Charitable Deduction Questions

WHAT ARE THE RULES REGARDING GIFTS TO CHARITY?

Congress has long recognized the need for public support of charitable religious organizations and has provided favorable tax treatment for gifts to organizations that the Internal Revenue Service determines to be qualified charities. Lifetime gifts to qualified charities are completely free of the federal gift tax without limit. Testamentary gifts are also deductible without limit in the computation of the federal estate (and state death) tax. Gifts of money and other property, within specified limitations (discussed below), are considered tax deductible for federal income tax purposes.


OTHER WAYS TO GIVE TO A CHARITY

There are nine major alternatives to making gifts to a charitable organization in trust:

1. Give cash (check or currency)
2. Give stock, bonds or real estate
3. Give tangible assets such as art, jewelry, antiques
4. Give business inventory or crops
5. Sell an asset to a charity at a bargain sale price
6. Gift through a partnership or limited liability company
7. Gift through your corporation
8. Leave property in your will
9. Use life insurance, in a variety of ways

The following are charitable deduction income tax rules with respect to each of these major alternatives to making charitable gifts in trust:


A GIFT OF CASH

You are allowed a current income tax deduction equal to 50 percent of your adjusted gross income for cash (including checks of course) you give to a school, synagogue, church, hospital or other publicly supported charity. If the total cash you give to charities in a given year exceeds that 50 percent limit, the excess is not wasted. The “excess” may be carried over for up to the next five years and used to reduce income taxes until you have used up your “carry-overs”.


GIFT OF STOCKS, BONDS OR REAL ESTATE

You are allowed a current income tax deduction of up to 30 percent of your adjusted gross income for a gift of appreciated securities or real estate. You can carry over any excess for up to five years. If you have held the asset for more than a year (so called “long term capital gain assets”), your deduction will be based on the full fair market value of the gift. Better yet, even if the property has appreciated substantially since you obtained it, you would not pay any tax on the built-in gain when you make your gift. At one time, the appreciation was considered a preference item subject to the Alternative Minimum Tax, but this AMT no longer applies.

There is even an election you can make that boosts your current deduction from 30 percent to 50 percent of your adjusted gross income - if you are willing to reduce the amount of the deduction by the amount of appreciation. If the appreciated securities or real estate you contribute are considered “short term” (held for 12 months or less), your deduction is limited to your “basis” (essentially, what you paid for the asset) rather than its fair market value. However, you can take a deduction for up to 50 percent of your adjusted gross income and still carry over any excess deduction for up to five years.


GIFTS OF TANGIBLE ASSETS

If you make a charitable gift of a tangible asset such as art, jewelry or antiques you have held for more than one year, your deduction depends on whether the property is “use related” or “use unrelated”. A property is “use related” if the property is to be used by the charity in its exempt function. The clearest example of a “use related” gift is where a Douglass Mellor fine art photograph is given to an art museum to be displayed to the public.

A property is “use unrelated” if the property is not used by the charity in its exempt function. For instance, if the same fine art Douglass Mellor photograph is given to the Philadelphia Museum of Art but it is then immediately sold by the Museum, the use is unrelated - even if the proceeds of the sale are then used by the Museum to purchase additional fine art photographs or paintings used in its exempt function.

An even clearer example of a use unrelated gift is where a Douglass Mellor photograph is given to the American College in Bryn Mawr, a qualified public charity, but not an institution whose exempt purpose pertains to the display of fine art.

You are allowed a deduction for the full fair market value for your gift of use related property. You can take that deduction in an amount of up to 30 percent of your adjusted gross income and carry over any excess for up to five years. If the property is not use related, your deduction is limited to your basis (cost) in the property. However, if this lower limit is imposed, you can currently deduct up an amount equal to 50 percent of your adjusted gross income, and you may carry over any excess for up to five years.

