Gifts of Cash

Here, you typically write a check or give cash. For contributions in excess of $250, you must receive and maintain a written acknowledgment from the charity. The advantages of this type of gift are its simplicity and full tax deductibility (assuming you itemize deductions on your income tax return), as well as the fact that you have removed the asset from your estate. However, you create very little leverage. You have a dollar, you give a dollar, you receive a dollar tax deduction. Depending on the type of assets, it may be preferable for you to donate some asset other than cash.

Gifts of Property

The types of property that you can give are as varied as the types of property you own. For example, you might own an old car that is in excellent condition but has little resale value. You may not want the car, but it may be of value to a charity.

If you give property such as real estate or securities, not only do you remove the asset from your estate, but you also remove the future growth of that asset from your estate. The actual transfer of your property to your selected charity can take some time. If you are giving securities that are held in a brokerage account, usually the simplest way to complete the transfer is to have your charity open an account at the same brokerage firm. You can then write your broker a letter and have him or her “journal” your selected securities over to the charity's account. For real property or tangible personal property, you need to have the deed or title transferred into the name of the charity. Most charities will conduct an environmental study to make sure real estate is free from liability.

Gifts of Appreciated Property

The best way to create leverage through outright gifts is by giving away appreciated property. Assume that you have made a $12,000 pledge to your church's building campaign. You are trying to decide whether to write a check for this amount or to donate the $12,000 worth of Coca-Cola stock that you bought 15 years ago for $2,000. You had planned to hold this stock as part of your long-term investment program. You are sentimental about your Coca-Cola stock and believe it will continue to be a good investment in the future. What should you do?

You should give away the stock. If you had to sell the stock now, perhaps because of an emergency, you would incur substantial capital gains taxes. However, even though you paid only $2,000 for the stock, when you give it to your church, you will receive a deduction for its full market value ($12,000). If you want to maintain the stock for your long-term investment program, you can simply buy the stock using the $12,000 cash you had planned to give your church. The result of these transactions is that you now own $12,000 worth of Coca-Cola stock with a $12,000 cost basis. Now, in the case of an emergency, you could sell your Coca-Cola stock and owe no taxes. Because your church is treated as a charity for tax purposes, when the charity sells the stock you gave it, it is a nontaxable event.

Gifts of appreciated securities and real estate are by far the most effective way to make outright gifts. For you to receive a deduction for fair market value on gifts of tangible personal property, the gift must be one usable to the charity as part of the charity's purpose. For example, the gift of a tractor to your church would likely qualify for a deduction based only on your cost basis in the tractor because it is not something that your church normally uses as part of its operations.

Gifts to Public Foundations

Like many people, you may have numerous charities that you would like to help. However, the transfer process described previously would be too burdensome for small contributions. Direct transfers would also not work if you want a deduction in this calendar year but are undecided about which charities you want to make gifts to or how much you want to give. Two excellent alternatives are the private foundation or a “donor-advised fund” of a community (or public) foundation. With this strategy, you are allowed to make a gift to foundations in cash, securities, or property and receive an immediate tax deduction. The foundation then holds your assets until you give them instructions on the disposition of your property to the charities you have chosen. Most of the public foundations can even provide you with information as to the worthiness of charities that you may be considering. For this service, you are charged a small fee that is usually based on a percentage of your contribution. For listings of community foundations in your area, go to the Resource Center at www.welchgroup.com; click on “Links,” then “Community Foundations—Search.” A more detailed discussion of private foundations is included later in this chapter.

Tax Deduction Limitations on Outright Gifts

Generally, you will receive a full tax deduction for gifts totaling up to 50 percent of your AGI during any calendar year. If your gift is to a nonpublic charity, your deduction is restricted to 30 percent of your AGI. Gifts in excess of these amounts can be carried forward for up to five years. However, there is also a limitation on itemized deductions that must be considered, and amounts disallowed by the itemized deduction rule are not eligible for carryover.

Charitable Remainder Annuity Trust

The charitable remainder annuity trust (CRAT) is an ideal vehicle for taking appreciated non-income-producing property and converting it into assets that can provide you or a family member with current income. Suppose you are age 55 and own land that is currently valued at $900,000. Your cost basis in the property is $90,000. You are considering an early retirement, but would need to convert assets to produce an income stream. Your first thought is to sell the property and reinvest the proceeds using our Growth Strategy with a Safety Net^® strategy described in Chapter 4. The results of the sale would be as follows:

As an alternative, you should consider a CRAT. Here's how it would work. Let's assume that you are interested in leaving assets to your alma mater. You can decide what interest rate you would like to receive and whom you would like to act as your trustee. In this case, you choose 5 percent and elect to serve as trustee yourself. You have your attorney draft the document formalizing the trust. Your attorney then assists you with transferring the deed from your name as an individual to your name as trustee of your charitable remainder annuity trust. Once the property is transferred, you, as trustee, sell it for $900,000. It is important that there be no prearranged sale of the trust asset before it is transferred to the trust. If that is the case, the donor (you!) will likely be responsible for the income tax from the sale of the assets.

