Charitable Planning Through Economic Turmoil

Charitable Planning Through Economic Turmoil

Charitable Planning Through Economic Turmoil

By: Martin M. Shenkman, CPA, MBA, JD


Charities are hurting. The number of people served by charities is continuing to grow as a result of the economic conditions. Yet as these needs have grown, donors are struggling to continue even prior levels of support because of the declines in their wealth, pressure on or reduced income, or even job loss. While you cannot give what you don’t have, there has not been a time in decades when your contributions were more important. There are also creative ways to contribute to charity, even in tough times. If you have charitable trusts or plans in place, they need to be reviewed and perhaps modified to consider recent changes. The charities that carry out the good deeds that make life special, that make us human, need more help, not less. So how can you creatively donate during tough times? There are a myriad of ways, including the use of gift annuities and charitable remainder trusts for donors uncomfortable parting with any cash now. Although outright gifts are best for any charity, a deferred gift sure beats no gift.

I Feel Good

“I feel good” could be a hit song about giving to charity, especially now. “Generosity is exactly this: to give that which is dearest to us. It is an act that transforms us. After it, we will be poorer, but we will feel richer. Perhaps we will feel less equipped and secure, but we will be freer. We will have made the world we live in a little kinder.” Piero Ferrucci in his book, The Power of Kindness . Feeling blue about the Dow? Make a donation. In fact, increase your donation over last year and tell the charity to use your name as an example for other donors. You’ll do good and feel good. There are so many factors that are affecting your life that you cannot control — take charge of a positive one that you can control.

Charitable Giving Generally

If you have charitable intent, you may be reticent to act on that intent in light of your financial insecurity stemming from recent economic developments. Some donors may have made a general charitable commitment, but are loath to pay it currently. It may be possible to use deferred or planned gifts to address philanthropic goals and economic worries. None of the techniques or thoughts are new or complex, but they might just provide a listing of ideas to help you and other donors remain generous and help charities through what has been, and will likely be, a very tough fund raising period. The needs that charities have to fund are great, whereas their ability to raise those funds is undoubtedly hampered. Encourage others to continue or, if feasible, enhance charitable commitments during this economic downturn.

Cash Strapped – Give Stuff

If you’re feeling the impact of recession on your portfolio and cash reserves, join the movement to less conspicuous consumption by donating that Miro and Dali to your favorite charity. The rules get tricky, so be cautious:
  • For claimed contributions of more than $5,000, in addition to a contemporaneous written acknowledgment, a qualified appraisal generally is required. A qualified appraisal is defined in IRC Sec. 170(f)(11)(E)(i). Either Section A or Section B of Form 8283 (depending on the type of property contributed) must be completed and filed with the tax return on which you claim the deduction.
  • Is the art or collectible you donate used for the charity’s exempt purpose?
  • Example: You donate furniture to a shelter for abused women. You paid $10,000 for the antique furniture, but it is now worth $15,000. Since the furniture is used for the charity’s exempt purpose, your deduction is the full $15,000.
  • Example: You donated a statue to the shelter that is valued at $16,000, that has a tax basis of $8,000. The charity sold the statue and used the proceeds for the charity’s exempt purpose. Since the statue was not used for the charity's exempt purpose, your charitable deduction is limited to $8,000. You must still attach a qualified appraisal to your tax return.
  • Example: Assume the same facts as the preceding example, except your tax basis in the statute was only $4,800. Your deduction is limited to $4,800, but since this amount is less then $5,000, you don’t require a qualified appraisal to substantiate your deduction.
  • The appraisal must be completed not more than 60 days before your contribution of the art, and no later than the extended due date for the tax return on which you claim the deduction. If the deduction is claimed on an amended return, the appraisal must be received by the day the return is filed. Reg. 1.170A-13(c)(3)(iv)(B).