When you make a gift of tangible personal property, you have held for 12 months or less, your deduction - regardless of whether or not it is use related - is limited to your basis. The most you can deduct in any given year is 50 percent of your adjusted gross income, but you are allowed a five-year carry-over.


GIFT OF BUSINESS INVENTORY OR CROPS

Your deduction in any year is limited to 50 percent of your adjusted gross income - with a five-year carry-over of any excess - if you give “ordinary income” property. Ordinary income property is property that - had you sold it on the date of your charitable gift - would have yielded ordinary income rather than capital gain.

Examples are a business owner’s gift of inventory, a farmer’s gift of wheat crops, or an artist’s gift of artwork. There are limited exceptions allowing larger deductions if a corporation makes a gift of inventory.


SALE OF ASSET TO CHARITY AT BARGAIN SALE PRICE

You are allowed a deduction for the difference between the fair market value of a long term appreciated security or real estate you sell to a charity and its sales price. In essence, you are considered to have (a) sold part of the property and (b) made a gift of the other portion of the property. Therefore, if you sell property worth $100,000 to a charity for $10,000, your charitable contribution is $90,000.

Assume you bought the property for $10,000. That basis is allocated between the $90,000 gift portion and the $10,000 sale portion. Since you gave away 9/10s of the property, 9/10s of your basis must be allocated to that portion. Since you sold 1/10 of the property, $1,000 (the remaining 1/10th of your $10,000 basis) can be applied to reduce your gain on the sale. Your capital gain would therefore be $9,000 ($10,000 sale portion less $1,000 cost basis).

Note that a gift to charity of mortgaged property will be treated as a bargain sale. You will be treated as if you had sold the property for the amount of your mortgage.


GIFT THROUGH PARTNERSHIP OR LIMITED LIABILITY COMPANY

You can take a deduction for gifts to charity made by your partnership on your individual return. No charitable deduction is allowed, however, on your firm’s partnership return.


GIFT THROUGH YOUR CORPORATION

Your corporation can make a charitable gift and it obtains a deduction equal to up to 10 percent of its taxable income. Any excess may be carried over for up to five years.

If your corporation is on an accrual basis of accounting, you can deduct the gift on this year’s corporate tax return, even though the actual gift is not made until the following tax year, if (a) payment is made within two and a half months from the close of this tax year and (b) the gift is authorized by your Board of Directors.


LEAVE PROPERTY IN YOUR WILL

You may obtain a federal estate tax deduction for the entire fair market value of property you leave to charity in your will. There is no limit to the amount of this deduction. Conceivably, you could leave a charity $20,000,000 outright and pay no federal estate tax. In almost every state, you would also receive a charitable deduction for the same gift on your state inheritance tax return.


USE OF LIFE INSURANCE

Life insurance is an excellent tool for making charitable gifts for a number of reasons:

1. The death benefit is guaranteed as long as premiums are paid. This means that the charity will receive an amount that is fixed (or perhaps increasing) in value and not subject to the potential downside volatile market risks of securities.

2. Life insurance provides an “amplified” gift that enables you to “purchase immortality on the installment plan”. Through a relatively small annual cost (the premium), a significant benefit can be provided for the charity of your choice. This sizable gift can be made without impairing or diluting the control of a family business or other investments. Assets earmarked for your family can be kept intact.

3. Life insurance is a self-completing gift. If you live, cash values (that can be used currently by the charity for an emergency or opportunity) grow constantly year after year. If you become disabled, the policy will remain in full force through the “Waiver of Premium” feature. This guarantees the ultimate death benefit to the charity as well as the same cash values and dividend build-up that would have been earned had you not become disabled. Even if you were to die after only one deposit, the charity is assured of your full gift.

4. Death proceeds of life insurance can be received by your designated charity free of federal income and estate taxes, probate and administrative costs and delays, brokerage fees, or other transfer costs. Therefore, your charity receives 100 cents on the dollars. This prompt (and certain) payment should be compared with the payment of a gift to the same charity under your will.

