Tax Strategies for Charitable Giving

Transcription

1 Tax Strategies for Charitable Giving Presented by Cassady V. Brewer Morris, Manning & Martin, LLP The author gratefully acknowledges Stephanie B. Casteel of King & Spalding for contributing significant portions of this presentation.

2 Charitable Giving: Why? In general, Americans are generous. In 2007, a record year, Americans gave $314 billion to charity. Even in 2008, during a severe recession, Americans gave $ billion. Source: Giving USA Foundation ( 2

3 Charitable Giving: Why? In general, Americans are rich. For example, in 2006, individuals with a net worth of $61,000 in assets were in the top 10% in terms of global household wealth. 1 billion people in the world live on less than $1 per day, while the average working American lives on $97 per day. 6.8 million teenagers in America have their own car while 92% of the world s population do not own a car. Source: UNU-WIDER Study, December 2006 ( 3

4 Charitable Giving: Why? W.K. Vanderbilt (heir to Commodore Cornelius Vanderbilt): inherited wealth... is as certain a death to ambition as cocaine is to morality. The Dalai Lama: The impermanence of this present life will force you to leave all wealth behind, but by giving it away, you can take it with you as good karma. Warren Buffett: I want to give my kids enough so that they feel that they can do anything, but not so much that they can do nothing. 4

5 Charitable Giving: Tax Rules As we all know, there are tax benefits as well. To take full advantage of these tax benefits, though, one must understand and apply two separate tax regimes under the IRC: the transfer (estate and gift) tax and the income tax. These two separate tax regimes have very different rules that govern charitable contributions. Note that this presentation focuses on charitable contributions by individuals, not on contributions by corporations, trusts, or estates. 5

6 Charitable Giving: Transfer Tax Rules The transfer tax rules applicable to charitable contributions by individuals are found in IRC Sections 2055 (estate tax) and 2522 (gift tax) and contain no significant limitations on charitable contributions. For transfer tax purposes, then, a contribution of cash or property for public, charitable, or religious uses may be deducted in full to the extent of the value of the cash or property donated and thus will not be subject to the estate or gift tax. Further, the estate and gift rules generally permit deductible transfers to non-us charities. 6

7 Charitable Giving: Income Tax Rules The income tax rules applicable to charitable contributions by individuals are found in IRC Section 170. These rules are complicated and much more restrictive than the transfer tax rules. 7

8 Charitable Giving: Income Tax Rules In particular, the amount of a charitable contribution deduction under IRC Section 170 will depend upon several factors such as: The type of charitable donee (i.e., public charity versus private foundation). Whether the contribution consists of cash or property. If property is contributed, (i) whether it is real property or tangible or intangible personal property and (ii) whether it is long-term capital gain property or ordinary income property. Unlike the transfer tax rules, no deduction is permitted for contributions to non-us charities. 8

9 Charitable Giving: Income Tax Matrix Type of Contribution IRC Section 170 US Public Charity Most US Private Foundations Cash Deduction = Amount of cash contributed up to 50% of AGI. Deduction = Amount of cash contributed up to 30% of AGI. Property *Tangible personal property = FMV only if used by charity (e.g., art for art museum). **Qualified appreciated securities = full FMV credit, but not more than 10% of corp. Deduction = FMV of LTCG property* up to 30% of AGI; otherwise, basis. Deduction = Lower of basis or FMV up to 20% of AGI.** 9

10 Charitable Giving: Income Tax Rules A number of other qualifications and limitations apply. These include rules relating to the timing and substantiation of charitable deductions. S corporation stock is subject to certain special rules. Further rules govern receipt of property or services in return for a charitable contribution (e.g., the charity banquet) and bargain sales (e.g., contributions of property subject to debt). Some, but not all, of these special rules are discussed later in this presentation. 10

11 Charitable Giving: Techniques Outright Gift IRA or Qualified Plan Beneficiary Designation Insurance Charitable Gift Annuity Charitable Remainder Trust Charitable Lead Trust Donor Advised Fund Supporting Organization Private Foundation 11

12 Outright Gift Donor does not need income. Donor wishes to benefit charity now. Donor wants optimal charitable income tax deduction. Donor does not want control over transferred assets. Donor likes simplicity. 12

