Spring 2019 Archive
Life insurance offers opportunities for making larger charitable gifts than might otherwise be possible. Here are several options, along with their tax benefits:
- Charity can be named the death beneficiary (or contingent beneficiary) of a policy. The gift is revocable, so no income tax deduction is available, but there is an estate tax deduction for amounts passing to charity if the estate is subject to tax.
- An outright gift of a policy that is no longer needed for family security yields an income tax deduction. If the policy is paid up, the deduction generally is the replacement cost—the cost of a single-premium policy for a person the donor’s age. For a whole-life policy that is not paid up, the deduction is the interpolated terminal reserve value, plus any unearned premiums. Deductions are limited to the lesser of the policy’s fair market value or the donor’s cost basis. Annual gifts to charity to cover premium costs result in additional charitable deductions.
- Employees are taxed on the premiums for group term life insurance coverage in excess of $50,000 [Code §79(a)]. If charity is the sole beneficiary of the excess coverage for the entire year, the value of the premium is removed from gross income [Reg. §1.79-2(c)(3)], although there is no charitable deduction.
- Life insurance can “replace” the value of assets given to charity. For example, a donor who creates a charitable remainder trust could fund an irrevocable life insurance trust and, through the use of the $15,000 annual exclusion and Crummey powers, avoid gift and estate tax on proceeds passing to family members.
It’s simple for a client who owns 100 shares of stock and wishes to give half to charity to transfer 50 shares. But what options are available for a client who wants to transfer less than 100% of an asset such as a home? A bargain sale may be the answer.
For example, consider a client who decides it’s time to sell a $250,000 vacation home originally purchased for $50,000. The gain isn’t sheltered by the $250,000/$500,000 exclusion for principal residences [Code §121]. But if the home is sold to charity for $150,000, the donor is entitled to a $100,000 charitable deduction, and a portion of the basis is allocated to the charitable gift [Code §1011(b)], thereby reducing the capital gains tax bill. Charity can sell the home for $250,000, keeping the $100,000 difference.
There are several ways donors can make inter vivos charitable gifts and enjoy immediate income tax charitable deductions, without visibly parting with any assets.
Remainder interest in home or farm—A donor who places a home or farm land into a charitable remainder trust is prohibited by the self-dealing rules [Code §4941(d)] from continuing to use the property, even if fair market rent is paid. But the donor can have the property eventually pass to charity, receive an immediate income tax charitable deduction and continue to use the property by deeding a home or farm to charity and retaining a life estate—a gift of a remainder interest, not in trust [Code §2055(d)(2)]. The donor can continue living in the home or rent it out and receive income. If the home is sold prior to the donor’s death, the proceeds are divided between the donor and the charitable remainderman, with each receiving the actuarial value of their interests.
Gifts for conservation, open space—The owner of property with significant historical or ecological features may make a gift to charity of an irrevocable easement in perpetuity and receive an income tax deduction while continuing to use the property for specified purposes [Code §§170(f), 170(h)]. If sold, the property is subject to the conditions of the easement, which may restrict the uses to which the land may be put or the alteration of structures on the property. The deduction is equal to the difference between the value of the property without the easement and the reduced value with the easement.
Undivided interests in property—A property owner can give charity an undivided interest (e.g., 25%), entitling charity to use the property for a portion of each year [Code §170(f)(3)(B)(ii)]. The donor is entitled to a deduction equal to the proportion of the interest, although some discounts might apply. When the property is eventually sold, charity is entitled to its proportionate share of the sale price.
A charitable remainder trust—even a one-life trust—will not qualify under Code §664 if the income beneficiary is too young. Under Code §§664(d)(1)(D) and 664(d)(2)(D), the value of charity’s remainder interest must be at least 10% of the value of the amount transferred. Low §7520 rates make it even more difficult to meet the 10% threshold. For example, the youngest age for an income beneficiary for a 5% charitable remainder unitrust is 27 years, assuming quarterly payments and the use of May’s 2.8% §7520 rate. For a charitable remainder annuity trust, which is also subject to the 5% probability test [Rev. Rul. 77-374], the minimum age is 69. Adding income beneficiaries increases the minimum ages for both unitrusts and annuity trusts to qualify.
Consider a grandfather who plans to transfer $300,000 to establish a 5% charitable remainder unitrust to benefit his three grandchildren, ages 28, 32 and 36. The value of charity’s remainder interest would be $17,946 and the trust would not qualify. If the grandfather instead created three trusts, funding each with $100,000, he would have the following deductions:
All three trusts satisfy the 10% test and the total deductions—$38,379—are more than double what the grandfather could have received with a single trust, even assuming it qualified. There are drawbacks to creating multiple trusts, however. The fees associated with creating and managing the trusts may be more, and small trusts may not be economically feasible, although if the trusts share the same trustee, it might be possible to commingle the funds to achieve a better overall return. In addition, as each grandchild dies, his or her trust will end, instead of continuing for the lives of the others.
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