CHARITABLE TRANSFERS

Charitable transfers generate an income tax deduction if made during life (inter vivos gifts), and are deductible for estate tax purposes when made at death (testamentary transfers). The advantage of inter vivos gifts over testamentary transfers is that they are tax deductible for income tax purposes, and also remove the gifted asset from your estate.

Lifetime gifts can substantially reduce the tax bite of high-income taxpayers with large estates. Apart from the obvious tax benefits associated with charitable giving, charitable transfers also fulfill your “social contract” by subsidizing programs, scholarships and other charitable endeavors that advance the charitable causes you support.

There are as many reasons for making charitable gifts, as there are charitable givers. Whether you want to give to charity in order to give something back to your community, for religious reasons, to better society, to repay an institution or cause that made a difference in your life, or just because you were brought up that way, why not give in a way that allows both the charity and you to benefit?

There are a myriad of options and gifting vehicles available to anyone with a charitable bent. Naturally, gifts can be made in cash. You may also gift personal property, appreciated stock, and real estate. The federal tax code also permits, and even promotes, a wide variety of gifting vehicles discussed below.

A charitable deduction is available for contributions to “501(c)(3)” organizations; which include churches, educational institutions, foundations and other organizations promoting charitable works. The philosophy behind the deduction is that taxpayers should be encouraged to support organizations engaged in charitable works that the government would otherwise be forced to provide.

To promote gifting, a number of “split interest” trust options are available. All split interests involve the division of the gifted assets into two component parts: income and principal.

The most common split interest gifts allow you to retain the income from the gifted asset for a period of years or your lifetime with the charity receiving the remaining principal at your death. “Charitable remainder trusts,” “pooled income funds” and “charitable gift annuities” fall into this category. “Charitable lead trusts,” by contrast, reverse the sharing of income and principal, allowing the charity to enjoy the income from the gifted asset for your life, with your family owning the gifted asset outright at your death.

You will need the assistance of an estate planning attorney to help choose the appropriate gifting vehicle for you. Most established charities have a planned giving professional on staff who can also provide valuable information.

Split interest gifts allow you a current income tax charitable deduction without requiring you to forfeit the entire enjoyment of the gifted asset. You give the charity future ownership and retain the income for a period of years (not exceeding 20) or life.

Your charitable deduction is less than the fair market value of the gift since the charity cannot immediately enjoy the gift. A somewhat complicated calculation of the present value of the gift must be made to determine your income tax deduction (see below).

CHARITABLE REMAINDER TRUSTS

Charitable remainder trusts (“CRT”) are the most common gift splitting vehicle. Highly appreciated assets that have been transferred to a CRT can be sold tax-free, solving the problem faced by older taxpayers who are often saddled with highly appreciated assets that cannot be sold without substantial capital gains.

Without a CRT, the standard of living of such individuals can suffer if the highly appreciated assets are not income generating. Despite their high net worth, people in this predicament have no spend able income.

The CRT itself is exempt from income tax, and therefore can sell highly appreciated property tax-free. After the transfer to the CRT, and the subsequent sale, the entire proceeds of the sale (undiminished by income tax) are available to pay an annual income.

You are entitled to a percentage (which must be at least 5%) of the value of the trust assets as valued on the first day of the year. Since the value of trust assts fluctuate, your income interest will change from year to year.

CRT distributions are taxable to you to the extent that the CRT has income. The character of the income is the same as in the hands of the CRT. Distributions are first considered ordinary income, then capital gains, then tax-exempt income, and finally tax-free return of principal.

The following example illustrates the use and operation of a CRT:

EXAMPLE: Assume that Mary (70 years old) has a substantial estate. She owns highly appreciated non-income producing stock worth $100,000 for which she only paid $5,000. If Mary were to sell the stock she would have a $95,000 capital gain. Hearing of the benefits of CRTs, Mary contributes the stock to a CRT. She elects to retain an 8% annual income interest for the balance of her lifetime. Based on tables provided by the IRS, Mary is entitled to a whopping $39,845 charitable income tax deduction (see chart) in the year the CRT is created.

In the first year, Mary will receive a distribution of approximately $8,000 (8% of $100,000) prorated to the extent the first year is not a full twelve-months. Mary, as Trustee of the CRT, will sell portions of the CRT stock as needed to pay herself her annual 8% amount. The sale of the appreciated stock by the CRT is not taxable to the CRT since it is tax exempt. The $8,000 received by Mary will be taxable to her as a capital gain since the trust had only capital gains. Note that if the CRT had ordinary income, the distribution to Mary would first be treated as ordinary income to the extent of the CRT’s ordinary income, with the excess treated as capital gains.

The actual dollar figure distributed to Mary will change from year to year depending on the fair market value of the CRT on January 1 of each year.

The table below illustrates the income tax deduction available to an individual creating a CRT. The calculation assumes a $100K contribution. The deduction depends on the age of the donor and the income interest retained.