Because it is a charitable trust, there are no taxes on the sale of the property. You then place the entire sum in investments of your choosing. As trustee, you have full discretion over investment decisions. Because you elected a 5 percent payout, you will withdraw $45,000 annually ($900,000 × .05 = $45,000) for as long as you live. Not only do you increase your annual income, but you also receive significant income tax deduction for the gift of your property to your CRAT (how large a deduction depends on federal discount and applicable interest rates).

This strategy is appealing, but you have two concerns. First, you are worried about your spouse's continuing need for income should you predecease him or her. Next, you are concerned about some potentially very unhappy heirs—your children. At your death, the remainder goes to your alma mater, and your children receive nothing. To resolve the spousal issue, you would set the trust up so that the income is paid over both of your lives. As long as either one of you is living, the trust will continue to pay $45,000 per year. The only thing this adjustment affects is your initial tax deduction. The deduction would be less because it includes two lives.

The issue concerning your children presents a more challenging, yet solvable, problem. Perhaps the best solution would be to take a portion your tax savings dollars and purchase a survivorship life insurance policy on the life of you and your spouse. Remember, you increased your cash flow by $8,100 per year by using the CRAT strategy versus an outright sale. An example of a $900,000 survivorship life policy is represented in Table 12.1. This policy should be purchased using an irrevocable insurance trust as described in Chapter 10. If your children are adults, an alternative would be to have them be the owner and beneficiary of the policy with you gifting them the cash to pay the premiums.

Charitable Remainder Unitrust

Structurally, the CRUT is set up similarly to the CRAT. You establish the trust and transfer property into it. As trustee, you then sell the property and reinvest it as you wish. You receive an income from the trust during your lifetime, and at your death, the remaining assets go to the charity of your choice. The income can be paid over the joint lives of you and your spouse if you so desire. What differs is how the income is figured. With a CRUT, you set an interest rate for purposes of calculating the amount of withdrawals that are due you each year. Although the interest rate never changes, the amount of dollars you receive fluctuates based on the changing value of the account each year. For instance, in our earlier example using a CRAT, you contributed $900,000 of real estate to your charitable trust, and from then on received $45,000 (5 percent) per year. The income amount never changed. Under a CRUT, you would receive 5 percent of the value of the account as of a certain date each year. If your account value increased to $1 million in the second year, a 5 percent distribution would produce $50,000 for you. This results in a growing income for you, assuming your total account values grow. The opposite is also true. If the account values decrease, so will your distributions. Because the account values of a CRUT must be determined each year, it is not an appropriate trust in which to place hard-to-value assets such as real estate or a closely held business interest.

Pooled Income Funds

One disadvantage of the charitable remainder trust is the cost involved in setting up the trust. It can cost several thousands of dollars to set one up, and you will also have annual maintenance costs of approximately $300 to $1,000 or more for tax returns and investment costs. Your trustee must obtain a taxpayer identification number and file annual trust tax returns. There is also the matter of trustee duties. Your trustee (often you) is legally a fiduciary to the trust and is required to follow certain rules and procedures. Failure to do so can result in legal liability. If all of this sounds like more than you expected, then you might want to consider a pooled income fund.

With a pooled income fund, the charity prepares all the documents and administers the fund for you (typically at no cost). You contribute property to the fund and receive interest income units during your lifetime or a specified period of time. Your deduction is calculated in the same manner as with the charitable remainder trust. This type of trust has several advantages over the charitable remainder trust, as well as some disadvantages.

Charitable Lead Trust

With a charitable lead trust, you and the charity switch positions. The charity receives the income from the trust for a specified period of time and the “remainder interest” then reverts to someone you designate (typically your child). This type of trust works well if the following are true:

1. You own income-producing property, but you do not need the income or the asset.
2. You would like to divert the income to a charity for a period of time.
3. You would ultimately like to transfer the asset to a family member but pay little or no gift or estate taxes.

This trust can be set up as either an inter vivos (during your lifetime) trust or a testamentary (under your will) trust.

Advantages

• Lifetime gifts to your private foundation generate an income tax deduction within certain limitations.
• Your foundation can create a lasting memorial to your family in much the same way as the Rockefellers and Kennedys have done.
• You can use your foundation to aid a specific cause, such as child abuse, or you can provide your directors broad discretion in deciding how to disperse charitable contributions.
• Your lineal descendants can serve as directors. This creates a lasting legacy of charitable giving for your heirs. It places them in a position of prominence in charitable circles. As directors, they can receive reasonable income for their services to achieve the foundation's charitable purpose.
• Assets contributed to your private foundation are removed from your estate and thus avoid estate taxes.