Charitable Bequests

If your net worth, or the economic status of your heirs, has been affected in a significant negative manner by the economy, you’ll need to reevaluate charitable bequests. If you have been charitable in prior years, you may be unable or uncomfortable continuing prior contributions this year. Perhaps instead of outright charitable gifts, you can add a bequest to your will, which you can revise if circumstances continue to deteriorate. If the charities that had been funded in the past are notified of the bequest, it will reconfirm your commitment as a donor. If the charity can add you as a planned giving donor, or if you were already on the list, add you as a higher category of planned giver, your actions will encourage others to continue to give. Review the size of your estate and the dollar figures of any charitable bequests to be certain that the significant changes in asset values have not undermined your goals. For example, if your estate was worth $5 million and you have four children, you may have been comfortable dividing your estate equally between your four children and a favorite charity. But if the decline in your IRA and home values reduced your estate to $3 million, you might prefer to leave it all to your children. Instead of cutting the charity out entirely, you could draft flexibly and distribute the first $4 million or less equally to your children, the next $1 million tier to charity, and then equally among your children and the charity above that threshold. This way, if asset values recover, your original goals will be met. If not, your children will still be protected. If you have a charitable bequest under your will, reevaluate it in light of the current status of your financial position and that of your heirs. Will the charitable bequest infringe on assets that are now needed for a surviving spouse or other heirs? Has a specific bequest that seemed of an appropriate amount when your will was drafted, seem disproportionately large now that your assets have been hammered or a child fired from his or her job? Perhaps the bequest can be scaled back to a smaller dollar figure or limited to a percentage (often tough to determine, especially if your estate has assets that are hard to value, such as interests in a closely held business), or perhaps it can be paid only after a specific pecuniary bequest is paid to your heirs. Sample Provision: I give, devise, and bequeath $250,000 to each child. My residuary estate shall be divided into equal shares, one equal share being distributed to each child and the XYZ charity.

Charitable Giving – During Economic Turmoil, Go For the Heart

At the heart of most charitable giving is your personal motivation to help a cause and goal you’re concerned about. Tax deductions, although important, are generally not a primary motivation. Charitable giving can be tailored to help the specific needs of a donor, or a donor’s loved one, when either has a chronic illness. When helping a particular person along with benefiting a cause important to you are combined, the personal gratification and benefits of charitable giving can outweigh the tax and financial rewards. When you, or a loved one, suffers from a chronic illness, commonly used charitable giving techniques can be tailored to address the needs of that specific person. An understanding of the particular chronic illness is crucial, although rarely addressed in professional literature. If your loved one has a chronic illness he or she will often feel powerless. Structuring a charitable gift, even if it does not make an immediate difference for the client’s loved one, will give you the feeling that you’re making a difference and doing something constructive to combat the illness affecting the chronically ill loved one. Typically a parent’s or sibling’s first reaction to a diagnosis is to wonder how they can help. Charitable giving, especially when the loved one with a chronic illness is also benefited, provides a concrete step. This can be far more important than any tax deduction. While many people will simply donate securities with no return other than a charitable deduction, for the donor with a chronic illness, more is often necessary; specifically, cash flow for living and medical costs. If a donor with a chronic illness sells appreciated securities, a capital gains tax will be incurred. The donor will then have to invest and manage the proceeds, which may not be practical or advisable as the chronic illness progresses. Instead, you can donate appreciated securities to a charity in exchange for a gift annuity. This can provide you with a charitable deduction, cash flow in the form of an annuity for the rest of your life and eliminate the need to manage the asset. If you are struggling with other demands and stresses of a particular chronic illness, having a portion of his portfolio converted to a tax advantaged annuity might be appropriate. Unlike a mere commercial annuity, a gift annuity can provide an important additional benefit by purchasing the annuity from a charitable organization that funds research into the very illness with which you are afflicted. For someone struggling with the powerlessness of a chronic illness, this can be very positive. However, the client should be cautioned as to how much can be committed to gift annuities since the principal cannot be accessed in the event of an emergency. A charitable lead trust (“CLT”) is a trust designed to benefit charity and at the same time provide a future gift to a chronically ill child at a substantially reduced gift tax cost. Upon establishing a CLT, the designated charity receives an annuity payment (the greater the percentage payment, the more substantial the tax benefit) for a specified number of years (the greater the number of years, the greater the tax benefit). After expiration of the specified time period, the assets in the trust will be distributed to the chronically ill child. When a child has a chronic illness, like Multiple Sclerosis, this provides a tremendous way to help fund research to find a cure for that illness, and then assure a safety net for the child’s financial future. It is a great way for the client to feel proactive in fighting their child’s disease. This approach may be viable for some chronic illnesses, but not for others. For example, a child with relapsing-remitting Multiple Sclerosis may have a relatively long work expectancy such that a charitable lead trust could be used over a long enough period to minimize gift tax, benefit a charity for MS research, and provide a financial safety net for the child. MS is typically diagnosed when the patient is in his or her 20s to 50s, which, depending on the type of MS, may permit this type of long term CLT planning. However, this approach may not be viable for a person diagnosed with Parkinson’s disease. Parkinson’s is typically found in older people and diagnosed in the age bracket from the 50s to 60s. Further, from initial diagnosis to the development of significant disability may be as short as 5-10 years. A client with Alzheimer’s is usually even older when diagnosed and the progression is even more rapid. Huntington's disease is a degenerative brain disorder that undermines an individual's ability to think, walk, and speak. Eventually, a person with Huntington’s disease becomes totally dependent upon others for care. If a CLT were used for a client with Huntington’s disease, the remainder interest should be paid to a trust for the child’s benefit as independent management may be essential. The CLT technique is even less useful for such a client. Thus, not only is planning for a client with a chronic illness somewhat different then planning for a client with no known illness, but planning for clients with different chronic illnesses can be materially different.

