gift. You will examine the tax benefits of making your gift, how to select the best type of gift to make, and which asset to use to fund it. You’ll also learn about charitable organizations and about how to research them, learn about the work they do, and feel secure that your gift will be used as you wish. Invest in Charity teaches you how to become a philanthropist on your own terms. Donors transfer over $190 billion to charities annually, and it is important for you to have access to the necessary information and resources to evaluate the appropriate gift options and charities. You may not know about life income gift options, such as charitable gift annuities and charitable remainder trusts. This book provides you with information about all charitable planned giving options and in a logical and sequential manner takes you through the steps necessary to make the right decision about your philanthropy. You worked hard to build your financial resources. Now you need to be smart and careful about your philanthropy. Until now there has been limited opportunities for people to learn about charitable giving. Donors must rely on others such as attorneys, certified public accountants, financial planners, or a charity’s professional staff. This book is a self-help resource for individuals who are considering making charitable gifts. Invest in Charity bridges the information gap that exists between individuals and charities and outlines strategies for effective charitable giving. Hundreds of self-help books teach individuals the how-to of financial planning, investing, and money management, but none teaches people how to best become donors. This book xix
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Preface
does just that, by providing information about charities, charitable giving, gift options, strategies and techniques, asset usage, and planning considerations to integrate charitable gift planning into your overall tax, estate, and financial plans. Reading this book will empower you with the techniques involved in charitable giving.
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ACKNOWLEDGMENTS
Writing a book like this one takes teamwork and many people made major contributions. The authors wish to thank the following individuals who read, edited, evaluated, revised, rewrote, double and triple checked, and juggled schedules to improve the quality of this work. Carolyn M. Osteen, Esq., and Martin Hall, Esq., of Ropes & Gray, Boston. The quality of this book has been enhanced by the careful and meticulous work of Carolyn Osteen and Martin Hall, who served as legal advisors with assistance from members of their firm, Christopher E. Houston, Anne Katsas, and Kathleen O’Neil Li. The authors consider themselves extremely fortunate to have Carolyn, Martin, and members of their firm involved in the production of this book. Carolyn has been a collaborator in all of our efforts and we thank her for her knowledge, effort, and friendship. Don Beasley, CPA, Beasley, Mitchell and Company, Las Cruces, New Mexico. As a CPA, Don has a practical approach to tax planning and he is intrigued with the opportunities that charitable gift planning presents. Manson P. “Pete” Dillaway, Ph.D., Academic Department Head of Accounting and Business Computer Systems, New Mexico State University, Las Cruces, New Mexico. Pete is both a student and teacher of estate and tax planning. As a professor, he is knowledgeable and experienced in tax planning and charitable giving. Ann Vail, Ph.D., Department Head of Family and Consumer Science, New Mexico State University. Ann is a wonderfully thoughtful and practical editor with keen insight on donors’ concerns. Diana Marie Garcia. Diana has worked with Ron Jordan for 10 years at New Mexico State University. Diana has been actively involved in the production and editing of this manuscript. The authors are indebted to her for her work as a volunteer in improving the manuscript. PG Calc, 129 Mount Auburn Street, Cambridge, Massachusetts, 617497-4970, www.pgcalc.com, for their generosity in allowing us to reprint their calculations and for creating such a great product. Bill Lutz, Esq., Martin, Lutz, Roggow, Hosford and Eubanks, P.C. Bill is an accomplished practitioner who carefully evaluated the manuscript.
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Acknowledgments
Massachusetts General Hospital Development Office colleagues, including the planned giving staff: Susan Ramsey, Brenda Dello Russo, and Jeffrey LeClair who make every work day challenging and fun. Gerald Nash, Penryn, California. Gerry read the entire manuscript and made significant contributions to the text. Gerry is a fine author and editor. Dianne C. Jordan. The authors wish to thank Ron’s wife, Dianne, for her work as a “production assistant” in the development of the manuscript. Our families. The authors thank their families — Dianne C. Jordan, Derek Jordan, and Barry, Henry, and Andrew Smith for giving us the time to develop and write this book. John Wiley & Sons, Inc. As usual, it was a pleasure to do business with the staff of John Wiley & Sons.
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Invest in Charity
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CHAPTER 1
Engaging in Philanthropy
You have made it! You have acquired substantial financial resources and are beginning to seriously consider the role of philanthropy and charity in your life. Perhaps you are considering making your first charitable gift; or you may have been making gifts for years and now want to know more about philanthropy. You are at a point in your life when you feel that you want to make a difference in the lives of others, and philanthropy may be a way to do this. You may be asking yourself, “Is there more to life than what I’m doing? Does acquiring material goods really fulfill me? Do I want to leave a legacy— something beyond what I do today? You have now reached a point when you have the capacity and desire to help others through charitable giving. Becoming a philanthropist is a wonderful experience. You may not yet see yourself as a philanthropist, but don’t worry, philanthropists make both large and small gifts. Many donors started out by making small gifts and gradually increased the size of their gifts over time, as they acquired greater wealth and more disposable income. One thing is certain about philanthropy. To be a philanthropist, you do not need to be rich, you need only to care about helping a charity or helping someone or something that the charity serves.
PHILANTHROPY IN THE UNITED STATES Philanthropy is uniquely American. Congress has provided the American public with incentives such as charitable income tax deductions, capital gains avoidance, and estate tax deductions to make charitable gifts. Charities provide services that federal, state, and local governments would have to offer if it were not for the nation’s charities. No other country in 1
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the world encourages private philanthropy more than the United States. Philanthropy has emerged as a part of everyday American culture. Highprofile cases, such as Bill Gates’s philanthropic activities, are well documented, as are stories about everyday people making spectacular gifts to deserving charities. Americans are intrigued by these stories as they wrestle with their own challenges to support charities and fulfill their philanthropic goals. Most of the country’s new donors are very “hands on” with their philanthropy. They explore and research thoroughly before they give. They want regular reporting on how their gift is used. And they want to see their money make a difference: that their gift ultimately helps those for whom it was intended. Philanthropists make an enormous difference in this country. Most nonprofits rely on fundraising to help do their work: many organizations can fund only about 60% of their work and look to donors and other sources to make up the difference. What is it about philanthropy that can make a donor part with assets that were painstakingly accumulated over a lifetime? Why does a donor make a gift that represents up to a third or half of his/her net worth to charity? The need to help others, to benefit charity, to do something noble and good are strong factors in helping donors make a gift. By providing the funding for a new wing on a hospital, buying books for a library, or creating a new children’s display at a museum, donors make a difference in the lives of others. Donors, by supporting charities, provide opportunities so that others can benefit. Were it not for the support of philanthropists, big and small, the nation’s libraries, museums, art galleries, hospitals, colleges, and universities would be without the resources that make them what they are today.
WHO ARE THE NATION’S PAST AND FUTURE DONORS AND WHERE DO YOU FIT IN? Traditionally, philanthropists were males or surviving spouses or childless couples. Many were older and had accumulated enough wealth and were at a sufficiently comfortable place financially to want to benefit charity. They felt connected to a charity or cause and they wanted to give something back. They made their gifts outright, through a life income arrangement, or through their estates. Today’s new donor is different. He or she tends to be self-made and has different expectations. If the donor is married, both spouses tend to be more involved in family giving. For other donors who live with a partner, philanthropy may be linked to specific causes that are important
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Who Are the Nation’s Past and Future Donors?
3
to them. Time is scarce, technology use greater. The demand on the charitable institution is greater too. Donors today tend to want to stay more involved with their gifts, looking for a way to control the gift and help with its investment. Gone are the days of saying “Here is my gift, do with it as you will.” After founding Microsoft, Bill Gates gave billions toward international vaccination programs, placed computers in libraries, and supported children’s health programs. Ted Turner’s philanthropy is also well known. Having founded Cable News Network (CNN), he has pledged over $1 billion to the United Nations Foundation as well as made gifts to support international children’s health and environmental programs. But not all of our philanthropists are so well known for their business acumen; Oseola McCarty, a family laundress, saved and made a generous gift to the University of Southern Mississippi for scholarships. Ms. McCarty lived simply and saved well. Her gift made a big impact on students who needed money to attend college. Where do you fit in? Surviving Spouses Surviving spouses are an important group who often make gifts to honor the family name or to memorialize a deceased spouse. Often a charity has played an important part in their lives and they wish to permanently link their name with the charity. Childless Couples Childless couples traditionally have turned to charity to be a beneficiary of their wealth. Some childless couples use charities as a substitute for a natural family. Often these donors are wealthy and have valuable assets and collections that can benefit a charity. They often make life income gifts and gifts through their estates. World War II Donors Donors who grew up in the shadow of World War II have been a great source of support for charities. Many received benefits through the GI Bill and graduated from colleges and universities. Many were entrepreneurs who, following the war, developed businesses to meet the needs of America’s returning servicemen and women. These donors have generously supported education, healthcare, the arts, and a variety of other causes important to them.
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Engaging in Philanthropy
Baby Boomers Baby boomers and others who were influenced by the causes of the 1960s now find themselves with financial resources to support charities related to many of these causes. Like all donors who make charitable gifts, baby boomers direct their gifts to charities that provide services to the causes they wish to impact. High-Tech Philanthropists High-tech philanthropists make up a new breed of donor. They tend to be much younger than most donors; many are not yet married and do not have children. They are in their 20s to mid-40s and feel very connected to their wealth, which they worked hard to earn. Many want to be actively involved with the charity they support. Others want to support a cause yet do not have the time to be involved closely with the charity. Investors Many donors secured their wealth through investments in the stock market. They invested in growth stocks, initial public offerings, or mutual funds. Unfortunately, success in investing means capital gains taxes and income taxes through interest income and dividends. In addition to philanthropic reasons, these donors look to charities to obtain tax benefits to offset gains. Corporate Employees and Professionals Corporate employees and professionals have acquired wealth through corporate stock options and by participating in 401k, 403(b)(7), and selfemployed retirement plans. Employees who worked during the last 20 years have seen spectacular growth in their retirement plans and in their net worth. These donors are prepared for the future and can now focus on philanthropy.
DONOR MOTIVATIONS: WHY MAKE A GIFT? Because philanthropy is so personal, each donor has his or her reasons for making a gift. Study the following common motivators among donors. What motivates you to make a charitable gift?
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Donor Motivations: Why Make a Gift?
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Philanthropy Philanthropic donors are truly the noblest — and scarcest — of all donors. They make gifts because they wish to better the world and view philanthropy as a personal duty. These donors often make their gifts anonymously and shun the spotlight. Philanthropic donors usually seek out an organization to make a gift. Osela McCarthy’s gift fits this category. Gratitude Grateful donors are those who want to repay a debt to a charity. Often they received a benefit from the charity and feel indebted to it. They may be college graduates who feel that everything they have achieved in life is due to the education they received, patients who feel that medical care saved their lives or greatly improved their quality of life, individuals who received social services in a difficult time, or those who want to support the religion they have believed in all their lives. Like philanthropic donors, most grateful donors seek out an organization and set the gift-giving process in motion themselves. Honoring Loved Ones Many donors make gifts to honor loved ones. Sometimes such gifts are made to honor a person who is living, but more are made as a memorial tribute to someone who has died. Donors of memorial gifts usually seek out the charity and have very specific ideas about how they want to honor their loved one. Often they are motivated to create a named endowed fund that allows them to pay lasting tribute. Several family members may contribute to the fund. Charity as Family Substitute Many donors make gifts to charities because they have no heirs to whom assets can be transferred, or because they do not wish to give family members their money. In effect, they are looking for alternate heirs and beneficiaries. Tax Benefits One reason for making charitable gifts is to realize financial or tax incentives. However, a donor must first have a philanthropic intent to make a gift. Tax benefits become increasingly attractive to the philanthropically minded donor. Charitable income tax deductions, avoidance of capital
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gains taxes, and a reduction in federal estate taxes are some of the strongest tax incentives. Financial Benefits Sophisticated donors, such as business professionals, have increasingly turned to charities as a way to maximize financial return while minimizing taxation. This relatively new breed of donors often uses an asset other than cash, such as real estate, securities, or closely held stock, to fund gifts. Usually they are looking for a stream of income or want to increase the yield they currently receive from low-paying investments. Social Standing and Prestige Some donors give to certain charities because they wish to become the charity’s “insiders.” They see their contributions as a form of membership dues. Others may give to well-established, long-standing traditional organizations so that they can be known as benefactors of those organizations. They perceive that their social standing will rise with each gift. Insurance Policy Some donors give to an organization because they want an “insurance policy” for the future. This practice is most prevalent at hospitals but is also seen at other charities. These donors want to make a gift so that they become known at the hospital. If anything were to happen to them, they feel they will be assured of getting first-class treatment because of their status as “big donors.” A gift also may be made to ensure that a son or daughter is accepted into a school, college, or university. Recognition For some donors, philanthropic intent is overshadowed by a desire for recognition. These donors seek to gain the most from their gifts and tend to favor high-profile opportunities, such as having their names engraved on a building.
GETTING STARTED Now that you have explored the reasons why donors make gifts, it is time to get started. The following questions will help you examine your motivations for making a gift, think about appropriate charities, and consider the type of gifts and assets that should be used to make the gift and the steps that follow in making your gift.
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• Why do I want to make a gift? Whom am I trying to help? Am I trying to help a charity do its work? Do I want to make a gift in honor or memory of someone close to me? Is tax savings a factor in my philanthropy? • What is the purpose of my gift? Once I make a gift to the charity, how do I want my gift to be used? Should I establish a scholarship or make a gift in support of a program for the public, such as a lecture series? Should it be used to support a display or exhibit? Should it be used to purchase equipment or computers, be used to establish a chair or professorship, or be used to support a capital project? Should it be used to provide research in medicine or underwrite a children’s play? • What are my interests? Would I make a gift to educational or healthcare organizations? Is social services or religion more important to me? Should I support the arts, or are local civic organizations most important to me? Do I want to support one charity at a larger level or several charities at smaller amounts? • Which asset will I use to make my gift? Should I use cash, stock, real estate, mutual funds, tangible personal property, or other assets to make my gift? Which provides the greatest benefits to the charity and me? • What are my tax motives? Do I need a charitable income tax deduction? Should I make a charitable gift with appreciated property to avoid capital gains taxes? Do I need to reduce the size of my estate? • What type of charitable gift should I make? Am I better off making an outright gift, a life income gift, or a gift through a charitable remainder trust or lead trust? Should I make the gift through my estate, or should I use a combination of these options? • What charity should I benefit? Which charities have made a difference in my life? My family’s life? Which charity focuses on issues that I think reflect my core values and beliefs? Which provide services or benefit society in a way I believe is important? • Whose input do I need? Does my family/partner understand my goals? Have I discussed this gift with my attorney, certified public accountant, and/or financial planner? Have I reconfirmed the benefits with the charity’s planned giving officer?
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• When do I want to make the gift? December 31 is the last day to make a charitable gift and receive a charitable income tax deduction for the tax year. Have I begun the process early enough to complete the gift by that date? Is timing linked to the availability of soon-to-be-accruing assets? Am I prepared so that the gift can be made on time? • Have I conducted due diligence on the charity? Have I conducted a site visit, read mission statements and charitable gift planning literature? Have I met with a development officer or planned giving officer to study the details of my gift? Do I have any doubts about the legitimacy of the charity?
THE DONOR’S ACTION PLAN A donor’s action plan is a checklist about issues related to charitable giving. It can help you decide what is important to you, which charities to benefit, which assets you have to make your gift, and for what purpose. The form can be copied and distributed to your family members to encourage them to share their thoughts about charitable giving. 1. Why do I want to make a gift?
❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏
Help others Help charity do its work Become involved with a charity Make a gift back as a thank you Create opportunities for others Make a gift in memory or in honor of Charitable income tax deduction Capital gains avoidance Estate tax savings
2. What is the purpose of the gift? How do I want my gift to be used?
❏ ❏ ❏ ❏ ❏
Current use Restricted gift Scholarship/fellowship Faculty support Lecture series
❏ ❏ ❏ ❏ ❏
Endowed fund Unrestricted gift Capital project Visiting scholar Guest speaker/speaker series
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The Donor’s Action Plan
❏ ❏ ❏ ❏ ❏
❏ ❏ ❏ ❏
Research Scholar in residence Display/exhibition Maintenance Chair/professorship
Honors’ programs Equipment Computers/electronics Program/departmental support
3. What are my interests? What is important to me? What are my priorities?
❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏
❏ ❏ ❏ ❏ ❏ ❏ ❏
Education Recreation Conservation Health Children/infants Social issues Religion Libraries
Politics Arts Local issues Environment Civic programs Music Social services (poverty/homeless)
4. What asset will I use to make the gift?
Estimated gift range $
❏ ❏ ❏ ❏ ❏
to $
Cash Securities Real estate Tangible personal property
❏ ❏ ❏ ❏
Stock Mutual funds Combination Other assets
Intellectual property
Cost basis $
Estimated value $
5. What are my tax motives?
❏ ❏ ❏ ❏ ❏ ❏
What is my adjusted gross income (AGI)?
❏ ❏
Deduct gifts of cash for up to 50 percent of AGI $ Deduct gifts of property for up to 30 percent of AGI $
Increase income Charitable income tax deduction Capital gains avoidance Estate tax charitable deduction Gift tax charitable deduction
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6. What type of charitable gifts do I want to make?
❏ ❏ ❏
❏
❏ ❏ ❏ ❏ ❏
Outright gift Pledge Life income gift/planned gift
❏ ❏ ❏
Charitable gift annuity Deferred gift annuity Pooled income fund
Charitable remainder trust
❏ ❏ ❏ ❏
Charitable remainder annuity trust Charitable remainder unitrust Charitable remainder unitrust with makeup provision Charitable remainder unitrust — net income with makeup provision
Lead trust Estate/bequest Structured gift Pledge Gift in kind
7. To which charity or charities?
After reviewing the following checklist, list charities’ legal name, address, telephone number, and contact person:
❏
Educational Institution
❏ ❏ ❏ ❏ ❏
College/university Trade/vocational Community college Local scholarship fund Other
❏ ❏ ❏ ❏
Professional/graduate school Day school Prep school Adult education
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The Donor’s Action Plan
❏
❏
❏
❏
❏
❏
❏
Medical
❏ ❏ ❏
Hospital Research Illness
❏ ❏ ❏
Medical disability
❏ ❏ ❏ ❏
Library
❏ ❏ ❏
Girl Scouts/Boy Scouts
❏ ❏ ❏ ❏ ❏
Municipal local parks
Hospice Other
Cultural
❏ ❏ ❏ ❏
Public television/radio Symphony Opera Theatre
Museum Arts organization Other
Social Services
❏ ❏ ❏
United Way American Red Cross YMCA/YWCA
Salvation Army Other
Environmental Organizations
❏ ❏ ❏ ❏ ❏
Greenpeace Nature Conservancy National parks Sierra Club State parks
Audubon Society National Trust Trustees of Reservations Other
Religious/Faith-based Organizations
❏ ❏ ❏
Catholic charities Church
❏ ❏
Synagogue
❏ ❏
NAACP
❏
Politics (some tax restrictions apply)
Other
Combined Jewish Philanthropies
Ethnic/Racial
❏ ❏ ❏
Black Latino
Other
American Negro College Fund
Civic/Community/Charities
❏
Chamber of Commerce
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❏ ❏ ❏ ❏
Arts organization City, town, or municipality Homeless shelters Meal programs
❏ ❏ ❏ ❏
Party Candidate(s) Cause Other
8. Whom do I need to help make my decision?
❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏
Family
❏
Spouse
❏
Children
❏
Parents
❏
Siblings
Attorney CPA Bank/trust officer Investment advisor Financial planner Charity’s planned giving officer/development officer/staff member Friend/colleague Mentor Other
9. What is my timing for the gift? *
❏ ❏ ❏ ❏ ❏
January
❏ ❏
Special date (birthday, wedding, anniversary, etc.)
April July October December 31, last day for charitable income tax deduction for that year Other
10. Have I conducted due diligence on the charity?
❏ ❏ ❏
Requested and reviewed charity’s mission statement Annual report Charitable gift literature
* Plan at least three months in advance for routine gifts and one year in advance for major gifts. Remember that year-end is an especially busy time for charitable giving, so plan accordingly.
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The Donor’s Action Plan
❏ ❏ ❏ ❏ ❏ ❏
13
On-site visit Meeting with planned giving officer/major gifts staff member Meeting with department head Meeting with charity’s volunteer or administrative leadership Confirm charity’s legitimacy at state/federal level Other
Once you have completed the donor’s action plan, you are ready to move forward.
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CHAPTER 2
Selecting a Charity to Benefit from Your Philanthropy
Selecting a charity is one of the most important parts of your philanthropy. Literally thousands and thousands of charities vie for your charitable gifts. Many offer similar services or serve similar causes, and you need to compare among the charities to determine the most appropriate one for your gift. You also need to compare charities that offer different services to consider all of the options available to you. Your alma mater, medical center, favorite museum, arts organization, religion, and environmental organization all need your support, as do many other fine charities. What does philanthropy in the United States look like? In 1999, $190 billion was given to charity. This equals one-third of the domestic federal budget or 2 percent of our national income. (See Exhibit 2.1.) This was a
EXHIBIT 2.1
Foundations 10.40 % $19.81
1999 Contributions: $190.16 Billion by Source of Contributions Bequests 8.20 % $15.61
Corporations 5.80 % $11.02
Individuals 75.60 % $143.71
Source: American Association of Fundraising Counsel (AAFRC) Trust for Philanthropy, Giving USA 2000.
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6.7 percent increase over giving in 1997. We give more than any other nation, both in money and in time. Individuals, as opposed to foundations or corporations, gave almost 84 percent of all charitable gifts. Those charities that receive the greatest percentage of charitable dollars are religious organizations, followed by education, health, human services, the arts, and environmental causes. (See Exhibit 2.2.) We have all read or heard about the multitrillion-dollar transfer of wealth that will take place over the next 50 years from aging parents to their baby-boomer children. This transfer is expected to substantially increase philanthropy in the future. Now is the time to consider selecting charities to benefit from this transfer of wealth. Individuals who have never considered themselves philanthropic will now have the chance. Individuals and corporations pay income taxes but qualified charities do not. Congress recognizes the important work that charities perform and exempt them from taxation. In addition, much of the revenue they receive is in the form of gifts. As mentioned, Congress also clearly recognizes that if it were not for the nation’s charities, the government would have to perform many of the services those charities offered. Charities also promote equality, enabling those with resources to redistribute them to those less fortunate. America also has had a long and proud tradition of volunteerism, and much of the organizational structure of most of the nation’s charities
EXHIBIT 2.2
1999 Contributions: $190.16 Billion by Type of Recipient Organization
Religion 43. 0 % $81.78
International Affairs 1.4 % $2.65
Environment 3.1% $5.83
Education 14.4 % $27.46
Health 9.4 % $17.95 Human Services 9.1% $17.36
Public/Society Benefit 5.8 % $10.94
Arts, Culture 5.8 % $11.07
Gifts in Foundations minus Unallocated Giving 7.9 % $15.11
Source: American Association of Fundraising Counsel (AAFRC) Trust for Philanthropy, Giving USA 2000.
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You and Charity
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depends on volunteers. Social and public good is done by charities and their volunteers who offer services and programs for the public. Charities serve as a vehicle to organize those who wish to help others through contributions of time, money, or both. The organizational structure of bringing people and resources together makes the charity and the individuals more powerful as a group than as individual members.
501(c)(3) CHARITIES The term “designated 501(c)(3)” comes from the section number of the Internal Revenue tax code that deals with tax-exempt organizations. 501(c)(3) organizations are public charities that afford donors the largest charitable income tax deduction as measured by the donors’ adjusted gross income. These qualified charities include many large, well-recognized educational, medical, arts, religious, environmental, and human services organizations. To claim the most valuable charitable income tax deduction, donors need to make gifts to qualified 501(c)(3) organizations. To confirm the status of your favorite charity, ask for a copy of its tax exemption letter. In addition to tax-exempt public charities, a number of other organizations are not 501(c)(3) but qualify as tax-exempt. These organizations include governmental units such as states, cities, towns, or other political subdivisions, and posts and organizations for war veterans, which are entitled to receive deductible contributions. In addition, there are other tax-exempt organizations, such as domestic fraternal societies operating under lodge systems, and cemeteries. Many donors know exactly the organization or type of organization that they care most about and wish to benefit. Others need to think about what motivates them philanthropically. Enjoy the journey and search for a charity that reflects your interests and needs your support.
YOU AND CHARITY Philanthropy is an intensely personal issue. It is your money, and it should go to support a charity and a cause that is vitally important to you and supports your beliefs, goals, and values. Your financial support makes a difference. Behind the walls of every charity are people who depend on your contributions to help them do their jobs. Recipients to whom the charity delivers its services also depend on your support. For example, behind every scholarship is a student who has dreams, goals, and ambitions. Your scholarship support proves to the student that his or her hard work has not gone unnoticed. For healthcare organizations, it is patients and physicians. For arts organizations, it is those who attend
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Selecting a Charity to Benefit from Your Philanthropy
exhibits and displays. For the many other charities, it is people who rely on the kindness of others. Your gift truly makes a difference and provides benefits that no one else provides.
WHAT DOES PHILANTHROPY MEAN TO YOU? If philanthropy is new to you and you are not sure what or where you most wish to benefit, consider the following: What does philanthropy mean to you? Does it mean helping others who cannot help themselves? Does it include empowering others to be able to support themselves eventually? Does philanthropy mean giving money to charity or your time and interest, or both? Reconsider your answers to the questions posed in the donor’s action plan at the end of Chapter 1. Think about what charity means to you and how you see your charitable activities. Usually most donors support charities that mean a great deal to them. Examine your past. What charitable services have made a difference in your life? Do you have a religious belief? Have you or a loved one benefited from healthcare services? Did you receive your education because of the generosity of someone else or a charitable organization? Are you receiving any charitable services now? Are you currently involved with a charitable organization? Many donors attribute some of the success of their careers to their alma mater and so they make gifts to their school. Is there charitable work being done somewhere that you would like to know more about? Ask questions, conduct research, and get involved in determining where to make your gifts.
CHARITIES A TO Z It is not possible to list all of the causes that charities support. However, the following list is an A to Z guide to charities: Animals Artists Arts Books Civic programs Colleges Community Conservation Cultural Disabilities
Diseases Education Environmental issues Faith Global issues Healthcare Homelessness Human rights issues Hunger Illnesses
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Charities
Infants Journals Juveniles Libraries Literacy Meal programs Museums Nursing Olympians Opera Politics Poverty Publications Recreation Red Cross
Religion Research Scouts Social causes Students Symphonies Theater United Way Universities Vocational schools/programs Wildlife Whales Women’s issues Youth services Zoos
CHARITIES Many different types of charities can be supported. They include: • Educational institutions • Hospital/healthcare/medical research organizations • Single-illness organizations • Cultural organizations • Performing arts • Human services • Environmental organizations • Religious organizations • Scientific organizations • Civic and community organizations Educational Institutions The broad topic of educational institutions includes colleges, universities, community colleges, preparatory schools, secondary schools, early childhood centers, trade schools, and other charities that provide education, such as adult education centers and foreign-language centers. Your philanthropy can benefit these organizations in many, many ways. You might
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Selecting a Charity to Benefit from Your Philanthropy
consider providing scholarships for students in financial need; giving money to improve teaching methods; providing equipment such as computers, overhead projectors, library books, and sports equipment. Capital projects including constructing buildings and rooms and providing furnishings are also greatly needed. Hospital/Healthcare/Medical Research Organizations Another worthy cause is healthcare. These charities include hospitals, clinics, rehabilitation facilities, extended care facilities, community mental health centers, and drug treatment facilities. Medical research organizations include charities that conduct investigations, perform research and experiments, and diagnose and treat diseases and impairments. Funds are needed primarily for patient care, including directly helping patients and providing programs that care for patients; teaching hospital programs for training younger or newer physicians, nurses, and other medical professionals; research, including research trials and staff time; and capital projects. Like other charities, medical organizations are constantly looking for new and additional space as well as equipment because medical equipment quickly becomes obsolete. The changing healthcare environment also has demonstrated a greater need for home healthcare providers and visiting nurses. Single-Illness Organizations Many charities exist to benefit a single issue or theme. Examples include the American Heart Association, the American Diabetes Foundation, and the American Cancer Society or other health-focused organizations. Cultural Organizations Cultural organizations include a wide range of organizations such as art galleries, museums, symphonies, and libraries. All of these organizations need support to maintain their buildings and to preserve paintings and artifacts and their collections. Scholarship and funding grants are also greatly needed. Performing Arts Performing arts charities include operas, symphonies, orchestras, and theater. Many of these charities struggle to offer high-quality productions and performances. Money is needed to fund artists in residence and to buy new musical scores, costumes, and sets.
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Due Diligence
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Human Services Human services organizations typically provide services to the needy or underserved and build character to promote relief from poverty, provide assistance to the indigent, and care for orphans (e.g., Salvation Army; United Way; Big Brother/Big Sister programs, and Habitat for Humanity). You may have the opportunity to get directly involved by volunteering as well as helping those in need by providing food, clothing, and shelter. Environmental Organizations Environmental organizations help the environment both today and in the future. These groups benefit natural resources such as water, air, land, forests, and also wildlife such as birds, whales, and other outdoor life. Religious Organizations The broad group of religious organizations includes churches, synagogues, and other places of worship. It also includes conventions and associations of churches, and church-run organizations, such as schools, hospitals, orphanages, nursing homes, cemeteries, religious orders, missionary organizations, and Bible societies. Scientific Organizations Scientific organizations include those engaged in scientific research and those that disseminate scientific information and knowledge. Civic and Community Organizations This group includes Boy Scouts and Girl Scouts along with other community youth-based organizations and civic programs.
DUE DILIGENCE Once you determine a charity or charities that you wish to consider benefiting, you need to learn more about the organization and its activities. You should do several things to satisfy your own “due diligence” on the charity. Request various types of documentation from the organization. Look at the annual report to determine its financial situation and how it spends its money. Look at a listing of the charity’s board of directors to
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Selecting a Charity to Benefit from Your Philanthropy
determine whether you know and trust any of the individuals who are making decisions on behalf of the organization. Also look at the organization’s donor report to see what areas are receiving gifts, lists of new projects and programs, and names of other donors to the charity. Request charitable giving information, including the charity’s case or mission statement, and other brochures that tell you what the organization is raising money for specifically, how the money will be spent, and why you should support this charity over others. Also look at brochures about how to make a gift; you can see different giving levels available for annual fund support and learn more about the life income and bequest options that the charity offers. Study publications and Web sites that evaluate charities.
VISIT THE CHARITY There is no substitute for making an on-site visit, meeting with individuals at the charity. See for yourself: Do the administrators seem committed? Are they interested in you and your philanthropic goals? Do the charity’s beneficiaries’ patients/students/recipients seem happy and motivated? Are the facilities clean and modern, or do they need upgrading? Where could your gift best be put to use? Meet as many people as you can: senior administration, planned giving and development professionals, and those doing the work day to day. The charity’s staff should be responsive to your needs. They should act in a timely manner and be willing to answer your questions patiently and completely. Ask friends and business associates for their impressions about the charity. Have receipts been issued regularly and on time? Have endowed fund reports that update donors on the status of their funds been issued annually? Has there been high staff turnover? How long has the president been in office? Ask financial questions: What is the size of the charity’s endowment? How are assets invested? What is the annual rate of return? Who will manage your gift? What amount of your gift is going to overhead costs? What is the charity’s cost per dollar raised — that is, how much money does the charity spend to raise a dollar? For due diligence: • Request documentation, • Visit the charity, • Meet the staff, and • Ask questions.
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Web Resources
23
WEB RESOURCES A great deal of Web-based information and resources on philanthropy can help individuals to become donors. In addition, charities are sponsoring Web sites offering information on charitable gift planning. Some sites are excellent but many are spotty and uneven. You need an independent and impartial resource to explain and confirm the concepts, techniques, and strategies involved in charitable gift planning. The Internet has changed, and is changing, philanthropy. Individual charities are now placing a great deal of importance on creating and maintaining Web sites, realizing that potential donors need Web site information about the charity and learn about ways to make gifts online. Through the World Wide Web you can access individual charities’ sites; find links to other charities; and access organizations that evaluate different charities with information from charities’ corporate tax returns (990s), public information on operating costs, salaries paid to individuals, and other important information. Explore the following Web sites for information about charities: • Guide Star (guidestar.com) • Give Nation (givenation.com) Also read the Web site for specific charities that interest you.
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CHAPTER 3
About the Charity
FREQUENTLY ASKED QUESTIONS
How are charities organized for purposes of charitable giving? Who makes policy decisions for the charity? Whom should I work with at the charity when I make a charitable gift? What is planned giving?
Q: How are charities organized for purposes of charitable giving? A: At the top of the charity is the president or chief executive officer
(CEO). Several vice presidents in charge of various functions report to the president. In particular, the vice president of development (or vice president for advancement or chief development officer) reports to the president about fund raising and charitable giving. Development officers, major gift officers, and planned giving officers report to the vice president. In addition, several administrative positions, including gift reporting, stewardship, and computer services, also report to the vice president for development. Most charities are complex organizations with many people having a voice in the decision-making process. It is important to know what you are likely to encounter at a charity, whom you should deal with, and what the charity’s policies and procedures are that affect your charitable
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About the Charity
gift. This chapter describes the charity’s key personnel, fund-raising officials, and fund-raising activities in the development office. It also discusses the charity’s policies and procedures that impact your gift.
THE PROCESS When you are ready to begin working with a charity, you should call the development office (advancement at some charities) and ask to speak with a planned giving officer, development officer, or major gifts officer. Large charities can be centralized or decentralized. At a college or university you might ask for the individual who raises money on behalf of the specific college or department where you wish to make your gift. At a hospital, call the development office and ask to speak with a member of the staff who handles charitable gifts for a specific department. Most development staff members handle gifts to any department, but some know more than others about specific units within the charity. Planned giving officers often have backgrounds in law, finance, or investment management. They can be especially helpful to you if you wish to make life income gifts, gifts through your estate, gifts using assets other than cash, and create endowed funds. However, if your gift is to the charity rather than to a single department, you should ask to meet with the associate vice president or the vice president of development/advancement or a person with a related title. These individuals, along with other members of the development staff, handle large gifts that benefit the charity. If your gift is very large, you should call the vice president of development/advancement or the president of the organization. In addition, if your gift is setting a new agenda at the charity or is your priority rather than the charity’s, you may need help from the top. For example, a donor who enjoys music may decide that the charity would benefit from having an outdoor performance facility or band shell. The donor can provide the funding but should request assistance and approval from the charity so the project can move forward. Charities have their own priority list, and it can be frustrating for a donor to promote a project that is not on the charity’s priority list. The organizational chart in Exhibit 3.1 outlines the hierarchy for giving purposes at a charity.
PRESIDENT/CEO/CHANCELLOR At a charity, the most critical leadership position is the president. The position may also be called chief executive officer or chancellor depending on the charity. Regardless of the title, it is important for you to meet
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President/CEO/Chancellor
EXHIBIT 3.1
Charity’s Organizational Chart for Charitable Gift Purposes
Charity
Board of Trustees
President/Chief Executive Officer
Vice President of Advancement/Development
Related Officials
Committees
Development
Support Staff
Vice President of Business
Gift Review
Annual Giving
Gift Accounting
Executive Vice President
Investment
Major Gifts
Stewardship
Legal Counsel
Planned Gifts
Computer Service
Real Estate Office
Foundations and Corporations
with the president regarding any gift in excess of $1 million for large charities and for gifts of $100,000 or more at smaller charities. One of the president’s key roles is to meet with donors and to raise funds on behalf of the charity. In addition, for any gift where you are motivated to provide funding for a project of personal interest, it is essential to have the president endorse the project. For example, every charity has its own list of priorities that it wishes to accomplish. It is essential to have the president involved in the negotiations so that once approved, the presidential seal
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About the Charity
of support will help the project move forward quickly. Obtain a memorandum of understanding signed by the president and/or the chairman of the governing board of the charity. Charities, especially large public ones, adhere to time-tested processes and are sometimes less responsive to donor-initiated projects. Occasionally charities appear bureaucratic in their administrative and management activities. Private charities are likely to be more responsive to donor-initiated projects because they depend so heavily on private support. Public charities include state-assisted universities, hospitals, and cultural and arts organizations. Private charities include private colleges and universities, private museums, and most nonprofit organizations. Exhibit 3.2, a memorandum of understanding, addresses a situation where the donors wish to provide funding to construct a building at a charity named in honor of the donors.
VICE PRESIDENT FOR DEVELOPMENT (ADVANCEMENT) At most charities, the vice president oversees annual giving, major gifts, planned giving, and, at some educational institutions, alumni relations. At some charities, the public relations office and/or communications office is also included under the vice president. For large gifts, the vice president should be involved in negotiations. It is important that the donor have an understanding with the vice president for development. If a conflict arises within the institution, the vice president for development serves as an advocate on behalf of the donor to articulate the importance of the project to both the donor and the charity. The vice president negotiates and approves most agreements between donors and the charity.
BOARD OF TRUSTEES (DIRECTORS) Q: Who makes policy decisions for the charity? A: The most important group is the board of trustees (directors or
regents at some charities), which makes policy decision at the highest levels. For large gift naming opportunities, donor-initiated projects, or for other complicated gifts, seek approval from this board. The gift review committee oversees and approves gifts of real estate, tangible personal property, closely held stock, restricted gifts, and endowed funds. In addition, the investment committee oversees investment policy, determines the rate that endowed funds pay, and formulates investment strategy, asset allocation, and portfolio management.
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Board of Trustees (Directors)
EXHIBIT 3.2
Memorandum of Understanding
MEMORANDUM OF UNDERSTANDING BETWEEN
AND and hereby agree to the terms of this Memorandum of Understanding which are as follows: 1.
It is the intent of to provide funding for the construction of to be located on a lot of land adjacent to the building.
2.
To provide funding for the , agree to transfer to the a warranty deed transferring #± acres of real estate in as described in the attached warranty deed. The property has been appraised at <$>.
3.
For purposes of valuing the property, the have had an appraisal conducted on their property at their expense and a copy has been provided to .
4.
The agrees to list the property with a local real estate brokerage firm as soon as possible.
5.
The parties intend that the property shall be placed on the market at a price that approximates the appraised value of the property.
6.
Proceeds from the sale of the property will be used to cover the cost of the purchase and installation of the .
7.
Surplus proceeds, if any, will be used to establish an endowment, the income of which will be used to provide funding to a graduate assistant in the Department of < > at . A copy of the proposed endowment agreement is attached.
8.
No construction shall begin until such time as the property has been sold. In the event that the funds realized from this sale of property are insufficient to provide funding for the construction of the shell, or due to delay in sale or decline in the market value of the property it becomes impossible or impracticable to construct the shell, then the funds shall be used to support the Endowment.
9.
Upon completion agrees to name the building in honor of the .
Date
Date
Date
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The charity’s governing board is responsible for policymaking and for governance of the charity. In addition, the board is responsible for approving all naming opportunities through which a donor’s funds will be used to name a building or other capital project, or for approving major donor-initiated projects. Before you make a gift to name a building or attach your name to another capital project, obtain the board’s approval and support. Any large or complicated project should have the approval of the chairman of the board and president.
DEVELOPMENT OFFICE Development offices are organized in a variety of ways, depending on the size and type of charity. For example, many development offices are organized as a centralized department, where employees are centrally managed by a main office and are physically located in a building housing the development office; or the development office may be a decentralized department where employees are physically located outside of the office and report to a particular dean, physician, administrator, or department head. If so, development officers are responsible for raising money from donors in that department. The development office also may be divided geographically within regions of the country. Often charities use a combination of these organizational approaches.
ANNUAL GIVING The annual giving program is the foundation of any development office effort; it is the development office’s largest marketing arm and one that, over time, identifies a significant number of major gifts and planned giving prospects. A development office uses annual giving to expand its base by soliciting donors for annual gifts through a personalized direct mail/telemarketing plan, which segments the potential donor population. In an educational institution, alumni of all schools and classes are solicited for the annual fund. In a hospital, prospects to the annual fund are primarily patients, doctors, employees, and friends of the hospital. In a museum, the prospects are patrons, subscribers, friends, and volunteers. The annual fund program has two main purposes, dollar acquisition and donor acquisition. An annual giving program’s success is defined by raising more dollars than the preceding year, receiving a higher average size gift, and showing a greater percentage of donor participation. Annual giving raises money through direct mail and the telefund program. These funds support departments, programs, or projects at the charity.
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Direct Mail A direct mail solicitation is the lifeblood of most annual fund programs and is the first and most common method of raising money. Charities receive immediate cash, usually in small amounts, for operating expenses and program support through direct mail solicitation. New prospects are solicited after graduation, a hospital stay, or a visit to the museum. Over time, many annual fund donors “graduate” to higher giving levels within the charity. Telefund Program Many organizations, as part of their annual giving program, operate a telefund or phonathon program. Telefund callers follow up on the direct mail effort by telephone, asking prospects and donors to make gifts to the organization’s annual fund. Telefund callers, whether volunteers, students, faculty, paid staff, or outside employees, often call throughout the year to solicit donors. Many organizations use automated telemarketing systems with computers that show a donor’s giving history and provide general information about the donor as well as scripts and files that are accessible online. Personalized pledge cards are sent to donors to confirm their pledges. Pledge bills are then issued, usually three to four times per year, although some organizations bill monthly or even on consecutive weeks following the pledge. Aside from the financial support produced by the telefund, a telefund program provides direct feedback from donors and prospects. Callers who speak with donors and prospects learn firsthand about their perceptions and feelings for the charity.
MAJOR GIFTS Q: Whom should I work with at the charity when I make a charitable gift? A: Most charities have a development office with development officers
who handle charitable gifts. Ask for the name of the development officer who handles gifts for the charity’s department you wish to benefit. In addition, if your gift is a life income gift, charitable remainder trust, or gift through your estate, ask for the name of the charity’s planned giving officer. Most development offices have several centrally based development officers who actively pursue prospects for major cash gifts. Most major
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gifts are outright gifts of cash or stock. The gift is outright in that the gift is not used to fund a planned gift such as a life income gift. What is considered a “major gift” varies among organizations. A minimum amount for a major gift is often $5,000 and can go up to $100,000. What is considered “major” for the charity might be beyond the scope of the donor’s capacity to give. It is important to give at whatever level you feel is appropriate. Some charities share major gifts officers with several departments while others have one or more full-time development officers concentrating solely on major gifts for that department.
PLANNED GIVING Q: What is planned giving? A: Planned giving involves giving through life income gifts, such as a
charitable gift annuity, deferred gift annuity, charitable remainder trust, and a gift to a pooled income fund. In addition, planned giving involves gifts of noncash assets, such as securities, real estate, tangible personal property, and gifts by will or trust. Planned giving officers also prepare fund descriptions (gift agreements) for endowed funds and often have degrees in law, financial planning, or asset management. Most planned giving officers work from a centralized development office and work with all departments in the organization. Along with the entire development staff, a planned giving officer raises money for the charity and builds relationships with donors. The planned giving department identifies, cultivates, and solicits donors who make planned gifts. Planned gifts include gifts that provide a lifetime income to donors, such as pooled income fund gifts, charitable gift annuities, and charitable remainder trusts; the use of assets other than cash, such as stock or real estate, and tangible personal property, such as art, antiques, and collections; and gifts from your estate, such as bequests. Planned giving officers specialize in handling gifts with tax and estate implications for donors.
STEWARDSHIP Some organizations have a separate stewardship office that oversees an organization’s endowed or restricted funds. Endowed restricted funds are gifts established for a specific purpose, such as to award a scholarship to a student majoring in biology or a gift to benefit the cardiac care center at a hospital. The primary responsibilities of the stewardship office
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are to cultivate the donors of these funds, serve as a liaison between the donor and the fund’s beneficiary, prepare annual reports on the status of the fund, and keep donors informed about additional donations to their fund.
GIFT ACCOUNTING AND PROCESSING The gift-accounting department tracks gifts and pledges made to the charity from individuals, foundations, and corporations. The gift-reporting department is responsible for maintaining donor records and processing gifts to the charity. Receipts and acknowledgment letters are issued to donors from this office and should be issued within a reasonable period of time following your gift.