13 IRA or Qualified Plan Beneficiary Designation Donor wants to optimize savings of income and estate tax. Donor wants to optimize dollars for charity. Donor wants simplicity. Donor wants to make a deferred gift (i.e., at death). 13

14 Lifetime IRA Gift Tax-free lifetime rollover to public charity (not supporting organization). Direct gift only. Up to $100,000 per individual per year. Donor must be at least 70 ½ years of age. Expires at end of 2009, but likely will be extended (again). 14

15 Insurance Donor wants to optimize savings of estate tax. Donor wants simplicity. Donor has paid-up policy. Note: There is no legal or tax reason the policy must be paid up, but some charities will not accept policies unless they are paid up. Under current law, though, the amount of the income tax deduction is not entirely clear. 15

16 Charitable Gift Annuity Donor Property Lifetime Annuity St. Charity Mary s A contract, not a trust. Charitable deduction for gift is reduced by present value of annuity. Annuity may be structured for lives of two individuals. Start of payment may be deferred. Fixed income payment backed by all of charity s assets and is not determined by donated asset s performance. May be more attractive for donors of smaller gifts. But remember that charities can declare bankruptcy too. 16

17 Charitable Gift Annuity Donor wants simplicity. Donor desires fixed income payment. Donor wishes to benefit no more than one other individual. Donor has cash or appreciated securities or real estate. Donor wants payments secured by charity s assets. Donor wishes to make smaller gift. 17

18 Charitable Remainder Trust Stock Donor Charitable Remainder Trust Remainder Charity Income Stream 18

19 Basic Characteristics of a CRT The income stream must be structured as either an annuity based upon the initial fair market value of the property contributed to the trust or a unitrust interest, based upon a fixed percentage of the trust s annual fair market value. The payment to the income beneficiaries must be between 5% and 50%, but the projected value of the remainder passing to charity must equal at least 10% of the trust s initial fair market value. The income stream may be paid over the lifetime of an individual(s) or for a term not to exceed twenty years. 19

20 Basic Characteristics of a CRT The value of the income interest is a taxable gift only if the donor names persons other than himself and/or his spouse as the income beneficiary. If the donor names another person as the income beneficiary, the value of the gift is the present value of the income stream. No limit to number of other beneficiaries. The value of the CRT is excluded from the donor s estate, and the remainder passes to the charity tax-free. 20

21 Basic Characteristics of a CRT Trust may be structured to flip from net-income trust to unitrust upon occurrence of pre-defined event, such as sale of real estate. Usually funded with greater value. 21

22 Charitable Remainder Trust Donor does not mind delaying gift to charity. Donor desires income stream. Donor has cash or appreciated securities or real estate. Donor may want multiple income recipients. Donor wants to select payout rate. Donor wants to select trustee. Donor wants payout determined by trust s assets only. Donor does not mind more complexity. 22

23 Charitable Lead Trust Donor Cash or Securities CLT Remainder Noncharitable Beneficiaries Income Stream Charity 23

24 Basic Characteristics of a CLT Annual annuity or unitrust payment for term of years or for lives of designated family members to charity. No minimum or maximum payout requirements, unlike charitable remainder trust. Payment comes from principal to the extent income is insufficient. At end of trust term, remainder passes to individual beneficiaries gift/estate tax free. 24

25 Basic Characteristics of a CLT No income tax charitable deduction, and trust is taxable (structured as non-grantor trust). Gift or estate tax deduction for present value of interest given to charity. Gift at creation of trust only of present value of projected remainder interest. CLT property and post-gift appreciation excluded from donor s estate. Actual remainder interest not subject to gift or estate tax. 25

26 Charitable Lead Trust Donor is wealthy. Donor does not need income. Donor wishes to benefit charity now. Donor wants to pass wealth to descendants. Descendants already are provided for. Donor does not want charitable income tax deduction. 26

27 Donor Advised Fund Donor wants simplicity in grant making. Donor wants advisory role. Donor desires more simplicity. Donor wants higher charitable deduction income limitations. Donor wishes to support multiple charities. Donor may wish to support a donor-controlled charity (which he/she may do as long as charity is not a supporting organization). 27

