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Charitable Giving
 
Gifts to qualified charitable organizations not only enhance the public good by furthering the benefit of the general population but also can give rise to income and estate tax benefits. There is a multitude of ways of giving to charity, both outright and in trust. The size and timing of the charitable deduction are determined by the structure of the gift, the nature, value and income tax basis of the gifted property and the identity of the charitable recipient. A charitable beneficiary can be a public charity or a private foundation. The following is a brief overview of some common ways of structuring charitable giving and the tax consequences.

Public Charities vs. Private Foundations

Public Charities are organizations which fall into one of the categories delineated in the Internal Revenue Code. These include churches, certain educational organizations, certain hospital and medical research organizations, University Endowment Funds, Governmental Units and charitable organizations that are publically supported.

A Private Foundation is basically a qualified charitable organization, other than a public charity. To be qualified the private foundation must meet the tests of being a charitable organization and must be administered in compliance with the Internal Revenue Code and the regulations thereunder. There are restrictions on transactions with disqualified persons and there are mandatory distributions to qualified public charities, which are required in order to continue the private foundation’s qualified status.

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Outright Gifts

Public Charities

Contributions of appreciated stock that would produce a long-term capital gain were it sold by the transferor, gives rise to an income tax deduction equal to the full fair market value of the stock, with no income tax on the appreciation. Contributions of appreciated stock that would produce ordinary income or a short-term capital gain were it sold by the transferor, gives rise to an income tax deduction equal to the cost basis of the stock, with no income tax on the appreciation.

There is a limit on the extent that such an income tax deduction can be utilized. Contributions of appreciated stock to a public charity are deductible up to thirty (30%) percent of the transferor’s “contribution base.” A transferor’s “contribution base” is his adjusted gross income without regard to net operating losses carried back to the current taxable year. Any deduction which is in excess of the contribution base limitations can be carried forward for five (5) years.

Private Foundations

Contributions of appreciated stock to a private foundation gives rise to an income tax deduction equal to the cost basis of the stock, with no income tax on the appreciation.

There is a limit on the extent that such an income tax deduction can be utilized. Contributions of appreciated stock to a private foundation (other than pass-through foundations) are deductible up to twenty (20%) percent of the transferor’s “contribution base.”

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Gifts in Trust

There are several types of trusts which are qualified under the Internal Revenue Code so that all or some portion of the value of the property transferred to the trust qualifies for a charitable deduction for income or estate tax purposes. These trusts may be created while the transferor is living (an intervivos trust) or on the death of the transferor (by Will or under a revocable trust).

Charitable Remainder Annuity Trust (CRAT)

A charitable remainder annuity trust is established by a gift of cash or property to an irrevocable trust. The trust consists of two portions (1) the non-charitable beneficiary's annuity (nondeductible) and (2) the value of the charitable remainder interest (deductible). The transferor (or another non-charitable beneficiary) retains an annuity (fixed payments of principal and interest) from the trust for a specified number of years or for the life or lives of the non-charitable beneficiaries. At the end of the term, the qualified charity specified in the trust document receives the property in the trust and any appreciation.

Gifts made to a charitable remainder annuity trust qualify for income and gift tax charitable deductions (or in some cases an estate tax charitable deduction). A charitable deduction is permitted for the remainder interest gift only if the trust meets certain criteria. A trust qualifies as a charitable remainder annuity trust if the following conditions are met: (a) The trust pays a specified annuity to at least one non-charitable beneficiary who is living when the trust is created; (b) The amount paid, as an annuity, must be at least 5%, but less than 50% of the initial net fair market value of the property placed in the trust; (c) The charity's interest at inception also must be worth at least 10% of the value transferred to the trust; (d) The annuity is payable each year for a specified number of years(no more than 20)or for the life or lives of the non-charitable beneficiaries; (e) No annuity is paid to anyone other than the specified non-charitable beneficiary and a qualified charitable organization; (f) When the specified term ends, the remainder interest is transferred to a qualified charity or is retained by the trust for the use of the qualified charity.

The Internal Revenue Service has ruled that a trust is not a CRAT if there is a greater than 5% chance that the trust fund will be exhausted before the trust ends.

The annuity paid must be a specified amount expressed in terms of a dollar amount or a fraction or a percentage of the initial fair market value of the property contributed to the trust.

The transferor will receive an income tax deduction for the present value of the remainder interest that will ultimately pass to the qualified charity. The Regulations determine this amount which is essentially calculated by subtracting the present value of the annuity from the fair market value of the property or cash placed in the trust. The balance is the amount that the grantor can deduct when the grantor contributes the property to the trust.

Charitable Remainder Unitrust (CRUT)

A charitable remainder unitrust is established by a transferor transferring cash or property to an irrevocable trust while retaining (either for himself or for one or more non-charitable beneficiaries) a variable annuity (payments that can vary in amount, but are a fixed percentage) from that trust. At the end of a specified term, or upon the death of the beneficiary the remainder interest in the property passes to the charity the transferor has specified.