COMPUTER SERVICES Each charity records information about donors, patients at hospitals, patrons at cultural organizations, and graduates of educational institutions. The computer services department records biographical and family information, giving records, and also may track your activities within the charity, including the names of people you know there as well as events that you attend. Donors can request that their gifts be treated confidentially or anonymously.
THE CHARITY’S GIFT REVIEW COMMITTEE Many charities create a gift review committee to approve gifts of tangible personal property, real estate restricted gifts, or endowed funds before they are accepted by the organization. A gift review committee also oversees complex, unusual, or potentially controversial gifts. The committee also may decide to delegate certain decisions to an appropriate officer at the charity. For example, if a donor wishes to make a gift of art to the organization, a number of issues need to be considered. Is the gift of real value to the charity? If not, is the relationship with the donor important enough for the charity to accept the gift? Does the donor insist that the artwork be displayed rather than sold? If so, do liability issues arise? Will the artwork be secure as well as properly cared for? What will it cost the charity to protect and insure the gift? Where will the artwork be displayed in the organization? Who will make this decision? You need to explore and obtain answers to these questions before you make your gift.
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A gift review committee also plays an important role with gifts of real estate. A situation can arise where a donor wishes to make a gift of real estate but requests that the charity use the property for a specific purpose. The gift review committee would be asked to explore the relationship the donor has with the organization; whether the organization actually can use the property; whether maintenance, taxes, and insurance are prohibitively expensive if the gift is accepted; and if the charity has the capacity to manage the property. You, too, should be asking similar questions to make sure the charity can accomplish your objectives.
THE CHARITY’S INVESTMENT POLICIES Sophisticated donors with large estates often accumulate or preserve their wealth through significant investments in the stock and bond markets. These individuals often expect that the charity will produce market returns equal to their personal performance in the stock market. Sometimes they are disappointed to learn that returns from the charity’s investment portfolio are less than expected, that not all income is distributed, that a portion of the income is used to pay a management fee, or that there is little flexibility among the charity’s investment options. For example, most charities pay out about 5 percent of the market value of your endowed fund and charge as a management fee 1 to 1.5 percent. Remember, the charity is managing someone else’s money— yours. It must preserve and grow the principal of your gift and develop an investment policy to govern the management and investment of your funds. The policy addresses appropriate investments, asset allocations, portfolio management, benchmarks, and a way to evaluate the performance of the portfolio and its investment managers. An investment policy must permit donors to feel confident about the management of their charitable gifts rather than feel that the investment policy is designed only for the benefit of the charity. A properly drafted investment policy can be of tremendous value, demonstrating to you the charity’s duty in managing the endowment, safeguarding the principal, and ensuring that the charity’s endowment and life income funds will support your wishes in perpetuity. Before you make your gift, ask for an explanation of the charity’s investment policy.
THE CHARITY’S PORTFOLIO Most charities’ operating expenses for items such as salaries, maintenance, equipment, and restoration have grown faster than increases in inflation, placing additional pressure on charities and their money managers to
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Separately Invested Endowed Funds
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perform well. To keep pace with these increases, at a minimum, the principal of the endowment must grow at a rate greater than the rate of inflation to maintain its purchasing power. Most endowment portfolios are invested heavily in stocks, including small-cap, mid-cap, large-cap, and blue chip stocks. The portfolio typically invests largely in domestic stocks but may also invest in foreign equities. As operating costs increase over time, income-only portfolios fail to produce growth in the underlying principal sufficient to preserve purchasing power. For example, a $1 million portfolio of bonds with a maturity of 20 years, paying 7 percent, produces income of $70,000 each year. That $70,000 may provide seven $10,000 full-tuition scholarships in year 1. But by year 20, if tuition increased 7 percent per year, tuition has grown to $38,700, and that same $70,000 would produce only 1.8 full scholarships. Stock and bond portfolios provide opportunities for diversification, stability, and growth. A few charities offer donors who establish endowed funds the choice of directing contributions to one of three investment portfolios, usually maximum income, growth and income, or growth. Giving donors a choice helps to meet donors’ needs and provides realistic expectations to the charity’s staff that prepares budgets in anticipation of endowment earnings. Like a mutual fund that offers growth, growth and income, and income funds, a charity can allow donors to allocate their charitable gifts to the endowment strategy compatible with their goals. Occasionally donors want their endowed funds to grow to a specific dollar amount, for example, $100,000, and then distribute income in accordance with their wishes as defined in the gift agreement. A growth portfolio would accommodate such a donor who could designate gifts to a portfolio that would offer opportunities for capital appreciation; once the fund reached the level of $100,000, it could be transferred to an income endowment designed to provide maximum income to satisfy the endowment’s objectives. Investment portfolios may be developed to balance the often-conflicting interests of the donor and the charity.
SEPARATELY INVESTED ENDOWED FUNDS For gifts in excess of $250,000, charities sometimes offer separately invested endowed funds. The endowed fund is invested in accordance with recommendations made by the donor, is designed to achieve a specific investment objective, and is funded with assets designed to accomplish those purposes. Separately invested funds can meet donors’ needs but can be more expensive to manage and cause administrative inconvenience due to separate reporting and accounting requirements when investing discrete funds for specific purposes. On the other hand, if you
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are dissatisfied with the charity’s investment policy or investment returns, a separately invested fund may be the only answer. Charities evaluate the specific accommodations requested by a particular donor to make certain that the benefit exceeds the cost. See Chapter 11 for more information on charitable gift options that can be customized significantly.
SPENDING PROVISIONS In setting the spending rate for endowed funds, the investment committee must consider the charity’s need for income, its historical precedents for distributions from endowment, and its investment strategies. Some donors prefer to see all income distributed rather than limiting the payment to a percentage of the market value whereas charities want to reduce the payout to allow the fund to build. Over the years, the trend has been to reduce the payout to 5 percent or less of the market value. Returns in excess of 5 percent are added to principal, allowing the fund to increase in value over time.
MANAGEMENT FEES AND EXPENSES Fees for professional investment services are a natural cost of doing business. Fees may be measured by basis points or as a percentage of the portfolio’s market value. Most charities charge management fees in the range of 1 to 1.5 percent of market value of the donor’s fund. A management fee of 2 percent or more strikes many donors as excessive. Fees represent a significant percentage of distributable income. In addition, fees are deducted from the portfolio’s market value prior to calculating the distribution. For example, for an endowment of $100,000, if the management fee is assessed as 2 percent of market value ($2,000) and the spending provision calls for a payout of 5 percent of market value less management fee ($4,900), the management fee represents almost 50 percent of the payout, which seems excessive to many donors. Some donors assume that investment expenses will be paid by the charity rather than be deducted from the principal or earnings of their gift, but this is not true. Investment expenses are allocated to donors’ funds on a pro-rated basis. Donors must remember that there is a cost for professional management of their funds. The degree of disclosure about management fees and expenses varies among charities. Some charities provide complete disclosure by including a statement in each donor’s gift agreement that explains how expenses will be handled. Others provide spending and performance figures net of
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Conclusion
fees and expenses. Ask the charity to explain their expenses related to the management of your funds.
CONCLUSION Every charity has its own personnel and policies to handle and accept charitable gifts, and it is important for you to get to know them. The charity’s staff can serve as part of your team of personal and professional advisors. Identify staff members who understand your goals, listen to your ideas, and are willing to help. Select the appropriate staff member based on the size and complexity of your gift. As your charitable giving becomes more complex, you need to select staff members at the highest level to help you. If your gift is substantial, do not be afraid to call the president to discuss your charitable giving agenda. Also understand the charity’s investment and management policies that pertain to your gift. Each charity has its own way of managing resources, and it is important to understand all of the issues involved.
CHECKLIST
❏
❏ ❏ ❏ ❏ ❏
ABOUT THE CHARITY
Whom will you deal with at the charity?
❏ ❏ ❏ ❏
Vice president Major gifts officer Development officer Planned giving officer
Will you need the assistance of the president or board of trustees? Will the charity be able to meet your needs in administering your gift? Are you satisfied with the charity’s investment policies? Have you explored management fees and expenses? Do you feel comfortable moving forward with a gift?
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CHAPTER 4
Professional Advisors, Family Members, and Your Philanthropy
In most cases, you alone do not decide to make a gift to a charitable organization. A variety of individuals, including your family, friends, mentors, professional advisors, and the charity, may advise you in making your gift or, in some cases, discourage you from making a charitable gift. Let us start by looking at those professionals who may have an opinion about your gift, and how you want them to assist you in your philanthropy, if at all. Then we will move to family members, friends, and mentors, and the impact they may have on your gift giving.
PROFESSIONAL ADVISORS Increasingly, professional advisors are becoming more involved in philanthropy. Many recognize that donors need assistance in their giftrelated activities. Some advisors can help you select the right type of gift to make, direct you toward the best assets in your portfolio to use for a gift, and help you with the timing of your gift. Many fine attorneys, accountants, and financial planners are knowledgeable about planned giving and charitable gift planning. Be wary of advisors who may simply see your philanthropy as a way to earn fees or generate a commission. Planned giving and charitable gift planning may seem complicated to practitioners who seldom get involved in charitable gift planning. Identifying qualified and competent advisors knowledgeable in charitable gift planning is critical. Beware of professional advisors who are unfamiliar with charitable gift planning techniques. Be cautious of advisors who divert your attention to unacceptable alternatives or those who discourage you from making a charitable gift. If they advise you against making the gift, make sure it is for the right reasons and that you understand and agree with these reasons. 39
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Some advisors, asked to do something new and unknown to them, advise the client against doing it. These advisors are few in number, but if you have such an advisor, it will be difficult to move ahead with philanthropy. If you reach an impasse with your advisor or feel that he or she is uncomfortable with giving concepts, ask for a referral to someone who specializes in charitable gift planning. In this chapter we explore your potential relationships with the following advisors: attorney, financial advisor, stockbroker/mutual fund companies, certified public accountant, trust officer, insurance agent, and the charity’s development/planned giving professional. It is likely that one or more of these professional advisors, along with the charity’s professional development staff members, will work closely with you to help you with your gift. When it comes to making a charitable gift, you are the decision maker and your advisors are just that — advisors. Many gifts have failed to materialize because no one is in charge. Take charge of your philanthropy, invite input, consult with your advisors, and then make your own decision.
ATTORNEY Your attorney can be a great help to you with your philanthropy. It is important to remember, however, that your attorney may not be an expert in charitable giving. Many attorneys do not have a large enough practice in gift planning to stay current with the issues. Even attorneys who are knowledgeable in estate planning and taxation may not understand the fine nuances associated with making a charitable gift. If they have a strong background in estate planning and taxation, they may be familiar with charitable giving, or those practicing in a large firm may be able to draw on the expertise of other lawyers in their firm who have a stronger charitable gift planning background. Ask your attorney about his or her experience in charitable gift planning. Your attorney should be able to advise you on how your gift fits into your overall estate plan. He or she should understand the tax impact of your gift on your estate and help advise on the timing of your gift, such as whether the gift should be made this year, next year, or spread over a number of years. Your attorney may need to draft trust documents, such as a charitable remainder trust or a charitable lead trust. He or she should be called on to review documents drafted by the charity, such as an endowed fund description, gift annuity contract, or pledge agreement. Remember that you get what you pay for. Over the years, charitable gift planning has become more sophisticated, and you need an attorney
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Certified Public Accountant
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who knows the subject matter or is willing to learn quickly. The charity’s planned giving officer should provide your attorney with information that will make the job easier.
FINANCIAL ADVISOR Your financial advisor can be an investment advisor, financial planner, or asset manager. He or she may function in a range of capacities, including advising you on activities about investing in an IRA, whether you can afford a new addition to your house, and how best to save for your children’s education and your retirement. Your financial advisor may also serve as your asset manager, investing your money for you. If your investment advisor does work for you in addition to, or exclusive from your investing, he or she may be in a position to help you decide if you can afford to make a gift and help select what asset to use. It would be helpful to you if your advisor advises other clients about charitable giving. Some financial planners are compensated based on a percentage of the value of your assets under management. Obviously, assets that are transferred to a charity are no longer part of your portfolio, and this can impact your advisor’s compensation.
STOCKBROKER/MUTUAL FUND COMPANIES Stockbrokers, brokerage companies, and mutual fund companies are actively becoming involved in the charitable business. Many offer charitable gift accounts and information on the gift planning process. Remember that their income may be derived from commissions from the purchase or sale of assets or from management fees based on the value of investment assets. Some may not be eager to transfer assets out of your account to a charity if that transfer will not trigger a commission. If their compensation is derived from the value of all assets under management, their compensation may be reduced when assets are transferred to a charity. Remember, too, that some gift vehicles, such as charitable remainder trusts, may be managed by a brokerage house mutual fund or by a charity. Explore the potential downside of any arrangement that promises unusually high returns.
CERTIFIED PUBLIC ACCOUNTANT Your certified public accountant (CPA) is most familiar with your tax situation. He or she should have a strong handle on the income that you
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earn or receive each year, the income you earn on your investments, and your tax situation. Your CPA may be an excellent source of information to you, especially related to what you can deduct for your gift (20, 30, or 50 percent) and how your charitable income tax deductions need to be spread over future years. Show your CPA planned giving software calculations that the charity prepares. He or she can provide advice on the option that is best for you.
TRUST OFFICER If you have funds invested in a trust or receive funds from a trust established by someone else, your trust officer may be familiar with your financial situation and be in a position to help with your charitable giving. This is especially true if most of your income is in a trust, managed by this trust officer. Because many trust officers are employed by large trust companies or banks, they generally can call on a host of colleagues to help with estate planning, tax returns, and settling an estate. Turn to your trust officer to help you with your charitable gift, especially if you are considering establishing a charitable remainder trust or lead trust.
INSURANCE AGENT Insurance companies often promote products that compete with life income gifts and other charitable gift options. Many insurance agents are looking to philanthropy to provide new opportunities to promote these products, such as buying life insurance or variable annuities. Their products may include funding trusts with insurance that will run for 20 years or more, which will include administrative and management fees. Carefully review these insurance arrangements to make certain they accomplish your charitable gift planning objectives. Be sure to bring in another advisor, such as your attorney or CPA, if you are evaluating a life insurance gift arrangement. Ask the charity’s planned giving officer for his or her opinion about the proposed insurance program. Make sure that all investment assumptions are realistic and sustainable. Ask about fees and commissions.
DEVELOPMENT/PLANNED GIVING PROFESSIONAL Most charities have several development professionals on staff. Their job is to raise money for the charitable institution. Development professionals
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usually believe in the cause for which they are raising funds and do not want to suggest or accept a gift arrangement that would ultimately reflect poorly on the charity or adversely affect you. Development professionals can provide a wealth of information about the charity and also suggest gift options that the charity offers. Since their services are free to you, you should work with them closely to gain as much information as possible, comparing their recommendations with those of your fee-based outside advisor. Many charities have specialists who advise donors about planned giving and charitable gift planning. These specialists are called planned giving officers, and they usually are very knowledgeable about tax, estate planning, and charitable giving. They should be able to provide you with the information you need to move forward with your charitable gift. They will meet with you and your professional advisors to answer questions and present charitable gift planning options.
WHAT TO ASK WHEN SELECTING AN ADVISOR Specific questions to ask a potential advisor vary from professional to professional; however, the following questions can get you started on what you will want to know about an advisor you are interviewing: 1. Experience
— How long in practice — Related companies, firms, and practices — Experience with individuals like you — Representative client list 2. Qualifications
— Degrees/licenses — Schools attended — Continuing education taken to stay current in field Check with the appropriate licensing board to determine the professional’s current status in the field or if any charges are pending against him or her. Contact the board of bar overseers, certified financial planning board, National Association of Securities Dealers, and state insurance and securities departments.
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3. Services offered
— Products sold — Type of advice given — Area of expertise 4. Advisor’s approach
— How does the advisor prefer to work? — Is the advisor’s approach compatible with your approach? — Will the advisor do everything from start to finish or bring in others professionals at some point? — Can you meet other professionals who may be involved? You may want to check the backgrounds of those outside professionals. 5. Compensation
Get an estimate (exact amount may be difficult to determine) of what you will be charged for work done and determine how payment will be measured. — Salary — Hourly fee — Flat rate — As a percentage of your assets or income — Commissions from products sold — Are there additional expenses you may be charged for? — How often will you be billed? 6. How long will this gift process take? 7. Conflict of interest
— Is there any conflict of interest in taking you on as a client? 8. Written agreement
— Ask for a written agreement that includes the details of the work that will be done and how the advisor will be paid. Knowledgeable and experienced professional advisors can make your work easier. Do your homework and select advisors who are interested in helping you fulfill your philanthropic goals. Next we take a look at the important role that your family plays in your charitable giving.
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Working with Friends and Mentors
45
CHARITABLE GIVING AND FAMILY DYNAMICS Charitable giving is an intensely personal issue. However, for most donors, family greatly influences not only the size of the gifts but the designation of that gift. Depending on the family structure, spouses may jointly make decisions about their charitable giving, or each spouse may make gifts independently. Unmarried individuals or individuals who live with a partner also may need assistance from members of their family unit. For most large gifts, families operate in concert. Large gifts impact the availability of disposable income, and gifts to charity reduce resources that could be transferred to other family members, such as children, nieces, nephews, and parents. To maintain harmony, it is important to discuss charitable giving with your family unit. Often when family members learn more about charitable giving, they feel comfortable with the concept of making a gift. They even can share in the gift to make it truly a family gift. Sometimes one spouse may be more philanthropic or at least may have more experience making charitable gifts than the other. Like all matters that involve money, special care should be taken to make sure that spouses are on the same page or at the least that the amount of the charitable gift is acceptable to both spouses. Often there are conflicts about the designation of the gift to charity. Many spouses have different alma maters and different perspectives about which charity should receive their support. These matters need to be negotiated; otherwise, charitable giving can become a divisive and contentious issue. Spouses often see things differently when they visit a charity, and these perceptions can be very helpful in the decision-making stage. Spouses may reach different conclusions about the worth of a particular charity or the value of its programs. It may be helpful to have a second opinion about an issue related to making a gift. In addition, the spouses can share the workload, making the job of philanthropy less demanding. Family discussions about charitable giving also create wonderful opportunities for parents and grandparents to teach children about the role of philanthropy. Parents or grandparents can make gifts in honor of their children or grandchildren to charities that they consider important. Children can add token amounts to their parents’ gifts so that they can share in philanthropy. Lessons learned at an early age enable families to pass the tradition of philanthropy from one generation to the next.
WORKING WITH FRIENDS AND MENTORS Friends and mentors, especially those who are philanthropic, can serve as a sounding board for individuals who are considering making a major
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Professional Advisors, Family Members, and Your Philanthropy
gift or for those who are uncertain about which charity to support. These advisors may know individuals who serve on boards of charities and may understand the workings of a particular charity. Friends and mentors also may have colleagues and associates with experience in philanthropy. They may be helpful in providing information on charities that you are considering. For truly large gifts, it is a good idea to ask for the advice of at least one mentor or friend.
CONCLUSION You have a wonderful array of both personal and professional advisors who can greatly assist you in your philanthropic decision making. These advisors can help you make the right decision and remove some of the pressure you may feel when it comes to deciding the amount and designation of your gift. You also have to remember that the final decision is yours. While it is smart to seek input from knowledgeable and helpful advisors, in the end, you must make the decision. Many gifts do not materialize because no one is in charge of the decision-making process. If philanthropy is important to you, make the decision to make the gift.
CHECKLIST
PROFESSIONAL ADVISORS AND FAMILY MEMBERS
❏
Have you discussed the impact of your gift on your estate with your attorney?
❏
Have you discussed fully the tax consequences of your charitable gifts with your CPA?
❏
Have you considered carefully the choice of which asset to use to make your gift?
❏
❏ ❏
Cash
❏
Real estate
Appreciated securities
❏
❏
Mutual funds
Tangible personal property
Have you asked your financial advisor or investment advisor for advice?
❏
Is your family in agreement with your decision about the gift and designation of the gift?
❏
If you are making a large gift, have you spoken with a mentor about this decision?
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CHAPTER 5
How Will the Gift Be Used? Endowed Funds
FREQUENTLY ASKED QUESTIONS
What is the difference between a restricted and unrestricted gift? What is the difference between a current use gift and an endowed fund? If I establish an endowed scholarship fund, can I ask the charity to give the scholarship to a specific recipient? Why don’t charities pay more than 4 to 5 percent on endowed funds? I can earn that on a CD.
Charitable gifts help charities offer programs, deliver services, conduct their business, and fulfill their missions. How your gift will be used is up to you. Your charitable gift can be used to meet the needs of the charity in a variety of ways limited only by your imagination. You may already have something very specific in mind. If not, to learn more about the charity’s needs, ask the charity for recommendations on ways that your gift could be used. What are the charity’s priorities? What is its greatest need? Which programs or activities need funds? What will the charity do with your gift? Do not forget that you must decide how your gift will be used. Put your resources into a program or department that means something to you. Have fun with your charitable giving. Your charitable gifts can be used to accomplish almost any charitable purpose that is important to you. The purpose must be charitable in nature and should not include
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discriminatory criteria based on race, ethnicity, or other related factors. Most charities allow you to restrict criteria based on gender, such as “female students pursuing a degree in engineering.” You always can express your wishes as a preference, such as “Preference shall be given to female students pursuing a degree in engineering.” Be creative and use your imagination. This chapter outlines the way you can use your gift to accomplish your charitable goals. Included are descriptions of the types of programs you can support and the ways to provide support through current use awards and endowed funds. It also explores the way you want your money to be used either immediately through a current use account or distributed as just income from your gift rather than the principal through an endowed fund. The following are definitions that are used throughout the chapter: Type of Gift
Definition
Unrestricted
Nondesignated gift used by the charity at its discretion
Restricted
Gift specifically designated by the donor for a purpose
Current Use
One-time restricted gift that provides immediate support to the charity for the purpose designated by the donor.
Endowed Funds
Fund is permanently managed in perpetuity with earnings distributed annually.
It is important to remember that both current use and endowed funds can be restricted or unrestricted.
UNRESTRICTED GIFTS Q: What is the difference between a restricted and an unrestricted gift? A: An unrestricted gift enables the charity to use your gift at its discre-
tion for any purpose it chooses. A gift is restricted when you place a limitation or restriction on the use of the gift. If the gift is restricted, the charity must honor the restriction and use the gift consistent with your wishes. Restrictions can be formalized through an agreement with the charity or informally by a note signed by the donor. For example, “I give $25,000 to XYZ charity to be used for restoration of the Art Gallery’s collection of the sixteenth-century artists.” Most large gifts are restricted.
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Current Use Awards
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Unrestricted gifts come with no strings attached. The gift is used at the discretion of the board of directors or president. The gift can be expended for any purpose that fulfills the charity’s mission. To a charity, unrestricted gifts are the most valuable, for they may be used for any purpose. These gifts are hard to come by; only thoroughly generous and trusting donors make such gifts. Many donors do not want to give charities broad discretion in utilizing their gifts. However, if you have faith in the charity and trust that its staff will use the funds wisely, unrestricted gifts are the most valuable ones you can make. They also enable the charity to respond to changes that could not be foreseen at the time of the gift. For example, a permanently endowed fund that allows the president to use the income at his or her discretion enables presidents over the years to use the income in support of a variety of projects. If you want to limit the use of your gift or designate it to benefit a specific purpose or program make a restricted gift.
RESTRICTED GIFTS Restricted gifts are gifts where the donor includes criteria limiting the use of the gift for a particular purpose (e.g., scholarships) or program (e.g., cardiac care). They are any gifts that limit the charity’s use. Gifts are restricted when criteria or guidelines are developed that limit their use. A gift agreement prepared by the charity defines the restrictions and limitations of your gift. This is discussed later in this chapter. Most large gifts are restricted because you, as the donor, have an agenda in mind when you make your gift.
CURRENT USE AWARDS Q: What is the difference between a current use gift and an endowed fund? A: A current use gift is a pass-through gift. You make a gift to the char-
ity and the charity immediately uses your gift consistent with your wishes. Your gift is not managed or invested. Although most current use gifts are one-time gifts, you can make additional current use gifts over time. On the other hand, through an endowed fund, the principal of your gift is managed in perpetuity and in most cases a percentage of the market value of your gift is distributed. The percentage is usually 4 to 5 percent at most charities.
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A current use gift provides immediate financial assistance to purchase books or supplies, cover operational expenses, or fund specific projects consistent with your wishes. Most current use awards are relatively small, but there is no reason why they should be. A donor can create a named current use fund for as little as $1,000 at many organizations. For example, you can send a check for $1,000 to your favorite charity and ask that it be called “The G. Nash Current Use Award.” Remember, the sky is the limit. Make your gift as large as you want it to be, just understand that with a current use gift, the money will be spent at once or within a year. Your gift will not grow but will be used immediately to support current projects, programs, or activities.
ENDOWED FUNDS Q: If I establish an endowed scholarship fund, can I ask the charity to give the scholarship to a specific recipient? A: If you do, you risk losing your charitable income tax deduction. Let
the charity make the decision about selecting recipients. You or a family member can serve on the selection committee, but the charity should make the final decision. Q: Why don’t charities pay more than 4 to 5 percent on endowed funds? I can earn that on a CD. A: Many donors are disappointed when they learn that charities distrib-
ute only 4 to 5 percent of the market value of their endowed funds. The principal of the endowed fund is typically invested for total return in a portfolio of stocks, bonds, and other investment assets. The charity distributes a percentage of the market value often averaged over a three-year period. After expenses are deducted, the excess earnings are returned to principal, enabling the fund to grow over time and to produce more income in future years to keep pace with inflation. The concept is similar to making withdrawals from your retirement portfolio. Most advisors suggest withdrawing no more than 4 to 6 percent per year from a retirement portfolio otherwise the principal may be depleted. An endowed fund is like an investment account or bank account. The principal is invested, and the endowed fund distributes income from the earnings of the fund. Only a portion of the earnings of an endowed fund are spent, preserving the principal intact. Endowed funds are managed in perpetuity and usually make distributions based on a percentage of the principal value of the endowment. After deducting management fees,
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Endowed Funds
most charities distribute 4 to 5 percent of the market value of the endowed fund, depending on the restriction included in the gift agreement and the charity’s investment policy. For example, if the market value of the fund is $10,000 and the payout is set at 5 percent, then $500 will be distributed this year. The distribution can be used immediately, or it may be added to the principal or reserved for future use. In most cases, endowed funds are restricted in that their income is designated to benefit a specific department, program, or project at the charity. The charity depends on income from endowed funds to continue programs from year to year. Endowed funds provide stability to a charity. The earnings from these funds can be used for scholarships, operating support, program support, or any other purpose consistent with the intent of the donor and the needs of the charity. You can allocate the distribution by providing that, for example, 50 percent be used for scholarships for chemistry majors and 50 percent be used for the chemistry department. Endowed funds also can be established in honor of a person who was important to you. People make gifts because of people, and you may
GIFT TIP! Over the years we have helped families increase the size of their endowed family funds, and we are pleased to share with you some ideas we have learned from them. Building Your Endowed Family Fund • Make an annual gift to the fund. Over time these annual gifts may double the size of your family fund. • Honor family members’ birthdays, anniversaries, and weddings by making gifts to the fund in their names. • Some families, in lieu of exchanging birthday or holiday presents, make a gift to the family fund. • Make a planned gift and designate your gift to benefit your family fund. • Through your will, leave a percentage of your estate or a specific dollar amount to your fund. • Let friends, colleagues, and relatives know about your fund and invite their support. Charities usually send a thank-you letter to each donor and let you know the names and addresses of contributors to your fund. • For memorial services, suggest that in lieu of flowers or fruit, gifts be made to your family fund.
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wish to make gifts in honor or memory of a parent, mentor, friend, child, or distinguished individual at the charity. Think of people who influenced you or who made a difference to you or impacted your life: a family member, a professor, doctor, curator, staff member, or a department head. When you establish an endowed fund, other donors can make gifts to it. You also can make additional annual gifts, planned gifts, and bequests in support of your endowed fund. You can add to your endowed fund at any time, and you also can make affordable multiyear pledges to provide significant financial support over time. Today all charities need cash for immediate use, but they also need funds to support their long-term needs. Current use gifts provide immediate financial resources to the charity for short-term goals, while endowed funds provide support for long-term goals. You can do both by making a gift for current use and a gift for an endowed fund.
CREATING AN ENDOWED FUND When you create an endowed fund, you make a lasting contribution to the charity’s future. An endowed fund provides annual support each year in perpetuity. Endowed funds help support faculty projects, research, scholarships, professorships, exhibits, lecture series, athletic programs, facility operations, and much more. You may honor the memory of a loved one and establish a memorial endowed fund. A named memorial gift fund becomes a lasting symbol of the bond between the charity and those who are forever honored and their families. The following sections provide an overview of the types of endowed funds you can create. Scholarship/Fellowship Funds At educational institutions, teaching hospitals, and other organizations that have a formal teaching component, endowed scholarship/fellowship funds provide much-needed financial assistance to worthy and financially needy students. Scholarships usually are awarded to undergraduate students, and fellowships are awarded to graduate students. You may choose to provide assistance to a student studying a specific major in a certain department or studying a particular subject. A graduate or an undergraduate student may be selected, perhaps majoring in a specific department, and you can decide whether and to what extent the candidate must be financially needy and/or academically worthy to receive the award. You may require that recipients maintain a minimum grade point average or require other criteria, such as participation in extracurricular activities. You establish the criteria — the decision is up to
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Creating an Endowed Fund
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you. Be careful not to make the criteria too restrictive. Otherwise, in the case of a scholarship fund, the pool of potential recipients will be too small. Other Endowed Funds Endowed funds can be established for almost any purpose that helps the charity fulfill its mission. The following list explains objectives for endowed funds and the purpose of the fund. Each of these endowed funds may bear your name or may be named in honor or in memory of someone important to you. Fund Objective
Purpose
Student Support
Financial aid, room and board, book funds
Scholarships
Financial support for students to offset tuition
Fellowships
Support for graduate students, teaching or research stipend
Awards
Merit awards for student performance, book awards
Seminars
For students, faculty, staff, and the public
Lecture Series
Underwrites honorarium of speaker and expense of series
Scholars in Residence
Brings to the charity a distinguished scholar for 4 to 6 weeks
Visiting Scholar
Brings to the charity a scholar for a semester or half a year
Guest Speaker
Underwrites a single speaker for a one-time event
Speaker Series
Underwrites annual series of two or more speakers
Equipment Computers
Charities need constant sources of support to secure, replace, and upgrade software, hardware, Internet access, connectivity, and networking capabilities
Technology
Software, servers, Internet access
Scientific Equipment
Telescopes, microscopes, medical supplies
Projects Display
Underwrites the cost of a display, exhibit, presentation, or performance at a theater, museum, opera, symphony, hospital, or university
Exhibition
Underwrites an exhibition at a charity
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How Will the Gift Be Used? Endowed Funds
Fund Objective
Purpose (continued)
Presentation
Provides resources to make presentations at public schools or community functions
Performance
Underwrites plays, experimental and traditional theater companies, or charities involved in music
Curation
Supports research activities and cataloging of valuable collections at museums and other charities
Restoration
Supports restoration and cleaning of collections and displays; especially important at museums
Faculty/Staff
Funds for achievement and incentive.
Awards
Recognize achievement or excellence
Release Time
Pays for the cost of a faculty member’s salary so that research or special projects can be conducted
Faculty Support
Supplements faculty salaries, attendance at conferences
Program Support
Funds for the charity’s departments or divisions
Departments
Underwrites the charity’s departments or programs
Services
Supplements the cost to deliver charity’s services to those who need them
Screenings
Medical evaluations, public education, clinics
Facilities Capital Projects
Add wing, addition, or new facility
Naming Opportunities
Naming an existing or new building
Operations
Supplement the charity’s budget
Maintenance
Pays for upgrades and improvements
Entrepreneurial Funds
Charities need donors to provide funds for entrepreneurial activities and for exploring new programs
Innovation
Spawn innovation, creativity, and exploration
Entrepreneur Funds
Provides seed money or research for start-up projects
Resources
All charities, but especially libraries, need scholarly journals, research books, and online resources
Books
Scholarly works for research and study
Periodicals
Research publications
Online Publications
Technology-based research promoting Web-based research
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Fund Description
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FINANCING YOUR ENDOWED FUND Once you decide to create an endowed fund, you must decide how to meet the minimum funding level required by the charity. Most charities offer a variety of endowed fund options with different minimum amounts. Many charities have minimums of $10,000, but the minimum can be as high as $50,000 to $100,000 or more depending on the type of endowed fund. The minimums usually are related to the scope of the purpose of the endowed fund and its cost. For example, at a university, establishing a chair might cost $2 million; a professorship, $500,000; a scholarship, $25,000. You may fund an endowed fund with cash, through a planned gift, or through a bequest from your estate. If the planned gift is a life income gift, the charity must wait until your death to use the remainder. This is an important point because many donors mistakenly believe that a life income gift provides resources to the charity at the time the gift is made. However, with most planned gifts, the income is paid to the donor for life. Only upon the death of the donor or other beneficiary is the remainder available to the charity. An exception to this is a Lead Trust, covered in detail in Chapter 8. Depending on the vehicle selected, the payout rate, and the life span of the beneficiaries, the remainder value may be 35 to 70 percent of the initial gift.
FUND DESCRIPTION When an endowed fund is established, the charity prepares a personalized fund description, sometimes called a gift agreement, that describes the purposes of the endowed fund. Your input is very important because you want the agreement to reflect your intentions. You should be involved in the process from the beginning, and development staff members should explain the way your money will be used and review any restrictions about the use of your gift. The fund description also should name a successor department or program in case the initial program ceases to exist. Each donor should receive an agreement that includes a statement about the fund’s purpose, a brief biographical sketch about the donor, and a distribution clause for paying income to designated purposes. The bio explains the reasons for the gift, the relationship of the donor to the charity, and lets future recipients know something about the people who established the fund and their motives. Selection of Recipient Donors sometimes wish to be involved in the selection of recipients for endowed scholarship funds. As mentioned earlier, if you make a gift to a
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charity and claim a charitable income tax deduction, you cannot be the sole decision maker in the selection of the recipient; otherwise, your charitable income tax deduction could be jeopardized. You may, however, serve as a member of a selection committee composed of the charity’s representatives. For scholarship funds, donors and charities also should avoid using overly restrictive criteria that effectively prevents the development of an adequate pool of candidates. Basic criteria should be established and restrictions should be expressed in the form of preferences.
MECHANICS OF A FUND DESCRIPTION Most fund descriptions are usually no more than one or two pages long, include an explanation of the fund, and have signature and date lines at the bottom. The following illustrates information that should be included. 1. Name of the fund. “The Diana Smith Endowed Scholarship Fund at
(XYZ Charity).” 2. Names of the parties creating the fund. Generally this includes one
or more donors and the name of the organization. “XYZ University and Miss Diana Smith hereby propose to establish The Diana Smith Endowed Scholarship Fund at XYZ University.” 3. Description of how the fund shall be funded, such as through a be-
quest, outright gift, planned gift, or a combination. Most charities permit and encourage additional gifts to be made to the fund. These gifts may be made by the donor or friends, family, and colleagues. 4. Biographical sketch about the donor(s) outlining their relationship
with the charity and motives for the gift. This information helps recipients know about the individual who created the fund and serves as a permanent memorial to the donor at the donor’s death. 5. Definition of the fund’s purpose reflecting the donor’s wishes. “The
income of the fund shall be awarded to a graduate student at The School of Medicine who wishes to study gerontology.” 6. Administration of the fund. For example, will the income be awarded
on an annual basis? Will some of the income be added to principal? If the income is not awarded, should it be added to principal or accumulated for future use? 7. Restrictions. For example, if the fund is for a scholarship, must the
recipient be financially needy, academically worthy, or have attained
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Mechanics of a Fund Description
a particular grade point average? Are there geographical requirements for recipients (resident of New York)? Should the recipient be focusing on a particular area of study? (History? Business?) The restrictions should reflect your interests. You also may express your wishes as a preference rather than an absolute requirement. Doing so provides more flexibility to the selection process. 8. How the recipient will be selected. Will a committee composed of
representatives from the charity be used? “Selection of candidates shall be made by the Office of Financial Aid in consultation with the Dean of the College of Liberal Arts.” Should candidates submit a one- to two-page essay outlining their achievements and goals to help the selection committee evaluate candidates? 9. Standard default clause. This clause should be included to protect
the donor if, in the future, the charity is unable to fulfill the terms of the fund. The clause may read: “If it becomes impossible to accomplish the purposes of this gift, the income or principal, or both, shall be used for scholarships in the department of XYZ.” Exhibit 5.1 shows an example of a current use gift agreement. Exhibit 5.2 shows an example of a multipurpose fund description. EXHIBIT 5.1
Current Use Gift Agreement Example
THE DENISE ANDREWS CURRENT USE AWARD Denise Andrews and XYZ charity hereby propose to establish the Denise Andrews Current Use Award at XYZ charity in accordance with the wishes of the donor. The award shall be supported by a gift of $3,000. The Award is defined and administered as follows: The title of the award shall be the Denise Andrews Current Use Award. The current use award shall be used to support the Mathematics Department at XYZ Charity. The award shall be used at the discretion of the Department Head of Mathematics to support the purchase of calculators. The Denise Andrews Current Use Scholarship Award shall be awarded in future years contingent upon the donor making additional gifts to fund the award.
Date
Denise Andrews
Date
[NAME] [TITLE]
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EXHIBIT 5.2
Multiple-Purpose Endowed Fund Description Example
MULTIPLE-PURPOSE ENDOWED FUND DESCRIPTION The Meriam Wilson Endowed Fund at Charity Charity and Meriam Wilson hereby propose to establish the Meriam Wilson Endowed Fund at Charity in accordance with the wishes of the donor, Meriam Wilson. Meriam Wilson is an alumna of the College of Art, Class of 1938. The fund shall be established through current gifts and the donor’s estate. The fund is defined and administered as follows: The title of the fund shall be the Meriam Wilson Endowed Fund. The fund shall be established in two parts: Part I
Financial Aid for Students
Three-fourths of the income shall be used to make an annual award to one or more full-time undergraduate or graduate students majoring in science or engineering. Eligible candidates for the fund must have a demonstrated financial need and solid academic standing. Selection of candidates shall be made by the Office of Financial Aid in consultation with the College of Art. Part II
Faculty Support
One-fourth of the income from the fund shall be used to make an annual award to a full-time member of the faculty at the College of Art for research and study of Alzheimer’s disease and related disorders. For both Part I and Part II, in any year in which there is no student or faculty member eligible to receive the award, any income not distributed shall be added to principal or accumulated for future use. If in the judgment of the Executive Committee of the XYZ Charity it becomes impossible to accomplish the purposes of this gift, the income or principal, or both, may be used for scholarships in such manner as determined by the charity.
Date
Meriam Wilson
Date
For Charity: , <TITLE>
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Conclusion
CONCLUSION Decisions about the way your gift will be used are up to you. Your gift may be restricted or unrestricted and may be a current use gift or used to establish an endowed fund. It may be funded through an outright gift, a planned gift, or a gift through your estate. Your gift can be used to help a charity in many ways. Be creative and put your money to work to help the charity do something that you believe is important. Make sure the description or gift agreement reflects your wishes. After all, it is your gift.
CHECKLIST
❏
❏ ❏ ❏
HOW THE GIFT WILL BE USED/ ENDOWED FUNDS
Have you decided which type of gift you will be making?
❏ ❏ ❏ ❏
Unrestricted Restricted Current Use Endowed
Have you decided on the purpose of your gift? Have you decided how to fund your gift? Have you approved a fund description (gift agreement) outlining your gift?
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CHAPTER 6
Types of Charitable Gifts
FREQUENTLY ASKED QUESTIONS
What types of gifts can I make? What type of gift is best for me? What issues should I consider in negotiating my gift? FREQUENTLY ASKED QUESTIONS Q: What types of gifts can I make? A: You can make charitable gifts including annual gifts, pledges, bind-
ing pledge agreements, major gifts, planned gifts, gifts-in-kind, and structured gifts. You must select the one that best accomplishes your goals. Q: What type of gift is best for me? A: The gift that is best for you is the one that is compatible with your
financial resources and is one that you feel comfortable making. You can make a charitable gift in a variety of ways, including outright gifts, annual gifts, major gifts, gifts from your estate, planned gifts, or a combination of each of these options. Finding the best option that matches your financial capability is the goal of charitable giving. You need to educate yourself about the charity, its departments, and programs and about the way that you can make a gift. Most charities prepare booklets, brochures, and guides about charitable gift planning
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Types of Charitable Gifts
to help donors understand the gift options offered by the charity. As discussed in Chapter 3, you should contact a member of the charity’s development staff about the types of charitable gifts offered. Before you can become a donor, you must learn about the charity and its mission, departments, programs, and services. The following is a general overview of the types of charitable gifts that you can make to most charities. The chapter concludes with advice on making a charitable gift. Type of Gifts
Description
Annual Gifts
Generally smaller gifts/help charities operate annually
Pledge
A promise to make gifts in intervals or at a time in the future
Binding Pledge
Binding contract drawn for a donor to make a gift
Major Gifts
Gifts of $5,000 to $100,000
Planned Gifts
Life income gifts, gifts by will or trust, gifts of assets other than cash, and endowed funds
Life Income Gifts
Gifts that provide an income stream to the donor
Gifts from the Estate
Gifts from the estate of an individual by will or trust
Structured Gifts
Gifts made up of annual gifts, major gifts, planned gifts, and bequests
Gifts in Kind
Tangible personal property, gifts of computers, equipment, etc.
ANNUAL GIFTS As discussed in Chapter 3, annual gifts are gifts solicited through direct mail or phonathons. The annual giving solicitations help to sustain interest in the institution, educate constituents, maintain contact, and stimulate financial support. No doubt you have received many solicitations for a year-end gift.
TAX TIP! Remember, you must make your gift by December 31 to obtain a charitable income tax deduction on your tax return for that year.
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PLEDGES A pledge is a promise to make a gift, payment, or series of payments over time or on a specified date. In most cases, the pledge is nonbinding on the donor and the fulfillment of the pledge is voluntary. However, at the time the pledge is made, both you and the charity expect that it will be fulfilled. You sign a pledge form that details the arrangement for the pledge. For example, the following language is likely to be included: “I pledge $ for years in support of XYZ Charity.” A pledge paid over a period of years helps to make charitable giving affordable.
Binding Pledge Agreements In many states, binding pledge agreements have been upheld as legally enforceable documents. These agreements are effective when you wish to provide funding at a point in the future, often through a bequest, and the charity relies on the funding, performing an act such as naming a building or erecting a wing. Like all financial transactions, a charitable gift is negotiated to make it affordable, attractive, and appropriate for both you and the charity.
MAJOR GIFTS At most charities, whether a gift is classified as a major gift depends on its size and form. Traditionally, a major gift is an outright gift in the amount of $10,000, $50,000 to $100,000, or more, depending on the individual donor’s giving pattern and the charity’s history and traditions. The gift may be 10, 25, 100, or even 1,000 times larger than the donor’s previously largest annual gift; alternatively, for some donors, a major gift may be their first gift. Regardless of the size, for both the donor and the charity, a major gift is a significant expression of commitment. Major gift prospects give support because they are committed to the charity and are willing to provide the financial support necessary to help it do its job.
PLANNED GIFTS Planned giving is a method of funding a gift rather than an end in itself. Planned giving benefits, such as life income streams and favorable tax consequences, are the financial incentives that can make these gifts materialize. Most planned gifts are major gifts.