28 Donor Advised Fund Donor either does not wish to make foreign grants or sponsoring charity agrees to exercise expenditure responsibility. Donor does not wish to contribute interests in operating business ( excess business holdings rules apply). Donor does not wish to be compensated or have his/her expenses reimbursed (DAF may not make payment to a donor or advisor or to family members of a donor or advisor or to a business in which a donor or advisor has a substantial interest). 28

29 Supporting Organization Donor wants to maintain more control. Donor wishes to benefit a limited number of charities. Donor wants higher charitable deduction income limitations. Donor does not mind complexity. Donor is wealthy. Generally, supporting organizations ( SOs ) are useful only for ultra-wealthy clients interested in control and advanced tax planning and are not practical for most donors. 29

30 Type I Supporting Organization Donor has least amount of control. SO may support charities in a class defined by type or geographic area. SO may support foreign charities. SO may be impractical for non-income producing property. 30

31 Type I Supporting Organization A donor may not control, directly or indirectly, a supported organization or be a relative of a person who controls, directly or indirectly, a supported organization. Donors generally do not use this type of SO; charities do. 31

32 Type II Supporting Organization Donor has least amount of control. SO may support foreign charities. SO may be impractical for non-income producing property. SO may not hold excess business holdings if it accepts contributions from a person (other than a public charity that is not a supporting organization) who controls, either alone or with family members and/or certain controlled entities, the governing body of a supported organization. 32

33 Type II Supporting Organization SO may not make payment to a substantial contributor or a family member or controlled business of a substantial contributor. SO may support a charity controlled by the donor. Donors generally do not use this type of SO; charities may. 33

34 Type III Non-functionally integrated Supporting Organization Donor may control. SO may not support foreign charities. SO may not hold excess business holdings. SO will be required to make annual minimum distributions. SO may not make payment to a substantial contributor or a family member or controlled business of a substantial contributor. 34

35 Type III Non-functionally integrated Supporting Organization A donor may not control, directly or indirectly, a supported organization or be a relative of a person who controls, directly or indirectly, a supported organization. Donors may use this type of SO; charities generally do not. This type of SO has been subject to much scrutiny and its use has been severely restricted since the PPA of

36 Type III Functionally integrated Supporting Organization Donor may control. SO may not support foreign charities. SO may be required to make annual minimum distributions. SO may not make payment to a substantial contributor or a family member or controlled business of a substantial contributor. 36

37 Type III Functionally integrated Supporting Organization A donor may not control, directly or indirectly, a supported organization or be a relative of a person who controls, directly or indirectly, a supported organization. Donors do not use this type of SO; charities may, but due to new restrictions generally do not use after the PPA of

38 Private Foundation Donor has maximum level of control. PF subject to private foundation rules. annual excise tax of 1-2% prohibition of certain transactions between it and certain disqualified persons prohibition of investment in certain jeopardizing investments annual minimum distribution requirement of 5% of fair market value of investment assets prohibition of owning excessive interests in a business enterprise also owned by certain disqualified persons requirement to exercise expenditure responsibility with regard to certain types of grants 38

39 Private Foundation Donor (and other disqualified persons) may be paid reasonable compensation and reimbursed for expenses. PF may support foreign charities (with grant expenditure responsibility). PF may be impractical for non-income producing property. If PF makes grant to non-functionally integrated Type III supporting organization, it will not be qualifying distribution for purposes of 5% minimum distribution. If PF makes grant to any type of supporting organization, it will not be a qualifying distribution if a disqualified person controls the supporting organization or any public charity supported by the supporting organization. 39

40 Charitable Giving: Three Factors to Consider THE ASSET: What is the type of asset that the donor wants to contribute? What is its fair market value? What are its tax attributes (basis, capital gain property, etc.) and deemed value for charitable deduction purposes? THE DONOR: Does the donor need income from the asset he/she wants to give? Does the donor want control over the gift? Can the donor tolerate complexity and/or ongoing legal and accounting compliance and fees? THE CHARITY: What is the nature of the charity (public charity or private foundation)? What does the charity want or need? 40

