Gift Planning Basics: Matching Methods to Motives

Clients have a variety of reasons for considering a significant charitable gift. Fortunately our tax structure and its incentives for philanthropy have developed an equally varied array of giving methods. Following is a basic overview of some of the most common and popular gift vehicles.

Generally, gifts fall into one of three groups: 1) a single outright lifetime transfer or series of annual gifts; 2) revocable arrangements for a future gift; and 3) irrevocable provisions for a deferred gift.

In order to choose the appropriate giving method, a good planner needs to understand the donor's motives. Factors influencing your recommendation include the donor's financial and tax situation and personal objectives. In some situations, the guidelines and needs defined by the charity will affect the decision.

Outright Lifetime Gifts
The most common form of charitable giving is writing a check, but that also can be the least cost-effective. The following alternatives to cash gifts produce current or near-term philanthropic support.

Long-term appreciated and readily marketable property. Other than cash, this is the simplest and most frequently used alternative. Stock is the most common type of asset used, but real property is also a viable option.

The result is a double tax savings: One from the itemized deduction, the other by completely avoiding capital gains taxes. One-seventh of total appreciation can be lost to capital gains taxes on a sale, a fourth or more if subject to state taxation as well as federal. When the gift reduces or eliminates the eventual transfer taxes, a third savings results.

A donor wishing to maintain a stock position may hesitate to make a gift of shares, preferring instead to use cash. The shares, however, should still be considered since cash can be used to buy the same number of shares at a higher basis. This can reduce any capital gains tax on a subsequent sale or produce a useful capital loss.

Nonmarketable closely held stock. A gift of a minority block of nonmarketable closely held stock can make an economical gift. The stock can be redeemed by the corporation at its discounted value, although the redemption cannot be a condition of the gift. If redeemed and not reissued, all retained shares increase in value. Also, an appraisal will be necessary if the donor wants to deduct more than $10,000.

Life insurance policies with cash surrender value. Donors who no longer need death benefits can discover hidden assets in their paid-up life insurance policies. By donating the policy to charity, the insured donor receives an income tax deduction for the surrender value, avoids the need for any subsequent premium payments and removes death benefits from a possibly taxable estate. The deduction is limited, however, to the lower of cost basis or fair market value.

Charitable lead trusts. This is an underused option for near-term support, such as for a capital campaign. For a term of years after funding the split-interest trust, payment of the income interest goes to one or more designated organizations. At termination of the trust the remainder passes to named individual beneficiaries, at a reduced taxable value.

Revocable Arrangements for Future Gifts

Estate distributions. These are the most frequently used revocable arrangements, which can be implemented by a bequest in the donor's will. They can also occur as a comparable provision of a living trust that serves as a dispositive instrument at the grantor's death. Since wills and living trusts can be revised, there is no income tax charitable deduction for establishing the plan. If tax laws are left unchanged, the charitable distributions are not subject to the unified federal gift and estate tax.

Life insurance. Aside from the outright gift of a policy with cash value, life insurance is a versatile tool for both revocable and irrevocable gift plans.

Advantages include:

• Death benefits for charity reduce a taxable estate and pass contractually outside of probate, in confidence, and are less subject to contest than a bequest.
• The gift involves no administrative expense or settlement costs.

The simplest way to use life insurance is to name a qualified charity, as the beneficiary of a new or existing policy. The insured policy owner retains the power to change the beneficiary clause, making it a revocable plan with no completed gift and no current income tax deduction. If the charitable nonprofits is made policy owner, annual unrestricted cash gifts to cover premium costs are tax deductible. Insurance can also effectively replace for heirs the value of philanthropic estate distributions.

Qualified pension plan assets. Many people remain unaware of how income tax liability erodes the value of their defined contribution pension plans. Funded with untaxed income, and appreciated without being taxed, their total value remains subject to income tax if taken by the participant, transferred to heirs or left to be taxed in the estate as Income in Respect of a Decedent. With a taxable estate, what is left is then taxed again.

These assets can be the most costly gift to heirs. Conversely, they make an efficient revocable charitable gift, easily arranged by a plan's beneficiary clause and not taxable as IRD to the charity.