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Several major gift alternatives are included within planned giving, and each of these can be used to support the charity. These major options are: • Life income gifts • Endowed funds • Assets other than cash • Gifts from the donor’s estate Life Income Gifts This major gift classification includes charitable gift annuities, deferred gift annuities, pooled income fund gifts, and charitable remainder trusts. Each of these options, covered in detail in Chapter 7, provides a stream of income to you, to your spouse if applicable, or to another beneficiary, and a charitable income tax deduction. A charity receives the remainder of the gift upon your death. A life income gift is truly a living gift, one that supports you during life and benefits the charity in the future. Outright major gifts are more valuable to charities than planned gifts, but for many donors, an outright gift is not feasible. The charity can use an outright gift of $100,000 in cash immediately to support operations, programs, or capital projects. The charity cannot utilize a planned gift of the same amount until the death of the beneficiary, which may not occur for 10, 20, or 30 or more years. A way to compare the relative value of gifts is to compare the amount of the charitable income tax deductions. An outright gift of $100,000 in cash produces a charitable income tax deduction of $100,000. Because it is an outright gift, the charity can use the gift immediately. In the case of a $100,000 planned gift, such as a charitable gift annuity with two beneficiaries ages 61 and 59, you receive an income stream and a charitable income tax deduction of $24,420, or 24 percent of the value of the outright cash gift. On its face, this planned gift could be considered to be approximately one-quarter as financially valuable to the charity as an outright gift. To provide equivalent value to the charity, consider making a planned gift that is four or more times greater than an outright major gift. Endowed Funds Either outright major gifts or planned gifts can be used to support endowed funds in the name of the donor or to memorialize or honor a loved one. The principal of the endowed fund is managed in perpetuity, and a portion of the earnings from the principal are distributed to
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support the donor’s wishes. Endowed funds are part of the charity’s endowment that provides financial stability and strength. Planned giving officers regularly work with donors to create endowed funds. Assets Other Than Cash Many planned gifts are made with assets other than cash, such as real estate, stocks, bonds, mutual funds, and tangible personal property including artwork, collectibles, and collections and other personal possessions. Planned giving officers specialize in handling gifts of these assets. You may own assets that are far more valuable than cash and prefer to make a gift of that property rather than cash. The choice of asset depends on your needs and resources and the ability of the charity to accept these gifts. For example, not all charities accept gifts of real estate or tangible personal property, and those that do may have restrictions. Gifts from the Donor’s Estate Gifts from your estate include gifts through bequests by will or distributions from a trust. Bequests, a planned giving staple, are used by donors who wish to make a major gift upon their death. These gifts provide either a specific dollar amount, such as “$100,000 to XYZ organization,” or all or a stated percentage of your estate, such as “50 percent of the residue of my estate to XYZ organization.” For donors who are unable to make an outright major gift, a bequest is most appropriate. In addition, many donors who have made planned gifts during their lifetimes make an additional gift to the charity through a bequest. Bequests often fund a project dear to the donor. There is no greater way to show commitment than to share one’s estate with the charity. Because of your gift and the support of many other donors, the charity can deliver services to its many constituents.
GIFTS IN KIND Gifts in kind include gifts of tangible property, such as computers, equipment, collections, and collectibles. Corporations often make gifts in kind of their own product lines or inventory. Donors often hold assets that can greatly enhance the charity’s resources. Geologists may be able to contribute valuable geological artifacts that contribute to the charity’s collection. Museums may find that patrons or benefactors contribute valuable art to improve the museum’s exhibits. At a hospital, a physician’s collection of medical equipment can provide direct benefits to the charity. Search your home or attic for items
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or collections that can be welcome additions to a charity. Many charities like to sell gifts of tangible personal property, so before making such a gift, clearly determine whether the gift will be held or sold. Whether the gift is held or sold by the charity affects your charitable income tax deduction. See Chapter 14 for more on gifts of noncash assets such as personal property.
STRUCTURED GIFTS This option is attractive to donors who wish to make major gifts to nonprofit organizations. Through a structured gift, you use a variety or combination of charitable giving methods. A structured gift is responsive to your wishes and is personalized to meet your financial needs and charitable objectives. The structured gift can include several components: • An outright gift • A pledge or commitment to a series of annual gifts over time • A gift of cash and/or assets, such as stock, real estate, or tangible personal property • A planned gift usually involving a life income gift • A gift through the donor’s estate Structured gifts can be used to fund capital projects, chairs, endowments, and other significant projects that can be achieved only with major gift funding. Structured gifts make charitable giving affordable, achievable, and feasible and help donors make large and valuable gifts. Example 6.1 provides an example of an endowment agreement funded by a structured gift.
NEGOTIATING GIFTS Q: What issues should I consider in negotiating my gift? A: In negotiating your gift, you should consider the size of the gift, the
type of gift, tax considerations, and whether the gift achieves your objectives. For a gift to move forward, both you and the charity must benefit. From your point of view, benefits may be tangible (tax deductions and income streams) or intangible (the good feeling that comes from making a gift).
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EXHIBIT 6.1
Endowment Agreement Funded by a Structured Gift Example
The Mildred Johnson Endowed Fund at XYZ Charity XYZ Charity and Mildred Johnson hereby propose to establish the Mildred Johnson Endowed Fund at XYZ Charity in accordance with the wishes of the donor. The fund shall be established through a structured gift consisting of an annual gift, planned gift, and gift through the estate of the donor. Mildred Johnson is a 1959 graduate of the College of Liberal Arts. She has served on the Board of Trustees of XYZ Charity. The fund is defined and administered as follows: The title of the fund shall be the Mildred Johnson Endowed Fund. The fund shall be established in three parts. PART I The donor agrees to make an outright gift of $25,000. PART II The second part shall be established through a charitable trust providing the remainder of the trust to charity upon the death of the income beneficiaries. The approximate value of the charity’s remainder interest is $250,000. The income shall be used to make annual awards to fulltime members of the faculty at the charity for research, release time, or independent study or to distinguished faculty members in honor of academic excellence. The selection of the recipients of the award shall be made by the Dean of the College of Liberal Arts. PART III The third part shall be established through a bequest from the donor’s estate providing $100,000 for scholarship assistance. The income shall be used to make an annual award to a full-time undergraduate student at the charity. Eligible candidates for the endowed fund must have demonstrated financial need and a solid academic standing. Selection of candidates shall be made by the Office of Financial Aid. Income not distributed in any given year shall be added to principal or accumulated for future use. If in the judgment of the charity it becomes impossible or impractical to accomplish the purposes of this gift, the income or principal, or both, may be used for scholarships in such manner as determined by charity. Date
XYZ Charity Official
Date
Ms. Mildred Johnson
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From the charity’s point of view, gifts that benefit one or more of the charity’s programs or help it fulfill its mission are valuable. The fewer strings attached, the better. For almost every large gift there exists a negotiation process involving the donor and a member of the charity’s staff. The negotiations often take place over several months or years. The following issues may be involved in the negotiation. • Size of the gift. How much should you give? • Form of the gift. What form will the gift take? (major, life income, gift from your estate) • Gift agreement. Are there restrictions on the use of the gift? What are terms for selecting recipients? • Tax considerations. Should you give cash or noncash assets? Which option or asset provides the greatest tax benefits? • Life income gift options. Have you compared the benefits of life income gifts? • Understanding the gift option. Have you studied the gift options carefully and reviewed them with your family and advisors? • Meeting of the minds. Are you in agreement with the charity on the use of your gift? Ask questions and make sure you feel comfortable with the answers. • Approvals by the charity. Are the president, vice president, and board of trustees in agreement on the gift?
MAKING THE RIGHT DECISION As the donor, you need to make sure that the charity has experience in handling the gift you are considering. For example, if you are planning to make a life income gift, make sure the charity has received other life income gifts. The administration of such gifts requires a certain amount of sophistication on the charity’s part. Also, if you are making a very large gift or one that is large for the specific charity, make sure resources are available to manage such a gift. One donor we knew first proposed to make a gift of several million dollars to a small start-up charity. The charity had a small endowment and had little experience managing and investing donors’ funds. The donor decided to make the gift to a charity that she knew could fulfill her objectives and manage her resources. Make sure that your gift does not eclipse the charity’s abilities or resources. If your proposed gift is larger than the charity’s overall endowment, be careful, unless you have complete faith in the charity and believe it will be responsible in the administration of your gift.
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Conclusion
CONCLUSION There are many choices about the type of charitable gift you can make. Start small with a series of annual gifts, then graduate to major gifts and planned gifts. Above all else, understand that the process of making a gift is a negotiation and to conclude the negotiation successfully, both parties, you and the charity, must benefit. Evaluate your choices and make the correct decision. Ask the charity for advice and talk with your advisors and other donors who have made gifts to the charity.
CHECKLIST
❏ ❏ ❏ ❏ ❏ ❏ ❏ ❏
CONSIDERATIONS IN MAKING YOUR CHARITABLE GIFT
Have you educated yourself about the types of gifts you can make? Have you determined which gift is the most feasible? Will your gift be an outright gift, a planned gift, or a gift through your estate?
❏
❏
Outright
❏
Planned
Through estate
Which asset will you use to fund the gift?
❏
Cash
❏
Securities
❏
Real estate
❏
Collections
Are you prepared to negotiate the terms of your gift? Have you selected the most appropriate charity? Does the charity’s needs match your interests? Does the charity have the resources to manage your gift?
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CHAPTER 7
Basic Life Income Gifts: Charitable Gift Annuities, Deferred Gift Annuities, and Pooled Income Funds FREQUENTLY ASKED QUESTIONS
What is a life income gift? What are the types of life income gifts? Do charitable gift annuities pay an income to a donor? In a nutshell, which life income gift options are appropriate for which donors? Why make life income gifts? What is a life income gift?
Q: What is a life income gift? A: A life income gift pays an income stream to you and, if you wish,
your spouse or a second beneficiary. It also provides a charitable income tax deduction for 35 to 70 percent of the amount of the gift. Q: What are the types of life income gifts? A: The major types are the charitable gift annuity, the deferred gift annuity,
and gifts to a pooled income fund. The other option is a charitable remainder trust, which is discussed in Chapter 8. Q: In a nutshell, which options are appropriate for which donors? A: Generally speaking, age and personal preference are the biggest fac-
tors in determining the appropriate option. Charitable gift annuities 71
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are best for donors age 65 and older, and because the rate is fixed, it is attractive to more conservative donors. Deferred gift annuities are best for donors age 25 to 60. Donors who are middle age to age 65 often make gifts to pooled income funds because the variable rate is generally higher than for a charitable gift annuity. Donors also make gifts of appreciated stock to a pooled income fund to avoid capital gains taxes. Q: Why make life income gifts? What is a life income gift? A: Life income gifts provide mutual benefits to both you and the char-
ity. These gifts provide income streams and tax advantages to donors and needed resources to charities. Life income gifts help you “leverage” your gifts by enabling you to make larger gifts than you thought were possible because of the income stream you receive. In addition, the charity receives the “remainder” of the gift, which is the amount that is left over upon the donor’s death after the life income has been paid to the donor. In general, the charity should receive about 35 to 70 percent of the gift amount at the donor’s death. This chapter explores three of the most common life income vehicles: charitable gift annuities, deferred gift annuities, and pooled income fund gifts.
CHARITABLE GIFT ANNUITIES Charitable gift annuities are among the most common and popular of the planned gifts that produce a life income. Through a charitable gift annuity you make a gift to a charity and receive an income for life and, if you desire, an income for a second beneficiary. Spouses can make a joint gift providing income streams for their joint lifetimes. GIFT TIP! If you are married, ask the charity to use its planned giving software to calculate if you made the gift both individually and jointly. Compare the benefits of the calculations to select the best option.
Unmarried individuals also may make gifts that provide income to annuitants. Upon the death of the survivor beneficiary, the charity receives the remainder of the gift. A portion of the income is tax free, and
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you claim a charitable income tax deduction that is based on the beneficiary’s age(s), discount rate, and frequency of payment. Charitable gift annuities are age sensitive — higher rates are paid to older donors. They provide the greatest financial benefit to donors over age 70, who receive the highest income rates. Benefits of charitable gift annuities include: • Income for life paid annually, semiannually, quarterly, or monthly • Fixed rate often greater than money market rates • Immediate charitable income tax deduction for 35 to 50 percent of the gift amount • Opportunity to support a charity The charitable gift annuity is a contract between you and the charity. The charity is legally obligated to pay a fixed rate of income for your lifetime that is locked in at the time the gift is made. However, if you make a new gift a year or two later, the rate will likely be a little higher for that gift annuity since you are a little older. A charitable gift annuity is in reality a bargain sale — part sale and part gift, because you are giving an amount to the charity that exceeds the annuity it promises you. The annuity is backed by the general assets of the charity but is an unsecured obligation. If the charity ceases to exist, suffers financial setbacks, or goes bankrupt, you may need to line up with other creditors to receive your payments, depending on the reason the charity failed and whether it holds insurance to cover that type of failure. In the event of a financial calamity, to be certain that payments are met, some charities purchase insurance to protect their charitable gift annuities, called “reinsurance.” Very few charities have ever defaulted on payments of gift annuities. Speak to the charity’s treasurer or business officer to determine the charity’s insurance coverage. Some states require a charity to register with the state if they offer charitable gift annuities. If you are unsure about the financial stability of the charity, check with the state’s insurance commission, secretary of state, or other offices depending on the state. If you require that the charity purchase a commercial annuity contract to insure that payments will be made, your charitable income tax deduction may be affected by the premium paid to the commercial carrier. Gift Annuity Rates and the American Council on Gift Annuities The number and age of the beneficiaries affect your annuity rate. Most charities follow the recommendations of the American Council on Gift Annuities, an organization that recommends rates that charities pay to
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annuitants. The rates are the same for both sexes at the same ages, encouraging donors to make gifts to the charity they truly wish to support rather than selecting one because it offers a higher rate. Occasionally charities deviate from the suggested rates. It is important to remember that asking for a rate that is greater than the recommended rate increases the risk that the charity’s remainder will be diminished or depleted. A charitable gift annuity is just that: a charitable gift that provides resources to charities. These options are not designed to compete with commercial annuities or other forms of financial investments. The American Council on Gift Annuities, an organization that recommends rates that charities may follow, revises the gift annuity rates periodically. The example below shows the financial benefits from a $10,000 charitable gift annuity. EXAMPLE: Financial Benefits from a $10,000 Charitable Gift Annuity A Gift Option for Donors Over Age 65 Age 65 70 75 70/68 75/73
Payout Rate
Annual Income
Tax Deduction*
7% 7.5% 8.2% 6.8% 7.2%
$700 $750 $820 $680 $720
$4,065 $4,330 $4,619 $3,634 $3,942
*Based on a discount rate of 7.8 percent.
Tax Consequences of Charitable Gift Annuities Various tax consequences occur for charitable gift annuities. In the following subsections, we examine the donor ’s charitable income tax deduction and gift, capital gains, and estate tax consequences. Valuation of the Charitable Income Tax Deduction Depending on your age, the discount rate, and the rates suggested by the American Council on Gift Annuities, you will likely receive a charitable income tax deduction of approximately 35 to 50 percent of the gift. Most charities use planned giving software to calculate your charitable income tax deduction and other financial consequences of the gift. The exact value of the deduction is determined by subtracting the present value of the annuity (life income interest) from the present value of the gift to determine the remainder interest to the charity, which is equal to the
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donor’s charitable income tax deduction. The value of the annuity is determined by applying the Internal Revenue Service (IRS) discount rate to the stream of payments over your life expectancy and that of any other beneficiary. (The IRS discount rate is 120 percent of the federal midterm rate, which changes monthly.) The charity, when calculating your charitable income tax deduction, can use the rate for the month in which the gift is made or use the rate from either of the two preceding months. The highest discount rate is usually selected to ensure the highest charitable income tax deduction. You obtain a charitable income tax deduction in the year the gift is made. If you cannot use the deduction completely in the first year, it is carried forward for up to five additional years. TAX TIP! For gifts of cash, the charitable income tax deduction may be used to offset up to 50 percent of the donor’s adjusted gross income. If the gift is funded with appreciated property (that would produce long-term capital gain on sale), the charitable income tax deduction may be used to offset up to 30 percent of the donor’s adjusted gross income.
Gift Taxes If you establish a charitable gift annuity for the benefit of someone other than your spouse, you have made a taxable gift and you may owe a gift tax on the value of the charitable gift annuity. The taxable gift is not based on the stream of income paid to the beneficiary but on the total value of the charitable gift annuity at the time the gift is made. If payments to the third party begin within the year, you can use the $10,000 annual gift tax exclusion to eliminate or reduce the gift tax due on the charitable gift annuity. If you are the first annuitant and reserve the right to revoke the interest of the second beneficiary, no gift is made until your
TAX TIP! Use your annual exclusion to reduce the size of your estate. You can make tax-free gifts of up to $10,000 per year to any number of beneficiaries. Married couples may combine their annual exclusions to make tax-free gifts of $20,000 per year.
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death. Your estate will pay tax on the value of the second beneficiary’s annuity at that time. Capital Gains Taxes and Income Taxation If you fund a charitable gift annuity with appreciated property held for more than a year and a day, you will have to pay capital gains taxes, currently assessed at a maximum rate of 20 percent on most investment property, such as stock or real estate. Don’t worry too much about how to calculate the tax. The charity’s planned giving software will calculate it for you. The tax is assessed on that portion of the property that is used to purchase the charitable gift annuity. If you are the sole beneficiary or the first beneficiary, the gain can be spread out by reporting it over your life expectancy. If your spouse is younger, you may prefer to report the gain over your spouse’s lifetime. If so, make an outright gift to your spouse of the appreciated property, which can be accomplished without tax consequences by using the unlimited marital deduction. The unlimited marital deduction allows spouses to freely transfer unlimited amounts of property, cash, or other assets to each other without paying gift or estate taxes on the transfer. See Chapter 9 for more information on the unlimited marital deduction. Your spouse then can make the gift to fund the charitable gift annuity. A portion of the stream of income received by the beneficiary will be excluded from gross income because it is considered a tax-free return of capital. The rest is taxed as ordinary income and as capital gain income, if appreciated property is used to fund the gift. Once you reach your life expectancy (calculated at the date of the gift), the entire amount of the annuity is taxable. TAX TIP! Spouses who are U.S. citizens can transfer any amount of property to each other tax free using the unlimited marital deduction.
Estate Taxes If you are the only annuitant, the income stream ceases on your death and the value of the annuity is excluded from your estate. If your spouse is the sole remaining annuitant, your spouse’s interest may qualify for the estate tax marital deduction. If a third person is the sole remaining annuitant and you have retained, but not exercised, the right to revoke that person’s annuity, the value of the third party’s annuity will be taxed in your estate.
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Acceptable Assets to Fund a Charitable Gift Annuity The most common and easiest way to fund a charitable gift annuity is to use cash. You also can fund charitable gift annuities with securities, but if the securities have appreciated, you still will have to pay capital gains taxes on the gain in the “sale” part of the transaction. For many donors, the capital gains tax rate (20 percent for most investment assets such as stock) is less than their marginal income tax rate. Tax-free securities are also acceptable to fund a charitable gift annuity, but the annuity will be taxed as if the assets transferred were not tax exempt. Occasionally real estate can be used to fund a charitable gift annuity, if the real estate can be sold and converted to cash quickly. Because the charitable gift annuity payment is an immediate obligation of the charity, non-income-producing assets, such as real estate, need to be sold and converted to income-producing assets so that the payment can be made. You and the charity need to be realistic about the likelihood of resale in case the real estate sale is delayed or the property sells for less than anticipated. Keep in mind that other costs associated with real estate, such as broker’s commissions and attorney’s fees, will reduce the amount of sale proceeds below the appraised fair market value of the contributed real estate. The charity and the donor should share the responsibility for these costs, or they should be negotiated. Gift Annuity Contract Because charitable gift annuities are contractual agreements, the only document needed is a one-page gift annuity contract, prepared by the charity, which includes the annuity rate, amount of payment, and the payment schedule, which is most often monthly but may be quarterly or annually. Many charitable gift annuities are managed in-house by the charity, although they can be administered outside of the charity, usually by a bank, trust company, or investment firm. Ask the charity how its program is managed and be sure you know whom to call in case of questions and/or late or missing payments. Exhibit 7.1 is an example of a two-beneficiary gift annuity agreement.
DEFERRED GIFT ANNUITIES Like the charitable gift annuity, the deferred gift annuity pays an income stream, but it begins at a point in the future. The deferred gift annuity is a very appropriate option for donors ages 25 to 60. When you make a gift, the charity agrees to pay you and, if you wish, a second beneficiary, a stream of income for life, beginning at a point in the future. The income
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EXHIBIT 7.1
Two-Beneficiary Charitable Gift Annuity Agreement Example
Charity, a charitable corporation located in , agrees to pay to , of (hereinafter called the “Donor”), for the Donor’s life and thereafter to the Donor’s spouse, <SPOUSE’S NAME>, for (HIS/HER) life if (HE/SHE) survives the Donor, an annuity in the annual sum of , () from the date hereof, in equal quarterly installments of <$> on the last day of March, June, September, and December; provided, however, that the Donor may by the Donor’s last will revoke the annuity to be paid to the Donor’s said spouse. The first installment shall be payable on . This annuity shall be nonassignable, except in the case of a voluntary transfer of part or all of such annuity to Charity. The obligation of Charity to make annuity payments shall terminate with the payment preceding the death of the survivor of the Donor and the Donor’s said spouse, unless the Donor revokes the annuity payable to the Donor’s said spouse, in which case obligation shall terminate with the payment preceding the death of the Donor. Charity certifies that the Donor, as an evidence of the Donor’s desire to support the work of Charity and to make a charitable gift, has this day contributed to Charity $ , receipt of which is acknowledged for its general charitable purposes. The annuity agreement has been entered into in (State of Charity’s primary office) and is governed by the law of the <STATE> (Charity’s Primary office). IN WITNESS WHEREOF, Charity has executed this instrument this day of , 20 . For Charity: By: , <TITLE>
stream must be deferred for at least one year after the gift is made. Upon your death, the charity has the use of the remainder of your gift. Many donors choose age 65 or older to receive the income stream because they will have retired and expect to be in a lower tax bracket. Used this way, the deferred gift annuity is similar to an IRA. Unlike the charitable gift annuity, the deferred gift annuity pays the highest rate to the youngest donors since there is a longer period of time between the date of the gift and the drawing of income. The charity invests your money for years, anticipating the time when income payments must be made.
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Older donors also may use a deferred gift annuity and defer income for several years. This may be especially useful for a donor who wants to defer receiving income until some time after age 70 or later. Benefits of deferred gift annuities include: • Immediate charitable income tax deduction • Guaranteed income in the future, often at retirement • Excellent yield The following example presents the financial benefits from a $10,000 deferred gift annuity deferred to age 65. EXAMPLE: Financial Benefits from a $10,000 Deferred Gift Annuity Deferred to Age 65 A Gift Option for Donors Ages 25 to 60 Age
Payout Rate
Annual Income
Tax Deduction*
40 45 50 55 40/45 50/55
26.8% 20.3% 15.3% 11.6% 18.2% 10.4%
$2,680 $2,030 $1,530 $1,160 $1,820 $1,040
$7,358 $6,994 $6,575 $6,033 $6,278 $5,248
*Based on a discount rate of 7.8 percent.
Charitable Income Tax Deduction The charitable income tax deduction is used in the year the gift is made, not in the year you begin receiving the income. The charitable income tax deduction is typically quite high, averaging about 50 to 70 percent of the gift. The charity will calculate the charitable income tax deduction for you. For example, a 55-year-old donor who makes a $10,000 deferred gift annuity to a charity and begins receiving payments at age 65 obtains approximately $6,033 as a charitable income tax deduction. The charitable income tax deduction is based on your age, current discount rate, and frequency and timing of payments. More frequent payments will reduce your charitable income tax deduction, as will receiving a payment at the beginning of the payment period rather than at the end of the payment period.
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Gift Taxes Currently, under present tax laws, it is unclear whether a donor is assessed a gift tax when creating a deferred gift annuity to benefit a person other than a spouse. The annual exclusion, discussed in Chapter 9, allows you to give up to $10,000 to any number of beneficiaries each year free of gift tax. However, the annual exclusion does not protect gifts of a future interest, which may include the deferred gift annuity because payments to a beneficiary do not begin immediately. If you make a deferred gift annuity to benefit someone other than your spouse, remember that you may be required to pay a gift tax. If you make a deferred gift annuity and benefit a spouse, no gift tax is due because of the unlimited marital deduction. The vast majority of gift annuities are made by single donors on their own lives or by married couples where they are the sole annuitants. In these cases there is no gift tax issue. Income Taxes Like a charitable gift annuity, a portion of the income from a deferred gift annuity is treated as both a return of your investment and taxable income from an investment. Therefore, you generally receive some tax-free income because part of the income is considered a return of the initial principal, which was already taxed. The charity’s software computes the tax consequences for such a gift. Call and ask for “the numbers.” The part considered investment income is taxed as ordinary income and as capital gain income if appreciated property is used to fund the deferred gift annuity.
POOLED INCOME FUNDS Recognized in 1969 when they were included in the Internal Revenue Code, pooled income funds are another important gift option for donors. The concept is simple: You make a gift to a pooled income fund, which works like a mutual fund. You receive a variable income based on market performance for your life and perhaps for another beneficiary’s lifetime. Unlike the charitable gift annuity, which is age sensitive, the pooled income fund rate is market sensitive, and the rate may increase or decrease depending on the fund’s investment performance and earnings. The income stream must run for the lives of the beneficiaries; an income stream for a specified number of years is not allowed. You obtain a charitable income tax deduction in the year the gift is made; upon the death of the last beneficiary, the charity receives the remainder interest — the
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amount that remains after payment of the income stream. The amount may be more or less than the original amount of the gift, depending on investment performance and market conditions. The remainder interest cannot be split among unrelated charities; it can only go to the charity that established and managed the fund. The fund is considered “pooled” since your gift is pooled, or commingled, with other donors’ gifts; the large amount of smaller gifts in the fund produces the opportunity for a higher rate of return than a single donor could achieve independently. Most charities require a minimum gift of $5,000 to a pooled income fund; additional gifts can be made, often as low as $1,000 or more. You can make a gift of appreciated securities to a pooled income fund and avoid paying capital gains taxes on the appreciation. You will obtain a current charitable income tax deduction for the present value of the remainder after the death of the last beneficiary. A gift to a pooled income fund offers significant tax advantages. Pooled income funds define income as income from earnings on investments, such as interest income, CD interest, bond income, and dividends from stock, net of investment expenses and management fees. Capital gains from the sale of assets are considered principal rather than income. No capital gain or any portion of the portfolio can be distributed as income for the beneficiaries. Instead, the actual net income produced by the fund, less expenses, is distributed proportionately to the beneficiaries. Charities can offer different types of pooled income funds that produce varying returns because of the structure of the fund. 1. A high-income fund 2. A balanced fund 3. A growth fund
A high-income fund typically is invested in high-yield corporate bonds, mortgage-backed securities, and utility stocks. The bonds are “laddered” so that they mature at five-, ten-, fifteen-, and twenty-year intervals. Laddering stabilizes income and preserves the underlying value in the bonds. A balanced fund contains a mix of fixed income investments, such as those in the high-yield fund plus growth assets such as blue chip stocks and other dividend paying stocks. A growth fund produces little income except for dividends from blue chip stocks and other types of investments. A growth pooled income fund preserves and “grows” the principal from the capital appreciation of the assets, providing maximum benefit to the charity; there is little income immediately,
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but as the fund grows so does the income. Upon the death of the beneficiary, the charity uses the remainder of the pooled income fund consistent with your wishes. Benefits of pooled income funds include: • Increase current yield • Avoid capital gains tax on gifts of appreciated securities • Receive an income for life • Receive an immediate charitable income tax deduction • Membership in a leadership club at the charity The following example presents the financial benefits from a $10,000 gift to a pooled income fund. EXAMPLE: Financial Benefits from a $10,000 Gift to the Pooled Income Fund Gift Options for Middle-Aged to Older Donors Age
Payout Rate
Annual Income
Tax Deduction*
60 65 70 70/68
6.75% 6.75% 6.75% 6.75%
$675 $675 $675 $675
$3,154 $3,816 $4,553 $3,153
75/73
6.75%
$675
$3,928
*Based on a discount rate of 7.8 percent.
Capital Gains Taxes By making a gift to a pooled income fund, you can completely avoid capital gains taxes on your gift. This is a significant incentive to make a gift to a pooled income fund, especially for donors who own highly appreciated securities. If the investment assets were sold, the donors would incur a capital gains tax rate of 20 percent. Example: If you sell securities for $10,000 that you purchased years ago for $1,000, you would be taxed at a maximum rate of 20 percent on the gain of $9,000 for a total capital gains tax of $1,800. If you instead made a gift of the appreciated securities to a charity, you avoid capital gains tax and preserve the principal for charity.
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Gift Taxes If you make a gift to a pooled income fund and either you or your spouse is the beneficiary of the income stream, no taxable gift is made. If the income interest is given to your spouse, it may qualify for the gift tax marital deduction, if you make a QTIP election. See Chapter 8 on estate planning for a further discussion of QTIP trusts. The assets are included in the donee spouse’s estate, but the donee spouse will receive a charitable income tax deduction for the amount going to the charity. If, however, you make a gift to a pooled income fund for the benefit of a third party other than you or your spouse, you make a taxable gift. The rate of the gift tax charged is the same as the estate tax, and all gifts made during lifetime or at death are ultimately aggregated. The gift/estate tax increases progressively from 37 to 55 percent. If the third party has the right to receive income currently from the pooled income fund, the gift may qualify for the $10,000 annual gift tax exclusion. See Chapter 16 for a full discussion of estate and gift taxes. Income Tax to Beneficiary The income distributed by the pooled income fund is taxed to the beneficiary (whether the donor, the spouse, or a third party) as ordinary income. If the donor is the first beneficiary, the income is taxable to the donor, while alive, and the value of any interest passing to a survivor beneficiary is included in the donor’s taxable estate at its value at that time. Alternatively, a donor who does not want to be taxed on the income may make a taxable gift of the income interest to the designated beneficiary during his or her lifetime and not reserve the right to revoke the beneficiary’s income interest. Charitable Income Tax Deduction A donor who makes a gift to a pooled income fund obtains a charitable income tax deduction in the year the gift is made. The charity’s planned giving software calculates the charitable income tax deduction by determining the value of the income stream over the life expectancy of the income beneficiary under IRS actuarial tables. The deduction is based on the highest return earned by the fund in the three preceding years. If the pooled income fund is less than three years old, the IRS preselects a rate based on current Treasury bill rates. Estate Taxes Once you make a gift to the pooled income fund, the value of the gift passes outside your estate for estate tax purposes except for the value of
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any life interest passing to a beneficiary other than your spouse at your death. Additionally, the asset used to fund the pooled income fund is removed from probate. Acceptable Assets for a Pooled Income Fund A pooled income fund is unique, and not all types of assets can be used to fund a pooled income fund gift. Because each beneficiary’s income is affected by all of the other donors’ gifts, you cannot make a gift that will not immediately generate an income. Otherwise, the total amount of income in the pool would stay the same while the number of beneficiaries would increase, reducing all beneficiaries’ income streams. Most gifts to a pooled income fund are made in the form of cash or readily marketable securities, which generate income immediately. Closely held securities usually are not accepted into a pooled income fund because they can be difficult to value, the transaction is time consuming, and a buyer is not always readily available. Self-dealing rules may prohibit a sale to you or your family. Tax-exempt securities are not permitted as gifts to a pooled income fund. If you want to give tax-exempt securities, which typically do not appreciate significantly, you may sell the securities and then contribute the cash proceeds. While theoretically gifts of real estate can be transferred to a pooled income fund, they are inappropriate for such funds and are not permitted by most charities. Making a Pooled Income Fund Gift through a Community Foundation Many community-based foundations offer pooled income funds under the name of the foundation, enabling area charities to participate in their fund. Donors to the organization can make a gift to the community foundation and designate the remainder of the gift to support a particular charity.
CONCLUSION Life income gifts, such as charitable gift annuities, deferred gift annuities, and gifts to a pooled income fund, provide incentives to donors and benefits to charities. These options are offered by most large charities; no doubt smaller ones will soon be offering some or all of these vehicles. These vehicles provide mutual benefits because both you and the charity benefit, making it easier for individuals to become major donors.
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Conclusion
CHECKLIST
BASIC LIFE INCOME GIFTS
❏ ❏ ❏
Is a life income gift option right for you?
❏
Do you understand the terms of the gift options, income stream payments, and tax deductions?
❏ ❏
Have you selected the correct assets to fund the life income gift?
❏
Have you discussed this gift option with your personal advisors?
Which life income gift option is best? Have you compared the planned giving options using software calculations provided by the charity?
Have you met with a staff member at the development office to ask for assistance?
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CHAPTER 8
Trusts
FREQUENTLY ASKED QUESTIONS
What is the difference between a charitable remainder annuity trust and a charitable remainder unitrust? Which one is best? If I can receive a typical rate of 5 to 8 percent on a regular charitable remainder unitrust, why shouldn’t I select 8 percent? I would receive a higher payment. FREQUENTLY ASKED QUESTIONS
Trusts are comprehensive, personalized asset management vehicles that can be used to accomplish specific purposes for both your family and your favorite charities. Trusts usually are combined with wills, a durable power of attorney, and a healthcare proxy to create an estate plan. There are several types of trusts, including revocable trusts, charitable remainder annuity trusts, and charitable lead trusts. This chapter begins with an overview of trusts: terms, types, funding, and distribution, and then focuses on charitable trusts and how they are used to accomplish charitable gift planning objectives.
PARTIES TO A TRUST There are a number of parties to a trust. They include the grantor of the trust, the trustee, and the beneficiaries. A trust is established by a written agreement between the maker of the trust and the trustee.
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Maker, Grantor, and Settlor The maker of a trust, often called the grantor, donor, or settlor, is the one who creates the trust. If the trust is created by more than one person (e.g., by spouses), those individuals usually are considered joint grantors. The grantor transfers his or her assets to a trustee. The trustee then holds and manages those assets in the trust. Trustee Depending on your preferences, the trustee may be the grantor, another individual, or an institution, such as a bank, trust company, or investment firm. The trustee manages assets for the benefit of one or more beneficiaries. The trustee is held to a standard of prudence as defined by state law. Current vs. Remainder Beneficiaries Broadly speaking, there are two types of beneficiaries: (1) current beneficiaries and (2) remainder beneficiaries. Current beneficiaries are those beneficiaries who may receive income or principal from the trust, either automatically or at the discretion of the trustee. Remainder beneficiaries receive the remaining principal or corpus of the trust upon its termination. In the context of charitable trusts, depending on the type of trust, a charity may be the beneficiary of either a remainder interest (charitable remainder trust) or a current interest (lead trust).
TRUST POWERS The grantor of a trust should define the obligations and duties of the trustee through trust powers enumerated in the trust document. Absent a provision in the document regarding trust powers, such powers will be limited by statute. Trust powers set forth in the trust document may be extensive and may permit the trustee to undertake a broad range of financial powers, such as permitting the trustee to buy, sell, mortgage, lease, rent, invest in, borrow, or lend property, or to perform any other act that the trustee powers permit. Conversely, the trust document can place limitations on trust powers, for example, by limiting the trustee to invest only in certain types of investments, such as Treasury bills or conservative equities. Distributions of Principal and Income The trustee, according to the terms of the trust, makes distributions to designated beneficiaries. Basically a trustee can make only two types of
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distributions: (1) principal and/or (2) income. The terms “principal” and “income” are defined under state law but may be modified (though not fundamentally altered) by the terms of the trust document. Special Provisions The trust document can be drafted to include a number of provisions to meet the requirements of beneficiaries with special needs. Careful planning must be undertaken to provide for beneficiaries with specific needs so as to not make them ineligible for federal, state, or local programs that provide benefits to disabled individuals. Spray and Sprinkle Provisions. According to the provisions in the trust, the trustee may have the power to distribute amounts of income or principal at his or her discretion. These powers are called “spray” or “sprinkle” provisions. Like a garden hose, the trustee is permitted to spray and sprinkle income and principal to beneficiaries in cases of specific need or simply at his or her discretion. Provisions for Minor Children. As described in Chapter 9 on estate planning, a guardian for minor children should be appointed through a will. A trust can be used to instruct the trustee to make payments for the benefit of a minor child, either at the trustee’s discretion or pursuant to an “ascertainable standard,” which is a measurable and defined standard to meet expenses related to a beneficiary’s health, education, support, and maintenance. Spray and sprinkle provisions could be used to give the trustee the ability to make additional distributions.
GIFTS TO A MINOR AND THE UNIFORM TRANSFER TO MINORS ACT Individuals, such as parents and grandparents, can transfer assets to a minor in several ways. Many states have adopted a version of the Uniform Transfer to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA), both of which can provide an easy and inexpensive way to make a gift without the use of trusts or guardians. Under the UTMA and UGMA, if an individual does not want to transfer property directly to a minor, that property can instead be transferred to a custodian, who holds it for the minor child. The custodian, an adult, is charged with the responsibility for investing the assets or property and must act prudently and impartially. The custodian may charge a reasonable fee for services and is entitled to reimbursement of expenses. The custodian is obligated to turn over all property transferred under the UTMA or UGMA when the minor child reaches the age of majority, 18 or 21 in most states. For gift tax purposes, the gift to the minor’s custodial account is considered an
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irrevocable transfer of a present interest to the minor and therefore qualifies for the annual gift tax exclusion, which is currently $10,000. Under a provision of the tax law commonly referred to as the “kiddie tax,” all unearned income paid to a minor under the age of 14, including income generated by the transferred assets, generally is taxed at the higher of the child’s or parent’s marginal tax rate. The choice of the custodian for the minor’s account can have important estate tax implications and should be made only after consultation with a competent professional.
GIFTS TO A MINOR AND A MINOR’S TRUST A minor ’s trust can be similar to a custodial account under UTMA. Through a minor’s trust, a donor transfers assets to a trustee to be held for the minor’s benefit. Funds may either be distributed or accumulated at the trustee’s discretion. Funds transferred to trusts that meet certain specific requirements prescribed by law can qualify for the $10,000 annual exclusion. Under some kinds of minor’s trusts, when the minor reaches the age of 21, the trustee must make the funds available to the minor. From a tax standpoint, a minor’s trust can avoid the kiddie tax, because the trust is treated as a separate taxpayer; however, the income tax rates on trusts quickly reach a maximum rate of 39.6 percent. The trust can, however, select investments that limit income and invest for growth, thereby limiting the exposure to income taxation. Because of the many complex rules regarding minor’s trusts, it is very important that individuals thinking about establishing such a trust first consult with a competent professional.
REVOCABLE INTER VIVOS TRUST (LIVING TRUST) A properly drafted revocable (one that you can revoke or change) inter vivos (established while you are alive) trust can be a very effective tool for managing assets during life and after death. It is revocable in that the grantor may revoke or amend all or part of the trust. The grantor can transfer assets to the trust during his or her life. Any assets that are transferred to the trust during the grantor’s lifetime will not be subject to probate, which is one advantage of an inter vivos trust. In addition, any asset owned in a state other than the state where the grantor is domiciled and where the grantor will be subject to probate may be held in the trust, thereby avoiding the extra burden of a separate probate proceeding (known as ancillary administration) in the other state. A revocable inter
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vivos trust may continue past the lifetime of the grantor for the benefit of the grantor’s spouse, children, grandchildren, or other beneficiaries. A successor trustee, such as a bank or trust company, is often appointed to serve as trustee after the grantor’s death. In most states, all noncharitable trusts, including revocable inter vivos trusts, must provide for a termination of the trust to comply with what is known as the Rule Against Perpetuities, which prevents trusts from operating in perpetuity. A trust may terminate upon the occurrence of a specific event, such as when the youngest beneficiary of the trust reaches the age of 21. Usually it is not possible or practical to transfer all assets you own to the trust during your lifetime. Any assets not transferred during life may be transferred at death through a “pour over” provision in your will. This provision transfers any remaining assets to the trustee of the trust, and these assets are then managed as part of the corpus of the trust. Any asset that is transferred through a pour over provision is subject to probate. Tax Implications Because you have all the elements of ownership and control over a revocable inter vivos trust, including the right to revoke and amend the trust, you are taxed on any income that the trust earns and on any capital gains that the trust produces. For gift tax purposes you have not made a completed gift through a transfer to a revocable trust but have retained ownership and control over the trust property. Therefore, there is no gift tax due on any asset transferred to a revocable inter vivos trust. For federal estate tax purposes, all assets in a revocable inter vivos trust are to be included in your estate. The following list compares the payout formulas for charitable remainder trusts and charitable lead trusts: Types of Charitable Trusts
Payout
Charitable Remainder Annuity Trust
Pays donor fixed payout dollar amount representing percentage of the trust’s assets on date established.
Charitable Remainder Unitrust
Pays income to donor for life or term of years. Remainder goes to charity.
Fixed Percentage
Pays donor fixed percentage of value of trust assets as valued annually.
Net Income
Pays lesser of stated percentage or actual net income.
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Types of Charitable Trusts
Payout (continued)
Net Income with Makeup
Pays lesser of stated percentage or actual net income and makes up difference between actual net income and stated percentage when income exceeds stated percentage.
Flip Trusts
Pays donor actual net income until trust “flips” to pay stated percentage.
Lead Trust
Pays income to charity, remainder to grantor or heirs.
Grantor Lead Trust
Pays income to charity, remainder to grantor.
Nongrantor Lead Trust
Pays income to charity, remainder to heirs.
Annuity Form
Pays charity fixed dollar amount.
Unitrust Form
Pays charity stated percentage of trust’s assets as valued annually.
CHARITABLE REMAINDER TRUSTS Q: What is the difference between a charitable remainder annuity trust and a charitable remainder unitrust? Which one is best? A: There are several differences, and the trust that is best depends on
your objectives. A charitable remainder annuity trust is good for conservative investors who want a specific amount of income each year. The amount is determined at the time the gift is made. A charitable remainder unitrust is good for donors who are less conservative and hope to see the principal of their trust grow so that it will provide a greater income. A charitable remainder unitrust makes annual payments of a specific percentage amount of the fair market value of the trust assets. The percentage amount is fixed at the start of the trust and cannot be changed. The percentage amount may be fixed at a minimum of 5 percent and a maximum of 50 percent, but is typically set in the 5 to 8 percent range. The fair market value of the trust assets, by contrast, is redetermined each year, so as the trust principal grows, so does the income. Other types of charitable remainder trusts distribute income differently and are discussed later in this chapter.
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Q: If I can receive a rate of 5 to 8 percent on a regular charitable remainder unitrust, why shouldn’t I select 8 percent? I would receive a higher payment. A: It is true that you would receive a higher payment at least for the first
year if you select the 8 percent rate. However, if you selected 5 percent and the trust earned 12 percent, then the excess, less expenses, would be added to principal. Due to this increase in the principal, next year you might receive a larger payment than you did this year provided that the value of the trust property did not subsequently decrease. By taking a large amount of income with the principal of the trust growing, you risk depletion of the entire trust. In addition, your charitable income tax deduction for a 5 percent payout would be larger. Compare the benefits of a variety of payout rates to select the best one for you. Charitable remainder trusts are important gift planning vehicles. They can produce substantial financial and tax benefits for you as well as gifts to charitable organizations. These trusts may be established either during your life, through an inter vivos trust, or at your death, through a testamentary trust. Charitable remainder trusts are established for the life of one or more beneficiaries for a period of years not exceeding 20 years. Like other life income gift options, charitable remainder trusts provide income to beneficiaries. Upon the death of the beneficiaries or the termination of the trust term, the remainder is transferred to benefit one or more charitable organizations. The Internal Revenue Service defines a charitable remainder trust as “a trust which provides for a specified distribution, at least annually, to one or more beneficiaries, at least one of which is not a charity, for life or for a term of years, with an irrevocable remainder interest to be held for the benefit of, or paid over to, charity.” There are two broad categories of charitable remainder trusts: (1) the charitable remainder annuity trust and (2) the charitable remainder unitrust. They are discussed later in detail. Benefits of charitable remainder trusts include: • Income to beneficiary for life or for a term of years; remainder to charity • Avoid capital gains tax upon the contribution of appreciated assets • You may obtain a significant charitable income tax deduction • The trust can be customized to meet your needs Historical Tier System and the Taxation of Trust Income Distributions from a charitable remainder trust and paid to a beneficiary are taxed to the beneficiary. Regardless of whether all income produced
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by the trust is distributed, the trust itself does not pay income taxes on its earnings so long as it has no unrelated business income, such as debtfinanced income. Distributions from a charitable remainder trust are characterized for purposes of the beneficiary’s tax liability according to the nature of the historical income of the trust. Distributions from the trust are characterized in the following order: 1. Ordinary income 2. Capital gain income 3. Tax-exempt income 4. Return of principal/corpus
For example, all ordinary income earned by the trust in prior years or during the current taxable year must be distributed to the beneficiaries prior to any capital gain income. Common Features of Charitable Remainder Trusts Features common to charitable remainder trusts include: • Income stream • Charitable income tax deduction • Capital gains taxes • Gift taxes • Estate taxes • Probate Income Stream As the grantor of a charitable remainder trust, you select a payout rate that will provide a stream of income to your beneficiaries for their lifetimes or for a term of years. By law the rate may not be less than 5 percent nor more than 50 percent, but the permissible range of rates in any particular case could be more limited due to the age of the beneficiaries, prevailing interest rates, and other requirements imposed by law. As the payout rate increases, your charitable income tax deduction decreases, and vice versa. The payout rate is established at the time the trust is created and should be selected to provide you with an appropriate income stream and the greatest tax benefits while still protecting the remainder value for the nonprofit.