Disadvantages

• A private foundation has many complex tax and nontax requirements. The costs of establishing one and maintaining it are relatively high. In addition to annual tax filing requirements, there are federal reporting requirements. Many states also impose reporting requirements. A private foundation is, therefore, more appropriate for large contributions. Many advisers suggest a minimum of $250,000 as an appropriate contribution. We normally would not recommend setting up a private foundation for less than $1 million to be given during life or at death.
• The people you would like to act as directors, typically your children, may lack the investment management skills or general management skills to run the foundation. They may also lack the interest. The directors are fiduciaries and, as such, are responsible for their actions. Violations of fiduciary responsibilities can result in personal liability for the directors.
• Private foundations are required to distribute at least 5 percent of the fair market value of the foundation's assets each year. The foundation must make certain that there is sufficient liquidity for this purpose.
• The federal government imposes a 2 percent excise tax on certain income earned by the private foundation.
• Generally, when a donor makes a gift of appreciated property to a private foundation, the donor must recognize as income the amount of gain inherent in the property, which essentially provides a deduction up to the donor's basis. This will not affect gifts under your will because all assets receive a stepped-up cost basis at death.

Although the restrictions on the private foundation may sound daunting, it can deliver powerful estate planning results. Consider the following case study:

Case Study

The year is 2014. Dr. John and Mary Thompson have a taxable estate of $16 million, which places them in the 40 percent estate tax bracket. Six million dollars of their estate is composed of retirement plan assets, and the balance is made up of family farm property, which is both something they would like to keep in the family and highly illiquid. To pay their estate taxes their heirs will need to use the money from the retirement plan. We examine the estate and income tax impact on the retirement plan at the last of the couple to die:

$16,000,000	Taxable estate
−$ 2,128,000	Estate taxes (assuming two credits)
−$ 663,000	Estimated income taxes on grossed-up retirement plan distributions @ 39.6% income tax rate (to cover estate tax and income tax on distribution needed)
$13,209,000	Net to heirs from taxable estate

In order to pay the taxes, the Thompsons' heirs will need to liquidate almost half of Dr. Thompson's retirement plan! When you use your retirement plan assets to pay estate taxes, you trigger income taxes. It's hard to imagine that you worked hard all your life and contributed diligently to your retirement plan only to have Uncle Sam eventually take two-thirds of it to pay the combination of estate and income taxes!

Now, assume that the Thompsons decide to establish a private foundation that they name “The John and Mary Thompson Family Foundation.” They contribute their entire $6 million retirement plan to their foundation. They elect to have their children serve as directors and give their children the right to elect their own successor directors, presumably their children.

$16,000,000	Gross estate
−$6,000,000	Gift to private foundation
$10,000,000	Taxable estate
−$                0	Estate taxes (assumes two credits)
−$                0	Income taxes
$10,000,000	Net to heirs
The taxable estate is reduced by the $6 million charitable contribution.

There are no estate or income taxes due because John and Mary are each able to use their $5 million-plus applicable exclusion amount. The private foundation by-laws will allow the directors or officers (the children in this case) to receive reasonable management fees for their services as trustees (Note: they must provide real services). The children will receive some income plus the pleasure of giving money to worthy charitable causes (without going into their own pocketbook!). However, they are likely to be unhappy that they receive a reduced inheritance. To address this concern, the Thompson's establish an irrevocable life insurance trust and place $6 million of survivorship life insurance in it. As a result, when they die, the children receive $6 million of life insurance and $10 million of property estate and income tax free plus management fees for acting as directors of their family private foundation.

The family foundation has $6 million, and, if it is managed well, it will grow in size and provide future descendants the opportunity to continue the family tradition of charitable giving. To pay for the survivorship life policy, the Thompsons make gifts of premiums to the irrevocable life insurance trust using their annual exclusion. An alternative to using an irrevocable life insurance trust would be to have the children own the survivorship life policy on the parent's life and have the parents make gifts to the children for premiums using the parent's annual exclusion. Based on the parents' ages (both are age 53), the annual premiums would be approximately $15,000 to $20,000 per year.

Our government has structured the tax laws in a way that encourages charitable giving. In most cases, the tax laws are merely an added benefit to philanthropists who give out of a moral sense of duty rather than tax benefit. Regardless, the tax benefits should be analyzed in a transaction to make sure that the end result is as intended. Additional tax benefits can be achieved through the use of a family limited partnership, which is described in detail in Chapter 13.