Charitable Giving – During Economic Turmoil, Get Funky

So you’re looking to attract the attention of donors, tell them about defined value clauses and charities. Becoming part of their overall estate plan will keep your charity’s name on the front burner. A prospective donor is structuring a substantial sale to a defective grantor dynasty trust (“IDIT”; “IDIGT”) and is concerned about possible valuation challenges in the event of an audit. The risk is that in an IDIT if the value is off there is no protection as in a GRAT. If the transfer documents limiting the sale to the IDIT to a fractional interest in the assets sold, keyed into the intended purchase price, the prospective donor would argue that they should be protected from gift tax even if appraisal or discounts are successfully challenged by the IRS. Similarly, a defined valuation clause may be an important tool to protect against retroactive tax law changes. If there is a retroactive change in the valuation method (e.g. a repeal of discounts) this type of clause might limit the amount of the transfer to avoid the prospective donor being exposed to gift tax because of a retroactive change in discounts. How does the defined value clause work? The excess of the gift as valued by the IRS on audit, over the defined value of the gift (the intended gift amount) passes as a result of the defined value clause to charity. See McCord and Christiansen cases. While IRS incentives to audit would be adversely effected, the charity’s interests should be protected by the state AG’s involvement and fiduciary duties of executor. The IRS has argued the rationale of the landmark decision in Commr. V. Procter, 4th Circuit 1944. Procter held that mechanisms that render an audit ineffectual won’t work if they create a condition subsequent. This creates a public policy problem since to enforce it renders the issue moot. Assignor hereby agrees to sell to Assignee a certain portion of the Assigned Interest calculated by the product of the Assigned Interest multiplied by a fraction the numerator of which is” (a) the Appraised Value plus (b) 1% of the excess, if any, of the Gift Tax Value over the Appraised Value, and the denominator of which is the Gift Tax Value. The Assigned Interest shall be allocated among the Assignees in the following order: That portion of the Assigned Interest having a fair market value as of the Effective Date equally to six million dollars to the Gift Trust. Any remaining portion of the Assigned interest shall go to Public Charity.