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Charitable Income Tax Deduction If you transfer assets to a charitable remainder trust, you probably will receive a charitable income tax deduction, which could produce significant tax savings. The amount of the charitable income tax deduction is the present value of the remainder interest passing to charity and is greatly affected by the number of beneficiaries and their ages. The charitable income tax deduction is often 35 to 50 percent of the amount used to fund the trust; of course, the exact figure depends on the terms of a particular trust. Call the charity and ask to see a printout showing the charitable income tax deduction for your gift you are considering. Most charities will run the numbers with no obligation. If you are not ready to move forward with a gift, tell them you will be in touch when the time is right. Capital Gains Taxes If assets such as appreciated securities are transferred to a charitable remainder trust, neither the transferor nor the charity will have to pay capital gains taxes on the gain when the trustee sells the securities. Distributions to beneficiaries, however, can be characterized as capital gains to the full extent of the trust’s total capital gains. Gift Taxes Transfers to a charitable remainder trust are eligible for a gift tax deduction to the extent of the present value of the charity’s remainder interest, but to claim this deduction, you will need to file a gift tax return. If the trust provides income only to you, the income payout does not have gift tax consequences. If your spouse receives a present stream of income from the charitable remainder trust, you have made a gift to your spouse of the present value (measured at the time the trust is established) of the total expected income stream, but the gift qualifies for the unlimited gift tax marital deduction for federal tax purposes, thereby creating no gift tax consequences. If you provide a present income stream from a charitable remainder trust to a person other than your spouse, you have made a taxable gift of the present value of the income interest with gift tax consequences. If you provide a future income stream to anyone, you have also made a taxable gift, unless you specify in the trust documents that you are retaining the right to revoke the future income interest through your will. If the gift is a present interest, the $10,000 annual exclusion (which is indexed for inflation but only in $1,000 increments) may offset some or all of the gift; if the value of the gift exceeds the annual exclusion, then the donor’s $675,000 lifetime exclusion (in 2001) may be used to eliminate or reduce any gift tax due.
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TAX TIP! The lifetime exclusion currently allows you to transfer during life or at death up to $675,000 of property without having to pay any gift tax or estate tax in 2001. The amount increases gradually until it reaches $1 million in 2006. Lifetime Exclusion Amount
Year
$ 675,000 $ 700,000 $ 850,000 $ 950,000 $1,000,000
2001 2002, 2003 2004 2005 2006
Estate Taxes Assets transferred to a charitable remainder trust could have estate tax consequences at a grantor’s death depending on whether the interest to the beneficiary flows for life or for a number of years and whether the beneficiary is the donor, a spouse, or another beneficiary. Assets transferred to a charitable remainder trust that provide income to the grantor will be included in the grantor’s gross estate, but the grantor’s estate will receive an estate tax charitable deduction for the value of the remainder interest earmarked for charity. An income interest shared by the grantor and the grantor’s spouse that continues for the spouse after the grantor’s death will escape estate tax due to the federal estate tax marital deduction, provided that the surviving spouse is a U.S. citizen. If the trust provides for income to anyone other than the grantor and/or the grantor’s spouse, then there will likely be gift or estate tax consequences. Probate Assets transferred through an inter vivos charitable remainder trust avoid probate. Assets transferred at death, through a will, must pass through probate. Some states, such as Florida and Virginia, have limitations on out-of-state trustees of trusts that receive assets at death. Drafting a Charitable Remainder Trust Your attorney can draft a charitable remainder trust. If you do not have an attorney, the charity’s planned giving officer can refer you to attorneys
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who specialize in estate or charitable gift planning. The Internal Revenue Service has provided model forms for drafting charitable remainder trusts. Naming the Trustee For many charitable remainder trusts, the trustee may be an institution such as a bank, trust company, or investment firm, although the charity remainderman may serve as trustee or co-trustee of a charitable remainder trust. As co-trustee, the charity is most often paired with an institutional trustee. You and the charity should be aware that a charity serving as trustee could present a potential conflict of interest. The conflict occurs in the selection of the investment assets of the trust. The income beneficiary might want maximum income while the charity wants to preserve the remainder; however, the charity also wants to maintain your goodwill and cannot afford to ignore the income beneficiary’s wishes. Naming of Charitable Remainderman To qualify as a charitable remainder trust, the trust must designate a charity having 501(c)(3) status to receive the remainder. You can reserve the right to change the charitable remainderman without jeopardizing the charitable nature of the trust; however, there can be no noncharitable remainder interest created by the trust. A donor also can name more than one charitable remainderman. If you want to deduct the charitable gift for income tax purposes to the maximum amount allowed (up to 50 percent of adjusted gross income for gifts of cash and up to 30 percent for most gifts of appreciated capital gain property), precise language must be used to limit the remainderman not only to a 501(c)(3) charity but also to one having public charity status. Most large charities, such as colleges, universities, medical centers, hospitals, and museums, are public charities and also have 501(c)(3) status as tax-exempt organizations. Be sure to check the status of your intended charitable remainderman before making a charitable gift. 5 Percent Exhaustion Test for Charitable Remainder Annuity Trusts The 5 percent exhaustion test provides that if there is more than a 5 percent chance that the assets in a charitable remainder annuity trust will be depleted so that the charitable remainderman will receive nothing, you are not entitled to a charitable income tax deduction. This provision does not apply to charitable remainder unitrusts. Many charities’ planned giving offices use software to model proposed gifts. Such computer programs will let you know if there is more than a 5 percent chance of asset depletion.
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Categories of Charitable Remainder Trusts The two basic categories of charitable remainder trusts are: (1) the charitable remainder annuity trust and (2) the charitable remainder unitrust. While these two types of trusts share many characteristics, they also have some differences. The type of trust you select will most likely be based on your risk tolerance, desire to secure a larger income, and desire to make additional gifts. We look first at the charitable remainder annuity trust, followed by a discussion of the charitable remainder unitrust. The following example presents the benefits of a $100,000 charitable remainder annuity trust and unitrust for a 70-year-old donor. EXAMPLE: Benefits of a $100,000 Charitable Remainder Annuity Trust and Unitrust for a Donor Age 70* Payout Rate
Annual Income**
Charitable Income Annuity Trust
Tax Deduction Unitrust
5%
$5,000
$61,274
$54,263
6%
$6,000
$53,528
$48,646
7%
$7,000
$45,783
$43,795
**Based on a discount rate of 7.8 percent. **For a unitrust this amount is first year income only; future years’ income wll vary.
Charitable Remainder Annuity Trust The charitable remainder annuity trust provides a fixed, guaranteed dollar amount paid to you or a beneficiary that is not less than 5 percent of the value of the trust’s assets at the time the trust is established. The distribution is paid at least once per year regardless of the trust’s investment performance, and the trustee must invade the principal of the trust, if necessary, to make the distribution to beneficiaries. The distribution may be obtained from income from fixed income investments or from the sale of capital assets. If the trust’s investments fail to perform, the trust principal can be diminished or depleted by the trustee in making the fixed, guaranteed dollar distribution to the beneficiaries. Depletion of trust assets further strains the ability of the trust to grow, resulting in further depletion of assets to make distributions in future years while reducing the value of the remainder to the charity. In many cases, if you select an amount that represents more than approximately 8 percent of the trust’s assets, you risk depleting the principal of the trust. Once a charitable remainder annuity trust is established, you cannot make any additional contributions to it, although you can establish more than one charitable
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remainder annuity trust. Benefits of a charitable remainder annuity trust include: • Income is a fixed dollar amount. • Trustee may invade principal if necessary to make payment. • Funded one time only; no additional gifts can be made to the trust. Example: Mr. and Mrs. Jackson, ages 70 and 75, make a gift to a charitable organization by establishing a charitable remainder annuity trust. The trustee is obligated to pay the Jacksons a fixed dollar amount regardless of the trust’s investment performance. If the Jacksons’ charitable remainder annuity trust is funded with $600,000 and pays out a 5 percent annuity, it will provide a fixed annual income of $30,000 a year for the Jacksons’ lifetimes. The charitable income tax deduction for a $600,000 charitable remainder annuity trust is $311,604, based on the Jacksons’ life expectancies. As a comparison, if the rate was set at 7 percent, the annual income would be $42,000 with a charitable income tax deduction of $196,248. Funding Tuition Charitable Remainder Annuity Trust/Tuition Trust Parents of students at secondary schools, colleges, and universities often ask for information about how to provide for their children’s education. The cost of tuition represents a major financial burden for many families, and some early financial planning can help. Parents and grandparents often are surprised to find that charitable giving can provide attractive financial benefits and tax savings and can greatly assist in offsetting the expense of tuition. Parents may consider establishing a charitable remainder trust for a term of years to help offset the cost of a child’s tuition. A charitable remainder trust, when used to pay for tuition, is sometimes called a charitable tuition trust. It can be a good choice for parents who would like to make a gift to an educational institution, provide income to their children for tuition, and realize substantial tax savings. Parents usually establish a charitable tuition trust for four to six years, during which time the prescribed payout from the trust is paid to the student and is taxed at the student’s income tax rate. Upon the termination of the trust, the trust property passes to the charity. The parent can designate the purpose for which the remaining trust property should be used. A $250,000 charitable remainder annuity tuition trust established for a four-year period paying 7 percent generates an income of $17,500 annually and produces a charitable income tax deduction of $190,102. In addition to the charitable income tax deduction, additional benefits and
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further tax savings are possible by funding the tuition trust with appreciated securities, which enables you to avoid the capital gains taxes you would have owed had you sold the securities. All gifts to a charitable remainder trust are irrevocable. You should consult with your lawyer, accountant, or financial advisor to ensure that the charitable tuition trust is structured to meet your particular tax needs. A charitable remainder trust for a term of years may be more broadly used to provide an income stream for a longer duration, 20 years maximum, so as to provide income for an extended period to offset educational costs for graduate work or to cover the cost of tuition for other children. Charitable Remainder Unitrust There are three types of charitable remainder unitrusts, each of which is used for different purposes and affects a beneficiary’s payout differently: 1. Straight fixed percentage 2. Net income unitrust 3. Net income unitrust with a makeup provision
Straight Fixed Percentage For the straight fixed percentage charitable remainder unitrust, the amount paid is not dependent on the income produced by the trust but is determined by multiplying the percentage payout rate by the fair market value of the trust’s assets as determined annually, usually on the first business day of the year. As with the annuity trust, the trustee is obligated to make the distribution and must invade the principal of the trust, if necessary, to make the payment. Unlike the annuity trust, the payment is variable and is affected by the increase or decrease in the market value of the trust’s assets. Depletion of principal is a concern to both the beneficiaries and the charity, as a reduction in principal jeopardizes the production of income and the remainder value. Charities do have some protection because the distribution is a function of the market value, calculated by multiplying the fixed percentage by the annual market value of the fund. Depending on the needs of the lifetime beneficiaries, trustees can invest in equity and fixed income assets to promote growth and generate income. Characteristics of a charitable remainder unitrust include: • Stated percentage of the value of the assets as valued annually • Invade principal to make payment, if necessary • Additional gifts can be made to a charitable remainder unitrust • Lifetime management tool
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Example: Mr. and Mrs. Jackson, ages 70 and 75, choose to make a gift through a charitable remainder unitrust of $600,000. The charitable remainder unitrust will pay the Jacksons a predetermined percentage of the fair market value of the trust’s assets, but not less than 5 percent, as revalued annually. If the payout rate is established for the Jacksons at 5 percent, they receive an annual income of $30,000 in the first year and a 5 percent payout each succeeding year based on the annual valuation of the trust. However, if the rate were set at 8 percent, the annual income would be $48,000. This type of trust can provide a hedge against inflation because as the assets of the trust increase in value, so does the income. Additional contributions can be made to a unitrust. The Jacksons also receive a charitable income tax deduction, which, if they cannot use the full amount in the first year, may be carried over for five additional years. The charitable income tax deduction for the Jacksons’ charitable remainder unitrust with the rate set at 5 percent is $277,836; at an 8 percent rate the charitable income tax deduction is $180,726. Net Income Unitrust The net income unitrust pays the lesser of actual net income or the stated percentage unitrust amount. Income is defined under state and local law, and most states follow the income-only rule, defining income as interest income, bond income, and dividends from stocks, excluding long- or short-term capital gain. In most states, capital gains are considered to be principal, not income. If no income is produced, then nothing is distributed. The trustee may not invade the principal to make the distribution since the distribution is measured as the lesser of actual net income or fixed percentage. The trustee must fully understand your wishes when this type of trust is established. For example, investments in growth stock will produce little or no income, although if market conditions are favorable, the portfolio may grow in value. This type of trust may be appropriate for a beneficiary who is younger and who would like to receive income in the future. Benefits of a net income unitrust include: • Income: Pays lesser of net income or stated percentage • May not invade principal to make payment A couple in their 50s who wish to retire after age 65 could fund the trust with growth stock. Over time the growth stock will likely increase the value of the corpus. As the couple approaches retirement, the trustee can gradually convert the growth assets to income investments, enabling the beneficiaries to receive net income from an asset pool that has greatly increased in value during the investment period. See Chapter 10, “Incorporating Charitable Giving and Retirement,” for an illustration of the use
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of growth stock to fund a net income charitable remainder unitrust for retirement. Net Income Unitrust with a Makeup Provision The charitable remainder unitrust with a makeup provision is similar to a net income unitrust except that, under certain circumstances, you can receive payments in excess of the percentage unitrust amount in order to “make up” for prior payments of net income that were less than the percentage unitrust amount. With this type of unitrust, you receive the stated percentage of the trust or the net income, whichever is less. However, if in one year you received net income only (because net income was less than the stated percentage amount), you can recover part or all of the shortfall between that year’s net income and the percentage amount in future years when the trust has net income that exceeds the stated percentage. In a year when a makeup payment is possible, the makeup payment is limited to the lesser of your total shortfall for all prior years and the amount by which the trust’s net income for the current year exceeds the percentage amount. This vehicle typically is funded with growth stock or real estate. As discussed earlier, net income may be defined in the trust to include realized capital gain. Benefits of the net income unitrust with makeup provision include: • Pays lesser of net income or stated percentage but can make up shortfall if net income is less than the stated percentage • No invasion of principal • Good for gifts of real estate Flip Trusts Flip trusts combine the benefits of a net income unitrust with a regular unitrust. Donors who wish to make gifts of assets that are likely to take some time to sell, such as real estate or stock of a closely held corporation, could transfer those assets to a net income unitrust. Through the net income unitrust, you receive the stated percentage or net income, whichever is less. Since the assets transferred are non-income-producing assets, no income is produced. However, following the sale of these assets (or some other triggering event), the trust “flips” to a regular unitrust, enabling the trustee to invest for total return. Return is measured by income (interest and dividends) and capital appreciation, such as gains on the value of the trust’s corpus. For example, if the income is earned at a rate of 3 percent of fair market value and the trust calls for a payout of 5 percent, then the additional 2 percent is obtained from the principal. If the trust assets have appreciated, then the payout is made
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from capital appreciation of the assets. A flip trust can work well for donors who are relatively young and likely to have a fairly long life expectancy. For these donors, capital appreciation is an important reason to establish a flip trust, and investing for total return enables capital appreciation to occur. Treatment of Capital Gains The Internal Revenue Service has suggested that, in some cases, a net income unitrust might be allowed to define income to include capital gains. The ability of a trust to include capital gains in income depends on whether local law permits such treatment. Furthermore, any inclusion of capital gains in income is limited to the gains that occur after the property is donated to the trust. As discussed earlier, historically trustees have selected investments that produced income by investing in bonds or stocks that paid interest and dividends equal to, or as near equal as possible, the percentage amount. Most trustees would prefer to invest for total return by selecting investments based on their potential for performance rather than whether their return would be considered income or capital gain. A net income unitrust that can be structured to include post-contribution capital gains in income would allow trustees to invest for total return, thereby enabling beneficiaries to receive capital gain earnings from the investments.
QUALIFIED TERMINABLE INTEREST PROPERTY (QTIP) WITH REMAINDER TO A NONPROFIT Through the use of a qualified terminable interest trust (QTIP trust), you can provide for your spouse and also benefit a nonprofit. A QTIP trust enables you to take full advantage of the unlimited marital gift and estate tax deduction by transferring assets to the trust. Your spouse has a right to income for life; in addition, you may give your spouse some degree of access to the principal. Upon the death of your spouse, the remainder of the trust is distributed to remainder beneficiaries of your choosing. These remainder beneficiaries may include a charity. Unlike a charitable remainder trust, where you receive a charitable income tax deduction, a QTIP trust with a charitable remainder beneficiary provides no income tax deduction to you. The transfer of assets to a QTIP trust qualifies for the estate and gift tax marital deduction, thus preventing the decedent spouse from having those assets actually taxed in his or her estate. The QTIP property is included in the estate of the surviving spouse, but the surviving spouse’s estate receives an estate tax charitable deduction for any portion distributed to a qualified charity.
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Any income distributed to the surviving spouse during his or her lifetime is taxable to that spouse. The QTIP trust itself is taxable, although it may deduct income paid to the surviving spouse. The trust will be taxed on capital gains that are realized in the trust.
CHARITABLE LEAD TRUSTS A lead trust is frequently described as the opposite of a charitable remainder trust. The “lead” income interest is paid to the charity, and after a number of years (based on a term of years or a lifetime), the remainder is distributed either to the grantor (a grantor lead trust) or to someone other than the grantor, such as the grantor’s heirs or other beneficiaries (a nongrantor lead trust). Unlike a charitable remainder trust, a charitable lead trust is not subject to a minimum payout of 5 percent. In addition, a charitable lead trust (other than a grantor lead trust) is a fully taxable trust. The lead trust pays taxes on its income and capital gains, unlike the charitable remainder trust, which is a tax-exempt trust. The lead trust may deduct amounts paid to the charitable beneficiary pursuant to the terms of the governing instrument. Lower interest rates coupled with high estate gift tax rates make for a potentially advantageous environment for using charitable lead trusts as part of an estate plan. Grantor lead trusts have limited usage, so this section focuses on the use of nongrantor charitable lead trusts. Characteristics of charitable lead trusts include: • Income to charity for a period of years • Remainder to grantor or heirs • Potential tax benefits • Estate tax savings for nongrantor lead trust
NONGRANTOR CHARITABLE LEAD TRUSTS A nongrantor charitable lead trust provides income to the nonprofit for a period of years. At the end of the term of years, the remainder is transferred to someone other than the grantor, often the grantor’s children. As the grantor, you do not receive a charitable income tax deduction but you do receive estate and gift tax benefits, and the trust income is not taxed to you. If the nongrantor charitable lead trust is an inter vivos trust (established during life), you obtain a gift tax charitable deduction on the present value of the stream of income passing to charity. If the nongrantor trust is a testamentary trust (established on the donor’s death),
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Nongrantor Charitable Lead Annuity Trusts
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your estate obtains an estate tax charitable deduction for that value. You do pay gift or estate tax on the present value of the remainder passing to heirs or other individual beneficiaries. Under some circumstances, grantors are able to use nongrantor lead trusts to help transfer assets to their heirs with reduced federal estate, gift, or generation-skipping transfer tax consequences; grantors may be able to pass a considerable amount of property to their offspring while substantially reducing taxes and benefiting a charity. Seek the advice of an experienced professional about charitable lead trusts.
NONGRANTOR CHARITABLE LEAD ANNUITY TRUSTS Through a nongrantor charitable lead annuity trust you irrevocably transfer assets, usually cash or securities, to a trustee. During the charitable lead annuity trust’s term, the trustee invests the trust’s assets and provides a fixed dollar amount each year to the charity. These payments continue until the trust term ends. The trust’s term may be for a specific number of years, one or more lifetimes, or a combination of the two. When the charitable lead annuity trust term ends, the trust distributes all of its accumulated assets to the remainder beneficiaries, who are often family members. Any asset appreciation that occurs within the trust will be distributed to the trust’s beneficiaries, free of additional gift or estate taxes. Example: If a donor’s estate has $4 million and the executor, after paying federal estate taxes of $1,043,799, transfers the balance of $2,956,201 to a nongrantor charitable lead annuity trust paying 6 percent for a period of 20 years, the following benefits ensue: 1. The donor’s estate pays federal estate taxes of only $1,043,799, which
may be partially offset by the unified credit. 2. The net principal placed in the trust is $2,956,201. 3. The 6 percent payout rate provides income to the charity in the
amount of $3,547,442 over the 20-year period. 4. If the trust grew at an income rate of 3 percent and capital apprecia-
tion at a rate of 8 percent, the trust could distribute to the remainder beneficiaries (e.g., the donor’s children) $12,120,155 in principal at the end of 20 years. 5. If the donor were to leave the property outright to his or her family
upon his or her death, without the use of a nongrantor lead trust, the donor’s estate would have to pay $2,200,000 in estate taxes and no benefit would flow to the nonprofit.
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NONGRANTOR CHARITABLE LEAD UNITRUST During the lead unitrust’s term the trustee invests the unitrust’s assets and pays a fixed percentage of the unitrust’s value, as valued annually, to the nonprofit. The lead unitrust’s term may be for a specific number of years, one or more lifetimes, or a combination of the two. When the lead unitrust term ends, the unitrust distributes the accumulated assets to family members or other beneficiaries. Example: If a donor’s estate has $4 million and his executor, after paying federal estate taxes of $1,100,116, transfers the balance of $2,899,884 to a nongrantor charitable lead unitrust paying 6 percent for a period of 20 years, the following benefits ensue: 1. The donor’s estate pays federal estate taxes of only $1,100,116, which
may be partially offset by the unified credit. 2. The net principal placed in the trust is $2,899,884. 3. The 6 percent payout rate provides income to the charity in the
amount of $5,753,246 over the 20-year period. 4. If the trust grew at an income rate of 3 percent and capital apprecia-
tion at a rate of 8 percent, the donor would be able to distribute to the remainder beneficiaries $7,694,255 in principal at the end of 20 years. 5. If the donor were to leave the property outright to his or her family
upon his or her death, without the use of a nongrantor lead trust, the donor’s estate would have to pay $2,200,000 in estate taxes and no benefit would flow to the charity.
CONCLUSION Trusts provide a variety of flexible alternatives to donors who want to make gifts to a charity. In particular, charitable remainder trusts and charitable lead trusts offer customized options that can meet your needs and support the charity. Compare the benefits of each trust option to select the one that is best for you. The charity should be able to provide information to you on the types of trusts that are appropriate for your situation. Take time to analyze the options. If you do not understand them or do not feel comfortable, slow the process down. Always consult with your financial and legal advisors about any large gift, especially one that involves a trust.
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Conclusion
CHECKLIST
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TRUSTS
Do you need or want a trust and, if so, for what reasons? Which trust most closely meets your planning objectives?
❏ ❏
❏
Straight percentage
Net income
Net income with makeup provision
If you are interested in a charitable remainder trust, will it be an annuity trust or unitrust? If it is a unitrust, will it be a straight percentage, net income, or net income with a makeup provision?
❏
❏ ❏
Annuity trust
❏
Unitrust
❏ ❏ ❏
Straight percentage Net income Net income with makeup provision
Which assets will you fund it with? What are the advantages of a lead trust?
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CHAPTER 9
Gifts Through Your Estate
FREQUENTLY ASKED QUESTIONS
What is the difference between a will and a trust? What is the best way to distribute my estate to my family and my favorite charities? FREQUENTLY ASKED QUESTIONS Q: What is the best way to distribute my estate to my family and my favorite charities? A: Use percentages to allocate your estate among your beneficiaries
instead of a dollar amount. For example, you could leave 20 percent to each of your four sisters and the remaining 20 percent could be distributed to charity. One of the most attractive ways you can make a gift to charity is through estate planning. One reason to make gifts through your estate, at death, rather than during your lifetime is to preserve your assets for your use and to maintain control over the assets in case you need them. On your death, the bequest transfers the property to your heirs, friends, or favorite charities. Estate planning includes making a bequest through your will, but it also can include making distributions through a testamentary trust, charitable remainder trust, or revocable trust discussed in Chapter 8. Charitable gifts through estate planning provisions provide substantial revenue to a charity without depleting or diminishing your estate during your lifetime. Through a bequest (a clause in your will) you may make a gift of a specific dollar amount ($100,000), a specific fraction (one-quarter), 109
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a percentage (25 percent), or your entire estate to a charity. Fractions or percentages are used most often because they allow you to allocate your estate equitably among your family, friends, and favorite charities. For example, you may leave 15 percent of your estate to each of your four siblings and distribute 20 percent each to two charities. Because you will never know the exact dollar amount of your estate, using fractions or percentages is the most efficient and effective method to distribute the proceeds. However, you also can make a specific gift of $25,000 to a charity and then distribute the rest of your estate to your heirs using fractions or percentages. In this case, the $25,000 is paid first and the balance of your estate is allocated accordingly. Charitable giving is a very effective way for you to reduce the size of your estate. Reducing the estate diminishes the impact of federal estate and gift taxes. You may wish to make charitable gifts so that your net taxable estate is less than the individual exemption from estate tax, $675,000 in 2001, $700,000 in 2002 and 2003, $850,000 in 2004, $950,000 in 2005 and by the year 2006 and thereafter the lifetime exemption will rise to $1 million. Congress is also considering legislation to eliminate estate taxes. See Chapter 16 for more information on tax consequences of charitable gifts. Estate planning involves the coordinated integration of several documents, typically including a will, trust, durable power of attorney, and living will or healthcare proxy. Estate planning also involves assessing several aspects of your life, including your business affairs, family planning issues, and personal goals and objectives. Charitable gift planning should be incorporated into your overall estate planning objectives rather than be treated as a separate activity.
TAX LAW AND CHARITABLE GIFT PLANNING Taxation, both federal and state, is an important consideration for most donors. The old adage, “You can give it to the IRS or your favorite charity,” is true. Taxation can serve as an incentive when it comes to charitable gift planning and can motivate philanthropically minded donors to benefit charities. Donors sometimes view charitable gift planning as the last tax shelter through which income, estate, gift and capital gains taxes can be diminished or avoided entirely. The United States system of taxation permits and encourages taxpayers to make gifts to charities, since without private support to our nation’s charities, many educational, health, social service, environmental, and cultural programs would go unfunded. Charities remove some of the pressure that the federal government would bear if it were obligated to deliver these charitable services. Many donors wish to benefit a charity during their lifetime but cannot afford to part with current assets. Bequests provide major benefits to
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charities yet allow donors to retain the use of their assets during their lifetime. Many donors who make major bequests to charities are childless couples or individuals who view the charity as a substitute for heirs, and these gifts can be substantial. This section focuses on issues related to making charitable gifts through bequests.
THE WILL Q: What is the difference between a will and a trust? A: A will transfers property from one person to another. Generally, all
property transferred by will must be probated. A will also enables a parent to nominate a guardian of minor children in the event the parent predeceases the children. A trust also transfers property from one person to another, but it provides much more flexibility. For example, if you wish, only income could be distributed from the assets of the trust, or you may distribute the principal from the trust over several years. Any asset transferred to the trust during the lifetime of the grantor (maker) passes outside of probate at the grantor’s death, which is a major advantage of a trust. Perhaps surprisingly, over one-half of all Americans die without a will. The reasons are varied. Sometimes it is due to a lack of knowledge or a failure to understand the need for a will. Sometimes the reasons are more complex, involving emotional and psychological factors that keep individuals from drafting a will. Whatever the reason, the result is the same— intestacy. When people die without a will, they are considered to have died intestate and the state where they are domiciled shall, in effect, make a will for them. Domicile is the state that you intend to be your permanent residence and the place where you have the most contact. Laws vary considerably from state to state. Intestacy has been described as a fate worse than death. Rather than you making decisions about distributing your assets, the state determines the formula for distributing your assets and adds extensive, expensive, and cumbersome legal formalities. There is no consideration for your needs or wishes. One can avoid intestacy simply by making a valid will. A will also enables a donor to make a charitable bequest. A revocable trust is often drafted at the same time as the will, and the charitable gift may be included in the revocable trust. The formal requirements for drafting wills are simple. Most states require that the testator (the person making the will) be 18 years of age or older, of sound mind, and sign or execute the will in the presence of two or more competent witnesses. Most donors meet these requirements easily.
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To make a charitable gift, you must either include the bequest to the charity in the body of the will or have a codicil drafted to include the bequest. A codicil (amendment to a will) is a written document, often one or two pages, that should be physically attached to your existing will. A codicil may confirm the validity of the existing will and also will include new provisions and/or exclude old provisions from the existing will. Many donors make bequests through a codicil because it is less expensive and less time consuming than drafting a new will. You should update your will at least every five years. If you have a will that is five years old or more, have a new will drafted. Changes in family situations or in the tax law can make your will obsolete practically overnight. Some changes in circumstances that may prompt you to update your will include: • Marriage, divorce, birth, adoption, or death • Marriage revokes a will in its entirety in most states, unless it is expressly contemplated in the will • Divorce or annulment generally revokes the disposition of property to a former spouse • Changes in the nature and value of your property, such as a substantial increase in the appreciation of your stock portfolio • Changes in state and federal laws, and the interpretation of those laws • Moving from one state to another, although a will validly executed in one state should be valid in all other states. If you move to or from a community property state, you may need to revise your will.
PARTS OF A WILL A properly executed will transfers property from the testator (maker of the will) to beneficiaries. Will requirements vary by state, but most wills include a number of standard provisions or clauses. These provisions include: • A clause revoking all previously drafted wills or codicils • A clause that directs the payment of all debts, taxes, funeral expenses, and administrative costs by one or more beneficiaries • A clause naming an executor or a personal representative of the estate • A clause appointing a guardian to act on behalf of minor children of the decedent • Distribution clauses, which permit personal and real property to be distributed to specific beneficiaries, including charities
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• A residuary clause that directs the distribution of the remainder or residue of the estate to individual beneficiaries or charities Guardianship Provision Estate planning requires planning for contingencies; often it is not enough to appoint a single guardian, executor, trustee, or beneficiary. You should choose successor parties and beneficiaries to act or benefit in the event of the death or disqualification of the first chosen party. A guardianship provision is of great importance to any family with minor children. A minor, under the age of 18 in most states, cannot legally make decisions on medical or healthcare issues, and contracts that a minor enter into are considered voidable. A simple clause that appoints a guardian to act on behalf of your minor children enables a guardian, with court approval, to take action for the benefit of your child. In the absence of a guardianship provision, the probate or family court must be petitioned to request that an individual be appointed to act as guardian.
SUGGESTED LANGUAGE FOR CHARITABLE BEQUESTS Charities can provide sample bequest language to donors who wish to make a gift through a bequest to the organization. Ask the charity’s planned giving officer for sample bequest language that you can show to your attorney, who will incorporate some or all of that language into your will. Sample bequest language follows. You are most likely to make a gift to a charity in one of two ways — (1) through a specific bequest or (2) as a percentage of your estate. Specific Bequest You can make a specific bequest by naming a certain sum of cash, securities, or property to the organization. For example, the following language is appropriate for a bequest of a specific dollar amount: I bequeath the sum of <$ > to <specific name of charity>, , to be used or disposed of for .
Percentage of Estate Your bequest also can provide for a percentage of your estate to benefit the charity, and you can make gifts through the residuary clause in your will. The residuary estate consists of everything that is not specifically given away and permits you to distribute a portion of the estate among
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individual beneficiaries or to a charity. The residuary clause is sometimes called the “remainder” or “residue” of the estate. Because you will not know the exact size of your estate at death, using a percentage or fraction is a more appropriate way to divide your estate. You can benefit organizations and individuals in relative proportion. Example: A donor wants to leave money to two charities but does not know the value of his estate. By leaving 10 percent of his estate to the Salvation Army and 5 percent to the American Red Cross, the donor is demonstrating a desire to leave twice as much to the Salvation Army as the American Red Cross. The following is sample bequest language for donors who wish to leave a percentage of their estate to a charity: I devise and bequeath [all or ( percent)] of the remainder of my property to [specific name] charity, to be used or disposed of for [or as its Board of Directors in its sole discretion deems appropriate.]
Note: Rather than provide an unrestricted bequest, you also can designate that the bequest be used to support an endowed fund or other project. Bequests to Charity/Sample Provisions A bequest to charity is a way of perpetuating your support for the role the charity plays in your life. It also enables you to make a major gift that might not otherwise be possible. Suggested Forms of Bequests When making or revising a will, you should obtain the assistance of an attorney. Members of the charity’s development staff will work with you and your attorney to design an estate plan specifically tailored to your wishes. The following are suggested forms for making various types of bequests. You can show this information to your attorney and ask him or her to draft appropriate clauses in your will to accomplish your goals. 1. Outright bequest in will
(a) Specific dollar amount: I bequeath the sum of Dollars [$ ] to [name of charity], , to be used or disposed of for [or as its Board of Directors in its sole discretion deems appropriate.]
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(b) Specific property (personal property): I bequeath to [name of charity], , to be used or disposed of for [or as its Board of Directors in its sole discretion deems appropriate.]
(c)
Specific property (real estate): I devise all of my right, title, and interest in and to the real estate located at to [name of charity], , to be used or disposed of for [or as its Board of Directors in its sole discretion deems appropriate].
(d) Share of, or entire residue, of estate: I devise and bequeath (all/or percent [ %]) of the remainder of my property to [name of charity], , to be used or disposed of for [or as its Board of Directors in its sole discretion deems appropriate]. 2. Conditional bequest in will
Insert the conditional language in one or more of the above provisions. For example: If my husband/wife does not survive me, I bequeath the sum of Dollars ($ ) to [name of charity], to be used or disposed of for [or as its Board of Directors in its sole discretion deems appropriate]. 3. Restricted bequest
If the gift to charity is restricted, insert the restriction in place of the words “to be used or disposed of as its Board of Directors in its sole discretion deems appropriate.” For example: I bequeath the sum of Dollars ($ ) to [name of charity], , for the following use and purpose: .
In the event of a gift subject to a restriction, we suggest including the following provision: If in the judgment of the Board of Directors of [name of charity] it becomes impossible to accomplish the purposes of this gift, the income or principal may be used for such related purposes and in such manner as determined by its Board of Directors.
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LEGALLY BINDING DOCUMENTS FOR BEQUESTS Courts in several states have upheld pledge documents, which place an obligation on you to carry through with an intention to make a gift through a bequest. To have a legally binding obligation there has to be “consideration.” Consideration, a legal term, is provided by the charity if it performs an act, such as erecting a building in exchange for and in reliance on your promise to provide funding. If consideration is provided by the charity, a charitable pledge agreement becomes binding. Even without consideration, a charitable pledge agreement may state that it is a binding obligation of your estate to have your executor (personal representative) transfer a certain amount of money to the charity. A contract to make a will places an obligation on you to execute a valid will, which honors your obligations to make a bequest to the charity. Once the binding legal pledge or contract to make a will is signed, your will should be amended if it does not currently provide for the gift to the charity.
PROBATE Probate is a state-sanctioned system that oversees the administration of your estate. The concept of probate is confusing since many people mistakenly believe that if one has a will, probate is avoided. At your death, your will is filed in probate court (district court in some states) and is probated. The main purposes of probate are to collect your probate assets, protect and preserve the property of the estate, pay debts, file federal and state estate tax returns and pay taxes, cut off creditors’ claims, and determine who is entitled to receive the decedent’s assets and distribute the property to them. If the estate is not probated because the trust is fully funded, the trustee will perform many of these tasks, including filing the estate’s tax returns and paying its debts and taxes. These tasks are not eliminated by avoiding probate. Probate can be an expensive process. Apart from the filing fees and notification requirements, significant executor’s and legal fees may be involved in settling an estate. Depending on the decedent’s domicile, probate fees may be billed hourly or may range from 3 to 8 percent of the estate’s probate assets. For an estate worth $500,000 in probate assets, depending on the assets, fees of 3 percent cost $15,000. In addition to being expensive, the probate process is also very time consuming and may last up to a year or more.
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Probate Assets What is probate property? Which assets need to be probated? The answer depends on the way in which title to your assets is held. The following is probate property: • Assets real or personal, owned in your own name at your death • Property in which you had an ownership interest as a tenant in common • Life insurance policies that name your estate as beneficiary Nonprobate Assets The following assets are not probate assets: • Assets transferred by designating a beneficiary other than your estate. For example, pension and retirement benefits or life insurance in which you name your spouse or other beneficiary pass outside of probate. In most cases, life insurance should not be payable to your estate but pass to the beneficiary outside of your estate. It is typically only appropriate to name your estate as a beneficiary of a life insurance policy when your estate does not have other significant liquid assets to pay debts, taxes, or funeral expenses. • Assets that pass automatically, by operation of law, to a joint tenant. These forms of ownership include joint tenancies and tenants by the entirety. They also may include property such as bank accounts where there is a designated joint owner. • Property that the testator has transferred to a revocable or irrevocable trust during lifetime.
PROPERTY HELD OUT OF STATE — ANCILLARY ADMINISTRATION Many individuals own property outside of the state in which they were domiciled. This property may include real estate such as retirement homes or recreational property such as mobile homes, boats, or yachts. Any asset that you own in another state that is considered a probate asset requires a separate probate filing in that state. This process, called ancillary administration, results in additional expenses and delay. To avoid ancillary administration, your assets located in another state should be
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transferred to an inter vivos trust or be held jointly. Remember, however, that a joint tenancy exists only as long as there are two or more joint tenants. Upon the death of one joint tenant, the survivor must make provisions to distribute his/her estate.
MEDICAID Medicaid is a jointly operated federal and state welfare program of healthcare for people in financial need. Unlike Medicare, Medicaid may provide for nursing home care. Even if you are stable financially, you still may need Medicaid benefits to cover nursing home care. However, a donor who makes a major gift and subsequently requires nursing home care may delay eligibility or jeopardize his or her benefits. Charities do not want a gift to turn into a financial nightmare for the donor and an embarrassment to them. Knowledge of the rules and regulations, combined with a careful planning process, can protect donors and charities while fulfilling a donor’s philanthropic desires. Consult with your financial advisor, attorney, certified public accountant, or Medicaid office for more information. Planning Strategies With proper planning, you can make a gift and still remain eligible for Medicaid benefits. The following are planning ideas to keep in mind concerning Medicaid eligibility: • Make gifts early, while you are still healthy. • Make gifts of assets such as antiques and artwork, because they will likely be considered household items that may be given away without jeopardizing Medicaid eligibility. You should not, however, buy antiques or artwork to make a gift to the institution, because these could be considered investments and be countable assets for Medicaid eligibility. • Make gifts through bequests. You and your spouse can make bequests to charities in your wills without affecting lifetime Medicaid eligibility (although you cannot guarantee that assets will remain to fulfill the bequest at your death). • You can purchase long-term care insurance to cover nursing home costs, although it is very expensive. Having insurance can enable you to avoid having to worry about Medicaid or the high cost of care. Check with your insurance company to see if you qualify for coverage and to find the best rates. Be sure to check the company’s reputation.
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• Keep a cash reserve on hand. You should build a cash reserve to cover yourself during any possible period of ineligibility. • Plan carefully when transferring assets to a trust.
CONCLUSION Studies show that many people do not have wills. If you want to make a gift to a charity in your will, you must become an exception by drafting a valid will. The will is important to you and your family and possibly to a charity, so do not delay. Drafting a will is an opportunity to make provisions for your favorite charities. Gifts through your estate to charity do not deplete your current assets but only transfer assets upon your death. Use percentages to divide your estate between your family and a charity. Ask the charity for sample bequest language that you can share with your attorney.
CHECKLIST
❏ ❏ ❏ ❏ ❏
GIFTS THROUGH YOUR ESTATE
Have you made a will? If you have minor children, have you selected a guardian? Have you included a bequest to charity? Have you considered the impact of probate? Should you reduce your estate to avoid significant estate taxes?
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C H A P T E R 10
Incorporating Charitable Giving and Retirement
FREQUENTLY ASKED QUESTIONS
Can I transfer my pension to a charity? Can I make a gift of my IRA to charity? What is the best way to make a transfer to charity of retirement plan assets? FREQUENTLY ASKED QUESTIONS Q: Can I transfer my pension to a charity? A: If your employer’s plan allows it you may be able to do so. However,
you are going to be taxed on the income first and then you can effectively give the proceeds to a charity. Charitable giving and retirement planning are interrelated. Through charitable gifts you can obtain financial benefits to assist in retirement, and gifts of retirement plan assets can be used, philanthropically, to benefit a charity. This chapter is divided into two parts, focusing on the ways in which (1) planned giving vehicles can assist in retirement planning and (2) retirement assets can be transferred to satisfy your philanthropic goals. Q: Can I make a gift of my IRA to charity? A: IRS rules require you to first pay income taxes on your IRA and then
you can give the proceeds. Legislation has been proposed that would change this rule. Check with your CPA or tax advisor.
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Retirement vehicles, such as employee benefit plans, Individual Retirement Accounts (IRAs), Roth IRAs, corporate savings plans, 401(k) pension and profit-sharing plans, and tax-sheltered 403(b) annuities, provide individuals with opportunities for tax-deferred investments that also may be used to help charities. Individuals who shelter income through retirement plans are not taxed on either the income earned or the capital appreciation of the assets until the funds are withdrawn. When you participate in a 401(k) or 403(b) plan, your employer may make an additional contribution to your retirement plan, thereby increasing your retirement benefits. Moreover, the initial 403(b) and 401(k) contributions are often made pretax, prior to income taxes being assessed against the employee’s contributions. Federal law limits the amount an individual can contribute each year to a retirement program. For example, if you qualify, you can contribute a maximum of $2,000 per year to a traditional IRA if you are not a participant in any other retirement plan and meet certain income limitations. The Roth IRA also has a $2,000 ceiling, but you can establish one even if you participate in a retirement plan if you meet certain income limitations. Unlike the IRA, there is no ceiling on the amount of money that you can contribute to a charitable gift, although your charitable income tax deduction may be limited by the annual percentage limitation applicable to charitable contributions. You can supplement retirement income through charitable gift planning and exceed the conservative limits of retirement planning vehicles. This chapter explores ways you can use planned giving ideas to supplement your income and also looks at ways you can make gifts of your retirement plan assets to charity.
USING PLANNED GIVING VEHICLES TO ASSIST IN RETIREMENT PLANNING Donors can complement and supplement their existing retirement programs through planned gifts. The following sections illustrate different life income vehicles and the benefits they provide in retirement. Deferred Gift Annuities Deferred gift annuities can serve as effective quasi-retirement vehicles. They are ideal for younger donors who wish to make charitable gifts while providing for retirement. A deferred gift annuity provides you with a life income stream, which is deferred until a later date. In addition, you obtain a substantial charitable income tax deduction in the year the gift is made. You can defer payments to a year when income is needed more, such as at retirement. Because the income stream is not paid currently,
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the deferred gift annuity compounds tax free, like an IRA, to produce a significant return in the future. The rate is based on the beneficiary’s age and the period between the initial contribution and the year in which the payment begins. The longer the delay, the higher the rate will be. See Chapter 7 for more information on deferred gift annuities. The example below illustrates the benefits of a deferred gift annuity and assumes that the income will be deferred to age 65. EXAMPLE: Benefits of a $10,000 Deferred Gift Annuity
Deferred to Age 65* Age
Payout Rate
Annual Income
Charitable Tax Deduction
25 30 35 40 45 50
61.9% 46.8% 35.4% 26.8% 10.3% 15.3%
$6,190 $4,680 $3,540 $2,680 $2,030 $1,530
$7,822 $7,589 $7,324 $7,021 $6,673 $6,279
*Based on a discount rate of 7.8 percent.