The principal difference between a CRUT and a CRAT is that a CRUT pays a varying annuity. In other words, the amount paid is likely to change each year. The amount payable is based on annual fluctuations in the value of the trust's property. As it goes up, so does the annuity paid each year. If it drops in value, so will the annuity. A gift to a CRUT will qualify for income and gift tax charitable deductions (or an estate tax charitable deduction) only if the following conditions are met: (a) A fixed percentage (not less than 5% nor more than 50%) of the net fair market value of the assets is paid to one or more non-charitable beneficiaries who are living when the unitrust is established; (b) The charity's actuarial interest must be at least 10% of any assets transferred to the trust; (c) The unitrust assets must be revalued each year, and the fixed percentage amount must be paid at least once a year for the term of the trust, which must be a fixed period of 20 years or less, or must be until the death of the non-charitable beneficiaries, all of whom must be living at the beginning of the trust; (d) No sum can be paid except the fixed percentage during the term of the trust; (e) At the end of the term of the trust, the entire balance of the trust's assets must be paid to one or more qualified charities.

The transferor receives an immediate income tax deduction for the present value of the remainder interest that will pass to the charity at the end of the term.

A CRUT is exempt from federal income tax (the income and gains of the trust are only taxed when they are distributed to the non-charitable beneficiaries as part of the fixed percentage of trust assets distributed each year). Accordingly, CRUTs are frequently used to defer income tax on gains about to be realized. For example, if a transferor has an appreciated asset that is about to be sold, the transferor can give the asset to a charitable remainder unitrust, reserving the right to received a fixed percentage of the value of the trust for life (and even for the life of the transferor's spouse as well) and the asset can then be sold by the trust and the proceeds of sale reinvested without payment of any federal income tax on capital gains. The capital gains will be taxable to the transferor (or the transferor's spouse) only as they are distributed to the transferor as part of the annual distributions from the trust.

A variation of the CRUT (which pays a fixed percentage of the value of the trust assets, regardless of income) is the net-income-with-makeup charitable remainder unitrust, or "NIMCRUT," which pays either the fixed percentage or the income actually received by the trust, whichever is less. However, if the income is less than the fixed percentage, the deficiency can be paid in a future year, as soon as the trust has income, which exceeds the fixed percentage.

Another variation of the CRUT is a "flip" unitrust, which is a trust that changes from a NIMCRUT to a regular CRUT upon the occurrence of a specific event, such as the sale of a specific asset that was contributed to the trust and was not expected to produce much income.

Both NIMCRUTs and "flip" CRUTs are valued in the same way as a regular CRUT for the purpose of determining the income, estate, and gift tax charitable deduction.

Charitable Lead Annuity Trust (CLAT)

In a CLAT cash or other assets are transferred to an irrevocable trust. A charity receives fixed annuity (principal and interest) payments from the trust for the number of years specified in the trust. At the end of that term, assets in the trust are transferred to the non-charitable remainder person (or persons) specified when the trust is established. Usually, this person is a family member, such as a child or grandchild. A CLAT can be set up during the transferor’s lifetime or at death. Both corporations and individuals may establish CLATs.

A CLAT can be set up so that the transferor will receive an immediate income tax deduction. In the following years, the transferor would report the income earned by the trust even though it is actually paid to the charity in the form of an annuity. The advantage of this is the acceleration of the income tax deduction. This can be beneficial for someone having large income in the current year but who expects that in future years, his income will drop considerably. In this manner the transferor is spreading out the income (and the tax) over many years.

Another advantage of the CLAT is that it allows a "discounted" gift to family members. Under present law, the value of a gift is determined at the time the gift is made. The family member remainderman must wait for the charity's term to expire; therefore, the value of that remainderman's interest is discounted for the "time cost" of waiting. In other words, the cost of making a gift is lowered because the value of the gift is decreased by the value of the annuity interest donated to charity. When the assets in the trust are transferred to the remainderman, any appreciation on the value of the assets is free of either gift or estate taxation in the transferor’s estate.

If a CLAT is created at death through a Will, the present value of the charity's annuity stream is deductible for estate tax purposes. Since the transferor’s heirs don't pay estate taxes on the charity's portion, the money that otherwise would have been paid in estate taxes can instead be invested. During the term of that trust, increased investment income can help pay for the fixed annuity promised to the charity. The surplus income can be compounded for the transferor’s heirs (or other designated beneficiaries) and pass to them - gift tax free - when the trust ends.

Charitable Lead Unitrust (CLUT)

When a term-of-years CLUT is established, a transferor transfers cash or other assets to an irrevocable trust. A designated charity receives variable annuity payments from the trust for the term of years as specified in the trust agreement. That means each year the value of the trust's assets is re-determined. Although the charity will continue to receive the same percentage of the trust's assets each year, as the total value increases, the charity receives more. If the value of the trust's assets falls, the charity will receive less. When the trust ends, assets in the trust will pass to the non-charitable remainder beneficiaries. A CLUT can be created during lifetime or at death as a form of bequest under a Will or Revocable Trust. Both corporations and individuals may establish lead trusts.

Like a CLAT, a CLUT can be established so that the transferor will receive an immediate income tax deduction and in following years, the transferor reports the income earned by the trust even though it is actually paid to the charity in the form of an annuity.

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