Irrevocable Provisions for Future Gifts

Split-interest charitable remainder trusts. These various arrangements provide donors the greatest tax advantages, including an immediate tax deduction, avoidance of capital gains tax, increased lifetime income and reduced estate taxation. Remainder trusts are mirror images of the previously mentioned charitable lead trusts.

There are two broad types of remainder trusts. Those with fixed dollar payments to income recipients are charitable remainder annuity trusts or CRATs, typically preferred by older grantors. Those with a variable income stream, depending on growth or decline in value, are charitable remainder unitrusts or CRUTs. Grantors with more years of life expectancy, and concerns about inflation, are likely to prefer a unitrust with its potential for growth in income when investments include equities. In addition, there are four variations of unitrusts to offer donors still more flexibility.

Charitable gift annuity contracts. CGAs are the oldest form of income-producing charitable gifts, dating back to the mid-1800s, but are not available in all states or offered by all organizations. Charitable organizations that enter into such contracts are the issuer and payor of income for one or two annuitants.

Some donors will prefer a gift annuity contract to a charitable remainder annuity trust, for any of several reasons. For older annuitants, the annuity rate can be higher than what would allow an annuity trust to qualify as tax-deductible. Payments received are partially nontaxable for a number of years, considered as return of investment in the contract.

The transaction is in part a charitable gift and in part the purchase of the income interest. When a donor transfers marketable, long-term capital gain property instead of cash in return for the annuity interest, the amount of appreciation in the property is prorated between the gift portion and the purchase portion. There are two advantages related to capital gain. One, the amount allocated to the gift portion completely avoids gains tax. Two, the portion to be recognized can be spread over the projected term of the contract, and any tax deferred is money saved. Note, however, that the last advantage is offset to some degree because the prorated lower-taxed capital gain portion of annuity payments squeezes out an equal amount of untaxed return of investment.

Other benefits of a CGA include:

• Requires a simple contract, with no need for a trust agreement.
• The obligation to pay the annuity is a claim on all assets of the issuer.
• Start of payments can be deferred, which increases the initial itemized deduction and the annuity rate.

Special Situations Tangible Personal Property
To be tax-deductible for its appraised value, tangible personal property must be long-term capital gain property, usable and used by the organization in a way that is related to its purpose. Otherwise the gift is deductible only for the lower of its fair market value or cost basis. The related use requirement does not apply to charitable bequests.

Potential benefits to the donor include the elimination of special insurance coverage for items in the home and a reduction of a taxable estate. If the items would otherwise be sold, donating them avoids the high commissions charged by auction houses or low prices paid by dealers compared to fair market value.

From the Files of
J. Richard Murray, charitable gift planner and life insurance agent
Daytona Beach, Florida

Do you ask people to buy life insurance to make charitable gifts? I have, to my dismay. A widow who bought a $100,000 life insurance policy from me to give to her church later wrote: "As each month goes by, I find it more difficult to eat or sleep. I am afraid to go near my church because I know everyone there is waiting for me to die. Cancel my policy."

A more marketable alternative is the use of a wealth replacement trust (I call it the "gift replacement trust") funded with life insurance. When Roy and Mary W. set up such a trust, their aim was to replace a major charitable gift with an equal or larger gift for their children. They funded their gift replacement trust with annual gifts generated, for the most part, by the income tax savings and increased spendable income they received from their charitable remainder unitrust gift to their church.

The trustee of the gift replacement trust used these annual gifts to pay the premiums on a second-to-die life insurance policy with the children as beneficiaries. Because it was properly designed and is properly maintained, this trust will distribute its large life insurance proceeds, estate-tax free, to the children. Just one premium payment guarantees the heirs their full inheritance if the parents die immediately after the trust is funded.

Promoting the use of life insurance to replace charitable gifts is an excellent way to encourage charitable giving by parents who fear such giving will deprive their heirs.

Please contact Mary Ludwig, Development Director at 712-732-5127, for more information.

The information on this site is not intended as legal, tax or investment advice. For such advice, please consult an attorney, tax professional or investment professional.

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