5. Because of the contractual nature of the life insurance contract, large gifts to charity are not easily subject to attack by disgruntled heirs.

6. A substantial gift can be easily made with no attending publicity. On the other hand, your amplified gift should lead to “amplified honor” and public recognition if desired.


LIFE INSURANCE BENEFITS THE CHARITY IN MANY WAYS

1. Name a charity as the annual recipient of any dividends you receive from life insurance. As dividends are paid to the charity, you will receive a current income tax deduction.

2. Use dividends from an existing policy to purchase a new policy and name the charity the owner and beneficiary of the new policy. You will receive an income tax deduction for the premiums you have paid.

3. Name a charity as contingent (backup) beneficiary or final beneficiary under a life insurance policy protecting your dependents.

4. Name a charity as the beneficiary of life insurance you currently own or a new life insurance policy. Although this will not yield a current income tax deduction, it will result in a federal estate tax deduction for the full amount of the proceeds payable to charity - regardless of how large the policy.

5. Make an absolute assignment (gift) of a life insurance policy you currently own or donate a new life insurance policy.

This will yield a current income tax deduction. Your immediate deduction is equal to the lower of: (a) your cost (premiums paid less any dividends you have received) or (b) the policy value.

You will also receive a deduction for amounts you pay to the charity in future years to help the charity pay premiums. Send your check directly to the charity and have it pay the premiums. That way you will have proof of the date of your contribution and the amount of the gift and assure yourself of the largest possible deduction. In addition to the income tax deduction, the life insurance proceeds will be removed from your estate - thus saving estate taxes.

Note that neither deduction will be allowed unless you make the charity itself the owner and beneficiary of the entire policy. The income tax deduction will be lost if you try to keep the cash values and name the charity as beneficiary or if you give away the cash values but name a family member as beneficiary.

The charitable tax deduction can also be lost for both the contribution of the policy and subsequent premium payments if the charity has no insurable interest.

6. Group term life insurance can be used to meet charitable objectives. By naming a charity as the (revocable) beneficiary of your group term life insurance for coverage over $50,000, you can not only make a significant gift to charity but also avoid any income tax on the economic benefit. For example, a 63 year old executive with an average top tax bracket of 28 percent who had $140,000 of coverage would save $353.80 each year, 28 percent of the $1,263.60 annual “Table I cost” (the amount reportable as income).

The advantage of this technique was significantly enhanced by the introduction of higher group term rates for individuals over age 65 who receive group term insurance. Therefore, you save income taxes every year the charity is named as beneficiary. In a later year, if you change your mind, your beneficiary designation can be changed and a new charity or even a personal beneficiary named.


WHY DO PEOPLE USE TRUSTS FOR GIFTS TO CHARITY?

Many people wish to give a portion of their estates to a charity during their lifetime but want to reserve some sort of life income for themselves, their spouse, or someone else. For example, a woman may create a trust that provides that she will receive an income from the trust as long as she lives and that the principal of the trust will be paid over to a qualified public charity at her death.

She will be allowed a deduction for the present value of the charity’s remainder interest in the principal of the trust (valued at the time the gift was made to the trust). She will receive an income tax deduction for the difference between the value of the property she contributes and the value of the lifetime interest she keeps. In other words, the asset she transferred to a charitable trust must first be valued.

Government actuarial tables must be used to value the property (the income stream) kept or other non-charitable beneficiaries. The right to a life income is valued at the age at the time the gift was made and can be determined from IRS actuarial tables. The difference, if any, is the amount deductible - up to the limits discussed above. The charity gets only what is left, what remains of the property, when the interest ends. For this reason, planners call these trusts “charitable remainder” trusts. Charitable remainder gifts can be made in one of three ways:

· A charitable remainder annuity trust (CRAT)
· A charitable remainder unitrust (CRUT)
· A pooled income fund

Source: Tax Facts 2002, National Underwriter Company