41 Asset Considerations Appreciated real estate and stock are good candidates for charitable contributions, especially lifetime contributions. Beware, however, that such assets must be LTCG property in order to be eligible for a deduction equal to the property s FMV. Under the right circumstances, assets that otherwise would be considered ordinary income may qualify for capital gains treatment. See, for example, Bruce A. Rice v. Comm r, T.C. Memo (Jun. 16, 2009), holding that the bulk sale of certain residential lots qualified for capital gain treatment. 41

42 Asset Considerations Generally, avoid property encumbered by debt as it may result in bargain sale treatment for the donor and/or UBIT to the charity. Remember that interests in partnerships and LLCs usually have allocated debt and thus ordinarily are not the best assets to contribute to charity. If the asset has depreciated (i.e., its tax basis exceeds its FMV) but the donor still desires to give the asset to charity, then (i) sell, (ii) recognize the loss, and (iii) contribute the cash proceeds. 42

43 Asset Considerations: Stock Appreciated corporate stock can be a great asset to contribute to charity, especially to a public charity. Note that stock contributed to a private foundation must be qualified appreciated securities and must not exceed 10% of the stock of the corporation to qualify for a FMV deduction. For contributions of stock to private foundations, the advisor must consider securities law restrictions as well. Rule 144 restrictions can make the stock unmarketable and thus defeat the FMV deduction private foundation may be an impermissible affiliate of the donor. 43

44 Asset Considerations: Stock Contributing closely-held stock to a public charity or to a charitable remainder trust prior to a sale or redemption of the stock can be a very effective technique. Consult Rev. Rul , though, to ensure that separate steps of (i) contribution to charity followed by (ii) sale or redemption of stock are respected for tax purposes. See also Palmer, Rauenhorst, and Ferguson cases. Further, if the transaction is a redemption involving a CRT or donor advised fund, compliance with the selfdealing rules (IRC Section 4941) is necessary. See PLRs and for guidelines. 44

45 Asset Considerations: Stock If your client has made the unfortunate mistake of contributing closely-held stock to his or her private foundation which ordinarily would permit deduction equal only to lower of FMV or basis then there is a possible solution. IRC Section 170(b)(1)(F) generally permits a donor to take a full FMV deduction if, not later than April 15 of the year following the donation, the recipient foundation distributes to a public charity an amount equal to the value of the contributed stock. Other requirements and limitations apply, but IRC Section 170(b)(1)(F) can be an effective remedy for an otherwise difficult situation. 45

46 Asset Considerations: Sub S Stock S corporation stock generally is not a good asset to contribute to charity for at least three reasons: Although it is possible for charities to own S corporation stock, some charitable techniques adversely impact subchapter S status CRTs cannot own S corporation stock and most CLTs would be problematic shareholders as well. The amount of any FMV charitable deduction for S corporation stock must be reduced by ordinary income inside the corporation that is attributable to the stock. S corporation stock generates UBIT to the charity, either via holding the stock or selling the stock. 46

47 Asset Considerations: Sub S Stock Better option for S corporations is for the corporation to make the contribution itself with the charitable deduction being allocated to the shareholders. PPA 2006 amendment prevents outside basis in S corporation stock from limiting the shareholder s allocable charitable deduction. This new provision expires at end of 2009, but is expected to be extended. Furthermore, charitable contribution of assets by an S corporation can avoid the built-in gains tax of IRC Section This technique also avoids the valuation discount that typically would apply to contributed stock. 47

48 Asset Considerations: Sub S Stock If the S corporation has multiple shareholders and each is interested in benefitting different charities, then the S corporation can make the contribution to a donor advised fund and the shareholders subsequently can direct distributions from the donor advised fund. If not all shareholders are charitably inclined, then as a practical matter any charitable planning should be done without involving the S corporation. 48

49 Asset Considerations: IRAs IRAs (non-roth) are subject to both income and estate tax, so they are terrific assets to leave to charity. Distributing IRA assets to charity during life should be undertaken only within the $100,000 per year exception noted above; otherwise, distribution is subject to income tax followed by charitable donation (which in turn may be subject to 50%/30% AGI limitations). Designation of charity as IRA beneficiary at death, though, avoids both income and estate tax. 49