Charitable Remainder Net Income Unitrust A net income unitrust or a net income unitrust with a makeup provision covered in Chapter 8 can help you produce income for retirement. Through these options, you fund a net income unitrust with growth stocks that you hope will appreciate in value. A net income unitrust pays the lesser of the stated percentage of the value of the assets as valued annually or the net income. Net income may be defined to include net unrealized long- and short-term gains. In most cases a portfolio of growth stock produces little income, and so none is distributed; however, the underlying assets may appreciate over time. The net income unitrust holds these growth stocks and permits the assets to appreciate tax free, because a capital gains tax is imposed only when a sale or disposition of capital assets occurs and the capital gain is distributed to the income beneficiary. Later, in your retirement years, the trustee of the trust can convert the assets into income/dividend-producing investments such as blue chip stocks, bonds, or utility stocks. Example: Professor and Mrs. Jones are both 50 years of age. Professor Jones is a college professor and Mrs. Jones is an officer in a large corporation. Professor and Mrs. Jones expect that they will retire in 15 years,
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when they reach age 65. To help them prepare for their retirement while fulfilling their goal of making a major gift to their local museum, they establish a unitrust paying the lesser of the net income or 5 percent of the trust assets and fund it with a portfolio consisting exclusively of growth stock valued at $100,000. Assume that the stock appreciates an average of 8 percent per year for the 15-year period. When Professor and Mrs. Jones reach retirement at age 65, the trustee converts the growth stock into income-producing assets. Professor and Mrs. Jones receive the lesser of the net income or 5 percent of the value of the assets, which have appreciated substantially. The initial gift of $100,000 has grown to be worth approximately $330,692. If the trust earnings are 8 percent, Professor and Mrs. Jones receive a 5 percent annual income of $16,534 based on the value of the appreciated assets of $330,692. The surplus 3 percent is returned to principal. A net income unitrust with a makeup provision enables the beneficiary of the trust to receive the lesser of the net income or stated percentage and make up for lost income during the term from the year of funding to the year of retirement. The makeup of the lost income would increase the income stream at a time when the donors need to obtain supplemental income at retirement. In the preceding example, the surplus 3 percent income would not be returned to principal but would be paid out to offset income lost during the time that the trust income was less than the percentage amount. In future years, any additional surplus income would be distributed until the shortfall is entirely recouped. Chapter 8 has more information on charitable remainder trusts. Charitable Gift Annuities and Pooled Income Fund Gifts Charitable gift annuities and pooled income fund gifts also can provide current income to retirees to supplement retirement income. Blue chip stocks may represent a significant portion of many individuals’ portfolios and often earn approximately 2 to 3 percent of fair market value in dividends. Charitable gift annuities typically generate 7 to 9 percent or more, and pooled income funds distribute 4 to 6 percent in income. By placing low- yielding stocks into a charitable gift annuity or pooled income fund, you can significantly increase income currently earned from these investments. In addition, if you sell appreciated assets held for more than one year, there is a maximum 20 percent federal capital gains tax for most investment assets on the appreciation; you can completely avoid this tax by making a gift to a pooled income fund and partially avoid the tax by funding a charitable gift annuity. For more information on charitable gift annuities and gifts to pooled income funds see Chapter 7.
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RETIREMENT VEHICLES FOR CHARITABLE GIVING Q: What is the best way to make a transfer to charity of retirement plan assets? A: There are several options. Depending on restrictions of your retire-
ment plan assets you may be able to make the transfer outright, designate the charity as the beneficiary, or by bequest leave to a charity your retirement assets. You also can transfer assets to a charitable remainder trust. Ask a professional for advice and check for new legislation. This section focuses on using various retirement plan assets to make a charitable gift. In theory, retirement vehicles such as IRAs, tax-sheltered annuities, or qualified employee benefit plans may be used to make gifts to a charity, but in practice there are a variety of obstacles. Some plans only permit the participant to name the participant’s spouse, or certain other beneficiaries such as children. When a charity can be named, federal law also requires, in most circumstances, that the participant’s spouse consents to the designation of a charity as beneficiary of a retirement plan at the employee’s death. Because most retirement plans are funded with pretax income, the Internal Revenue Code requires that the assets of such plans be taxed at ordinary income rates before any transfer of the asset during the donor’s lifetime, even if the asset will be used to make a gift to charity. The donor obtains an offsetting charitable income tax deduction, but only subject to the applicable income percentage limitations. Some attractive options do still exist if your retirement plan does not prohibit the transfer of the plan assets to a charity or planned gift vehicle. Recently legislation was proposed in Congress that would allow donors to make gifts of IRAs directly to a charity without first having to pay income taxes on the withdrawal but also without receiving a charitable income tax deduction. If passed, this legislation will allow you to make charitable gifts of IRA assets; if future legislation is broad enough, it may cover other retirement plan assets, such as 401(k), 403(b)7, SEP, and other related employer-sponsored plan assets without being affected by the income percentage limitations. At press time, legislation had not been passed. Check with your senators, representatives, certified public accountant, or charity’s planned giving officer for more information on the status of this legislation, which, if passed, would open desirable avenues. Many wealthy donors, especially those with fully funded retirement programs, were adversely affected by a 15 percent excise tax on excess distributions from qualified retirement plans, tax-sheltered annuities, and individual retirement accounts. The Taxpayer Relief Act of 1997 repealed this excise tax, which acted as a deterrent to donors wishing to
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make a gift of such assets. Donors who now make a lifetime gift of retirement plan assets will pay federal and state ordinary income taxes on the distribution (as ordinary income, not capital gains) but will receive a charitable income tax deduction, which may largely offset the income tax effects of the distribution.
TAX CONSEQUENCES OF CHARITABLE GIFTS OF RETIREMENT ACCOUNTS AT DEATH As discussed earlier, most withdrawals of or distributions from retirement account assets are fully taxable as ordinary income to the plan participant or to any noncharitable beneficiary. In addition, for estate tax purposes, the value of these assets is included in the participant’s estate. If your spouse (a U.S. citizen) is designated as beneficiary, the estate tax is avoided because of the estate tax marital deduction; however, the assets are taxed in your surviving spouse’s estate. If a charity is designated as beneficiary, the estate tax is also avoided due to the estate tax charitable deduction. Retirement accounts are characterized as income in respect of a decedent (IRD). IRD items are taxable to the beneficiary and are also included in the decedent’s estate. The beneficiary may obtain an income tax deduction for estate taxes paid, with respect to the IRD assets. Retirement accounts transferred to a charity at death avoid income tax because of the tax-exempt status of a charity. Assets transferred to a charitable remainder trust will avoid income tax upon distribution because the trust itself is tax exempt although ordinary income will be carried out with distributions to the income beneficiary. The estate tax will also be reduced by the charitable deduction in respect of the remainder interest.
TYPES OF RETIREMENT PLANS There are many types of retirement plans. The following list includes the most common types of retirement plans. • Individual Retirement Accounts (IRAs) Individuals make contributions to IRAs up to a maximum of $2,000 per year, subject to various limitations and tax consequences upon distribution. • Roth IRAs New Roth IRA provisions enable taxpayers to transfer up to $2,000 posttax to an IRA account, provided their adjusted gross income is
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below certain limits. Any capital appreciation or income produced by the principal may be withdrawn tax free so long as the taxpayer is 59 1⁄ 2 years old or older and the principal has been in the account for five years or more. The new IRA provisions apply even if the taxpayer is covered under an employer’s retirement program. • Section 401(k) Plans Pretax voluntary contributions by an employee. Corporate employers often match.
• Section 403(b) Plans (sometimes referred to as tax-sheltered annuities) A retirement plan for employees of nonprofit (501)(c)(3) organizations and public schools. • Qualified Pension Plans Regular contributions by an employer are used to fund retirement benefits for qualifying employees. • Qualified Profit-sharing Plans These plans are similar to pension plans, but the employer contributions are based on profits and the amount of the contribution may vary from year to year. • Self-employed Retirement Plans These include Keogh SEP-IRA and other self-directed retirement plans.
WAYS TO TRANSFER RETIREMENT ASSETS TO A CHARITY There are several ways to make gifts of retirement accounts to a charity. These options include: outright gift, designation of a beneficiary, bequest, and transfer to a charitable remainder trust. Retirement Assets Transferred Through Outright Charitable Gifts You can make an outright gift of a retirement account to a charity during your lifetime. Unfortunately, you must withdraw the assets, pay income taxes, and transfer the balance to the charity. These assets are fully taxable to you as ordinary income at your marginal tax rate, but you can obtain a charitable income tax deduction albeit limited to 50 percent of your adjusted gross income for gifts to public charities. If you are under age 59 1⁄ 2, then additional penalties are imposed for early withdrawal
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unless you have retired and you are at least 55 years old. Individuals must commence withdrawal of their retirement accounts by age 70 1⁄ 2. Many donors choose to make the gift at that age because they want to offset the additional income. The inclusion in your income of distributions from the retirement account and the subsequent charitable income tax deduction for the value of the gift results in a wash at best and the income percentage limitations may mean that the income will not be fully offset. Since the donor does not obtain favorable tax consequences and may incur relatively unfavorable consequences for a gift of a retirement plan, the use of this option is limited, but it is one way to make a gift. Designation of Beneficiary If your retirement plan is not depleted at your death, you also can designate a charity as a beneficiary to receive all or a stated percentage of your retirement account upon your death. You receive an estate tax charitable tax deduction for the value of the assets distributed to charity. Like a bequest, a beneficiary designation provides you with an opportunity to make a considerable gift while avoiding income and estate tax on the assets remaining in the retirement account upon your death. Your estate obtains an estate tax charitable deduction for the value of the gift, and the charity is not taxed on the income arising from distribution. Unless the donor has created a separate account within the retirement account and has designated the charity as the beneficiary of that separate account, designating both an individual and a charity as partial beneficiaries of a retirement plan will severely limit the individual beneficiaries’ withdrawal options and may have adverse income tax consequences that will limit the donor’s withdrawal options and cause the IRA to be withdrawn over the donor’s life expectancy alone. Bequest of Retirement Account Most retirement accounts are transferred by designating a recipient as a beneficiary at your death. In the absence of a beneficiary designation, the account generally will be payable to your estate, if not your spouse, and you may then transfer your retirement account through a bequest in your will. Technically, the bequest should be a specific transfer. A transfer of a retirement account to a charity, if properly made, avoids income taxation on the assets remaining in the retirement account at death. Because the transfer is made to a tax-exempt organization, your estate also obtains an estate tax charitable deduction for the value of the account.
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Transfer to a Charitable Remainder Trust If the retirement plan permits it, you may transfer the retirement account to a charitable remainder trust. You will be taxed on distributions from the retirement account as they are paid to you during life. At death, the assets remaining in the retirement account will be transferred to a charitable remainder trust, providing income to an individual beneficiary for life, with the remainder going to a charity at the individual beneficiary’s death. Ordinary taxable income is distributed to the income beneficiary according to the terms of the trust. The retirement account is also included in your estate, but your estate also receives an estate tax charitable deduction for the remainder value of the unitrust. Caveat: The full value of the account is included in your estate, and the estate tax charitable deduction for the remainder is significantly less than the value of the account. Since a qualified charitable remainder trust is exempt from income tax, the retirement account proceeds are not taxed to the trust and the corpus is preserved. In addition, although retirement accounts are IRD items, IRD items transferred to a qualified charitable remainder trust avoid taxation because of the trust’s tax-exempt status. As the income distributions are subsequently made to the life income beneficiary, they are taxed as ordinary income to that beneficiary. Charitable Remainder Unitrust for Spouse Funded with a Retirement Plan A charitable remainder unitrust can be named as a beneficiary of a retirement plan that can provide income for life to a spouse, with the remainder going to a charity. Upon the death of the first spouse, the qualified plan assets are distributed to the charitable remainder unitrust. The estate of the first spouse to die receives an estate tax charitable deduction for the remainder of the trust. However, the difference between the remainder and the initial transfer passes as a surviving spouse’s income interest that qualifies for the marital deduction and therefore avoids estate taxes completely.
IN SUMMARY The use of planned giving vehicles to assist in retirement planning is well accepted. The real challenge is finding ways to access the retirement plans to benefit charity and satisfy a donor’s financial and estate planning goals.
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GIFT TIP! Gifts of Retirement Assets • Some plans prohibit the transfer of assets to a charity, whether by outright gift or by beneficiary designation. • In cases where there is no prohibition, there may be little or no net tax benefit from a lifetime gift because you must withdraw assets which will be fully taxed. You receive a charitable income tax deduction for the contribution to charity, but it may not fully offset the income. • Retirement plan assets are characterized as IRD income. They are included in your estate for federal estate tax purposes and are subject to an income tax assessed to the beneficiary recipient. The recipient does receive an income tax deduction for the estate tax paid with respect to the retirement account. • If the plan permits, donors may transfer retirement plan assets at death by designating the charity as the beneficiary or by making a bequest of the assets to a charity or to a charitable remainder trust. This may avoid or at least defer income taxation because the charity is tax exempt and income realized by the charitable remainder trust is not taxable until distributed to the income beneficiary. • In the case of a charitable remainder trust funded at your death and paying income to a survivor beneficiary, the value of the retirement account assets are included in full in your estate and your estate receives a charitable estate tax deduction for the value of the charitable remainder. • However, in the case of a charitable remainder trust that provides for only your spouse for life with no other income beneficiary (either concurrent or subsequent) the spouse’s interest qualifies for the estate tax marital deduction. Therefore the entire value of the plan assets escapes federal estate taxation. • Watch for legislation that will allow for transfers during lifetime of retirement plan assets to charity without donors having to pay income taxes on the withdrawal but also without receiving a charitable income tax deduction.
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Conclusion
CONCLUSION Planned giving options such as life income gifts can supplement your income during retirement while providing favorable tax benefits. Income streams from charitable gift annuities, deferred gift annuities, pooled income funds, and charitable remainder trusts can provide streams of income to retirees. In addition, if your retirement plan permits it, you may make distributions from your retirement plan assets to charity. In the future, Congress may pass legislation that will allow transfer of retirement fund assets without individuals first paying taxes on the withdrawal. If so, gifts of retirement fund assets can provide valuable tools to donors who want to make charitable gifts.
CHECKLIST
INCORPORATING CHARITABLE GIVING AND RETIREMENT
❏
Can a life income gift option help provide income streams to supplement your retirement?
❏
Do you have retirement plan assets, such as individual retirement assets, Roth IRAs, or pension plan assets, that can be used to make a gift?
❏
Which option is most appropriate for you?
❏ ❏
❏ ❏ ❏ ❏
Charitable gift annuity Deferred gift annuity Pooled income fund Charitable remainder trust
Have you explored the tax consequences of a gift of these assets? Has Congress enacted legislation making gifts of retirement plan assets more attractive?
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C H A P T E R 11
Private Foundations, Supporting Organizations, and Donor-Advised Funds
FREQUENTLY ASKED QUESTIONS
What are the major benefits of the vehicles discussed in this chapter? What is the difference between these options? Why doesn’t everyone set up a private foundation? What is my charitable income tax deduction for a gift to a private foundation? FREQUENTLY ASKED QUESTIONS
Q: What are the major benefits of the vehicles discussed in this chapter? A: These vehicles allow donors to maintain greater control and involve-
ment with the use, management, and investment of their gift. Q: What is the difference between these options? A: For most donors, the size of the gift and issues of control dictate
the choice. Private foundations are designed for the largest gifts and provide maximum control to donors. Supporting organizations are good for donors who want to support a few charities and who wish to fund the gift with appreciated property. Donor-advised funds may be established with relatively small gifts, and donors may influence where their gifts are made. Charitable income tax deductions are more favorable for donors who make gifts through supporting organizations 133
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and donor-advised funds. Donor-advised funds and supporting organizations follow rules for public charities allowing deductions for up to 50 percent of adjusted gross income for cash gifts and 30 percent for gifts of appreciated property. Increasingly, donors are creating gift arrangements that are more complex than the traditional planned gift arrangements of pooled income fund gifts, charitable gift annuities, and charitable remainder trusts. Enhanced donor education and competent professional advice about philanthropy and charitable giving have encouraged individuals to make larger gifts while maintaining greater control over their gifts. Private foundations, supporting organizations, and donor-advised funds are charitable gift options that help you make substantial gifts to charity and maintain greater involvement with the investment and management of your gift. Each, with its own unique characteristics, advantages, and disadvantages, will be explored in this chapter. Work with your advisors to select the option that best fits your needs.
PRIVATE FOUNDATIONS Q: Why doesn’t everyone set up a private foundation? A: Private foundations are most appropriate for donors who want to
make gifts in excess of $1 million and perhaps $5 million or more. They are expensive to create and maintain. Definition A private foundation is a personalized charitable gift option for donors who want to be involved in all aspects of their philanthropy. Private foundations may evaluate proposals from others, identify eligible recipients, screen charities, and make decisions about distributions. Large public foundations have executive directors and a staff that administers the foundation. Private foundations by law must donate at least 5 percent of their market value each year. Public charities, such as most educational institutions, museums, and hospitals, enjoy favorable tax treatment under the Internal Revenue Code. Public charities are tax-exempt, and donors who make gifts to these organizations are allowed higher percent limitations (50 percent for gifts of cash and 30 percent for gifts of property) of their adjusted gross income. By contrast, private non-operating foundations are subject to a range of
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additional taxes, limitations, and restrictions. A private foundation may be small and supported by a single individual or family or be very large, such as the Ford Foundation, and run by a large staff of administrators. Who Should Create a Private Foundation? If you wish to make a sizable charitable gift, you may be a good candidate for creating a private foundation. This option works best for donors who: wish to maintain maximum control over their gifts, wish to benefit many different charities, want to be involved with the investment of the foundation, and want to allow their families to be actively involved in their philanthropy. You will, however, incur expenses in creating, administering, and managing the private foundation, including filing annual reports and providing financial accountings. You also will need to determine who needs and should receive your financial support. Advantages and Disadvantages of Private Foundations Donors and charities find both advantages and disadvantages in creating private foundations. Consider the following. Advantages • Personal Creating a private foundation is like creating one’s own personal charity. A private foundation’s board can be private and handpicked. • Family Oriented You and your children or family members commonly serve on the board of a private foundation. A private foundation can provide a structure for your entire family’s charitable activities. Younger family members can be involved in making grants to help future generations understand the value of philanthropy. • Control The donor and board have absolute control, can hire staff, and choose which charities to benefit. A private foundation provides freedom and spontaneity in gift giving. Disadvantages • Cost Legal counsel must be obtained to create a private foundation. The start-up and administrative costs for creating a private foundation are relatively high.
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• Administration You are responsible for administration, investment, record keeping, and tax return preparation for the foundation. Detailed reporting and allocation of expenditures is required, adding to the expense of creating a private foundation. You also need to screen and evaluate requests for assistance and make distributions to charities. Basic Deduction Rules Q: What is my charitable income tax deduction for a gift to a private foundation? A: If you make a cash gift, you are limited to 30 percent of your adjusted
gross income per year. If you make a gift of appreciated marketable securities held long-term, you are limited to 20 percent of your adjusted gross income. Cash Your charitable income tax deduction for a gift of cash to a private foundation is limited to 30 percent of your adjusted gross income. The excess may be carried over for five additional tax years. Remember, cash gifts to a public charity are deductible up to 50 percent of your adjusted gross income, with a similar five year carryforward. Appreciated Property You may deduct up to 20 percent of your adjusted gross income for gifts of appreciated marketable securities, and if the gift is valued at fair market value you can carry over any excess of your charitable income tax deduction for up to five additional years. This lower 20 percent limit (versus the 30 percent limit above) applies to gifts of appreciated marketable securities only, not other appreciated property, such as real estate or closely held stock which qualifies for the 30 percent limit but must be valued at the lower of cost basis or fair market value. Remember, for gifts of appreciated property to a public charity, you may deduct up to 30 percent of your adjusted gross income per year with the gift valued at fair market value. Minimum Distribution Requirements At a minimum, a private foundation must make distributions of 5 percent of the fair market value of its net investment assets each year, regardless of actual income earned. Grants must be made to public organizations for charitable purposes. Distributions cannot be made to charities controlled
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by the private foundation or to its disqualified persons. A disqualified person is one who is a substantial contributor to the private foundation, foundation managers such as officers and trustees, an owner of more than 20 percent of a corporation or other entity that is a substantial contributor to the private foundation, a member of the family of one named above, or another entity controlled to an extent of 35 percent by those above, and a government official. On a limited basis, gifts from a private foundation may be made to another private foundation. Unlike a public charity, which is tax-exempt, an excise tax of 2 percent is imposed on a private foundation’s net investment income, although the excise tax can be reduced to 1 percent if sufficient amounts are donated to qualified charities. Prohibitions and Excise Taxes The rules for private foundations are stringent and must be followed closely. Tax laws and regulations restrict various activities and investments of a private foundation. The following acts, described in more detail below, are subject to substantial excise taxes and are prohibited by a private foundation and those involved with it. • Failure to distribute a minimum amount of a foundation’s income for its exempt purposes (as discussed above) • Acts of self-dealing between a foundation and disqualified persons • Holdings in business enterprises that are in excess of prescribed maximum amounts • Investments that jeopardize the private foundation’s tax exempt purpose • Expenditures made for lobbying or other prohibited activities Self-Dealing You must be careful about your dealings with a private foundation. A donor may be subject to excise taxes for engaging in various activities with the private foundation. The following self-dealing transactions are prohibited between you and the private foundation: • Selling, exchanging, or leasing property • Lending money to the foundation for anything except furthering the foundation’s tax-exempt purposes • Paying compensation or reimbursing expenses by the foundation to you unless such amounts are reasonable and necessary to carry out the foundation’s exempt purposes
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• Transferring income or assets from the foundation to you for your use or benefit • Transferring certain mortgaged properties to the foundation Excess Business Holdings A donor cannot use a private foundation to preserve intact the control, management, and operations of a closely held business during lifetime or after death. In general, a private foundation cannot hold more than 20 percent of a corporation’s voting stock. In determining the 20 percent limit, the foundation’s holdings must be aggregated with those of all disqualified persons. A foundation may hold an unlimited percentage of a corporation’s nonvoting stock, but only if all disqualified persons together with the foundation hold less than 20 percent of the voting stock. Investments Investments that jeopardize a private foundation’s exempt purpose are prohibited. Such investments may include puts, calls, straddles, derivatives, and registered stock. Expenditures for Lobbying Expenditures from a private foundation for lobbying and other activities to influence elections or legislation, or to make certain grants to individuals or organizations involved with the same, are strictly prohibited. Termination A private foundation can terminate its status by becoming a publicly supported organization, or it may go out of existence by distributing its assets to a public charity. Under appropriate circumstances it may distribute its assets to another private foundation.
SUPPORTING ORGANIZATIONS A supporting organization offers both the operational advantages of a private foundation and the tax advantages of the public charities they support. A supporting organization is less restrictive and complicated than the private foundation but offers less control. Definition A supporting organization is a unique type of charitable organization because of its special relationship to a public charity. It is classified as a
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public charity rather than as a private foundation, thus providing a larger charitable income tax deduction to donors. To establish a supporting organization, you select one charitable organization to house and manage the supporting organization. The supporting organization may support additional charities, but all charities must be named at the time the supporting organization is established. Who Should Create a Supporting Organization? If you wish to make a very substantial gift to charity, you should consider establishing a supporting organization. This gift option is most appropriate if you are willing to maintain less control than you would by creating a private foundation, but enjoy fewer restrictions in making and maintaining your gift. If you wish to make a gift using assets other than cash or securities, such as real estate or closely held stock, a supporting organization is an option. Advantages and Disadvantages of Supporting Organizations There are many advantages to qualifying for public charity status as a supporting organization rather than being classified as a private foundation. Supporting organizations provide donors with great flexibility, including selecting the type of assets used to fund the supporting organization. They also allow more control over the timing of your gifts. Advantages • No minimum distribution requirements. No minimum amount of money in the supporting organization must be distributed annually, unlike the private foundation that is subject to a required payout of 5 percent of asset value for annual distribution. • Higher percent limitation on adjusted gross income for allowable income tax deductions. • No excise tax: A supporting organization avoids the 2 percent private foundation excise tax on its net investment income. • No private foundation self-dealing limitations. • No limit on holdings in business corporations and enterprises. • No restrictions on potentially risky investments. A supporting organization can accept gifts of real estate, restricted stock, and closely held stock. • Gifts may be made to several institutions. Most supporting organizations benefit three to five charitable organizations.
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• You can be involved with board members allowing you to work closely with and get to know more about the charitable organization(s). Disadvantages • Supporting organizations offer less control to the donor than a private foundation. • A supporting organization can support fewer individual charities, and they must be named at the time of the supporting organization’s creation, reducing freedom and spontaneity about where to make gifts. • Transactions between the supporting organization and the donor may be subject to the private inurement and intermediate sanction rules applicable to all public charities. Basic Deduction Rules The deduction rules follow the rules for gifts to public charities. Donors may deduct up to 50 percent of their adjusted gross income for gifts of cash to a supporting organization and up to 30 percent of adjusted gross income for gifts of appreciated property. General Requirements A supporting organization must be structured to meet the following requirements of the Internal Revenue Code. • Organizational and Operational Test The supporting organization must be organized and operated exclusively for the benefit of, perform the functions of, or carry out the purposes of one or more specified public charities. Generally, if the supporting organization’s documents state its purposes as being as broad as those of the charity, it qualifies. To satisfy the operational test, the supporting organization must make grants that support the charity or further the charity’s charitable purposes.
• Control by Nondisqualified Persons Test As with private foundations, you must be cautious in your dealings with a supporting organization. Disqualified persons cannot control the supporting organization, directly or indirectly. Disqualified persons are those described earlier under the discussion of private foundations. Therefore, a donor and his or her family can have only
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a minority representation on the governing body of the organization if it is to qualify as a supporting organization. Prohibited control occurs if any of the following exist: — 50 percent or more of the voting power of the governing body consists of disqualified persons — A disqualified person has a veto power over the actions of the organization — A contributor retains the right to designate who will receive the income or principal from a contribution. • Relationship Test This test requires that the supporting organization must be operated, supervised, or controlled by or in connection with the one or more charities as defined below. This requirement is usually satisfied by meeting the “controlled by” test, but some are established under the “operated in connection with” test. The relationship test is usually satisfied in one of the following three ways: — Control. A majority of the governing body of the supporting organization (either the board of directors or the trustees) is appointed by the charity. For example, a university elects the board members of the supporting organization and essentially runs it. — Supervised or controlled in connection with. This test is met only if both the supporting organization and the charity are under common control. Board members may include individuals from the charity as well as those elected from outside the charity. — Operated in connection with. This is the most complicated and interesting of the three tests. To meet this test, the supporting organization must meet two different tests, the responsiveness test and the integral part test. Responsiveness test: A supporting organization meets this test if it is responsive to the needs or demands of the supported organization. At a minimum the charity must have a voice by having at least one representative on the governing body of the supporting organization. Integral part test: This test is met if the supporting organization maintains a significant involvement in the operations of one or more publicly supported organizations and the publicly supported organizations depend on the supporting organization for the support it provides. Under this test neither the
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charity nor the supporting organization has total control. The charity can provide a voice and input. Usually there is a three to seven member board established, with a swing vote provided by an individual such as the donor’s lawyer or financial advisor. The donor may serve on the board, but cannot control it. Creation A supporting organization can be created as either a corporation or a trust. Selection should be based on the donor’s preference. The supporting organization created as a trust is easier to create and operate and is less expensive. Termination A supporting organization can be terminated and the funds placed in restricted funds at the supported organizations.
DONOR-ADVISED FUNDS Donor-advised funds offer a third option to donors who wish to support a charity and exercise more control and input than by making an outright gift but prefer an alternative to the private foundation or supporting organization. Like supporting organizations, donor-advised funds are treated for tax purposes as public charities. They tend to be more flexible than private foundations and are enjoying tremendous popularity. Many donor-advised funds are created through community foundations, but increasingly individual charities are offering donor-advised funds, as are for-profit organizations such as mutual fund companies. Definition A donor-advised fund creates a specially named fund at either a charitable or for-profit institution, such as a mutual fund or financial institution. The fund can be a permanently endowed fund from which only income is distributed or a fund from which principal can be distributed. The agreement creating the fund must state that you can make only nonbinding recommendations to the institution for distributions it makes from the fund. Your suggestions to the charity are advisory only; you do not exercise complete control over the workings of the fund. Most institutions listen to your suggestions and, in most cases, follow your suggestions, but they are not obligated to do so.
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Who Should Create a Donor-Advised Fund? A donor-advised fund is best for a donor who wants to support a few named charities at a substantial level and for the donor who wants to support many charities at lesser amounts through a donor-advised fund located at a community foundation or for-profit organization. If you wish to have the investment decisions and administration handled by someone else, consider establishing a donor-advised fund. You must be willing to make your gift with cash, marketable securities, or shares in a mutual fund. Advantages and Disadvantages of Donor-Advised Funds There are both advantages and disadvantages to donor-advised funds. Advantages In many ways, donor-advised funds are versatile and offer donors more control over their gift than an outright or life income gift. You can continue to be involved with the management and distribution of your donor-advised fund. The following outlines some advantages to creating a donor-advised fund. • Small Gift Minimums Donor-advised funds often can be established at for-profit organizations or community foundations for a small amount of money, such as $10,000. The fund can be added to at any time. • Flexibility in Timing of Gifts You can make a gift to a donor-advised fund and take an immediate charitable income tax deduction. But you can decide later which charities should receive the proceeds and how the named charity or charities will benefit from the gift. • Tax Benefits Tax benefits are more attractive than those of private foundations. • Administration The fund is not required to file separate tax returns or accountings. Donor-advised funds are not subject to the private foundation rules. • Resources Donor-advised funds bring more charitable dollars into the philanthropic community. • Investment Donor-advised funds may grow depending on investment performance providing additional support to charity.
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Disadvantages • Perception For-profit institutions that offer donor-advised funds may care more about acquiring assets to manage than philanthropy. They compete using extensive marketing efforts to attract donors to establish donor-advised funds at their institution rather than at nonprofits. Basic Deduction Rules You can deduct up to 50 percent of adjusted gross income each year for cash gifts and up to 30 percent of adjusted gross income for gifts of appreciated property to a donor-advised fund. Investments You may be given the opportunity to select investment options for the donor-advised fund. The options should be developed and controlled by the charity or for-profit organization. The investment suggestions are advisory and are not binding on the charity administering the fund. Charity’s Obligations The charity should have charitable programs that are separate from those selected by the donor for his or her donor-advised fund. It is desirable for the institution managing the donor-advised fund to recommend different programs and options to you, which you may choose to support. Limits on Grants All gifts from donor-advised funds must be made to properly qualified charitable organizations. Gifts cannot be made for the benefit of the donor advisor, such as to a private foundation or any organization controlled by the donor or family members or agents. Donor Advice You may retain the privilege of making recommendations to the charity about the timing, amount, and recipient of distributions from the donoradvised fund, but all such recommendations are nonbinding and unenforceable. You retain no legal rights guaranteeing that your suggestions will be followed. All communications from the institution managing the donor-advised fund, whether written or oral, should make this limitation clear. Caveat: The White House, Congress, and the IRS may scrutinize donoradvised funds more closely in the future. At press time, legislation was
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being proposed that would require donor-advised funds to make minimum annual distributions to charities. In addition, donors would be discouraged from recommending inappropriate uses for their gifts. Under some proposals, donor-advised funds could be penalized if they fail to meet three requirements: 1. Donors can make only nonbinding recommendations about the use
of the funds. 2. Distributions may be made only to charities, private foundations, or
government-related groups. 3. The annual distribution must be at least 5 percent of the fund’s
value. Why Charities Establish Donor-Advised Funds Many individual public charities offer donor-advised funds as a way to keep your assets close to the charity. Most charities require you to commit a portion, usually 50 percent or more of your gift, to the charity that is managing the donor-advised fund. The complexity of the donoradvised fund can vary depending on whether the charity creates a separate, legal entity for the donor-advised fund or invests the fund as part of its endowment. Donor-Advised Funds at For-Profit Organizations and Community Foundations Many organizations offer donor-advised funds, which provide the advantages of a private foundation but avoid the administrative and reporting responsibilities. Most funds can be established quickly and easily, usually with a small minimum gift amount. You obtain a charitable income tax deduction in the year the gift is made, but you retain the right to recommend charities over your lifetime. Your gift is pooled and invested with other donors’ gifts. (See Exhibit 11.1.)
CONCLUSION Private foundations, supporting organizations, and donor-advised funds offer wonderful options to donors who want to make large gifts to a charity while maintaining greater control. These options are more personalized and allow you and your family to have greater involvement in your philanthropic pursuits. Consult with your accountant, tax advisor, or attorney to analyze the choices and select the most appropriate option.
Status
Private
Public charity
Private Foundations
Supporting Organizations
Prohibited Transactions
None • No self-dealing limitations • No limit on holdings in business corporations and enterprises • No restrictions on risky investments: can accept any type of appreciated asset, such as restricted stock and real estate • No prohibitions on certain noncharitable expenditures
2% on • Failure to distribute net minimum amount of investment foundation’s income • Self-dealing income • Excess business holdings • Certain investments • Expenditures for lobbying
Excise Tax
• Less than private foundation • Supported organizations are limited and named at time of creation • Can make gifts to many organizations
• Greatest amount available in terms of whom to support and how
Control
Moderate: some cost involved in creating the supporting organization and keeping it running (about $5,000 – $10,000 to create and $2,000 – $5,000 for annual accountings and returns). Works particularly well if the donor is interested and involved. Less complicated tax forms than private foundations
High: Standard private foundation may cost $5,000 – $10,000; annual cost for administration and filing $2,000 – $5,000/yr
Costs to Create and Maintain
No limit
No limit
Term of Years to Run
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85% of net income
5% annually of fair market value of net investments
Minimum Distribution Requirements
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Cash 50% adjusted gross income; apprec. prop. 30%
Cash 30% adjusted gross income; apprec. secs. 20% adjusted gross income
Deductibility
Gift Vehicles
Type
EXHIBIT 11.1
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Status
Public charity
Donoradvised Funds
Cash 50% adjusted gross income; apprec. secs. 30%
Deductibility None
Minimum Distribution Requirements
Gift Vehicles (continued)
Type
EXHIBIT 11.1
None
Excise Tax • Gift must be made to a public charity, not a private foundation • More restrictive as to investment options it will accept
Prohibited Transactions • Donor can offer nonbinding recommendations to charity on how to use gift • Use of the charity’s investment expertise
Control
Low for the donor: usually a small minimum gift amount to create • Legal fees low: legal counsel usually needed only as advisory • Little or no reporting or administrative responsibilities by the donor
Costs to Create and Maintain
Negotiable — often runs for parents’ and children’s lives
Term of Years to Run
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PRIVATE FOUNDATIONS, SUPPORTING ORGANIZATIONS, AND DONOR-ADVISED FUNDS
❏
Is your gift large enough to warrant establishing a complex gift option such as a private foundation or supporting organization?
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Do you want to be involved with gift administration, or do you want to make your gift directly to the charity and let it administer your gift?
❏ ❏ ❏
Are you funding the gift option with the appropriate asset? Have you considered the tax consequences of the gift options? Is this option right for you?
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C H A P T E R 12
Gifts of Securities
FREQUENTLY ASKED QUESTIONS
What kinds of securities are appropriate for charitable gifts? What is the best way to transfer stock held in street name at my broker’s office? What is the tax deduction for a gift of securities? Can I make a gift of stock that is worth less than I paid for it? I can make a major gift of either cash or appreciated securities. Which is best?
Q: What kinds of securities are appropriate for charitable gifts? A: Publicly traded stocks and bonds are easy to transfer to a charity.
Mutual fund shares also can be used, although the gift will take longer to finalize. Gifts of closely held stock can be transferred to a charity so long as there are no restrictions on transfer. S corporation stock is of limited value to a charity. Second only to gifts of cash, the most popular way to make a gift to charity is through gifts of securities. Gifts of securities include not only publicly traded stocks like IBM, Microsoft, and GE but gifts of mutual funds, Treasury bills, notes, corporate and municipal bonds, and closely held stock. Most organizations do not retain small blocks of stock given by donors but sell the stock upon receipt. You should assume that in all likelihood, 149
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your securities will be sold. Because timing can be important in the transfer or subsequent sale of a security, you should ask the charity in advance about its policies for handling gifts of securities. Typically, you either hold the securities in a “street account” with a stockbroker or at a bank, or you physically hold the securities in certificate form in your possession. The transfer of your securities to the charity differs depending on the way the securities are held. The following are some of the issues involved in making a gift of securities.
SECURITIES HELD BY THE DONOR’S STOCKBROKER OR BANKER Q: What is the best way to transfer stock held in street name at my broker’s office? A: The best way is to transfer it is electronically through Depository
Trust Company (DTC) transfer instructions. Call the charity and ask for its DTC transfer instructions. It is easy. Simply instruct your broker to transfer 100 shares of X securities to the charity’s account # , DTC # . When you make a gift of securities, call the charity to let it know that a gift of securities is being made. You will need to know the organization’s tax identification number, which enables the securities to be transferred to the charity. In most cases, the charity has an outside broker handle gifts of securities. Once the securities are in the charity’s account, they are typically sold and the charity’s broker receives a commission. If you want your broker to receive the commission, he or she may establish an account in the charity’s name and transfer the stock to that account. Sometimes it takes time for the charity’s account to be established, so ask in advance. The stock can then be sold directly from this account, resulting in a check being mailed to the organization for the proceeds, minus your broker’s commission. You or your broker should not sell appreciated securities until they are in the charity’s account; otherwise you will incur a capital gains tax on any appreciation. A charitable organization is not liable for any capital gains taxes on its sale of appreciated securities.
SECURITIES GIFTED VIA DTC A DTC transfer is the most efficient way for you to make a gift of securities to a charity. Most securities are transferred easily and efficiently through the Depository Trust Company. This electronic system allows
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easy transfer of securities from your account to the charity’s account at a brokerage firm or to an outside manager administering charitable gifts. Always call the charity to let it know you are making a gift of securities via a DTC transfer and include the number of shares and name of the stock. Your name is not attached to the transfer, so when the securities arrive, the charity does not know who sent them unless you alert it first.
SECURITIES HELD IN THE DONOR’S POSSESSION If you have physical possession of stock certificates in your name, you should sign a stock power for each stock certificate that will be transferred to the charity. A stock power is a document that allows the charity to sell the securities. For example, if you have a certificate for IBM stock, you need to sign a stock power for the IBM certificate with signature guarantees. The signature guarantee proves that your signature is valid and that you are known to the person guaranteeing your signature. Stock powers can be obtained from a broker, bank, or business stationery store, and signature guarantees can be obtained from your bank or brokerage company. If delivered by mail, the stock powers should be sent to the charity in a separate envelope, apart from the stock certificates. If the stock certificates and powers are sent in the same envelope and the envelope is lost or stolen, they could be negotiated by anyone. By sending them separately, the securities and stock powers cannot be negotiated until both are together, because one is not negotiable without the other. Alternatively, you can endorse the back of a stock certificate, signing your name exactly as it appears on the stock certificate. Use this method to transfer securities only if the certificates can be hand-carried immediately to the charity or to an outside financial manager, because once they are signed, the certificates are immediately negotiable. If the company issuing the stock is a small corporation, it may be convenient for you to ask the corporation to transfer the stock by issuing a new certificate in the charity’s name.
DONOR WISHES TO GIVE PART OF A STOCK CERTIFICATE You may wish to give to a charity a stock certificate that represents more shares than you wish to transfer. It is easy for a donor to give only a portion of the shares owned. You need to instruct your broker or the charity’s broker, usually in writing, to transfer a specific number of shares to the charity while retaining the remaining shares in your account. You
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must enclose a signed stock power with instructions as to when and where to send the gift. The broker then requests that two new stock certificates be issued, one to the charity for a specific number of shares and one to you for the remaining shares.
VALUE OF THE GIFT If the securities have been held by you “long term” (held at least one year and a day), the value of the securities for tax purposes is the average of the high and the low values of the security (“the mean value”) on the date the gift is made. If the gift is made on a Saturday, Sunday, or holiday, or if no trades occurred on the date of gift, a weighted average of the mean values on the preceding and succeeding business days must be used. If no high and low value information is available (which is sometimes the case with bonds), bid and ask prices must be averaged. The charity or your broker will help you determine the value of your gift for tax purposes, or you can look in the Wall Street Journal the day after the gift is made. The Journal quotes prices for the close of business from the prior day. To calculate the value of your gift, take the daily average of the high and the low, and multiply it by the number of shares the charity received. For example, if you transfer 100 shares of stock that traded that day between $10 and $11 per share on the date the stock was delivered to the charity, the mean is $10.50 and the value of the gift (100 times $10.50) is $1,050. The charity will issue a receipt for your charitable income tax deduction.
DATE OF THE GIFT If you make an outright gift (not a gift to a trust or a pooled income fund) of securities through the mail either to the charity or to the charity’s broker or outside financial manager, the date on which the envelope is postmarked is the date of the gift. Thus, if you wish to make a year-end gift of securities and the envelope is postmarked in one year but received the following year, you are credited as making the gift in the year the envelope was postmarked. If you personally deliver the stock certificate(s) and power(s) to the charity, the day of delivery is the date of the gift. If you make a gift of securities by telling your broker to transfer shares of stock from your account to the charity, the date the stocks are actually delivered to the charity or to an account in the name of the charity (even
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if the account is with your broker) is the date of the gift. If you send securities by special courier, such as Federal Express, the date the charity receives the securities is the date of the gift.
YOUR CHARITABLE INCOME TAX DEDUCTION Q: What is the tax deduction for a gift of securities? A: If the securities have been held long term (over one year and a day),
you receive a charitable income tax deduction equal to the average of the low and the high price of the stock on the day of the transfer. It is also called the “mean value.” Q: Can I make a gift of stock that is worth less than I paid for it? A: Whether you have held the stock long term or short term, you are
better off selling the stock to obtain a capital loss (which can offset capital gains and even some ordinary income) and give the proceeds to charity to obtain a charitable income tax deduction. Q: I can make a major gift of either cash or appreciated securities. Which is best? A: With cash you may receive a larger charitable income tax deduction
because of the 50 percent of adjusted gross income limitation. With appreciated securities, you use the 30 percent of adjusted gross income rule. Many donors prefer to use appreciated securities first and save the cash for the future. It also depends on whether you think the stock has peaked in value. If you have held the gifted securities for more than one year (long term), you may generally claim the mean value of the securities on the date of the gift as a charitable income tax deduction in the year the gift is made. You may deduct up to 30 percent of your adjusted gross income (assuming you have not made cash gifts to public charities in excess of 20 percent of your adjusted gross income), and any excess may be carried forward for up to five additional years. If you have held the securities for one year or less (short term), your deduction is limited to the cost basis of the securities. If you wish to make a gift of securities that have decreased in value, you will find it more advantageous to sell the shares of stock, deduct the capital loss from any capital gain you have for that year, and contribute the proceeds to the charity. You can make a gift of stock and purchase similar shares without triggering the so-called wash-sale rules. Under the wash-sale rules, a loss
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sustained upon a sale or disposition of stock is disallowed if the taxpayer acquires substantially identical stock 30 days prior to or after the sale. However, a gift is not a sale or disposition, so wash-sale rules do not apply. The following chart summarizes the benefits of various gifts of securities. GIFTS OF SECURITIES Security
Tax Consequence or Strategy
Publicly traded stock held long term*
Deduction equal to mean value on date of gift
Publicly traded stock held short term
Deduction equal to cost basis
Stock with a built-in loss*
Sell stock, take loss, and give proceeds in cash
Closely held stock*
Deduction equal to appraisal value
S corporation stock*
Deduction equal to shareholder’s cost basis Creates unfavorable tax consequences for the charity
Dividend reinvestment plans*
Deduction for fair market value of full shares; then receive deduction for gift of partial shares
Series EE bonds*
Pay tax on ordinary income from bond interest; then give proceeds
Preferred stock
Deduction equal to cost basis
Series HH bonds*
Pay tax on ordinary income from bond interest; then give proceeds
Zero coupon bonds*
Deduction equal to market value of bond
Mutual funds*
Deduction equal to market value of fund
*Held long term ( for over one year).
