by Jonathan Curry
A long-overlooked charitable giving tax planning technique is getting renewed attention amid growing concern over the direction of the economy and the recent decline in charitable giving overall.
“I was in the school of estate planners who had probably dismissed charitable gift annuities as a sort of poor man’s charitable remainder trust,” said Alan F. Rothschild Jr. of Page, Scrantom, Sprouse, Tucker & Ford PC.
“But I realized that other planners and many charities find that gift annuities can be very attractive tools for our clients’ charitable planning goals,” he continued, speaking on a September 12 American Law Institute webinar.
Charitable giving declined in 2018 for the first time in several years despite a strong economy, noted Michele A. W. McKinnon of McGuireWoods LLP. A strong economy should have correlated with strong giving, but some of the changes wrought by the Tax Cuts and Jobs Act, particularly the increased standard deduction, reduced the incentive to give, she said.
Now, the uncertainty around whether those temporary provisions are going to stick around, as well as about the direction of the economy, is hurting giving, she said.
Charitable giving dropped during the last recession and “the fears of 2008 still linger,” McKinnon said. “Many people just weren’t comfortable letting go of assets, there was so much uncertainty,” she added.
A Solution
Charitable gift annuities may not be a flashy tax planning technique, but they’re an attractive opportunity for many charitably minded taxpayers. “Most of my clients are rather conservative folks,” Rothschild said. “Simpler is better, and certainty is better than uncertainty, and charitable gift annuities are a rather simple and straightforward arrangement.” Rothschild explained that in the standard charitable gift annuity arrangement, a donor transfers assets to the charity of his choice in exchange for annuity payments from the charity over the remainder of his lifetime. The donor is then entitled to an immediate charitable deduction equal to the difference between the fair market value of the property that was given beyond the actuarial value of the stream of income the donor agreed to receive. Some of the donor’s annuity income is taxed as ordinary income, while some is exempt from tax.
That technique is fairly inexpensive to draw up and easier for a client to understand than some other complex charitable giving structures, Rothschild said. But it’s also attractive during times of economic uncertainty with low interest rates because “the promise by the charity of a fixed payment for life is probably something that’s very appealing to more clients than I know,” he said.
Charitable gift annuities might not seem like the ideal vehicle for charitable giving at first, given that the IRS section 7520 rate is low, which in turn negatively affects the charitable deduction that the donor would receive, Rothschild observed.
Nevertheless, the low section 7520 rate has an “interesting effect” on the income tax side, he continued. The low rates increase the exclusion ratio, which determines how much of the annuity payment is going to be taxable to the donor, he explained.
“I think many of our clients would be much more attracted by the higher exclusion ratio than they would be by concern about the amount of their charitable deduction,” he said.
The technique isn’t without some risk, though. Rothschild said attorneys and clients need to do due diligence to ensure the charity will remain solvent so it will be able to make those annuity payments for the duration of the term.
“They might want to think hard about whether the charity that they care about has the fiscal responsibility and track record to honor their long term — hopefully long-term — commitment to the donor,” he said.
Charitable gift annuities may not be a flashy tax planning technique, but they’re an attractive opportunity for many charitably minded taxpayers.
“Most of my clients are rather conservative folks,” Rothschild said. “Simpler is better, and certainty is better than uncertainty, and charitable gift annuities are a rather simple and straightforward arrangement.” Rothschild explained that in the standard charitable gift annuity arrangement, a donor transfers assets to the charity of his choice in exchange for annuity payments from the charity over the remainder of his lifetime. The donor is then entitled to an immediate charitable deduction equal to the difference between the fair market value of the property that was given beyond the actuarial value of the stream of income the donor agreed to receive. Some of the donor’s annuity income is taxed as ordinary income, while some is exempt from tax.
That technique is fairly inexpensive to draw up and easier for a client to understand than some other complex charitable giving structures, Rothschild said. But it’s also attractive during times of economic uncertainty with low interest rates because “the promise by the charity of a fixed payment for life is probably something that’s very appealing to more clients than I know,” he said.
Charitable gift annuities might not seem like the ideal vehicle for charitable giving at first, given that the IRS section 7520 rate is low, which in turn negatively affects the charitable deduction that the donor would receive, Rothschild observed.
Nevertheless, the low section 7520 rate has an “interesting effect” on the income tax side, he continued. The low rates increase the exclusion ratio, which determines how much of the annuity payment is going to be taxable to the donor, he explained.
“I think many of our clients would be much more attracted by the higher exclusion ratio than they would be by concern about the amount of their charitable deduction,” he said.
The technique isn’t without some risk, though. Rothschild said attorneys and clients need to do due diligence to ensure the charity will remain solvent so it will be able to make those annuity payments for the duration of the term.
“They might want to think hard about whether the charity that they care about has the fiscal responsibility and track record to honor their long term — hopefully long-term — commitment to the donor,” he said.
Let’s Get Creative
Charitable gift annuities can be structured in many different ways to benefit both the taxpayer and the charity.
Rothschild said they can be used to make gifts of a property that isn’t suitable for a charitable remainder trust, like gifts of artwork. They can also be used as a retirement vehicle for the donor by providing a fixed stream of payments, which could be ideal for risk-averse donors, or as testamentary gifts in which the annuity payment is received by someone other than the donor.
One type of charitable gift annuity that’s getting increased attention is a gift of a remainder interest in a personal residence or a farm.
“It’s one technique that I think we generally overlook, but in this age of clients without sufficient cash and more aggressive advancement officers, I’m finding more and more charities suggesting this idea to clients,” Rothschild said.
Generally, charitable deduction rules disallow the deduction for the gift of a partial interest, but this is one exception, according to Rothschild.
“What I think is particularly attractive about this technique is that for clients who consider doing it, it really has little impact on their lives or their other, more liquid assets,” he said.
With a farm, for example, the taxpayer doesn’t have to contribute the entire farm to charity.
Instead, the taxpayer could gift a portion of the farm to charity and retain a remainder interest, keeping the other part of the property in the family.
As for a personal residence, Rothschild shared an example of some clients who were retired college professors without children and who wanted to give back to the college. After being presented with the option of gifting a remainder interest in their home to the college, “they realized this was perfect for them: They could give the college remainder interest in their home, continue to live there for the rest of their respective lives, it really wouldn’t change anything for them, and they got a nice charitable deduction,” he said.
This technique is also timely: Remainder interest gifts are enhanced by the present low- interest-rate environment, and in general real estate market prices are fairly high, Rothschild said.
McKinnon confirmed that she’s also seen a renewed focus on charitable gifts of remainder interests in personal homes. One example involved a client who was a board member of an organization and had made a charitable commitment, but was having trouble coming up with a way to satisfy the commitment without it affecting his lifestyle. The remainder interest gift technique presented a solution in that case, McKinnon said. “I hadn’t seen many for a while, and all of a sudden it’s popped back up,” she added.
This article was written by Jonathan Curry and originally published by Tax Notes. To learn more about the author and Tax Notes, please visit taxnotes.com.