50 Asset Considerations: IRAs In general, IRA beneficiary designation form should name the charity as the direct beneficiary. If possible, even where charity participates via an estate or trust, avoid naming the estate or trust as beneficiary of the charitable portion of any IRA. See GCM for how problems can arise. If donor wishes to benefit both children and the charity, then best practice is to divide the IRA into two (one for children and one for charity) and complete beneficiary designation forms accordingly. 50

51 Donor Considerations: Grant Making Foreign grants: Type I or Type II supporting organization or, if exercise expenditure responsibility, donor advised fund or private foundation. Funding with operating business interest: Type I or Type II supporting organization that does not accept contributions from certain control parties. Funding with non-income producing property: outright gift to public charity. 51

52 Donor Considerations: Grant Making Compensation to related persons: private foundation. Support of controlled charity: Type II supporting organization, private foundation (if donee charity is not a supporting organization), or donor advised fund (as long as donee charity is not a supporting organization). Control: private foundation or Type III supporting organization. 52

53 Donor Considerations: Planned Giving Vehicle Control: charitable remainder trust. Impacted capital gains: outright gift, charitable remainder trust, or gift annuity. Simplicity: gift annuity, outright gift, IRA, qualified plan or insurance policy beneficiary designation. Income: charitable remainder trust or gift annuity. Non-income producing property: charitable remainder trust, gift annuity, or outright gift. Gift tax leverage: charitable lead trust. 53

54 Donor Considerations: Planned Giving Vehicle Low interest rate environment: June 7520 rate was 2.8% (May 2.4%; July 3.4%). Future interests are worth more and present interests are worth less. Charitable lead annuity trust--decreases charitable deduction, but more likely to pay remainder to descendants. Charitable remainder annuity trust: more flexibility to use rate for month of gift or either of two previous months (but lower income stream because lower rate decreases value of income stream). Charitable remainder/lead unitrust: rate has no impact. 54

55 Charity Considerations As noted above, it is critical to consider the recipient charity (i.e., distinguishing among public charities, donor advised funds, private foundations, and supporting organizations) before recommending any particular charitable technique. From the donor s perspective, this is important for determining the correct AGI limitations as well as for determining whether contributions of property will be deductible at FMV. There are critical issues at stake for the charity as well. 55

56 Charity Considerations In general, charities will be concerned about the following: Disposing of the contributed asset as quickly as possible in order to generate cash. Avoiding receipt of an asset that eats [i.e., that generates UBIT, that creates a potential liability to the charity, or that otherwise requires additional funds to preserve its value (like life insurance)]. If necessary, consider using a single-member LLC to protect the charity from certain types of liability exposure (such as environmental liability from real estate). 56

57 Charity Considerations For example, the donor can contribute the asset to a single-member LLC, then donate the LLC interest to the charity. Because the single-member LLC is disregarded for income tax purposes, the transaction is treated for charitable deduction purposes as if the donor had contributed the asset itself to the charity. For state law purposes, however, if the LLC is organized and operated correctly it protects the charity from potential liability with respect to the underlying asset. This does not, though, protect the charity from UBIT. 57

58 Charity Considerations Remember that a donor advised fund can offer the tax benefits of public charity status while simultaneously offering control (albeit only tacit control) similar to a private foundation. Due to the restrictions on private foundations, donor advised funds can be especially useful when considering property contributions or when self-dealing or other special tax rules apply. Another option may be the use of a supporting organization, but recall that SOs generally are useful only for exceptionally wealthy donors willing to deal with a high level of complexity and a significant compliance burden. 58

59 Some Final Tips to Remember Do not forget compliance with the income tax deduction substantiation rules. Contributions of $250 or more require the donor to receive a contemporaneous written acknowledgment from the recipient charitable organization. Although it may seem silly, this literally requires a donor s own private foundation to provide the donor with a written acknowledgement of any contributions of $250 or more. Non-cash contributions require further compliance. See IRS Publication 1771 for more information. 59

60 Additional Resources Additional resources to consult: American Heart Association Matrix Georgia Planned Giving Council Leave a Legacy Georgia IRS Publication