GIFTS FROM DIVIDEND REINVESTMENT PLANS Increasingly, donors are making gifts of securities that have been purchased through a dividend reinvestment program. Mutual funds and blue chip corporations are especially likely to offer dividend reinvestment programs. With a dividend reinvestment program, the dividend or other
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income earned on the securities is reinvested rather than paid to the donor. If you wish to make a gift of shares in a mutual fund or corporation with a dividend reinvestment program, you should send a letter instructing the agent holding the shares (whether the mutual fund or corporation itself, your broker, or another party) to stop the automatic reinvestment immediately. In addition, you must send a signed stock power with your signature guaranteed for your original shares and any shares acquired through reinvestment. The agent will need to issue a new stock certificate in the charity’s name or credit the charity’s account for any full shares; depending on the program, fractional shares may be transferred as well or liquidated instead. Completion of this transaction sometimes can require a significant amount of time. A gift through a dividend reinvestment plan is also challenging in that it can be difficult to determine your total cost basis. Each month or quarter as the dividend is reinvested, you own a greater overall number of securities and the monthly price of the stock is likely to change. Fortunately, the company will provide cost basis information. Gifts of reinvested stock often turn into two separate gifts, one gift of the originally owned shares, which will be delivered to the charity promptly, and the second gift of shares acquired through reinvestment (which may include fractional shares), which may be delivered several months later. Most donors prefer to treat this as one gift, with a charitable income tax deduction that can be taken in one year. However, if this transaction is done at year-end and any of the shares are not issued by the company until the new year, you will obtain a deduction for those shares only in the later year. Any shares bought through the dividend reinvestment plan within one year of the gift are of course short-term shares, and no deduction will be available for any appreciation over the cost basis.
SERIES EE AND HH BONDS Series EE savings bonds are discount bonds purchased for 50 percent of their face value. The difference between their value at maturity and their purchase price is interest, which is taxed at your ordinary income tax rate. The interest can be reported annually or deferred until maturity. At maturity, series EE bonds also can be traded for HH bonds, which postpones the payment of income tax. Series HH bonds can be purchased only at face value through the exchange of series EE bonds. These bonds pay interest semiannually until they reach maturity in five years. You cannot make a gift of series EE and
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HH bonds directly to a charity without first being taxed on any accumulated income. The income from the bond is considered ordinary income, and the IRS does not allow a donor to avoid the taxation of ordinary income by transfer to a charity. To transfer the bond, you must redeem the bond at a Federal Reserve Bank or an appropriate national bank. Income taxes will be payable on the accumulated interest earned on the bond. You may then transfer the proceeds of the bond to a charity and receive a charitable income tax deduction equal to the value of the proceeds.
ZERO COUPON BONDS Zero coupon bonds are sold by corporations and governments at a discount. The bonds reach their full value when they mature. Holders of zero coupon bonds must pay taxes each year on the accrued interest even though they do not actually receive the interest. Holders may defer paying taxes on the accrued interest when the zero coupon bonds are in a tax-deferred retirement account or may avoid such taxes on the interest component on tax-free municipal zero coupon bonds. If the bonds are sold before reaching full value, owners will not receive the maturity value and may pay a penalty for selling before maturity. Sellers of zero coupon bonds receive the value of the bond on the date of the sale. If you wish to make a charitable gift of a zero coupon bond, you will receive a charitable income tax deduction for the market value of the bond on the date of gift, but income tax still will be payable on any interest accumulated through the date of the gift.
GIFTS OF SHARES OF A MUTUAL FUND As discussed earlier, you can make a gift of your shares in a mutual fund to a charity. The fair market value of a mutual fund is its public redemption price (net asset value) on the valuation date, which is quoted daily in the business section of most newspapers and the Wall Street Journal. It is not as easy or fast to transfer shares of a mutual fund as it is to transfer shares of stock. Mutual fund companies usually require written authorization to transfer shares, and the authorization must be mailed to the mutual fund company, which further delays the transfer. You should thus be prepared for some delay (especially if timing is important, as with year-end gifts) and be careful of market fluctuations that can affect the value of your gift during the transfer process. Once the mutual fund shares are transferred to an account in the name of the charity, the charity can sell them.
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Restrictions on Transfer
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CLOSELY HELD STOCK One of the most significant assets of a small business owner is likely to be the value of the company’s closely held stock. Closely held stock, unlike publicly traded stock, is not freely marketable, nor is its value as apparent or as easily determined. Closely held stock is mostly held by individuals who started family-run businesses or private businesses with relatively few stockholders. It is private because it is not publicly traded. There are usually restrictions on the transfer of the stock to third parties. If permitted, the owner of closely held stock can give the stock to a charity and deduct its appraised value. If you wish to make a gift of closely held stock, you should consult with your attorney or tax advisor because there are a number of important issues to consider in handling this type of gift.
VALUATION OF CLOSELY HELD STOCK Closely held stock is not traded on an exchange. Therefore, it is not easy to determine its value. To ascertain the value of closely held stock, an appraiser who is knowledgeable about corporate valuation must determine its value. To approximate the value of your closely held stock, you can contact the treasurer of the closely held corporation or business. You cannot deduct a gift of closely held stock having a value of $10,000 or more unless you obtain a qualified appraisal and attach Form 8283, summarizing the appraisal, to your federal income tax return for the year of the gift.
RESTRICTIONS ON TRANSFER Most closely held stock is subject to restrictions on the transfer of the stock to a third party. Many closely held corporations are family businesses or were started by friends or close associates who intended to keep the stock controlled by the original shareholders. As such, shareholders usually have repurchase agreements, which forbid the stock from being sold to a third-party purchaser without first being offered to the corporation or other shareholders of the corporation. Restrictions on transfer usually are located on the face of the stock certificate, but you should read all of the corporate documents, including the articles of incorporation, bylaws, and stock transfer agreements, carefully for any restrictions on transfer. These restrictions may prevent the transfer of the stock to a charity or reduce its value.
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GIFT OF CLOSELY HELD STOCK — AN ARM’S-LENGTH TRANSACTION Donors who make gifts of closely held stock and charities that receive such stock must do so with no strings attached, even though the charity may be eager to sell the stock promptly. Be cautious about placing conditions on the transfer of closely held stock by trying to control the timing of the resale or redemption, or by directing the sale of the stock to a specific third-party purchaser and be especially careful not to enter into a prior written agreement with either the closely held corporation or a potential third-party purchaser. So long as the transfer is an arm’s-length, independent transaction and the charity is free to accept or reject any offer to purchase or redeem the stock, you will not be taxed on the charity’s gain on sale. In a typical case, a donor makes a gift of closely held stock to a charity. The donor must have the stock appraised to obtain a charitable income tax deduction equal to the value of the stock. The appraisal must be conducted by an appraiser who is knowledgeable in establishing the value of closely held stock. The charity then typically asks the issuing corporation to redeem the stock and receives a check for the redemption price. It is important that the appraised price bear some relation to the redemption price, although it need not be identical. If the stock is sold within two years of the gift, the charity is required to notify the Internal Revenue Service on Form 8282.
CLOSELY HELD STOCK AND DEBT Be careful if you are personally liable for debt on gifted stock. As a donor, you may attempt to make a gift of stock of a closely held company to a charity where the stock was subject to debt for which you were personally liable. Relief from debt is a taxable event. A charity that unwittingly assumes debt of a donor or accepts property that is subject to a mortgage, even if the donor were not personally liable (as in the case of a nonrecourse obligation), has conferred a benefit upon you. This gift creates a gain to you, and you are taxed accordingly.
TRANSFER TO A CHARITABLE REMAINDER UNITRUST In theory, a holder of closely held stock also may gift the stock to a charitable remainder unitrust, paying the lesser of net income or the percentage amount. As the owner of the stock, you transfer the stock to the trustee of the charitable remainder trust, which may ask the corporation
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S Corporation Stock
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to redeem the stock or sell it to an Employee Stock Ownership Plan (ESOP) or a third-party purchaser. However, a redemption of closely held stock by a charitable remainder trust invokes the self-dealing rules. Self-dealing rules prohibit you and your family from buying, selling, or dealing with a trust that has been the recipient of your property. If you transfer shares of closely held stock to a charitable remainder trust and you and your family have more than a 35 percent interest in the corporation (immediately prior to the transfer), a redemption of those shares by the corporation violates the self-dealing rules unless a special procedure is followed that involves an offer to redeem being made to all holders of the class of stock being redeemed. If it appears that the self-dealing rules may be violated if a charitable remainder trust is used, you may consider the use of a charitable gift annuity, which is not subject to those rules. In addition, the trustee of a charitable remainder trust, as a fiduciary, is expected to make prudent investments. It may not be considered a prudent investment for a trustee to hold indefinitely a single asset with limited marketability, such as closely held stock. Before making a gift of closely held stock, consult with your attorney.
S CORPORATION STOCK Before proceeding with any gift of closely held stock, it is important to determine if the stock is issued by a regular (or C) corporation or by an S corporation. Like C corporations, S corporations offer their shareholders protection from personal liability, but for tax purposes they are similar to partnerships. An S corporation’s gains and losses are allocated proportionately to each shareholder and are included in the individual shareholder’s tax return, which avoids the double taxation that occurs when a C corporation pays tax and then issues an after-tax dividend to its shareholders, who must then pay tax on the dividends. Shareholders of an S corporation must be no more than 75 in number, and the corporation may have only one class of stock. A change in the law now allows a charity to be a holder of S corporation stock. Prior to this change, S corporation stock status would be lost if any stock in the corporation were transferred to a charity. A gift of S corporation stock is deductible by the individual shareholder, subject to the regular 30 to 50 percent limitation, so long as the gift is made to a public charity, not a private foundation. However, the income tax deduction must be reduced by any gain other than a long-term capital gain that would be realized if the assets of the S corporation were sold. Moreover, if the gift is made to a private foundation, it is deductible only to the extent of your basis in the S corporation stock. Although the new law
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permits the transfer of S corporation stock to a charity, all income or loss flows through to the charity as unrelated business taxable income, which can substantially diminish the value of the gift to the charity. In addition, any capital gains on the charity’s sale of appreciated S corporation stock also will be treated as unrelated business taxable income. The donee charity must be a 501(c)(3) charity. The change in the law does not extend to transfers to a charitable remainder trust. A transfer of stock to a charitable remainder trust will result in a loss of S corporation status, and if the charitable remainder trust had unrelated business taxable income by virtue of the S corporation stock, it would not be tax-exempt for that year. Private foundations may have their own difficulties in holding S corporation stock, as doing so for certain periods will violate the excess business holding rules applicable to private foundations. S corporations can make gifts of their assets to charities. Doing so may produce income tax deductions for the S corporation shareholders.
PREFERRED STOCK — SECTION 306 STOCK Section 306 of the Internal Revenue Code provides that certain preferred stock received as a tax-free stock dividend shall be treated as ordinary income property if sold. (Otherwise, this stock would be treated as capital gain property and its sale taxed accordingly.) The rule that ordinary income property contributed to charity may be deducted only to the extent of the cost basis (rather than the fair market value of the stock) thus applies to Section 306 stock and diminishes the benefit of a making a gift of such stock.
CONCLUSION When planning to make a charitable gift, look at your investment portfolio for securities that can be used to fund the gift. Appreciated securities provide tremendous benefits to donors through the avoidance of tax on capital gains and a charitable income tax deduction equal to the value of the security if it has been held long term. Mutual funds also provide similar attractive benefits. For some donors whose primary asset is a closely held corporation, the value of their closely held stock may provide a valuable asset for gift purposes, although various considerations warrant caution. Analyze and assess your options and ask the charity’s planned giving officer for help on how best to accomplish your goals. Consult with your personal advisors.
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Conclusion
CHECKLIST
GIFTS OF SECURITIES
❏ ❏ ❏
Do you own securities that can be used to make a charitable gift?
❏ ❏ ❏ ❏
Has the security been held long term?
Is a gift of securities the best way to make your charitable gift? Which security should you give? What is its value? What is its cost basis? Do you know how to transfer the securities? Do you understand the tax consequences of the gift? Have you met with your accountant or tax advisor and the charity’s development or planned giving officer?
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C H A P T E R 13
Gifts of Real Estate
FREQUENTLY ASKED QUESTIONS
What types of real estate can I use to make charitable gifts? Are there specific requirements about the property itself? What is the best gift option for my home? What other planned giving options are attractive for gifts of real estate?
Q: What types of real estate can I use to make charitable gifts? A: Depending on the type of gift, you can choose from a wide variety of
options, including a personal residence, farm, vacation home, vacant land, or commercial property. Real estate is one of the most valuable assets that you can use to make a charitable gift. Depending on how you structure your gift, real estate could be a personal residence, vacant land, a farm, a second home, vacation home, or just about any other type of real property. Your real estate can be given outright or can be used to fund a variety of charitable gift planning vehicles. This chapter discusses the ways that real estate can be used to make a gift to charity.
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FACTORS TO CONSIDER Q: Are there specific requirements about the property itself? A: Generally, you should have clear title to the property, and generally
it should be mortgage free. In addition, the property should be marketable and free from environmental hazards and damage. You transfer the property to the charity by deed. There are a number of issues to consider when you make a gift of real estate. • Title to real estate. The title to the real estate should be free and clear of defects and liens. Restrictions on the use of the property or easements that affect the use and enjoyment of the property also can reduce the property’s value and the ability of the charity to sell it. • Mortgage. Many charities do not accept gifts of real estate with a mortgage attached to it. Even if the property is desirable, these charities do not wish to incur liability for the mortgage or deal with other related legal issues. In addition, your charitable income tax deduction for the gift of real estate is reduced by the amount of the mortgage, and you may realize some income subject to taxation through the transfer. Generally, the best plan, for both you and the charity, is to make gifts of mortgage-free property. • Marketability. Unless the property will be held by the charity and maintained as part of its real estate holdings, most likely the property will be sold and the proceeds used to support the charity as directed by the donor. If you have had the property up for sale for some time and there has been little interest in it, a gift of this property is likely to be of little immediate value to the charity. If you really want to help the charity, make a gift of a valuable and marketable piece of real estate. • Environmental risk. There are a number of environmental risks involved in gifts of real estate. Farm or agricultural property may be contaminated through overuse of pesticides or herbicides or may contain buried tanks, oil drums, or fertilizer. Residential property may have been the former site of a landfill, or the property may be adjacent to a landfill, resulting in damage to well systems. Commercial businesses also may pollute groundwater or release dangerous emissions into the air. Charities have become increasingly aware of the need to check the property for environmental damage and hazards. Typically, a member of the charity’s staff who is knowledgeable in real estate will conduct a physical site inspection, walking the
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property to detect discoloration in the soil, depressions in the land, foul or noxious odors, or other evidence of environmental damage or hazards. The following summarizes ways to make gifts of real estate. GIFTS OF REAL ESTATE Type
Benefit
Outright Gift
Income tax deduction equal to appraised value
Gift of Fractional Interest
Income tax deduction equal to appraised value
Retained Life Estate
Partial tax deduction
Charitable Gift Annuity
Income stream and deduction — only an option if property can be sold quickly
Deferred Gift Annuity
Income stream and deduction
Charitable Remainder Trust
Income stream and deduction
— Net income
— Lesser of net income or percentage
— Net income with makeup
— Makes up income later
Conservation Easement
Income tax deduction, estate deduction, and property tax deduction
OUTRIGHT GIFTS OF ENTIRE PROPERTY OR FRACTIONAL INTEREST Through a deed, you can make a gift of real estate by giving your full ownership interest in the property to a charity. The most typical gifts include an outright gift of vacant land, a farm, a second home, or a vacation home. You also may make a gift of an undivided fractional interest in property, such as one-quarter, two-thirds, or one-half. To determine the property’s value, in most cases a qualified appraisal of the property must be conducted. To meet IRS requirements, the appraisal TAX TIP! Donors sometimes want to make a gift of use of their real estate for a period of time, such as a week or a month. You may do so but you do not receive a charitable income tax deduction for a gift of the use of your property.
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must be conducted no more than 60 days prior to the transfer, but it may be conducted some time after that date, as long as the donor receives the appraisal report before the due date of the tax return on which he or she first claims a charitable deduction for the real estate.
GIFT OF A PERSONAL RESIDENCE OR FARM WITH A RETAINED LIFE ESTATE Q: What is the best gift option for my residence? A: You should consider a gift with a retained life estate. Through this
option you retain the right to live in your home for your lifetime. You obtain a charitable income tax deduction for the present value of the gift of the remainder interest to charity. You are still responsible for maintenance, insurance, and taxes during the time you occupy the property. You can make a gift of a personal residence or farm, retain the right to live in it for your lifetime, and obtain a charitable income tax deduction. Retained life estates are most appropriate for donors who intend to give the property to a charity at their deaths. By doing so before death through a retained life estate, you receive a current charitable income tax deduction and still have the use and enjoyment of your property. You are still responsible for maintenance, insurance, and real estate taxes, but your property produces a charitable income tax deduction that you can use on your tax return for the year in which you made the gift (subject to the limits on charitable deductions imposed by the IRS). The property will be included in your estate when you die, but your estate will receive an estate tax charitable deduction for the value of the charitable interest. To be eligible for treatment as a gift to charity with a retained life estate, the donated property must be a personal residence or farm and it may also be a houseboat, yacht, or other property that serves as a personal residence. Benefits of a retained life estate include: • You retain the right to live in the property for life. • You receive a charitable income tax deduction. • You are obligated to pay for maintenance, insurance, and taxes. For example, if a husband and wife, ages 70 and 72, make a gift of a retained life estate for their personal residence, they receive a charitable income tax deduction of $50,209 if their home was valued at $200,000. Real estate can be used to fund life income gifts such as charitable gift annuities, deferred gift annuities, and some types of charitable remainder
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trusts. The following sections describe ways to make gifts of real estate using planned gift or life income gift options.
GIFTS OF REAL ESTATE TO FUND CHARITABLE GIFT ANNUITIES Real estate can be used to fund a charitable gift annuity if it is likely that the property can be sold relatively quickly. As described in Chapter 7, through a charitable gift annuity a donor makes a gift to a charity and receives an income stream for life and a charitable income tax deduction. (The income stream may be paid to someone other than the donor.) The rate is fixed and the annuity must begin to be paid within one year, if not sooner, according to the terms of the annuity contract. The charitable gift annuity rate is generally based on the rates suggested by the American Council on Gift Annuities, based on the ages of the donors at the time their gift is made. Because there is frequently a delay in the sale of real estate, a charitable gift annuity funded with real estate is often not an attractive option for either the donor or the charity. Remember also that once a gift of real estate is made to fund a charitable gift annuity, the donors cannot continue to occupy the property. Why, then, use real estate to fund a charitable gift annuity? In most cases, doing so is not advisable unless the charity can sell the property immediately or within one year. The charity also may accept property that it is interested in keeping for its own use to fund a charitable gift annuity. Example: Assume that Mr. and Mrs. Jackson, ages 83 and 79, wish to give their home and surrounding property valued at $600,000 to a charity. In return they wish to receive a guaranteed fixed income for their lifetimes through a charitable gift annuity. For donors ages 83 and 79 making a $600,000 gift, the annuity rate is currently 8.1 percent, which produces an annual payment of $48,600. Additionally, the donors receive a charitable income tax deduction of approximately $259,224, which they can use for up to 30 percent of their adjusted gross income. Any excess can be carried over for up to five years. When real estate is transferred to fund a charitable gift annuity, an irrevocable gift is made which precludes the donors from occupying their property. If you make a gift of real estate through a retained life estate, you still retain the right to live in your residence.
CHARITABLE DEFERRED GIFT ANNUITY Unlike a charitable gift annuity, which requires payments to begin within a year after the transfer of the property to charity, the charitable deferred
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gift annuity allows payments to the annuitant to be delayed to an agreedupon date of at least one year after the gift is made. This option is a more acceptable life income gift option for a gift of real estate. The deferred charitable gift annuity postpones the payment to the annuitant until a time when it is likely that the property can be sold and can generate an income. Like a charitable gift annuity, the deferred charitable gift annuity is a contract between the annuitant and the charity that provides a stream of income to the annuitant for life, beginning at a predetermined date in the future. A gift made through a deferred charitable gift annuity is irrevocable, and the donor is prohibited from occupying property once it has been transferred. A deferred gift annuity is a very appropriate gift option for real estate since its very nature contemplates beginning payments at a point in the future, which can coincide with the sale of the property. GIFT TIP! Think about using real estate to fund a deferred gift annuity. The payment of the annuity can be delayed until it is likely that the property is sold.
Example: Mr. and Mrs. Jackson, ages 60 and 56, wish to give their home and surrounding property valued at $600,000 to a charity and in return wish to receive a guaranteed fixed income for their lifetimes. The deferred gift annuity rate is based on the donors’ ages at the time the gift is made. For donors ages 60 and 56 making a $600,000 gift and deferring payments five years until ages 65 and 61, the annuity rate is 8.1 percent, which produces an annual income payment of $48,600 to begin in five years. The Jacksons also receive a charitable income tax deduction of $251,910 in the year the gift is made (which they can use to offset up to 30 percent of their adjusted gross income).
GIFT OF REAL ESTATE TO A CHARITABLE REMAINDER UNITRUST Q: What other planned giving options are attractive for gifts of real estate? A: If you are looking for an income stream, you should explore a chari-
table remainder net income unitrust with a makeup provision. Also consider a deferred gift annuity. Remember that real estate is often a non–income-producing asset, so you must match real estate to the
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appropriate gift option. Otherwise, the ability to generate an income stream will be adversely affected. Like other life income gift options, a charitable remainder trust provides a stream of income and a charitable income tax deduction. In addition, using a charitable remainder trust avoids any capital gains taxes on the transfer of appreciated real estate that the donor might have to pay if he or she sold it. A charitable remainder unitrust pays a beneficiary a predetermined percentage, but not less than 5 percent, of the fair market value of the trust’s assets, as revalued annually. The higher the payout rate chosen for the trust, the lower the donor’s charitable income tax deduction. Net Income Unitrust Net income unitrusts can be well suited to gifts of real estate in situations where the donor wishes to receive a life income and there is likely to be a delay in the sale of the property. Most parcels of real estate are usually non–income-producing assets, meaning that there is no stream of income available to pay the unitrust amount to the trust’s beneficiary. A net income unitrust is a solution that enables a donor to make a gift yet protects the charity from the obligation to pay the beneficiary a stream of income until the property is sold. Through a net income unitrust, a beneficiary receives the lesser of the stated percentage of the trust’s value or the actual net income. Upon the eventual sale of the property, the proceeds received by the trust are invested, producing a stream of income for the donor’s lifetime. In this way, a charity can accept a gift of real estate without having to pay the income before the property is sold. The donor still receives a charitable income tax deduction in the year the gift is made. The trust must receive from the donor sufficient cash or marketable securities to enable it to meet expenses, such as real estate taxes, insurance, and maintenance costs until the property is sold. GIFT TIP! Consider funding a net income unitrust with appreciated securities in your 50s; when you are in your 60s, the trustee invests in a balanced income portfolio to provide income to you during your retirement.
For example, if you make a gift of $100,000 of real estate to a 5 percent net income unitrust and you are age 68, you will receive a charitable income
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tax deduction of $51,388. If the property is sold at the end of two years for $120,000, during the first year you receive the lesser of the stated percentage or actual net income. In this case, the actual net income was less than the stated percentage, so you will receive the actual net income (which is likely zero) in year 1. The same is true for the second year. Eventually, in the third year, after the property is sold, you would receive 5 percent or the actual net income based on the value of the assets of $120,000. Net Income Unitrust with a Makeup Provision Donors who wish to give the trust’s beneficiaries the possibility of making up the income forgone in years when the trust’s net income of the trust is less than the stated percentage amount should consider a net income unitrust with a makeup provision. A net income unitrust with makeup provision, like a net income unitrust, permits a beneficiary to receive the lesser of the stated percentage or the net income, but provides for the possibility of a makeup of the shortfall that the beneficiary experiences in years when net income is less than the stated percentage amount. Such “lost” income may be recouped in any later year in which the trust’s income exceeds the stated percentage. GIFT TIP! Consider using a net income unitrust with a makeup provision for gifts of real estate where there is likely to be a delay in the sale of the property. This option pays the lesser of the net income or stated percentage but makes up lost income in any later years in which the trust’s income exceeds the stated percentage.
Example: Assume that real estate worth $600,000 is transferred to a net income unitrust with a makeup provision. Assume that the donors, who are also the income beneficiaries, are ages 75 and 77 years old and that they select a payment rate of 6 percent. Assume further that the property sells for $600,000 in year 1 and earns 8 percent in year 2. With a net income unitrust with a makeup provision, the donors receive the stated percentage of the trust’s value or the net income, whichever is less; if no income is produced in year 1, the donors receive nothing. However, they now have a “makeup” balance of the amount by which the actual net income (0) fell short of the stated percentage amount (6 percent of $600,000); the makeup balance is $36,000. In year 2, the property produces 8 percent. The donors receive the lesser of net income and the percentage amount, which in this case is the percentage amount (6 percent
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of $600,000, or $36,000). However, they also can receive a distribution from the “makeup” balance so that their aggregate payment for the year will equal the trust’s net income for the year (in this case, 8 percent of $600,000, or $48,000). The donors would thus receive $12,000 from the makeup balance in addition to the regular payment of $36,000. This process can continue each year until the deficit is completely recouped. You also will receive a charitable income tax deduction in the year the trust is established, limited to 30 percent of your adjusted gross income. In this example, the charitable income tax deduction for a $600,000 charitable remainder unitrust is $276,270. With the rate of 6 percent, the percentage amount would be $36,000. If the entire tax deduction is not used in the first year, it can be carried over for five years. Flip Unitrust The flip unitrust, described in Chapter 8, is often the best type of unitrust to use for gifts of real estate. A flip unitrust starts out as a net-income unitrust, but in the year following a triggering event, it “flips” into a unitrust that pays a fixed percentage amount. In the context of a gift of real estate, the sale of real estate is generally the triggering event. Thus, if you contribute real estate to a flip unitrust where the triggering event is the sale of the real estate, in the years up through and including the year of sale, you will receive the lesser of the net income and unitrust amount. Net income is likely to be zero in this situation, so you would receive nothing. In each year following the year of sale, however, you will receive the unitrust amount. The advantage of the flip trust is that donors have greater certainty regarding what their annual payment will be in the years following the triggering event. Furthermore, after the triggering event, the trustee can invest for total return and need not feel hampered by a perceived need to generate high levels of income. GIFT TIP! Now that flip unitrusts have been sanctioned by law, they may be the best option for people who want to fund a charitable remainder trust with real estate.
CONSERVATION EASEMENTS If you are interested in land preservation or wish to preserve open space and own real estate that you want to protect from development, you
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should explore the use of a conservation easement. Conservation easements help charities preserve and conserve certain attributes of real property such as open space, and, at the same time, can offer significant income and estate tax benefits to donors if a variety of conditions are met. Income tax and estate tax deductions for conservation easements have been available for years, and a tax law change in 1997 increased the possibility of obtaining a significant estate tax deduction for a conservation easement. Through a conservation easement a donor grants to a qualified organization a permanent restriction of the use which may be made of real property owned by the donor. A conservation easement can, for example, restrict development of a landowner’s property, preserving views and open space. Restrictions on the property must be transferred to a charity or governmental unit. In turn, the landowner receives favorable tax benefits and preserves and conserves desirable aspects of the real estate. The easement will often prevent or limit development of the property except that which is specifically allowed by the easement. In return, provided that the easement meets numerous requirements under tax laws, the donor receives a charitable income tax deduction equal to the difference between the value of his or her property without the easement and the value with the easement. The amount of the decrease in the property’s value due to the easement will also be excluded from the donor’s estate, thus reducing federal estate taxes, which range from 37 to 55 percent of a donor’s taxable estate. Benefits of conservation easements include: • Preservation of open space • Preservation of wildlife habitat • Land preservation • Protection of scenic views • Income tax benefits • Estate tax benefits • Local property tax reductions Tax Consequences of Conservation Easements As discussed earlier, you obtain favorable tax treatment for the contribution of a conservation easement, provided that the easement meets the many requirements imposed by the tax laws. Charitable Income Tax Benefits You receive a charitable income tax deduction for the value of the conservation easement. The value of an easement is generally the difference between the fair market value of the property before the granting of the
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easement and the fair market value of the property afterward. The fair market value of the property is determined by its “highest and best use.” In many cases, development rights are an important part of the land’s highest and best use. For example, a five-acre tract of land with ocean view has multiple values, depending on the land use. To determine the highest and best use, an appraiser examines the possible purposes of the property. Could the land be used for: • One single-family residence • Five single-family homes • A condominium complex • A hotel • A commercial mall • A park An appraiser may determine that the value of the land is $500,000 if the land is to be used for a single-family residence. But if the land is used to support a luxury hotel, the land’s value may be $3,000,000. As with other gifts of property, your charitable income tax deduction is limited to 30 percent of your adjusted gross income, and any excess may be carried forward for up to five additional years. Donors typically pay for the appraisal. Estate Tax Benefits For wealthy donors, federal estate taxes remain a formidable obstacle. Tax rates range from 37 to 55 percent and for many donors the value of real property represents a significant portion of their estates. Through a conservation easement, you reduce the value of your estate by an amount equal to the value of the relinquished property rights. This technique allows you to substantially decrease the value of your estate while enjoying the use of your property. Congress has provided additional incentives for donors to make conservation easements on property located in or near a metropolitan area, a national park or wilderness area, or an urban national forest. The estates of donors who make such gifts are eligible to receive additional estate tax benefits. The estate can receive a deduction for up to 40 percent of the value of the property (up to a dollar limit, which will reach $500,000 in 2002). In addition, this tax treatment can be obtained through the creation of a postmortem conservation easement. The rules regarding conservation easements are highly complex, so it is very important to obtain advice from a competent professional before creating an easement.
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Property Tax Consequences Local real estate property taxes are assessed on the property’s value. The taxes are assessed by a municipality, county, or other governmental unit. For tax purposes, the property is allocated into two parts: 1. The value of the buildings and improvements to the land 2. The value of the land itself
Since the value of the land can be substantially diminished by a conservation easement, the donor’s property tax bill can also be reduced, resulting in a lower tax. Because the donee charity or governmental unit that received the easement is a tax-exempt organization, and holding the easement is a part of the donee’s charitable purpose, the value of the development right generally escapes local property taxes.
CONCLUSION Gifts of real estate provide options to donors who own various types of real estate, including personal residences, vacation property, vacant land, or other real estate. Regardless of the type of property, it should be mortgage free, marketable, have a clear title, and not be environmentally damaged. There are a number of very attractive planned giving options for gifts of real estate, such as a gift with a retained life estate, charitable remainder trust, charitable gift annuity, or deferred gift annuity. In addition, for property owners interested in preservation or conservation, a gift of a conservation easement may be most attractive. Evaluate your choices and consult with a charity and your advisors.
CHECKLIST
GIFTS OF REAL ESTATE
❏ ❏ ❏
Is a gift of real estate the best gift option for you?
❏ ❏
Do you own land that should be preserved or conserved?
Which option should you use? Is your real estate mortgage free? Marketable? Do you have clear title? Is your property free from environmental damage? Have you met with your attorney and the charity’s planned giving officer?
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C H A P T E R 14
Gifts of Noncash Assets: Tangible Personal Property, Intellectual Property, and Inventory FREQUENTLY ASKED QUESTIONS
Explain the tax consequences for a gift of tangible personal property. Why can’t the charity put a value on a gift of my collection of artwork? What is the charitable income tax deduction for a gift of artwork that I created? What is intellectual property?
You may hold a variety of valuable and unique assets that you can use to make charitable gifts. These assets include tangible personal property such as artwork, antiques, or collections; intellectual property, such as patents, copyrights, trademarks, inventions, and royalties, and other types of property, such as inventory. This chapter provides an overview of the unique requirements involved in transferring these noncash assets to charity and examines the tax treatment for each type of noncash asset.
TANGIBLE PERSONAL PROPERTY Tangible personal property includes art, antiques, collections, collectibles, and many other assets that can be used to enhance existing collections at 175
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a charity or start new ones. The rules for making gifts of tangible personal property are different from the rules for making gifts of other assets, such as securities or real estate. Generally, for a gift of tangible personal property, the IRS requires that the property be related to the taxexempt purposes of the charity for the donor to receive the largest charitable income tax deduction. Gifts of farm implements to an agricultural college or museum satisfy this requirement, as does a gift of art to a museum. This chapter provides an overview on gifts of tangible personal property and the issues associated with making a gift of this kind to a charity.
DEFINITION OF TANGIBLE PERSONAL PROPERTY Tangible personal property is property that can be held physically and often include a donor’s possessions. A variety of tangible personal property can be used to make a gift including: • Furniture • Art • Antiques • Coin and stamp collections • Livestock (cattle, horses, breeding stock) • Jewelry • Equipment • Collections/Collectibles • Boats, yachts, recreational vehicles • Automobiles • Aircraft • Books • Clothing • Computers, hardware and software
TRANSFER OF PERSONAL PROPERTY To transfer ownership or legal title to a charity, the property must be physically transferred and the charity should formally accept the property. In many cases, a simple deed of gift drafted by the organization is
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sufficient. A deed of gift is a document that identifies or inventories the property being transferred and includes a statement signed by the donor demonstrating an intent to transfer. Exhibit 14.1 is a sample of a deed for a gift. Exhibit 14.2 is a sample gift acceptance form. Certain types of tangible personal property have a more formal way to transfer title. For example, automobiles and recreational vehicles must be transferred at a registry of motor vehicles, and yachts and boats are transferred at the appropriate state agency or registry.
RELATED USE Q: Explain the tax consequences for a gift of tangible personal property. A: First, the property must be held for at least a year and a day to be a
long-term capital asset. In addition, to deduct the full fair market value of the asset, the property must have a use related to the exempt purpose of the charity. For example, a gift of a book to a library is related to the library’s charitable purpose, as is a gift of artwork to a museum. If the property has a related use and has been held long term, you will receive a charitable income tax deduction for the full fair market value of the property. If the property is worth over $5,000, you’ll need an appraisal. To obtain the maximum charitable income tax deduction benefits, the property given to the charity must be related to the charity’s exempt purposes. For example, a gift of art is almost always related to the exempt purpose of the charity if it is placed on display. A gift of a painting to a museum clearly satisfies the related use rule. In most cases, a gift of artwork to be displayed at a university or hospital passes the related use test. Other examples that pass the related use test include books donated to a school library and medical equipment given to a hospital. Property that is given to a charity for auction will not pass the related use test. Q: Why can’t the charity put a value on a gift of my collection of artwork? A: To determine the value of your artwork, you generally need to have
an appraiser determine its value. If your gift is in excess of $5,000, an appraiser must appraise the property. Because you claim the tax deduction, it is your responsibility to ascertain the value through an appraiser, not the charity’s.
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EXHIBIT 14.1
Deed of Gift
DEED OF GIFT DONOR: Name(s) ADDRESS: Street City, State Zip I /We, , represent and guarantee that I/We is/are the lawful owners of the property described below, that it is free of all encumbrances, and that I/We have the right to give or transfer the property to legal title to the following property: I (We) declare the appraised value of the above listed property(s) on this date as $ . Donor Signature STATE OF
Date
Donor Signature
Date
, COUNTY OF
The foregoing instrument was acknowledged before me this day of , 20 . My commission expires: NOTARY PUBLIC EXHIBIT 14.2 Acceptance of Gift
ACCEPTANCE OF GIFT , on behalf of , accept the legal title of the gift from , donor(s), of the above described property. Signature STATE OF
Title , COUNTY OF
The foregoing instrument was acknowledged before me this day of , 20 . My commission expires: NOTARY PUBLIC
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If you are considering making a gift of tangible personal property, inquire whether the property will be used or sold by the charity. You may also want to obtain a written statement from the charity indicating the anticipated use of the property. If the property has a use related to the exempt purposes of the charity, you can claim a charitable income tax deduction equal to the full fair market value of the property (if you have held the property for at least a year and a day to qualify as a long-term capital asset). To have a related use, it must be “reasonable to anticipate” that the charity will use the property in a way related to the mission of the charity for its exempt purposes. The related use rule only limits the charitable income tax deduction. You can make a gift of tangible personal property through your will even if it is unrelated to the exempt purposes of the charity and still obtain an estate tax charitable deduction, or for gifts during life a gift tax charitable deduction, equal to the property’s fair market value.
GIFT OF A FUTURE INTEREST IN TANGIBLE PERSONAL PROPERTY Sometimes donors want to make a gift of a future interest in tangible personal property. This situation occurs when you transfer ownership of the tangible personal property, such as a painting, by deed of gift to a charity but retain the right to the possession of the property. A similar situation occurs when you lend the property to the charity, retaining ownership, and in your will transfer the property by bequest to the charity. In each situation, you will not receive a charitable income tax deduction until you have given up all rights to the use and enjoyment of the property. However, you may make a gift of an undivided fractional interest in tangible personal property. In this case, you may give, for example, a one-half interest in a painting to a museum that is able to display it. You must allow the charity to have physical possession of the painting for that fraction of the year. You will then be entitled to a charitable income tax deduction for that fraction of the value of the artwork.
UNRELATED USE Q: What about a gift of artwork that I created? A: Simply because the donor is also the creator, your charitable income
tax deduction is limited to your cost basis of the canvas, paint, brushes, and frame. If Picasso gave a Picasso to charity, he’d receive
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a deduction for the cost of his painting materials. If Picasso gave a Van Gogh, he’d receive a deduction for the appraised value of the property. If you make a gift of property to a charity that has an unrelated use or that you believe will be sold by the charity at auction, you can obtain a charitable income tax deduction equal only to the cost basis of the property, limited to 50 percent of your adjusted gross income (with some adjustments). If you are the maker or creator of the tangible personal property, you are only entitled to a charitable income tax deduction equal to the cost basis of the materials used to construct the property. For example, if a painter makes a gift of her painting to a charity, she may deduct only the cost of materials. If there is no related use, you may be better off selling the property and making a gift of the proceeds to obtain a charitable income tax deduction for the fair market value of the property. When selling the property, you will pay any capital gains taxes due on the appreciation of the property.
INTANGIBLE ASSETS Q: What is intellectual property? A: Intellectual property includes patents, copyrights, trademarks, and
the royalties that flow from these holdings. Most intangible assets are passive ones that require low maintenance and little care but can provide important sources of income to charities. In most cases the income stream is linked to the success of the underlying asset (e.g., a right to royalty income from a book is linked to the book sales). Alternately, if there is a market for the asset, it may be sold to a third party and the proceeds used to support the mission of the charity consistent with your wishes. Intangible assets must be appraised by a qualified appraiser who is knowledgeable about intangible assets. Because nontraditional assets are noncash assets, you must file IRS Form 8283 with your federal income tax return for the year of the gift if the appraised value of the asset exceeds $5,000. The charity must file IRS Form 8282 if the property is sold within two years. Patents You can make a gift of a patent to a charity. A patent is defined as a document granting the right to produce, sell, or receive profit from an invention or process for a specific number of years. A patent is considered a
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capital asset in the hands of the inventor or a transferor. As with all gifts of tangible personal property, a patent or other intellectual property must be appraised to determine its value. As long as you transfer your entire interest in the patent, including all right to royalties, you receive a charitable income tax deduction equal to the appraised value of the patent based on the anticipated stream of income to be produced by the patent. For example, if you transfer a patent that is expected to produce $10,000 annually for 10 years, the present value of the gift, discounted at 8 percent, is $67,100. Appropriate steps to record the change of ownership of the patent must be taken to transfer the patent to the charity. Consult with an attorney who is knowledgeable in intellectual property law. Copyrights A copyright is an exclusive right to a publication, production, or sale of the rights to a literary, dramatic, musical, or artistic work, or the use of a commercial print or label, granted by law for a specified period of time to an author, composer, artist, distributor, or publisher. A holder of a copyright receives income for the right of another to use the work that the copyright protects. If the holder of the work also holds the copyright, a transfer of either the underlying work or the copyright alone is considered a transfer of a partial interest. Under the partial interest rules, a charitable income tax deduction is not allowed for transfers of property in which the donor retains an interest or transfers less than the whole, except under limited circumstances. To be eligible for a charitable income tax deduction, if you own both the work and the copyright, you must transfer the work along with a written agreement transferring the copyright. If you are also the creator of the copyrighted work of art, this property is ordinary income property, and the charitable income tax deduction is limited to your cost basis. With some limitations, if you are not the creator but you are the holder of both the copyright and the work of art, you receive a charitable income tax deduction equal to the current appraised value, as long as you held the property for a year and a day or longer. Check with your attorney or tax advisor for more information on this specialized topic. For purposes of estate and gift taxes, you may give either the work of art or the copyright without violating the partial interest rules. Royalties A royalty is a share of the proceeds or product paid to the owner of a right, such as a copyright or patent, for permission to use it or operate under it. For example, the author of a book is paid a royalty by the publisher;
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a manufacturer pays the holder of a patent to authorize the patent’s use. You may not assign income to another while retaining the property that generates the income. If you transfer both the royalty payments and the copyright that produces the royalty, then you receive a charitable income tax deduction equal to the appraised value of the copyright and the present value of the stream of income.
INVENTORY Inventory includes products, goods, or stock purchased or produced for sale to a third party, such as by a manufacturer who sells to retail customers. Donors who make a gift of inventory to a charitable organization receive a charitable income tax deduction that may not exceed the cost basis of those goods, because this property is ordinary income property. For example, if a piano manufacturer makes a gift of one of its pianos, the manufacturer receives a charitable income tax deduction equal to the raw materials used to construct the piano, unless the cost of materials has already been deducted as a cost of doing business, in which case no deduction is allowed. If the same piano were sold to a dealer for the wholesale price of $3,000 and the dealer made a gift of the piano from inventory to a charity, the dealer would receive a charitable income tax deduction equal to the piano’s cost basis, or $3,000 (again unless the dealer had deducted the acquisition cost as a cost of doing business). If the piano were sold by the dealer to a third party who held it for at least one full year following the date of acquisition and until it became a very valuable antique, a gift of that piano produces a charitable income tax deduction equal to the appraised value of the property. If the property was appraised at $50,000, the donor would receive a charitable income tax deduction equal to the appraised value, or $50,000, assuming the piano was used for the charity’s exempt purposes to satisfy the related use rule.
TAX CONSIDERATIONS FOR GIFTS OF NONCASH ASSETS Noncash assets may be either ordinary income property or capital gain property. Tax treatment differs depending upon the classification of the property. Donors who hold tangible personal property that, if sold, would produce ordinary income or short-term capital gains receive a charitable income tax deduction equal to the cost basis of the property. Donors who hold capital gain property long term (for at least a year and a day) may be able to deduct the appraised value of the property.
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GIFTS OF NONCASH ASSETS Asset
Tax Consequences to Donor
Tangible Personal Property
If “related-use,” held long term, deduction equal to appraisal value
Tangible Personal Property Created by Donor
Deduction equal to cost basis
Tangible Personal Property Donated for Resale by Charity
Deduction equal to cost basis
Patents
Treated as capital assets Deduction equal to fair market value (normally present value of stream of royalty income)
Copyrights and Royalties
If donor owns both copyright and work it protects, both must be transferred to charity together to qualify for income tax deduction because of the partial interest rules Income tax: Deduction equal to appraised value of royalties if the donor is a third party but is limited to basis if the donor is also the creator of the work Gift and estate tax: Deduction allowed for copyright or work of art individually even if donor owns both because of a special exception to the partial interest rules
Inventory
Deduction equal to cost basis
Ordinary Income Property
Deduction equal to cost basis
Capital Gain Property
If held long term, deduction equal to appraisal value (subject to above rules) If held short term, deduction equal to cost basis
For example, a breeder of thoroughbreds may own horses for breeding and for sale. The horses for breeding are considered capital assets, and a gift of these horses to a college of agriculture entitles the breeder to a charitable income tax deduction equal to the fair market value of the horses so long as the horses have been held long term. If, on the other hand, you make your living selling yearlings, a gift of these horses would produce ordinary income, so you obtain a charitable income tax deduction equal to the cost basis.
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Artists, authors, and playwrights who donate their own creations are limited to a charitable income tax deduction equal to the cost basis of their work unless those costs have already been deducted as business expenses, in which case no deduction is permitted. This charitable income tax deduction is equal to the cost of materials used by the artist, such as paint and canvas. If the artist were to sell the work, ordinary income would be produced; hence the charitable income tax deduction is equal to the cost basis.
SUBSTANTIATION REQUIREMENTS When a noncash gift is made to a charity, the IRS requires strict reporting. You have the burden of substantiating a noncash gift. Both you and the charity can be penalized if the reporting requirements are not followed. Form 8283 (Appraisal Summary) IRS Form 8283 must be filed by donors, including individuals, partnerships, and S corporations, that make noncash charitable contributions in certain circumstances. The need to file Form 8283 depends on the status of the taxpayer and the size and type of gift. The following sections summarize Form 8283 requirements: Gifts Valued at $500 or Less If your gift is valued at $500 or less, you do not have to complete Form 8283. However, if the gift to a charity is one of a number of similar gifts donated to one or more charitable organizations, you should total the value of the gifts and follow the guidelines for a gift of the total amount. For example, you can donate five paintings worth $300 each to five different charities, bringing the total gift to $1,500. You are required to complete Form 8283, Part A, for a gift of $1,500. The donor should provide the charity with a statement of the value of the gift(s) for its internal accounting purposes. Gifts Valued between $501 and $5,000 If a gift is valued between $501 and $5,000, the donation must be reported on Part A of IRS Form 8283, which should be attached to your income tax return. An appraisal is not required. However, the organization should have a copy of the Form 8283 for its records.
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Gifts Valued Over $5,000 If the amount claimed as a charitable income tax deduction exceeds $5,000, the IRS requires that you complete Part B of Form 8283, including a signature from a qualified appraiser. Gifts of Non-Publicly Traded Stock Non-publicly traded stock is stock not listed on an exchange or not regularly traded. If you make a gift of non-publicly traded stock, you must complete Part B of Form 8283 regardless of the value of the stock. A qualified appraisal is required if the value of the stock exceeds $10,000. For more information, see Chapter 12.
APPRAISALS You must have a qualified appraisal when the amount of the noncash gift reported as a charitable income tax deduction exceeds $5,000. You do not need a written appraisal if the donated property consists of publicly traded securities or non-publicly traded stock worth $10,000 or less.
GIFTS OF ART WORTH $5,000 OR MORE A qualified appraisal must be made for art worth $5,000 or more. A qualified appraiser is an individual who is in the business of making appraisals. You must attach a completed appraisal summary to your tax return. If your total deduction for art is $20,000 or more, you must attach a completed copy of the signed appraisal (in addition to an appraisal summary). If a single piece of art is valued at $20,000 or more, you may be required to supply a Form 8283 with an 8 10 inch color photograph or a 4 5 inch or larger color transparency of the item. In cases where the value is less than $5,000, you are encouraged, but not required, to submit an appraisal.
TAX DEDUCTIBILITY OF APPRAISAL You, as the donor, are responsible for the cost of the appraisal. It is a miscellaneous itemized deduction. Current tax provisions limit tax benefits from miscellaneous deductions. Only aggregate miscellaneous deductions in excess of 2 percent of your adjusted gross income are deductible.
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FORM 8282 If the charity sells, exchanges, or disposes of contributed property other than cash or marketable securities for which a Form 8283 was required within two years of the date of the gift, the charity must complete and file Form 8282 with the IRS and send a copy to the donor. Form 8282 allows the IRS to monitor potential fraud. The appraisal must be realistic and approximate the value of the item in case the charity eventually sells the property for substantially less than the appraised value.
CONCLUSION Noncash assets include a wide variety of options, such as tangible personal property, intellectual property, inventory, and other property. The rules for gifts of these types of assets vary considerably from gifts of more traditional assets such as securities or real estate. Once you become familiar with these rules, these assets may offer options that you previously had not considered. Contact your favorite charity for information on ways to make gifts of noncash assets.
CHECKLIST
GIFTS OF NONCASH ASSETS
❏
Do you own noncash assets that can be used to make a charitable gift?
❏ ❏
Which assets are most appropriate?
❏
If you make the gift, will the charity be able to maintain, display, insure, and manage your assets?
❏ ❏ ❏
Have you analyzed the tax consequences of your gift?
If the gift is tangible personal property, does it have a related use to the exempt purposes of the charity?
Do you need to have an appraisal to determine value? Have you consulted with your attorney and the charity’s planned giving officer?
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C H A P T E R 15
Gifts of Life Insurance
FREQUENTLY ASKED QUESTIONS
What are the pros and cons of a gift of life insurance? My insurance agent has suggested that making a gift through life insurance is the best way to make a gift. Is this correct? I can make a major gift through life insurance. Won’t that help my favorite charity?
Q: What are the pros and cons of a gift of life insurance? A: Life insurance enables donors to make a large gift for a relatively
small amount. A gift of life insurance is affordable if the premiums are paid over a period of years. The disadvantage is that the charity must wait years to receive the death benefit. Some donors who could make larger gifts opt for gift options like life insurance. The charity will not receive the death benefit until the death of the insured. Other gift options such as gifts of cash, stock, or real estate are more attractive to charity. Life insurance is a potentially valuable gift option that can be used to make charitable gifts. Life insurance is a leveraged gift, meaning that for a relatively small sum of money (the premium), you can produce a substantial death benefit for charity. However, it may take years or decades before the charity receives the death benefit.
187
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The following defines terms and parties associated with life insurance: • The subscriber is the individual who takes out a life insurance policy. • The insurer is the company or carrier of the life insurance policy. • The beneficiary is the one who receives the death benefit upon the death of the insured. A charity is the beneficiary for charitable gifts of life insurance. • The premium is the cost of the policy paid to secure coverage. It may be paid monthly, quarterly, or annually, depending on the terms of the policy. • The owner of the policy is the one who has the right to deal with the policy or select the beneficiary. The charity is the owner of a gifted life insurance policy. • The death benefit or face value reflects the amount of money that is paid upon the death of the insured to the beneficiary. • The cash surrender value is the amount the subscriber or insured would receive if the policy were cashed in to the insurance company. The cash surrender value reflects the value of premiums paid and any investment growth, minus administrative expenses. • The insured is generally the individual on whose life the policy is issued (although this term can also be used to describe the policy’s owner).
WAYS TO USE LIFE INSURANCE Q: My insurance agent has suggested that making a gift through life insurance is the best way to make a gift. Is this correct? A: Life insurance can be an effective option, but it should not be pro-
moted as the only option. Life insurance has a place in fund raising, but it should be used in limited circumstances. Life insurance companies see charities as a way to expand their business by mass marketing life insurance policies to constituents as generic fund-raising options. The best option is an outright gift of cash and other assets, life income gifts, and a gift from one’s estate. Only after all these options have been considered should life insurance be offered. In the case of asset replacement trusts, life insurance can be an attractive option. Often life insurance is used as a bequest. Through this approach a donor, usually older, transfers an insurance policy to a charity and, like a bequest, the charity receives a lump-sum payment upon the death of the insured.
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Outright Gift of a Partially Paid-Up Life Insurance Policy
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You can make a gift of a fully or partially paid-up policy. There are different tax consequences for full or partially paid-up policies, which are explored below. Note that in some states, a charity might not be allowed to hold a policy on your life, so it is very important that you consult with a professional who is familiar with your state’s insurance laws before making a gift of a policy to charity. The following summarizes the tax benefits for gifts of life insurance. GIFTS OF LIFE INSURANCE Type
Consequences
Outright Gift
Deduction equal to policy’s replacement value
Partially Paid Up Policy
Daily Current Value
STEP Policy
Deduction equal to premiums paid
Asset Replacement Trust
Replace loss due to charitable gift through life insurance
Life Insurance Unitrust
Fund unitrust with life insurance, pay income to survivor
CHARITABLE INCOME TAX DEDUCTION FOR AN OUTRIGHT GIFT OF A PAID-UP POLICY When you make an outright gift of a whole-life or other cash-accumulation life insurance policy, you should name the charity as owner and beneficiary of the policy. By doing this, you completely give up ownership of the policy, waiving the right to assign or borrow against the policy or to change the beneficiary. If you name the charity as owner and beneficiary of the policy, you obtain a charitable income tax deduction for the paid-up life insurance policy’s replacement value, the cost to purchase an identical policy. If the replacement value exceeds your basis (cost), the deduction is limited to the basis. You can deduct up to 50 percent of your adjusted gross income in the year the gift is made and can carry any unused amount of the charitable deduction forward for up to five additional years.
OUTRIGHT GIFT OF A PARTIALLY PAID-UP LIFE INSURANCE POLICY You also can name a charity as owner and beneficiary of a life insurance policy that is only partially paid-up. You need to determine if you intend
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to pay for the remaining premiums or if the charity accepts the obligation of continuing payments.
CHARITABLE INCOME TAX DEDUCTION FOR A PARTIALLY PAID-UP POLICY Your charitable income tax deduction for a partially paid-up life insurance policy is based on the value of the “interpolated terminal reserve.” This is an amount that reflects the daily current value of the policy when it is donated between policy anniversary dates. Your charitable income tax deduction is limited to 50 percent of your adjusted gross income (with the five-year carry-forward).
CHARITABLE INCOME TAX DEDUCTION WHEN DONOR MAKES PREMIUM PAYMENTS If you make insurance premium payments in cash directly to the insurer rather than to the charity, your charitable income tax deduction is limited to 30 percent of your adjusted gross income. This is because the gift is considered “for the benefit of” the charity rather than a gift to the charity. If you make the payments directly to the charity, the charitable income tax deduction is increased to 50 percent of your adjusted gross income.
SHORT-TERM ENDOWMENT POLICIES Through short-term endowment policies, you make a series of five to eight annual gifts to cover the policy’s premium. In the insurance business, these policies are called five-pay or eight-pay policies. The charity is the owner and beneficiary of the policy. The annual premiums typically will produce a death benefit of ten to fifteen times the sum of the annual premiums depending on your age. Be careful! STEPS can generate more of a benefit for the agent and the life insurance company than for the charity. Insurance companies’ commission fees and expenses erode the premium payments. Also make sure that investment assumptions are based on realistic returns, not on artificially high returns that are uncharacteristic of market returns over longer time frames. For example, donors sometimes have financial setbacks and are unable to continue paying the annual premiums, or they are no longer associated with the charity and do not wish to complete payments. The charity must decide whether to
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continue to make payments or to cancel the lapsed policy based on the amount of premiums contributed to date. Canceling the policy early reduces the benefit of the gift to the charity.
INSURANCE USED IN ASSET REPLACEMENT ARRANGEMENTS Q: I can make a major gift through life insurance. Won’t that help my favorite charity? A: It may, but it depends on many factors. What is the commission?
What investment assumptions did the insurance company use in calculating the return? How long is your actuarial life expectancy? Are there alternatives that help the charity sooner? Donors often struggle between a desire to achieve philanthropic goals and the need to preserve assets for their family. An asset replacement trust funded with life insurance may be a solution that enables some donors to make a major gift while putting their estate back into the position it was in prior to making the gift. The arrangement can be illustrated as follows: In anticipation of receiving tax benefits and possibly a stream of income from their gift, you (for these types of gifts typically a husband and wife) fund an irrevocable charitable remainder unitrust, naming as current beneficiaries individuals such as your children. The beneficiaries use the cash received annually from the unitrust to purchase and maintain a “second-to-die” life insurance policy on you and your spouse that is owned by the trust. A second-to-die policy reduces the overall cost of the life insurance since the policy accumulates retained earnings and pays a death benefit only on the death of the surviving spouse. The second-to-die life insurance policy can likely be purchased for approximately 3 to 8 percent of the death benefit or face value of the life insurance. The actual cost depends on the insurance carrier and your age and health. You should price-shop for a carrier that offers competitive premiums, because costs vary. Since the death benefit will not be paid for some time, the individuals who purchase the policy should select a life insurance company that is financially secure. Upon the death of the survivor, the beneficiaries (typically the couple’s children) receive the death benefit from the insurance policy. Because the death benefit is not part of the parents’ estates, federal estate taxes on the benefit are avoided. Note that if parents transfer assets to children to enable them to purchase a life insurance policy or to an irrevocable life insurance trust that purchases a policy for the ultimate benefit of the children, the transfers will be treated as a gift for gift tax purposes. However,
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if structured correctly, such gifts can qualify for the $10,000 annual gift tax exclusion. Through a wealth replacement arrangement you can make a major gift to a charity but still provide for family members.
FUNDING A CHARITABLE REMAINDER NET INCOME UNITRUST/FLIP WITH LIFE INSURANCE As discussed in Chapter 8, you can fund an income-only charitable remainder unitrust. An income-only unitrust pays to a beneficiary, for life, the lesser of the stated percentage or net income earned. This type of unitrust can be funded with life insurance on the life of the grantor, with the trust naming the grantor’s spouse as a life income beneficiary. Such a trust, a so-called flip unitrust (upon the death of the grantor, it “flips” to become a straight percentage unitrust), provides the spouse with an annual payment based on the fair market value of the assets. The grantor, through the unitrust, is able to make a series of payments to cover the cost of the premiums. The payments will be treated as additional contributions to the unitrust and as such will produce a charitable income tax deduction. TAX TIP! A key characteristic of a unitrust is that you can make additional contributions to unitrusts, whereas only one contribution can be made to an annuity trust. Thus unitrusts are the preferred trust option for most donors.
REPORTING REQUIREMENTS A life insurance gift is a noncash property item and must be reported on Form 8283 if you claim a charitable income tax deduction for $500 or more. In addition, if the value of the life insurance policy you are donating to charity is $5,000 or more, you also are required to provide a qualified appraisal for the policy.
CONCLUSION In limited circumstances, life insurance can be an effective tool to make a charitable gift. It works best for donors who are younger to middle age so that premiums will be relatively more affordable. From the charity’s
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standpoint, many other options might be more attractive, such as outright gifts, life income gifts, or gifts through an estate. Life insurance can be used effectively when used as part of an asset replacement arrangement. These arrangements can help to put your family back in the financial position they were in prior to the charitable gift. Last, be cautious about insurance companies that offer mass-marketed life insurance programs to charities, donors, and prospects. Some such programs are more beneficial to the insurance company than to the charity.
CHECKLIST
❏ ❏ ❏ ❏ ❏
GIFTS OF LIFE INSURANCE
Why do you want to make a gift of life insurance? Have you selected this option or is the charity promoting it?
❏
My selection
❏
Charity’s selection
Will a gift accomplish your goals? Have you considered gifts of other assets that might be more appropriate? Will an asset replacement trust assist your family in the future?
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Tax Consequences of Charitable Gifts
FREQUENTLY ASKED QUESTIONS
How much of my charitable income tax deductions may I deduct in one year? Why must I itemize deductions to claim charitable income tax deductions? I do not itemize my deductions so I am not able to claim a charitable income tax deduction. What can I do? Our local charity held an auction as a fund raiser and I gave the charity my beautiful antique collection of Hummels. I started collecting them in 1925. My cost basis in the collection was $11,000 and their appraised value is $52,000. What is my deduction? I know the tax rules changed on the sale of a personal residence. What are the new rules?
Donors make gifts not because of tax considerations but because of philanthropic motivations that match their interests. However, all donors are still motivated to make their gift “taxwise,” seeking income, capital gains, estate, and gift tax relief through charitable giving. Donors must have a comprehensive understanding of the tax consequences of charitable contributions and the underlying tax considerations that can impact their charitable gifts. 195
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Potentially, four different types of taxes may be involved when a donor makes a single charitable gift: 1. Income taxes 2. Capital gains taxes 3. Estate taxes 4. Gift taxes
In addition to federal taxes imposed by the Internal Revenue Code and assessed by the Internal Revenue Service, related taxes may sometimes be assessed by a state or local government. The following is an overview of the tax consequences of charitable giving.
FEDERAL AND STATE INCOME TAXES You are taxed on income earned as well as investment income produced by your assets. The current marginal federal income taxation rates are 15, 28, 31, 36, and 39.6 percent. Most taxpayers who have the capacity to make major charitable gifts are in the upper tax brackets. In addition to federal income taxes, in most cases state income taxes are assessed on a similar basis, although at lower rates. Donors who are citizens and residents of foreign countries and who have no U.S. income are not subjected to federal income taxation nor do they obtain the tax benefits of charitable giving. Canadian citizens who give to certain U.S. colleges and universities, designated by Revenue Canada because they accept Canadian citizens as students, are permitted to deduct their gifts for Canadian income tax purposes. Adjusted Gross Income Your adjusted gross income (AGI) is an important benchmark in calculating your allowable deductions. The adjusted gross income is your total income derived from all sources, minus deductions for alimony, IRA contributions, and other specific expenses and items. Your AGI is the starting point for computing the charitable income tax deduction, medical deductions, casualty losses, and miscellaneous deductions. Some deductions may be available subject to certain limits; for example, only medical expenses (for yourself, your spouse, or a dependent) in excess of 7.5 percent of your adjusted gross income are deductible.
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Taxable Income Personal exemptions and itemized deductions are subtracted from the AGI, resulting in taxable income. One of the most advantageous deductions to income is the charitable income tax deduction. There are two types of taxpayers for federal income purposes: (1) the nonitemizer and (2) the itemizer. Charitable contributions benefit only those taxpayers who itemize their deductions. Nonitemizers Nonitemizers most likely rent or own a personal residence without a mortgage. Home ownership provides important tax deductions for mortgage interest, real estate taxes, and home equity loan interest. Taxpayers may not deduct their charitable contributions unless charitable contributions, along with all other permitted deductions such as mortgage interest, real estate, and state taxes, exceed the estimated standard deduction levels of $7,600 in 2001 for taxpayers who are married individuals filing jointly or $4,550 for taxpayers filing singly. Once these levels are reached, these taxpayers can become itemizers. The standard deduction levels are adjusted annually and are indexed to inflation. You may choose to accumulate contributions that would otherwise have been made over several years and make them all in a single year instead. By “bunching” ordinary deductions and charitable contributions, you may exceed the standard deduction thresholds and qualify as an itemizer. Q: How much of my charitable income tax deductions may I deduct in one year? A: For gifts of cash contributions to public charities, you may claim de-
ductions up to 50 percent of your contribution base (which equals your adjusted gross income) if your gift is to a public charity. For gifts of property such as real estate or securities where property has been held long term, you may claim deductions up to 30 percent of your contribution base. If your gift is made to other than a public charity, the amounts fall to 30 percent for cash gifts or 20 percent for gifts of appreciated securities. Q: Why must I itemize deductions to claim charitable income tax deductions? A: You must be an itemizer to take full advantage of your deductions.
These deductions include mortgage interest, state taxes, medical deductions, real estate taxes, and deductions for charitable contributions. The total of these allowable deductions must exceed the standard
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deduction estimated for 2001 at $4,550 if you are single and $7,600 if married filing jointly. Q: I do not itemize my deductions so I am not able to claim a charitable income tax deduction. What can I do? A: Many donors “bunch” their contributions so that they give three or
four years’ worth of charitable gifts in one year. When added to mortgage interest, real estate taxes, and any other allowable deductions, these deductions may enable you to become an itemizer, exceeding the standard deduction thresholds. Itemizers For gifts of cash, itemizers may deduct the value of their contributions to public charities up to 50 percent of their contribution base. If the entire deduction cannot be used in the first year, it may be carried over for five additional years. If it is carried over, you are required to use as much of the charitable income tax deduction as possible each year up to 50 percent of your contribution base. In other words, you may not voluntarily apportion the contribution over several years. For certain gifts of investment property, such as real estate or securities, if the property has been held for at least one year and a day and would produce long-term capital gain on sale (a “long-term capital asset”), you may deduct the fair market value of the property, up to 30 percent of your contribution base.
FAIR MARKET VALUE Fair market value is the price at which property would change hands between a willing buyer and a willing seller, with neither one being under an obligation to act and both having reasonable knowledge of the relevant facts. If the property is held for a year or less (a “short-term capital asset”), then you may deduct only the cost basis of the property, which is an amount that equals the purchase price of the property.
COST BASIS The cost basis and the fair market value for cash are the same amount. For gifts of securities, such as stocks or bonds, the cost basis is the purchase price of the securities in addition to any costs associated with the purchase, such as commissions and transfer fees. For real property, the cost basis is the purchase price plus legal fees, recording costs, and settlement
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or closing costs plus the cost of improvements. For lifetime transfers (property that is transferred by gift), the cost basis to the donees (or recipients of the gift) is the donor’s cost basis plus the value of any gift tax paid by the donor. For example, if your mother while living gave you 1,000 shares of Exxon and her cost basis in the stock was $50 per share, then your cost basis is $50 per share (plus any gift tax your mother paid on the gift). However, for property transferred to a donee through an estate, the basis is stepped up to the fair market value of the asset at the donor’s date of death. If you inherited property from your father, your basis is the fair market value of the property as of the date of your father’s death. If you continue to hold the property and the property appreciates and is later sold, then a capital gains tax is due upon the sale of the asset on the difference between the value of the property at your father’s death and the value of the property upon sale. In community property states, each spouse is considered to own an undivided one-half interest in the community property. Upon the death of one spouse, that spouse’s property receives a stepped-up basis, based on the date-of-death value of the decedent spouse. The surviving spouse also receives a stepped-up basis for his or her own interest. This double step-up in basis occurs as long as at least one-half of the community property interest is included in the decedent spouse’s gross estate.
DEDUCTIBILITY OF TANGIBLE PERSONAL PROPERTY Q: Our local charity held an auction as a fund raiser and I gave the charity my beautiful antique collection of Hummels. I started collecting them in 1925. My cost basis in the collection is $11,000 and their appraised value is $52,000. What is my deduction? A: Eleven thousand dollars. If you make a gift of tangible personal prop-
erty that will be sold by the charity at an auction, your charitable income tax deduction is, in this circumstance, equal to your cost basis because a gift for resale is not considered to be a “related use.” As discussed in Chapter 14, for a donor to obtain a charitable income tax deduction for the full fair market value of gifts of tangible personal property such as artwork, antiques, and stamp and coin collections, there is an additional requirement that it is reasonable to anticipate that the donated tangible personal property will be used in a way that relates to “the business of the charity.” This rule only applies to the income tax deduction and not to the gift or estate tax deduction. The “related use” rule generally is met if a donor makes a gift of a painting to a museum or a book to a library. The purpose of the related use rule is to diminish the
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charitable income tax deduction for gifts of tangible personal property where there is no related use to the charitable organization’s exempt purpose or where the property, even though related, will immediately be sold by the charity at an auction or other event. For most large charities, especially universities, arguably almost any gift can satisfy the related use test since it probably could be used by at least one of the many departments or for display. However, if the donor knows that the charity intends to sell or lease the property, the gift will fail the related use test. If the property is a gift of long-term appreciated tangible personal property and the charity uses it in a related use, you can deduct the fair market value of the property up to 30 percent of your contribution base. If the gift of tangible personal property is unrelated, then your deduction is limited to your cost basis, up to 50 percent of your contribution base. If the donated property is not related to the business of the charitable organization, you may prefer to sell the asset and give the proceeds to the charity. In this case, you obtain a charitable income tax deduction equal to the proceeds less any capital gains. If you make a gift of “ordinary income property” that is used in your trade, then you may deduct the cost basis of the property, up to 50 percent of your contribution base, assuming you have not already deducted the cost as a business expense, in which case no deduction is allowed. Donors do not receive a charitable income tax deduction for the value of the use of their property, such as a ski condominium or vacation property contributed for a weekend to a charity or auctioned at a charity auction. Only the donor’s out-ofpocket expenses, such as cleaning or heating costs, associated with such use may be deducted as a gift. If you are a volunteer, you do not receive a charitable income tax deduction for a gift of your services, such as time volunteering at the charity. However, you may receive a charitable income tax deduction for unreimbursed out-of-pocket expenses incurred while serving as a volunteer on behalf of the organization, including transportation expenses.
ACCELERATION OF DEDUCTION AND ALTERNATIVE VALUATION Taxpayers may utilize an alternative to permit an increase in the percentage of income that may be offset by the charitable income tax deduction. You may increase the limitation from 30 to 50 percent of your contribution base for gifts of property if you elect to deduct the cost basis rather than the fair market value. If the asset has not appreciated significantly, you may want to elect to accelerate the deduction by choosing to deduct the cost basis limited to 50 percent of your contribution base.
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Example: If you bought real estate for $100,000 and the property has a current value of $105,000, you may choose to deduct the cost basis of $100,000 up to 50 percent of your contribution base rather than the fair market value of $105,000 limited to 30 percent of your contribution base.
DEDUCTION REDUCTION PROVISION The 1993 Omnibus Budget Reconciliation Act (OBRA) adopted a provision that reduced the value of deductions for upper-income taxpayers. Married taxpayers filing jointly with AGI of $199,450 or more will have the total value of their itemized income tax deductions reduced by the lesser of (1) 3 percent of that portion of their AGI that exceeds a base level $199,450 in 2001 or (2) 80 percent of their itemized deduction otherwise allowable for the taxable year. The threshold amounts are indexed and change annually. Itemized deductions include home mortgage interest, real estate taxes, state taxes, medical expenses, excise taxes, and charitable deductions. The deduction reduction formula reduces the value of these types of deductions for certain taxpayers. This provision has a negative impact on the value of all deductions (except for medical, investment interest, or casualty and theft losses), including the charitable income tax deduction. However, most wealthy donors have involuntary types of deductions, such as state income taxes and real estate taxes, in amounts that exceed the 3 percent threshold; therefore, charitable contributions, which are voluntary, may be considered on top of the 3 percent limit.
PLEDGE AND PROMISSORY NOTE A pledge generates a charitable income tax deduction only in the year the pledge is actually paid. Likewise, a promissory note from you to a charity does not generate a charitable income tax deduction until the note is paid in full.
BENEFITS TO DONORS Donors can jeopardize their charitable income tax deductions and charities can jeopardize their nonprofit status by improperly crediting the value of a charitable gift. If you make a contribution and receive a benefit, such as a product or service, the value of the benefit must be deducted from the contribution to determine your actual charitable income tax deduction.
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For example, if you make a gift of $100 to a charity to attend a fund raiser, the fair market value of the meal, entertainment, and other benefits enjoyed must be deducted from the gift of $100 to determine the real value of the gift. The IRS requires charities that receive a gift of $75 and above for which you obtain a benefit to disclose the following information: 1. The amount of the contribution deductible for federal income tax
purposes, which is limited to the excess of the money or the value of any property other than money contributed by the donor over the value of the goods and services provided by the organization 2. A good faith estimate of the value of such goods and services.
In addition, in order for the donor to deduct a contribution of $250 or more, the charity must issue a receipt for the gift and must state whether (and give an estimated value of) any portion of the gift was made in exchange for a benefit. Gifts by a donor who receives goods or services from the charity are called quid pro quo contributions. Under the quid pro quo rules, goods or services having an insubstantial value may be disregarded when calculating the charitable income tax deduction. It is also possible to disregard goods or services having a value of the lesser of $72 (in 1999 and indexed for inflation) or 2 percent of the donor’s gift, so that the donor who makes a gift of $1,000 and is invited to a reception where she receives food having a value of $20 may be treated as if the full gift is deductible. Volunteers may deduct out-of-pocket expenses incurred in the course of traveling or otherwise contributing their services to the charity so long as they receive an acknowledgment recognizing the date of the volunteered service and a statement that the service was a benefit to the charity.
ORDINARY INCOME REDUCTION RULE The ordinary income reduction rule reduces the value of the charitable income tax deduction for contributions by donors of assets that are characterized as ordinary income property. The rule applies only to the charitable income tax deduction, not to the estate tax deduction. Ordinary income property is property that would result in ordinary income or a short-term capital gain if the property were sold on the date contributed. Ordinary income properties are assets that a taxpayer sells or uses to produce ordinary income, such as a retailer who sells inventory to customers or an artist who sells items that the artist produced or created. Property is characterized as ordinary income property based on the nature of the property in the hands of the donor.
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For example, sales of the following property would produce ordinary income: • Short-term capital assets • Inventory in the hands of a retailer, dealer, or merchant • Artwork in the hands of the artist; a manuscript in the hands of the author • Section 306 stock of which any dividend produced would be treated as ordinary income • Certain property that has been subject to depreciation recapture • Annuity or life insurance contract For gifts of ordinary income property, you are entitled to claim a charitable income tax deduction equal to the cost basis of the asset. The rule limits the value of contributions of ordinary income property by donors to charities because the value of the charitable income tax deduction is reduced. Artists, authors, or playwrights who donate their own works of art or manuscripts are limited to a charitable income tax deduction equal to the cost basis, which for an artist usually amounts to the cost of materials used to make the artwork (i.e., paint, brushes, and canvas for a painting), assuming that the cost has not already been deducted as a business expense (in which case no deduction is available). However, inventors who make gifts of their own patents are entitled to a charitable income tax deduction equal to the fair market value of the patent since patents are characterized as capital gains property rather than ordinary income property.
INCOME IN RESPECT OF A DECEDENT As discussed earlier, most assets transferred at death receive a stepped-up basis, which means that the donee obtains a new basis in transferred property equal to the fair market value of the property at the date of the donor’s death. However, items that are classified as income in respect of a decedent (IRD) do not receive a stepped-up basis. Income in respect of a decedent is taxable income that the decedent was entitled to at death but that was not included in any previous income tax return. The term “income in respect of a decedent” includes the following categories of income: • Wages • Accounts receivable (for a cash-basis taxpayer) • Untaxed interest income on savings or Treasury bonds
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• Deferred compensation, such as individual retirement accounts and qualified plans • Series EE bond interest • Installment contracts These types of income are subject to an income tax and are also included in the decedent’s estate. Beneficiaries receiving IRD items pay an income tax and receive an income tax deduction for the estate tax that was assessed against the estate for the IRD items. This partial double taxation of IRD items can be avoided if these items are gifted to charities, which do not pay income tax. Unlike the charitable income tax deduction, which is limited by a percentage of the taxpayer’s contribution base, there is no limit on the amount that an individual may contribute to charities for purposes of the estate tax charitable deduction. Items classified as income in respect of a decedent may be transferred in one of two ways; either (1) outright or to (2) a charitable remainder trust. Outright Transfers IRD items may be transferred by will to a charity. They should be transferred as a specific legacy to a charity or may be transferred through the residuary clause in a will if the charity is the recipient of the residue. Series EE bonds, for example, can be transferred to a charity through a specific legacy by will, or retirement plans can name the charity directly as the beneficiary. Charitable Remainder Trust IRD items also may be transferred to a charitable remainder trust. A charitable remainder trust is exempt from income taxation, and IRD items transferred to it avoid income taxation until the trust makes a distribution to the beneficiaries. See Chapter 10 for more on IRD transfers to a charitable remainder trust.
DEDUCTIBILITY OF CHARITABLE CONTRIBUTIONS FOR BUSINESS ORGANIZATIONS Business organizations, like individuals, can make tax-deductible charitable contributions to a charity. The several types of business organizations, such as regular business corporations known as C corporations,
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S corporations, and partnerships, are treated differently for tax purposes depending on the business organization. C Corporations A C corporation may deduct charitable gifts of cash or property and obtain a charitable income tax deduction limited to 10 percent of the corporation’s taxable income (with certain adjustments) for the year in which the deduction is made. Like individuals, the corporation is permitted to carry over any excess for up to five additional tax years. S Corporations An S corporation is a special type of corporation. An S corporation is limited to no more than 75 shareholders (with certain limitation on who those shareholders can be) who, along with the corporate entity, elect to be treated as an S corporation. An S corporation does not pay income taxes but instead passes through to its shareholders income, expenses, and profit or loss, all of which are included in the shareholders’ individual tax returns. An S corporation can make charitable gifts. Unlike a C corporation, the gifts are not limited to a ceiling of 10 percent of taxable income. Instead, the value of any charitable gifts is passed through to the shareholders. The charitable income tax deduction available to the shareholders is limited to the extent of each shareholder’s basis in the stock. The deduction is still limited to the taxpayer’s (shareholder’s) contribution base levels of 30 percent for gifts of property or 50 percent for gifts of cash. Under previous tax law, a charity could not own shares or an ownership interest in an S corporation; otherwise the S corporation status was lost. Now charities (but not charitable remainder trusts) may own S corporation stocks although the value of the stock to the charity is greatly diminished. All income or loss flows through to the charity as unrelated business taxable income or loss. In addition, any capital gain on the sale of S Corporation stock is taxed as unrelated business taxable income. See Chapter 12 for more information on making gifts of S corporation stock. Partnerships Under current tax law, a partnership is not entitled to deduct charitable contributions directly. The partnership itself files a tax return but does not pay tax because gains and losses from the partnership are passed through to the partners. A partner may be allowed deductions for the partnership’s charitable contributions.
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DEPRECIATION Depreciation is a tax concept that enables a taxpayer “a reasonable allowance for the exhaustion, wear and tear of property used in a trade or business, or of property held for the production of income.” The depreciation deduction is applied against ordinary income earned by the taxpayer and effectively reduces the taxpayer’s income tax liability. To be depreciable, an asset must have a useful life of more than one year. Items that have a useful life of less than a year are expensed, and the cost is recovered as a deduction against revenue in the year the item is acquired. In the case of repairs, the cost of repairs is expensed unless the repairs amount to capital improvements, in which case they are depreciated. There are several ways to claim depreciation. For example, in straightline depreciation, the asset is deducted on a prorated basis over the useful life of the capital asset. The IRS has established asset depreciation tables for tax purposes to measure the useful life of any asset. The impact of depreciation on an asset that is gifted depends on whether the asset is considered ordinary income property or capital gains property. The difference as to whether an asset is ordinary income property rather than capital gains property is based on the nature and use of the asset in the hands of the donor. Ordinary income property is property that, if sold, would produce ordinary income, such as art in the hands of an artist or property that, if sold, would produce a short-term gain. Capital gains property is property held for investment; some property used in a trade or business is treated as capital gains property. You may obtain a charitable income tax deduction for the full fair market value of the asset as long as the asset was held for at least a year and a day and qualifies as a long-term capital asset. Certain depreciation of assets must be recaptured or taxed on the sale of the property. Under the ordinary income reduction rule, the donor of ordinary income property must reduce the full market value of that property by the amount of depreciation that would have been recaptured had the property been sold. The basis of an asset is important for gifts made to fund a charitable gift annuity, since the difference between the fair market value and the cost basis is capital gain and is taxed accordingly, although such tax, in most cases, may be deferred over the course of the annuity payout. Long-term capital gains are not taxed when capital gain property is transferred outright to a charity or to a charitable remainder trust or a pooled income fund.
CAPITAL GAINS TAXES Long-term capital gains taxes are assessed on the sale of an appreciated capital asset that has been held by the taxpayer for more than a year. The
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appreciation is measured by the difference between the fair market value of the asset and the original price, or cost basis, less depreciation of the asset. Currently, capital gains are taxed at a maximum rate of 20 percent for most investment assets. Donors may gift long-term appreciated assets to a charitable organization and avoid capital gains taxes while obtaining a charitable income tax deduction equal to the fair market value of the asset.
FEDERAL ESTATE AND GIFT TAXES Federal estate and gift taxes are sometimes referred to as wealth transfer taxes. You can either make a transfer of property during your lifetime and be subject to a gift tax, or make a transfer of property at death and be subject to an estate tax. The estate and gift tax rate is “uniform,” which means that the same rate of tax is assessed to you whether the asset is transferred during your life or at death in your estate, although the estate tax is assessed on the value of the asset transferred and the amount needed to pay the estate tax, whereas the gift tax is assessed only on the amount transferred. All taxpayers are entitled to an exemption that permits them to transfer $675,000 (in 2001) of assets during their lifetime or at death, without incurring any federal gift or estate taxes. For transfers above $675,000, unless the transfers are between spouses (both of whom are U.S. citizens), the rates progress from 37 to 55 percent of net taxable estate. The lifetime exemption increases gradually until it reaches $1 million in 2006. For 2001, it is $675,000; 2002, $700,000; 2004, $850,000; 2005, $950,000. New tax provisions allow up to $1.3 million for transfers to heirs of family farms and closely held businesses. Wealthy taxpayers with significant assets may wish to make charitable gifts rather than pay hefty estate and gift taxes. Many donors are motivated to reduce their estate taxes through lifetime charitable gifts supplemented by additional gifts to reduce their estate. Charitable gifts made during your life are deductible for gift tax purposes. To be deductible for gift tax purposes, the contribution also must be deductible for income tax purposes. When making a taxable gift of assets that are likely to appreciate in value, it is more advantageous to make a lifetime gift of the assets prior to the anticipated appreciation, thereby avoiding higher taxes later. This option is better than transferring the assets at death and paying the higher estate taxes on the assets plus its appreciated value. Charitable gifts made through a decedent’s estate are deducted from the decedent’s gross estate, which lessens the estate tax burden. To take advantage of such a deduction, the gift must be irrevocable. It may be made through a will, an irrevocable charitable remainder trust, or a revocable trust that becomes irrevocable at the donor’s death.
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LEGISLATIVE PROPOSALS At press time, legislation had been proposed that would reduce or eliminate the federal estate tax over a period of several years. If passed, this legislation would enable individuals to transfer any amount of property at their death to heirs, family members, or other individuals free of tax or at reduced rates. Philanthropically motivated donors will always make gifts through their estates, even if there is no longer an estate tax charitable deduction. For example, because donors do not know exactly how much of their estate they will need for their own use during their lifetime, many donors prefer to make the largest of their charitable gifts through their estates. For other donors, this legislation would be a disincentive to make charitable gifts. Check with your tax advisors for more information about this legislation. Remember, to function, charities need private support. For many donors, there is no better way to provide that support than by will or trust.
GIFT TAX ANNUAL EXCLUSION You are entitled to an annual exclusion that permits you to make a present gift of up to $10,000 each year to any number of donees without gift tax consequences and without using any of the $675,000 (in 2001) lifetime exemption equivalent. Spouses can pool annual exclusions, enabling a couple to give up to $20,000 each year to any number of donees. Parents and grandparents who wish to take advantage of the annual exclusion can make gifts to their children and grandchildren while substantially reducing their estate tax liability. The annual exclusion applies only to gifts of a present interest and not a future interest, such as a deferred gift annuity. Charitable gifts are unaffected by the $10,000 annual exclusion limit that exists for gifts to individuals. In addition, gifts to charity do not diminish an individual’s lifetime exemption nor do gifts to charity incur a gift tax.
PAYMENTS FOR TUITION AND MEDICAL BILLS You also may give any amount, including an amount over $10,000, without gift tax consequences, if the gift takes the form of a direct payment of tuition or medical expenses. The payment must be made by the taxpayer directly to the provider (university, hospital, etc.) rather than to an individual. For example, an individual can pay to a university on behalf of
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another individual a payment for tuition of $19,000 without being subject to a gift tax.
GIFTS BY HUSBAND AND WIFE/UNLIMITED MARITAL DEDUCTION When spouses contemplate making gifts, they should consider whether the gift should be made by an individual spouse or as a couple. For federal gift and estate tax purposes, each spouse is considered to have contributed one-half of the purchase price of an asset if the property is held jointly. By transferring assets jointly instead of from a single spouse, the couple can elect to split gifts of property. In this manner, each spouse obtains one-half of the charitable income tax deduction. Current federal tax law provides spouses who are U.S. citizens with an unlimited marital deduction, allowing one spouse to make an outright gift to the other of an unlimited amount of marital property without incurring any federal estate or gift tax and without using any of their lifetime gift or estate tax exemption. The transfer may be made either as a lifetime transfer (inter vivos) or a transfer at death (testamentary). There is both an estate tax marital deduction and a gift tax marital deduction. To qualify as a transfer under the gift tax marital deduction, the spouses must be married and the transfers must take place during the marriage. If a surviving spouse disclaims a property interest, then the marital deduction will not be allowed for that property. Any property interest subject to a mortgage that passes to a surviving spouse will be reduced by the amount of that mortgage. If one spouse is infirm, that spouse may wish to take advantage of the marital deduction by gifting his or her interest in the property to the other spouse and having the healthy spouse donate the property to charity. This technique allows the healthy spouse to receive the full charitable income tax deduction for the donation, including any contribution carryover that would otherwise expire at the first spouse’s death.
STREAMS OF INCOME AND GIFT TAX CONSEQUENCES A future interest is created when a gift is made of an interest that begins at a point in the future. A gift of a future interest to an individual does not qualify for the gift tax annual exclusion of $10,000. A gift of a future interest to a spouse (other than through a charitable remainder trust) also does not qualify for the marital deduction. In both cases, there is no present interest created. You can avoid creating a future interest, and making a taxable gift, by reserving the right to revoke the future interest. The
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reservation of the right to revoke is generally exercisable by will and must be included in appropriate language in the legal document. In the case of a charitable gift annuity with an income stream paid to someone other than you or your spouse, the charitable gift annuity agreement should include the following language: “The donor may, by the donor’s will, revoke the annuity to be paid to Mr. Donee X.” Seek the advice of a professional knowledgeable in estate taxation. Taxation of a Stream of Income from a Life Income Gift Depending on the life income gift option selected (charitable gift annuity, deferred gift annuity, pooled income fund, etc.) and the beneficiary (donor, spouse, relative, etc.), there are different tax consequences associated with the gift of a stream of income. Generally, the gift of a present stream of income qualifies for the annual exclusion, but any gift of a future stream of income to another person raises gift tax considerations. Taxation of a Present Interest For life income gifts such as charitable remainder trusts, charitable gift annuities, and pooled income funds, all of which may create a present stream of income for the benefit of another, the stream of income is an interest that is eligible for the annual exclusion of $10,000. If the stream of income is payable to a spouse, then the stream is also eligible for the marital deduction. Taxation of a Future Interest If the stream is not a present interest but a future interest payable on a contingency, such as the death of a first beneficiary, the annual exclusion does not apply, nor in the case of a spouse does the marital deduction apply. In this case you may reserve the right to revoke the income stream, exercisable by will or during one’s lifetime (although a lifetime right to revoke may disqualify a charitable remainder trust). This reservation has the effect of suspending the stream of income and making the gift incomplete. If the right to revoke is not exercised, then the present interest of the gift to a nonspouse will become part of the donor’s taxable estate. In the case of a deferred gift annuity, an income stream is created to be paid beginning at a point in the future. The law is currently unclear as to whether a gift tax is due on the creation of a deferred gift annuity payable to a beneficiary other than the donor.
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SALE OF A PERSONAL RESIDENCE Q: I know the tax rules changed on the sale of a personal residence. What are the new rules? A: If you or your spouse have owned your home and used it as your pri-
mary residence during at least two (although not necessarily consecutive) of the last five years, the new rules enable you to sell and exclude up to $250,000 of capital gains if you are single and up to $500,000 if you are married filing jointly. Under prior law, taxpayers were subject to a capital gains tax on any gain realized from the sale of a principal residence unless the taxpayer purchased a replacement principal residence of equal or greater value within a specified period of time. Under that law, if the taxpayer was 55 years of age or older and did not replace the residence, the gain on the sale of the principal residence could have been offset by the one-time, lifetime exclusion that permitted a taxpayer to sell a principal residence and exclude up to $125,000 of the gain. New tax law permits a taxpayer of any age to exclude up to $500,000, if married filing jointly, of capital gain ($250,000 if single) upon the sale of a personal residence if the taxpayer lived in the residence for at least two of the last five years.
GIFTS OF REAL ESTATE SUBJECT TO A MORTGAGE Donors who make a gift of mortgaged real estate obtain a charitable income tax deduction equal to the fair market value of the property minus the value of the mortgage. See Chapter 13 for an in-depth look at gifts of real estate.
TAX IMPLICATIONS OF A BARGAIN SALE If you make a partial gift, partial sale, or transfer real estate worth, for example, $100,000, to a charity in exchange for a payment of $50,000, you are making a bargain sale and you are taxed on the gain. Assuming the property is capital gain property, the gain is treated as a capital gain. The same is true in a charitable gift annuity situation. When you transfer capital gain property in exchange for a gift annuity, you will receive part ordinary income and part capital gain. For tax purposes, a bargain sale is treated as two transactions, one part sale and one part gift. To determine gain, the basis of the property has to
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be allocated between the sale portion and the gift portion. To calculate the gain, divide the sale price by the fair market value of the property. This will produce a ratio expressed as a percentage. To determine the cost basis to be allocated to the sale portion, multiply the percentage (a ratio of the sales price to market value) times the cost basis of the property. Last, subtract from the sale price the cost basis allocated to the sale to arrive at the reportable gain. Your CPA will be familiar with this calculation.
SUBSTANTIATION REQUIREMENTS A taxpayer who makes a gift of $250 or more must obtain a receipt from the charity to claim a charitable income tax deduction. The receipt or acknowledgment must state the amount of cash or the nature of the property received and whether you received any goods or services in exchange for the gift; if any were so received, the value of the goods and services must be stated. If you make a gift of property other than cash and marketable securities, you need to prove that the gift was made and also need to substantiate value. The IRS has specific requirements for the substantiation of noncash gifts, including forms and appraisals. Form 8283 The Internal Revenue Service requires that donors who make gifts having a value of $5,000 or more of any property other than cash or marketable securities to charitable organizations have a formal appraisal and report these gifts on Form 8283. Gifts of closely held stock with a value of $10,000 or more require an appraisal. Noncash contributions include gifts in kind, such as artwork, musical instruments, real estate, antiques, jewelry, computer hardware and software, and securities. In each of these cases the determination of the value of the contribution is complex. The purpose of the appraisal and Form 8283 is to require taxpayers who make noncash gifts to be honest and accurate in substantiating the value of those assets for charitable income tax deduction purposes.
APPRAISALS For situations where an appraisal is necessary, the appraisal must be conducted by an independent qualified appraiser. Form 8283 is a summary of the gift appraisal and must be attached to your federal income tax return. (A partially completed Form 8283 is also required for some gifts
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that do not require an appraisal.) The cost of the appraisal is borne by you and is treated as a miscellaneous deduction subject to the 2 percent limit. The charitable organization recipient is not required to attest to the value of the property but is required to acknowledge receipt of the gift on Form 8283. The appraisal must be conducted no more than 60 days prior to the transfer of the property and no later than the date your federal income tax return is filed for the year of the donation. Failure to obtain an appraisal and to file Form 8283 could result in a disallowance of the charitable income tax deduction. A good-faith failure to obtain an appraisal is not a defense to the disallowance of the deduction. Form 8282 If the charitable organization sells the contributed assets reported on Form 8283 within two years from the date of the gift, the organization must file Form 8282 with the Internal Revenue Service. If the charity sells the asset for an amount that does not closely approximate the appraised value, your charitable income tax deduction may be challenged.
PARTIAL INTERESTS A charitable income tax deduction is not allowed for charitable gifts, whether made outright or in trust, that represent less than your entire interest in the gift. The loss of the deduction applies to the charitable income tax deduction, the charitable gift tax deduction, and the charitable estate tax deduction. Partial interests are created when you retain a right or ownership interest in property transferred to a charity. A number of important exceptions to this rule enable donors to obtain a charitable income tax deduction: • Gift of your entire interest where your interest is less than full property rights You may obtain a charitable income tax deduction for a gift of a partial property interest as long as that interest represents your entire interest in the property and the partial interest was not created for purposes of the gift. • Gifts in trust As discussed earlier, you are entitled to a charitable income tax deduction for a gift of a remainder interest in trust as long as the trust is a qualified charitable remainder unitrust, charitable remainder annuity trust, or pooled income fund. In addition, you may obtain
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a charitable income tax deduction for the gift of a lead interest (income interest) in a grantor charitable lead trust as long as you are taxed on the income of the trust. • Gifts of a remainder interest in a personal residence or farm This exception permits you to obtain a charitable income tax deduction less depreciation for a gift of a remainder interest in a personal residence or farm. For example, in a retained life estate, you retain a life estate or the right to occupy the property for life, with the remainder to a charity. You receive a current charitable income tax deduction for the present value of the gift of the remainder. A personal residence is defined as any residence used by the taxpayer as a personal residence, although it does not need to be your primary residence. A farm is defined as any land used by the taxpayer in the production of crops, fruits, agricultural products, or livestock. • Gifts of an undivided interest in your entire interest An undivided fractional interest of your entire interest often is expressed as a percentage or a fraction. If you transfer 25 percent, or a one-quarter interest, in property, you are conveying a portion of your interest. It is undivided in that the charity’s interest does not represent a certain right or a specific area or acreage but rather has use of the entire property for a certain fraction of the year. • Gift of a partial interest in real property for conservation purposes You can obtain a charitable income tax deduction for a gift of less than your entire interest if the interest is an easement or conservation restriction imposed for conservation purposes. Conservation purposes include the preservation, protection, or creation of open space, natural habitat, recreation, or historic preservation if the use is for public purposes or education. See Chapter 13 for more information on the use of conservation easements.
CONCLUSION Becoming an educated donor requires that you understand the tax consequences of your charitable gifts. Four types of tax savings may be available, including a charitable income tax deduction, capital gains avoidance, gift tax, or estate tax deductions. In addition, you also may avoid or reduce taxes assessed by a state. Knowing the tax consequences of charitable gifts improves the financial benefits that come with charitable giving. However, to fully appreciate philanthropy, you first have to want to make a gift to help support the mission of a charity.
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CHECKLIST
TAX CONSEQUENCES OF CHARITABLE GIFTS
❏ ❏ ❏
Do you understand the tax consequences of charitable giving?
❏ ❏
Have you received receipts for all of your charitable gifts?
Do you have enough deductions to become an itemizer? Which type of tax savings is most advantageous — income? capital gains? estate? gift? If appropriate, do you have appraisals for your gifts of noncash assets?
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C H A P T E R 17
Consumer Issues and Charitable Giving
In handling and managing charitable gifts, donors have rights and charities have responsibilities. You have a right to expect that the charity’s staff and your financial advisors will provide sound advice, that the gift option is appropriate for you, that it is funded with the proper asset, and that the gift will be used for its intended purpose. You also have a right to be fully informed about the charity, its mission, board members, and financial statements, and whether its fund-raising staff are employees or paid solicitors. In addition, you have a right to have your questions answered, to be treated with respect, to have your privacy protected, and to have your name deleted from mailing lists. Consumer rights attach to financially insignificant transactions, yet donors who make major gifts have little protection and few options for recourse. Congress, the Internal Revenue Service, the Securities and Exchange Commission, and states, through the regulation of charitable gift annuities by states’ insurance commissioners, have sought to protect donors and to encourage charities to engage in practices that are designed to meet or exceed donors’ expectations. This chapter addresses a donor’s rights and the charity’s responsibilities involving charitable giving.
PHILANTHROPY PROTECTION ACT OF 1995 The Philanthropy Protection Act of 1995 (PPA) requires charities to provide written disclosure to donors who make a gift but not an outright gift. In other words, they retain some interest in the contributed assets if that property will be commingled with other charitable funds, such as a gift to a pooled income fund. The following items are typically included in PPA disclosure documents. 217
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• The name and address of the charity • The name and membership of the charity’s governing board and committee responsible for managing the fund • A description of the objective of the fund with an explanation about the method of distributing earnings to the fund • The name and address of investment advisors and other fund managers who invest assets on behalf of the charity • An annual statement regarding the value of the principal in the account • A statement describing whether the fund is a trust, corporation, or pooled fund • A representative list of the types of securities held by the fund • A statement that the donors’ funds will be commingled with other donors’ funds in a collective investment vehicle • A statement that the fund is exempt from registration under federal securities laws • A statement regarding the total market value of the fund • A statement regarding restrictions or limitations for the investments of the fund • A statement regarding the impact of risk on the market value of the investments in the pool The act provides that employees, volunteers, officers, directors, and trustees who solicit funds on behalf of a charity are exempt from the registration requirements of federal securities laws, providing they have not received a commission or special compensation based on the number or value of donations collected for the fund. Most charities pay salaries to employees who raise money on behalf of the charity. PPA applies to charitable income funds, which include pooled income funds, collective trust funds, collective investment funds, and other funds maintained by charities exclusively for the investment and reinvestment of charitable gift annuities, charitable remainder trusts, lead trusts, or common endowment funds.
TRUTH IN PHILANTHROPY Like “truth in lending,” which protects consumers by requiring disclosure about financial terms, conditions, and expenses on loans by
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financial institutions, a charity should offer to donors “truth in philanthropy” even though no statute may compel such conduct. Truth in philanthropy means a number of things. It means that a charity and its staff members must: • Engage only in activities that fulfill the charity’s mission statement • Spend a donor’s funds consistent with the mission statement • Engage in practices consistent with the charity’s tax-exempt status • Disclose investment and management practices about endowed funds, life income gift funds, and common pooled endowment funds, consistent with the provisions of the Philanthropy Protection Act • Disclose the cost of fund-raising fees and administrative expenses that must be deducted prior to the gift reaching its intended purpose • Honor the donor’s restrictions on the use of funds • Disclose both the benefits and consequences of making a gift • Distinguish planned giving vehicles from financial investment vehicles • Consider a donor’s financial welfare when accepting gifts • Comply not only with the letter of the law but with the spirit and intent of the Internal Revenue Service guidelines and regulations regarding charitable giving Exhibit 17.1, “A Donor’s Bill of Rights,” is included at the end of this chapter.
DONOR RIGHTS: THE PLANNED GIFT SHOULD BE COMPATIBLE WITH THE DONOR’S GOALS You can make gifts in a variety of ways, including outright gifts, gifts from your estate, planned gifts, or a combination of these options. As discussed throughout this book, a donor must have donative intent to make a gift. Donative intent can be enhanced by the attractive benefits of planned gifts. Life income streams, charitable income tax deductions, estate or gift tax deductions, and capital gains tax avoidance provide additional financial incentives to donors. Select the appropriate life income gift option to accomplish your goals before you make a decision. For example, if you prefer the certainty of a fixed life income stream, choose a charitable gift annuity rather than a gift to a pooled income
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fund. In addition, if you prefer a larger charitable income tax deduction rather than a larger income stream, you should be presented with gift options that achieve your goals. Go to the charity’s Web site to learn about the options. Some charities also are offering interactive planned giving software so you can calculate income streams and tax deductions easily. If you wish to provide an immediate financial benefit to a department, a life income arrangement such as a charitable gift annuity may frustrate your wishes since it provides delayed benefits. Instead, consider an outright gift as a way to accomplish your goals. If you are uncertain about gift options, talk to your attorney, CPA, or financial advisor. Ask the charity to prepare planned giving projections on all options for you alone and, if you are married, for your spouse. Also compare the benefits if you make the gift as a couple. Size of Gift The decision about the size of the gift is up to you. It is important to remember that the main purpose of the charity’s fund-raising staff is to raise money and solicit donors for gifts. Most are helpful and knowledgeable staff members who care greatly about the charity they work for and want to help you do your job — make a gift. That said, you need to make your gift consistent with your own financial resources and wellbeing. The best way to learn to become a philanthropist is to make smaller gifts at first until you get used to the experience. After a while, you can make gifts at larger levels — always within your comfort zone. Time Frame You should have a reasonable time frame to make a decision about your charitable gift. You must have time to fully understand the gift option: its benefits, detriments, and consequences to you, your family, and your overall charitable giving objectives. Designation of Gift You also have the right to designate your gift in support of any program or department at the charity, or you may allow the charity to use it at its discretion. The charity must honor your request and use your gift consistent with your wishes. If the charity believes that accepting your gift is not in its best interest, it may decline to accept the gift. This happens occasionally when a donor proposes using the gift to start a new program that the charity believes is not feasible.
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Disclosure of Fees You have the right to request information about the financial expenses associated with the charity’s management of endowed funds. The charity should disclose to you expenses associated with its administration for endowments, charitable remainder trusts, and other life income gifts. In addition, it should disclose its policies for distributing income from endowed funds, so that you are fully informed about the income to be distributed from the fund. The charity should tell you whether the fees will be taken from the income generated by the gift or charged as a separate cost of administration.
Privacy Most donors have expectations about their rights to privacy regarding their gifts. The charity owes you privacy in several ways. News of your gift should not be communicated to other donors or to departments within the charity without your consent. If you request anonymity or confidentiality, the charity must honor and protect your wishes. Many donors make anonymous gifts; they may not wish to make themselves susceptible to requests for funding from other charities, offend other charities in the area, or have family members know about their gifts. Keep in mind that when you make a gift you are a role model for other donors. However, be clear about your expectations of privacy.
Donor’s Recourse As a donor to the charity, you should be treated with respect and fairness. If you have questions regarding the use, designation, or investment of your gift, ask for the name of the charity’s officer in charge of gift administration. In most cases, questions can be directed to the vice president for development, a stewardship officer, or the director of planned giving, in the case of planned gifts.
THE CHARITY’S RESPONSIBILITIES Many retailers offer “money-back guarantees—no questions asked.” That may work for retailers and, to a lesser extent, professional services, but it does not work when a charitable gift is made. A charitable gift is irrevocable, and you cannot obtain a “money-back guarantee.” In exchange for your gift, you obtain a charitable income tax deduction. Except in
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limited circumstances, you cannot take the gift back, nor can the charity give it back. A gift to a charity generally involves three parties: you, the charity, and the Internal Revenue Service. Both you and the charity must ensure that the gift is, in fact, a charitable gift and satisfies provisions of the Internal Revenue Code. In addition, the charity must protect your charitable income tax deduction by complying and adhering to IRS regulations. You obtain a charitable income tax deduction in exchange for your gift to charity, and the charity has an obligation to issue proper receipts and to comply with IRS procedures to protect your charitable income tax deduction. As the taxpayer, you must honestly and fairly value noncash gifts, such as real estate and tangible personal property. The burden is on you, not the charity, to value your gift. You must not be a party to an overly inflated valuation or to a transaction that allows you to receive a deduction in excess of the true value of the gift. Remember, a responsibility that comes with philanthropy is to provide resources to accomplish a public good. Remember also that for all gifts other than cash or marketable securities, the IRS is watching. You must file Form 8283 and the charity must file Form 8282 if the property is sold within two years of the date of your gift.
UNFAIR AND DECEPTIVE PRACTICES Charities operate as a public trust and for the public good. They must adhere to the highest standards to uphold their position as tax-exempt organizations. Do not make gifts to a charity that engages in any practice that is unfair or deceptive. Marketing materials or advertisements that confuse the reader hurt all charities and jeopardize future financial support. False or misleading claims that misstate the charitable purposes or overstate the financial benefits are illegal. High-pressure tactics that unfairly raise funds from the elderly, impaired, or infirm or from those who are unfamiliar with the gift options are also inappropriate. Be cautious; a number of charities advertise artificially high rates for planned gifts. Also, a few charities are confusing planned gifts with investment vehicles. Charities and their planned giving options are not designed to compete with financial investment options. The American Council on Gift Annuities recommends rates for charitable gift annuities to prevent competition among charities, promoting philanthropy over financial reward. Planned giving vehicles are not financial investments, they are charitable gifts. Last, charities must respect other charities that offer similar services or that operate in the same region. Be cautious of any charity that tries to improve its standing by disparaging other charities. All charities should
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engage in practices that promote professionalism, integrity, and truth in philanthropy.
CONCLUSION Every year donors transfer billions of dollars to charities. A significant percentage of these funds is contributed to the charity’s endowment or to a life income gift fund. Charities have a responsibility to preserve the principal of donors’ gifts and to use donors’ funds to provide support to the charity, its programs and departments, consistent with donors’ wishes. The charity’s staff must share with donors the details that surround the management and investment of nonprofit funds. As donors learn that charities are careful, scrupulous, and diligent in the management of funds, they are likely to provide additional funds. Remember that the charity manages your endowed fund as a part of its endowment pool or life income gift fund. Your contributions are pooled with funds from thousands of other donors, providing stability to the charity. As a consumer, you have rights when you make your charitable gifts. You have rights to information about the charity, its policies, and its governing boards and administration. You also have rights to privacy and basic courtesies, such as having your questions answered and being treated with respect. You have the right to be fully informed about the gift options, to not be rushed, and to make careful decisions about the nature and extent of your gift. (See Exhibit 17.1.) Likewise, the charity has responsibilities to make sure that you receive the appropriate IRS charitable deduction. The charity also must not engage in unethical or inappropriate practices or unfairly confuse charitable giving with financial investment vehicles. CHECKLIST
CONSUMER ISSUES AND CHARITABLE GIVING
❏
If the charity commingles funds, have you received a disclosure statement from the Philanthropy Protection Act?
❏ ❏ ❏ ❏
Have you taken time to evaluate your options?
❏ ❏
Have you conveyed to the charity your expectations about privacy?
Have you educated yourself about the charity? Have you decided how large your gift will be? Have you designated your gift to benefit a specific department or program at the charity? Are you satisfied that the charity engages in ethical practices?
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INDEX
A
tax deductibility of cost of appraisal, 185 tax forms and requirements, 212 – 213 Artwork, gifts of See also Personal property, tangible appraisals, 177, 185 copyrights, 181 donor, artwork created by, 179 –180, 184, 202 – 203 fractional interests, 179 generally, 175 –176 ordinary income reduction rule, 202 – 203 related use rules, 177, 179 tax consequences, 185 unrelated use rules, 179 –180 valuation of, 177 Attorneys as professional advisors, 40 – 41
Administration charity’s experience and gift-giving decision, 68 organizational structure, 25 – 28, 37 American Council on Gift Annuities, 74 Annual gifts defined, 62 generally, 62 solicitations for, 31 Annual giving programs direct mail solicitations, 31 generally, 30 purposes of, 30 – 31 telefund or phonathon programs, 31 Annuities charitable gift annuities. See Charitable gift annuities deferred gift annuities. See Deferred gift annuities gift annuity contracts, 77, 78 Anonymous gifts, 33 Appraisals appraisal summary (IRS Form 8283). See Internal Revenue Service (IRS) forms artwork, 177, 185 generally, 185 inventory, gifts of, 182 life insurance policies, 192 non-publicly traded stock, 185 patents, 181 real property, 165 –166 qualified appraisals, 185
B Baby boomers as donors, 4 transfer of wealth to, 16 Beneficiaries See also Minors of charitable remainder trusts, tax consequences, 93 – 94 charity as beneficiary of retirement plan, 128 current, 88 life income gifts, 72 remainder, 88 Bequests See also Wills
225
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226 Bequests (cont.) generally, 65 Board of regents, 28, 30 Board of trustees, policy decisions, 28 – 30 Bonds gifts of, generally, 149 Series EE and HH savings bonds, gifts of, 155 –156 zero coupon bonds, 156 Bureaucracy, 28 Businesses See also Corporations deductibility of charitable contributions corporations, 205 generally, 204 – 205 partnerships, 205
C Certified public accountants (CPAs), 41– 42 Charitable deferred gift annuities. See Deferred gift annuities Charitable gift annuities advantages of, 73 American Council on Gift Annuities, 73 –74 funding, 77 generally, 72 –73 gift annuity contracts, 77 gift annuity rates, 73 –74 real property, funding with, 167 retirement planning and, 124 tax benefits, 73 tax consequences capital gains taxes, 76 charitable income tax deduction, valuation of, 74 –75 estate taxes, 76 generally, 74 gift taxes, 75 –76 income taxes, 76 two-beneficiary charitable gift annuity agreement, example, 78
Index
Charitable lead trusts. See Lead trusts Charitable remainder annuity trusts See also Charitable remainder trusts charitable remainder unitrust compared, 92 five percent exhaustion test, 97 generally, 98 – 99 tax consequences, gifts of partial interests, 213 – 214 tuition trust, 99 –100 Charitable remainder net income unitrust. See Net income unitrusts Charitable remainder trusts beneficiaries, tax consequences, 93 – 94 capital gains taxes, 95 categories of, 98 charitable income tax deduction, 95 charitable remainder annuity trusts. See Charitable remainder annuity trusts charitable remainder unitrusts. See Charitable remainder unitrusts charitable remainderman, restrictions on, 97 distributions, characterization of for tax purposes, 94 drafting, 96 – 97 estate taxes, 96 features of, generally, 94 five percent exhaustion test, 97 gift taxes, 95 – 96 income payout rate, 93, 94 income in respect of a decedent, 204 income stream, 94 probate, 96 qualified terminable interest property (QTIP) trusts with remainder to nonprofit, 103 –104
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retirement assets, transfer to, 129 taxation of trust income, 93 – 94 trustee, naming, 97 types of, chart, 91– 92 Charitable remainder unitrusts capital gains taxes, 103 closely-held stock, gifts of, 158 –159 flip trusts, 102 –103 funding with retirement plan, 129 net income unitrust. See Net income unitrusts real property, funding with, 168 –169 straight fixed percentage unitrust, 100 –101 tax consequences, gifts of partial interests, 213 – 214 types of, 100 Charities government and role of charities, 16 responsibilities of. See Consumer issues selection of. See Selection of charity Checklists consumer issues, 223 donor-advised funds, 148 donor’s action plan, 8 –13 gifts through the estate, 119 life income gifts, 85 life insurance, gifts of, 193 noncash assets, gifts of, 186 organization of and information on charity, 37 private foundations, 148 professional advisors and family members, 46 real estate, gifts of, 174 retirement planning and charitable giving, 131 securities, gifts of, 161 supporting organizations, 148 tax consequences of charitable gifts, 215
227 trusts, 107 types of gifts and choices in gift-giving, 69 purpose of gift and funding, 59 wills and bequests to charity, 119 Children. See Minors Civic and community organizations, 19, 21 Closely-held stock. See Securities Communications office, 28 Computer services department, 33 Confidentiality and privacy, 33, 221 Conservation easements preservation of open space or land, 171–172 tax consequences of charitable income tax deduction, 172 –173 generally, 172 estate tax benefits, 173 property taxes, 174 Consumer issues charities, responsibilities of, generally, 217, 221– 222 checklist, 223 compatibility of gift with donor’s goals, generally, 219 – 220 designation of gift for particular purpose, 220 donor’s bill of rights, 224 donors’ rights, generally, 217 fees, disclosure of, 221 generally, 223 Internal Revenue Code and responsibilities of donor and charity, 221– 222 irrevocability of gift, 221 Philanthropy Protection Act (PPA), 217– 218 privacy rights, 221 questions concerning gift, 221 size of gift, 220 time frame for decision-making, 220 truth in philanthropy, 218 – 219 unfair and deceptive practices, 222 – 223
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228 Controversial gifts, gift review committee, 33 – 34 Copyrights, 180, 181 Corporations C corporations deductibility of charitable contributions, 204 – 205 generally, 159 –160 employees as donors, 4 S corporations deductibility of charitable contributions, 205 generally, 159 –160 Cultural organizations, 19, 20 Current use awards defined, 48 endowed fund compared, 49 – 50 Current use gifts generally, 52 gift agreement example, 57
D Deed of gift future interest in tangible personal property, 179 generally, 176 –177 sample form, 178 Deferred gift annuities generally, 77–79 real property, transfers of, 167–168 retirement planning and, 122 –123 charitable income tax deduction, 79 generally, 210 gift taxes, 80 income taxes, 80 Depository Trust Company (DTC), 150 –151 Development office annual giving program, 30 – 31 direct mail solicitations, 21 generally, 25 – 26, 30 major gifts, 31– 32 planned giving, 32
Index
telefund or phonathon programs, 31 Development officers as advisors, 42 – 43 generally, 25, 26 Directors. See Board of trustees Disclosures fees and financial expenses of charity, 221 generally, 217– 219 Donative intent, 219 Donor-advised funds advantages and disadvantages of, 143 –144 charitable deduction rules, 144 –145 checklist, 148 community foundations, 145 comparison chart, 146 –147 defined, 142 generally, 133 –134, 142, 145 reasons for establishing, 143, 145 Donor-directed projects, 26 Donor-initiated projects board approval, 30 generally, 26, 28 memorandum of understanding, example, 29 Donors, rights of. See Consumer issues Due diligence, 8, 21– 22
E Easements, conservation. See Conservation easements Educational institutions, 17, 19 – 20 Endowed funds checklist, 59 creating, 52 current use gift compared, 49 – 50 defined, 48 distributions, 50 – 52 earnings and distributions, 50 – 51 endowment agreement funded by structured gift, example, 67 family funds, building, 51
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financing of, 55 fund description, 55 – 58 generally, 59 gift agreement, 55 – 58 gift review committee, 33 – 34 major gifts and planned gifts as funding for, 64 – 65 memorial gifts, 51– 52 minimum funding levels, 55 multiple-purpose endowed fund description example, 58 objectives of, 53 – 54 planned giving, 32 portfolio, 34 – 35 principal, growth of, 35 purposes of, 53 – 54 scholarship funds and fellowship funds, 52 – 53 fund description example, 58 specifying recipient, 50 separately invested funds, 35 – 36 spending provisions, 36 stewardship office, 32 – 33 types of, 52 – 54 Environmental organizations, 17, 19, 21 Estate planning charitable gift planning, 110 –111 checklist, 119 distribution of estate to family and charities, 109 –110 estate and gift taxes. See Tax consequences generally, 118 gifts from estate, 62, 65 Medicaid benefits and nursing home care generally, 118 planning strategies, 118 –119 probate ancillary administration, 117–118 generally, 116 nonprobate assets, 117 probate assets, 117 property held out of state, 117–118
tax benefits and motivation for giving, 110 –111 wills. See Wills
F 501(c)(3) organizations, generally, 17 Family considerations, 45 Financial advisors, 41 Financial benefits as reason for giving, 6 Five-percent exhaustion test, 97 Flip trusts, 102 –103 Flip unitrust real property, gifts of, 171 life insurance, funding with, 192 Friends as advisors, 45 – 46 Fund description. See Gift agreement
G Gates, Bill, 2, 3 Gift accounting department, 33 Gift agreement current use gift agreement, example, 57 generally, 49, 55 information included in, 56 – 57 multiple-purpose endowed fund description example, 58 restrictions in, 51 restrictive criteria, 55 – 56 Gift reporting department, 33 Gift review committees, 33 – 34 Gift-giving considerations donor’s action plan checklist, 8 –13 questions to consider, 7– 8 selection of charity. See Selection of charity Gifts from the estate defined, 62 generally, 65 Gifts in kind defined, 62
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230 Gifts in kind (cont.) generally, 65 – 66 Gifts, types of. See Types of gifts Government and charities, 16 Grantors, 87– 88 Gratitude as reason for giving, 5 Guardianship, provisions for minors in will, 113
Index
Hospitals, health care, and medical research organizations, 17, 19, 20 Human services charities, 17, 19, 21
Inventory, gifts of generally, 182 tax consequences, ordinary income reduction rule, 202 – 203 Investigating the charity. See Due diligence Investment policies endowed funds, 35 – 36 generally, 34 management fees and expenses, 36 portfolio, 34 – 35 Investors as donors, 4 IRAs. See Individual retirement accounts (IRAs)
I
L
Importance of giving, 17–18 Income in respect of a decedent (IRD). See Tax consequences Income taxes, federal and state. See Tax consequences Individual retirement accounts (IRAs) generally, 126 giving to charity, 121–122 proposed legislation on gifts of, 125 Roth IRAs, 122, 126 –127 Insurance agents See also Life insurance, gifts of as advisors, 42 Intellectual property copyrights, 181 defined, 180 patents, 180 –181 royalties, gift of, 181–182 tax consequences of gifts of, ordinary income reduction rule, 202 – 203 Internal Revenue Service (IRS) forms Form 8282, 180, 186, 213, 222 Form 8283 (appraisal summary), 180, 184 –185, 186, 192, 212, 222
Lead trusts generally, 55, 104 nongrantor charitable lead annuity trusts, 105 nongrantor charitable lead trusts, 104 –105 nongrantor charitable lead unitrust, 106 tax consequences, gifts of partial interests, 213 – 214 Life estate, gift of residence with retained life estate, 166 –167, 214 Life income gifts advantages of, 72 charitable gift annuities. See Charitable gift annuities checklist, 85 deferred gift annuities. See Deferred gift annuities defined, 62 endowed funds and, 55 generally, 64, 71–72, 84 planned giving, 32 pooled income fund gifts. See Pooled income fund gifts present interest stream of income, tax consequences, 210 types of, 71
H
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Index
Life insurance, gifts of advantages and disadvantages of, 187–188 appraisals, 192 asset replacement trust funded with life insurance, 191–192 checklist, 193 commissions, 190 definitions, 188 flip unitrust, funding, 192 generally, 192 –193 net income unitrust, funding, 192 outright gifts paid-up policy, 189 partially paid-up policy, 189 –190 partially paid-up policy, 190 premium payments made by donor, 190 reporting requirements, 192 short-term endowment policies (STEPS), 190 –191 tax consequences of, 189 types of life insurance gifts generally, 189 other types of gifts compared, 188
M Major gifts defined, 62 development office personnel, 31– 32 donor-advised funds. See Donoradvised funds generally, 63 private foundations. See Private foundations structured gifts, 66 supporting organizations. See Supporting organizations Major gifts officers, 25, 26 Management fees and expenses endowed funds, 50 investment services, 36 McCarty, Osceola, 3, 5
Medicaid benefits generally, 118 giving and effect on eligibility, 118 planning strategies, 118 –119 Memorial gifts endowed funds, 51– 52 as reason for giving, 5 Minors gifts to, 89 – 90 minor’s trust, 90 trusts, provisions for minor children, 89 Uniform Gifts to Minors Act (UGMA), 89 Uniform Transfer to Minors Act (UTMA), 89 wills, guardianship provisions, 113 Mutual fund companies, 41 Mutual funds See also Securities gifts of, 149, 156
N Naming buildings or other projects, 6, 30 Naming funds, current use gifts, 50 Negotiations, considerations in negotiating gift, 66, 68 Net income unitrusts generally, 101–102 life insurance, funding with, 192 with makeup provision generally, 102 real property, gifts of, 170 –171 real property, gifts of, 169 –170 retirement planning and, 123 –124
O Officers chancellor, 26 – 28 chief executive officer (CEO), 25 – 28
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232 Officers (cont.) development officer, 26 hierarchy chart, 27 major gifts officer, 26 organizational structure, 25 planned giving officer, 26 president, 25 – 28 vice president for development or advancement, 25, 26, 28 Operating expenses, 34 – 35 Organizational chart, 27 Organizational structure, 25 – 28, 37
P Partnerships, deductibility of charitable contributions, 205 Patents, 180 –181 Pension plans See also Retirement planning qualified pension plans, 127 transfer to charity, 121 Performing arts charities, 17, 19, 20 Personal property, tangible artwork. See Artwork, gifts of checklist, gifts of noncash assets, 186 deed of gift, 176 –178 defined, 176 fractional interests, 179 future interest, gift of, 179 generally, 175 –176 gift review committee, 33 – 34 gifts of, 65 gifts in kind, 62, 65 – 66 inventory, gift of, 182 possession, retaining right of, 179 tax consequences appraisals, 185 comparison chart, gifts of noncash assets, 183 Form 8282, 186 generally, 177, 179, 182 –184, 186 ordinary income reduction rule, 202 – 203
Index
related use, 199 – 200 substantiation requirements, 184 –185 unrelated use, 179 –180, 199 – 200 transfer of, 176 –177 types of, 176 Philanthropists baby boomers, 4 characteristics of, 2 – 3 childless couples as, 3 considerations, 6 – 8 corporate employees, 4 generally, 1 high-tech donors, 4 investors, 4 motivations to give, 4 –7 professionals, 4 role of in United States, 1– 2 surviving spouses as, 3 World War II donors, 3 Philanthropy federal regulation of, 217 importance of, 2 Philanthropy Protection Act (PPA), 217– 218 Planned gifts defined, 62 endowed funds and, 64 – 65 generally, 63 – 65 gifts from the estate, 65 personal property and other assets, 65 Planned giving officers as advisors, 42 – 43 generally, 25, 26, 32 Planned giving, 32 Pledges binding pledge agreements estate, obligation of, 116 generally, 63 defined, 62 generally, 31, 63 tax consequences, 201 Policy decisions, 28 – 29 Pooled income funds community foundations and, 84
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funding, 84 generally, 80 – 82 retirement planning and pooled income fund gifts, 124 tax consequences capital gains taxes, 82 charitable income tax deduction, 83 estate taxes, 83 – 84 gift taxes, 83 income tax to beneficiary, 83 partial interests, gifts of, 213 – 214 Portfolios, endowments, 34 – 35 Preferential treatment as reason for giving, 6 President, 25, 26 – 28 Prestige as reason for giving, 6 Privacy rights of donors, 33, 221 Private foundations advantages and disadvantages of, 135 –136 charitable income tax deduction rules, 136 checklist, 148 comparison chart, 146 –147 defined, 134 –135 excess business holdings, 138 excise taxes, 137 generally, 133, 145 investments prohibited, 138 lobbying expenditures, 138 minimum distribution requirements, 136 –137 prohibitions, 137–138 reasons for establishing, 135 self-dealing, 137 termination of, 138 Probate See also Estate planning ancillary administration, 117–118 generally, 116 joint ownership of property, 117 nonprobate assets, 117 probate assets, 117 property held out of state, 117–118
Professional advisors attorneys, 40 – 41 certified public accountants (CPAs), 41– 42 checklist, 46 development or planned giving professionals, 42 – 43 financial advisors, 41 generally, 39 – 40, 46 gift options and meeting donor’s goals, 220 insurance agents, 42, 188, 190 responsibilities of, 217 selection of, questions to ask, 43 – 44 stockbrokers and mutual fund companies, 41 trust officers, 42 Promissory notes, tax consequences, 201 Public relations office, 28 Purpose of gift, 47– 48
Q Qualified terminable interest property (QTIP) trusts, 103 –104
R Real estate. See Real property Real property appraisals, 165 –166 charitable deferred gift annuities, 167–168 charitable gift annuities, funding, 167 charitable remainder unitrusts, 168 –169 checklist, 174 conservation easements charitable income tax benefits, 172 –173 estate tax benefits, 173 generally, 171–172 property tax consequences, 174 tax consequences of, 172
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234 Real property (cont.) environmental risks, 164 –165 flip unitrust, 171 generally, 174 gift review committee, 33 – 34 mortgages on, 164 marketability, 164 net income unitrust, 169 –170 net income unitrust with makeup provision, 170 –171 outright gift of entire property or fractional interest, 165 personal residence or farm with retained life estate, 166 –167 tax consequences personal residence or farm, gifts of remainder interest in, 214 partial interest for conservation purposes, 214 title, 164 types of gifts, 165 types of real property, 163 Reasons for giving, 4 – 6 Receipts and acknowledgments, 33, 212 Recognition as reason for giving, 6 Religious organizations, 17, 19, 21 contributions to, 16 generally, 17, 19, 21 Remainderman, charitable, 97 Residence, personal gift of with retained life estate, 166 –167 tax consequences, 211, 214 Restricted gifts current use awards, 49 – 50 defined, 48 generally, 49 unrestricted gifts compared, 48 – 49 Retirement planning charitable remainder net income unitrust. See Net income unitrust charitable gift annuities. See Charitable gift annuities
Index
checklist, 131 deferred gift annuities. See Deferred gift annuities generally, 129, 131 IRAs, giving to charity, 121–122 pensions, transfer to charity, 121 planned giving and, 122 pooled income fund gifts. See Pooled income fund gifts retirement plans assets, transfer to charity, 125 –126, 130 giving to charity, 122 types of, 126 –127 tax considerations, 125 –126 transfer of assets to charity, methods of bequests, 128 charitable remainder unitrust for spouse funded with retirement plan, 129 designation of charity as beneficiary, 128 generally, 127 outright charitable gifts, 127–128 transfer to charitable remainder trust, 129 Revocable inter vivos trusts charitable remainder trusts. See Charitable remainder trusts charitable trusts, types of, 91– 92 generally, 90 – 91 lead trusts. See Lead trusts pour over provision, 91 rule against perpetuities, 91 tax consequences, 91 Royalties, 180, 181–182 Rule against perpetuities, 91
S Scholarships See also Endowed funds recipient, selection of, 55 – 56 specific recipients, 50 Scientific organizations, 19, 21
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Securities charitable tax deduction, 153 –154 checklist, 161 closely-held stock generally, 157 valuation of, 157 restrictions on transfer of, 157 arm’s-length transaction, 158 debt, personal liability for, 158 charitable remainder unitrust, transfer to, 158 –159 S and C corporations, 159 –160 date of gift, 152 –153 Depository Trust Company (DTC) transfers, 150 –151 dividend reinvestment plans, gifts from, 154 –155 generally, 149 –150, 160 mutual fund shares, 156 non-publicly traded stock, appraisal of, 185 partial transfer of stock certificate, 151–152 preferred stock, Section 306 provisions, 160 savings bonds, Series EE and HH, 155 –156 stock certificates, transfer of, 151 tax consequences generally, 154 non-publicly traded stock, gifts of, 185 transfers of securities held by donor’s stockbroker or banker, 150 value of gift, 152 zero coupon bonds, 156 Selection of charity civic and community organizations, 21 cultural organizations, 20 due diligence, 8, 21– 22 educational institutions, 19 – 20 environmental organizations, 21 hospital, health care, and medical research organizations, 20
235 human services organizations, 21 performing arts, 20 personal considerations, 17–18 religious organizations, 21 scientific organizations, 21 single-illness organizations, 20 tax-exempt organizations, 17 types of charities, 18 –19 Web resources, 23 Single-illness organizations, 19, 20 Social standing as reason for giving, 6 Sources of contributions, 15 –16 Spouses childless couples as donors, 3 family dynamics and charitable giving, 45 giving, involvement in, 2 life income gifts, 72 surviving spouse as donor, 3 Statistics on giving, 15 –16 Stewardship office, 32 – 33 Stock. See Securities Stockbrokers, 41 Straight fixed percentage charitable remainder unitrust, 100 –101 Structured gifts defined, 62 endowment agreement fund by structured gift, example, 67 generally, 66 Supporting organizations advantages and disadvantages of, 139 –140 charitable deduction rules, 140 checklist, 148 choice of entity and creation of, 142 comparison chart, 146 –147 control by nondisqualified persons test, 140 –141 defined, 138 –139 generally, 133 –134, 138, 145 organizational and operational test, 140 reasons for creating, 139 relationship test, 141–142
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236 Supporting organizations (cont.) requirements, 140 –142 termination of, 142
T Tangible personal property, gifts of. See Personal property, tangible Tax benefits as reason for giving, 5–6 Tax consequences acceleration of charitable deduction, 200 – 201 adjusted gross income (AGI), 196, 201 appraisals. See Appraisals alternative valuation, 200 – 201 benefits from gift to donor, effect of, 201– 202 businesses, deductibility of charitable contributions C corporations, 205 depreciation of assets, effect of, 206 generally, 204 – 205 S corporations, 205 partnerships, 205 capital gain property, 182 –184 capital gains taxes generally, 206 – 207 net income unitrusts, 103 charitable gift annuities. See Charitable gift annuities charitable remainder trusts capital gains taxes, 95 charitable income tax deduction, 95 distributions, characterization of, 94 estate taxes, 96 generally, 93 gift taxes, 95 – 96 probate, 96 trust income, taxation of, 93 – 94 charitable remainder unitrusts capital gains taxes, 103 partial interest gifts, 213 – 214
Index
checklist, 215 conservation easements. See Conservation easements copyrights, gifts of, 181 cost basis generally, 198 –199 ordinary income reduction rule, 202 – 203 deduction reduction provisions, 201 deductions, limitations on, 201 deferred gift annuities. See Deferred gift annuities depreciation, 206 dividend reinvestment plans, gifts from, 154 –155 estate and gift taxes future interests, 209 – 210 generally, 126, 207 gift tax annual exclusion, 208 income stream, 209 – 210 legislative proposals, 208 life income gifts, 209 – 210 marital deduction, 209 – 210 as motivation for giving, 110 –111 present interests, 210 tuition and medical bill payments, 208 – 209 unlimited marital deduction, 209 fair market value, 198 generally, 214 income in respect of a decedent (IRD) charitable remainder trust, transfer to, 204 generally, 126, 203 – 204 outright transfers by will, 204 income taxes, federal and state acceleration of deduction, 200 – 201 adjusted gross income (AGI), 196, 201 capital gains taxes, 206 – 207, 211 cost basis, 198 –199
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deduction reduction provisions, 201 deductions and itemizers, 198 deductions and nonitemizers, 197–198 depreciated assets, 206 donors, effect of benefits to, 201– 202 fair market value, 198 generally, 196 income in respect of a decedent, 126, 203 – 204 ordinary income reduction rule, 202 – 203 personal residence, sale of, 211 pledges and promissory notes, 201 tangible personal property, deductibility of, 199 – 200 taxable income, 197–198 inventory, gifts of, 182 kiddie tax, 90 life insurance, gifts of outright gift of paid-up policy, 189 outright gift of partially paid-up policy, 189 –190 partially paid-up policy, 190 premiums paid by donor, 190 minor’s trust, 90 motivation for gift-giving, 195 net income unitrusts, 103 noncash assets, reporting rules appraisal summary (Form 8283), 184 generally, 184 gifts valued at $500 or less, 184 gifts valued between $501 and $5,000, 184 –185 gifts valued over $5,000, 185 non-publicly traded stock, 185 ordinary income property, 182 –184 ordinary income reduction rule, 202 – 203 out-of-pocket expenses, 202 partial interests, gifts of, 213 – 214
237 patents, gifts of, 181 personal property, gifts of. See Personal property, tangible pledges and promissory notes, deductibility of, 201 pooled income funds. See Pooled income funds preferred stock, 160 private foundations. See Private foundations quid pro quo rules, 202 real property, gifts of bargain sales to charity, 211– 212 gifts subject to mortgage, 211 partial interest for conservation purposes, 214 personal residence, sale of, 211 remainder interest in personal residence or farm, gifts of, 214 related use and unrelated use rules, 177, 179 –180, 199 – 200 retirement accounts, charitable gift of at death, 126 revocable inter vivos trusts, 91 royalties, gifts of, 182 securities, gifts of, 153 –154, 185 substantiation requirements, gifts of $250 or more generally, 212 IRS forms. See Internal Revenue Service (IRS) receipts, 33, 212 supporting organizations, 140 tangible personal property, gifts of, 177, 199 – 200 types of taxes, 196 volunteers, expenses incurred, 202 Tax-exempt organizations, generally, 17 Technology and high-tech philanthropists, 4 Trust officers as advisor, 42 Trustees generally, 88
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238 Trustees (cont.) naming, 97 powers of distributions of principal and income, 88 – 89 generally, 88 special provisions, 89 naming, 97 Trusts beneficiaries, 88 charitable remainder trusts. See Charitable remainder trusts checklist, 107 donor, 88 generally, 87, 106 grantor, 87– 88 lead trusts. See Lead trusts living trusts. See Revocable inter vivos trusts minor children, provisions for, 89 minor’s trust, 90 parties to, 87– 88 qualified terminable interest property (QTIP) trusts, 103 –104 settlor, 88 spray and sprinkle provisions, 89 trustees. See Trustees tuition trusts, 99 –100 types of, 87 wills compared, 111–112 Tuition trusts, 99 –100 Turner, Ted, 3 Types of gifts charity’s ability to handle gift, 68 choices concerning, 61– 62, 69 donor’s goals, meeting, 219 – 220 generally, 48, 59, 61– 62
Index
U Unfair and deceptive practices, 222 – 223 Uniform Gifts to Minors Act (UGMA), 89 – 90 Uniform Transfer to Minors Act (UTMA), 89 United States, philanthropy in, 1– 2 United Way, 21 Unrestricted gifts defined, 48 generally, 47– 49 restricted gifts compared, 48 – 49
V Vice presidents, 25, 26, 28 Volunteerism, 16 –17
W Web sites, 23 Wills See also Estate planning bequests to charity, sample provisions, 114 –115 charitable bequests, 113 generally, 119 guardianship provisions, 112 percentage of estate bequests, 109 –110, 113 –114 pledge documents and, 116 specific bequest, 113 standard provisions of, 112 –113 trusts compared, 111–112