Charitable Gift Annuities for Those Reticent to Fund Current Gifts

You wanted to make a $10,000 donation, but are feeling the pinch of the stock market meltdown. Gift annuities are a hybrid to let you give and receive! A gift annuity is a contract between you and your favorite charity in which you give the charity a one time payment and receive a periodic payment, an annuity, for life. The amount of the annuity is determined at inception, without worries about stock market volatility. On your death (or the death of a spouse or other loved one, since you can name up to two people to get the annuity) the charity will receive the funds that remain for its charitable purposes. The rates paid on many gift annuities are structured in accordance with the criteria promulgated by the American Council on Gift Annuities. These recommendations provide for annuity rates that result in an average residual gift to the recipient/payor charitable organization of approximately 50 percent of the amount originally donated. Thus, you would be making a substantial future gift, which the charity can count on and use as an example of continued support to motivate other donors. Yet you will receive a cash flow that will seem substantial in comparison to current interest rates, possibly providing you with the emotional comfort to make such a commitment.
  • Benefits to Charity: The assumption used in calculating a charitable gift annuity is that about 50% of the value of your gift for the annuity should ultimately go to the issuing charity. So there is a substantial charitable benefit in purchasing a gift annuity. But this also leaves a significant benefit for you which might be essential in light of recent economic developments.
  • Benefits to You: When you purchase a gift annuity you’ll realize an income tax deduction based on the value of what the charity will receive. You will receive a monthly or quarterly cash flow stream for the rest of your life. Cash flow payments that are fixed regardless of stock market performance. Your payments will generally be substantially greater then what you would earn on a CD (assuming you’re old enough when you make the purchase). If you gift appreciated property (some of you might be old enough to remember the concept) to purchase the gift annuity, you won’t recognize capital gains immediately (as you would if you simply sold the property and purchased a commercial annuity). Instead, the taxable gain will be recognized over your actuarial life expectancy. Gift annuities are highly regulated (by the same folks that watched our backs with sub-prime mortgages?) so that there is assurance that you’ll receive the payments expected. If the Charity cannot meet the payments required from the reserve it sets up, it will have to use its general funds to make the payments. If the charity failed, your payments would stop. Thus, while gift annuities are safe, they are not an absolute guarantee.
Example: John Doe is 67 and single. John has generally made six figure gifts to his favorite charity. However, since his savings have been cut in half by recent market declines, he’s feeling uncomfortable. John believes it important to show some commitment to the charity, but is reluctant to part with cash. John figures he can earn about 4% on CD. Instead of forgoing any charitable efforts, John opts to purchase a $200,000 gift annuity from the charity. At his age, the rate of payment he will receive is 5.9%. So his annual annuity will be about $11,800, substantially more than he could get on a CD. In addition, then the amount John receives from his gift annuity is not fully taxable, so he will net even more after tax then with a CD. John knows that on a present value basis about ½ of the $200,000 will eventually inure to the benefit of the charity. Issues Affecting Gift Annuities: Gift annuities have a number of shortcomings. The main negative to the charity is that there are no immediate dollars to spend. For you as a donor, there is no flexibility. You cannot reach the principal of the gift annuity if you need it for an emergency. Your annuity is a fixed payment which may not keep pace with inflation so that over time your purchasing power will erode. Part of the solution to these issues is to limit the portion of your investment assets you use to purchase gift annuities. Thus, it might be better in some instances to give a smaller outright gift and retain complete control over the investment of the funds you retain.

Charitable Remainder Trusts for Those Reticent to Fund Current Gifts

If you had planned to make a donation, but now feel economically unable to make the permanent payment currently, you might consider, as an alternative to making no gift and if you wish flexibility, funding a charitable remainder trust (“CRT”). A gift annuity or CRT may assure you (and your spouse, or perhaps another designated donor) a monthly or quarterly check for a lifetime (and that of your spouse or other heir) after which, the remainder is distributed to your designated charity. For CRTs, the 10 percent remainder test must be satisfied, but a larger remainder (larger benefit for the charity) can be structured into the transaction if you wish. These methods can be used to address gifts which you might feel desirous or obligated to make, but can also preserve a meaningful economic benefit for you until you feel more secure financially.

Give-Back Charitable Remainder Trusts

If you feel too financially insecure to make a large outright contribution, consider a charitable remainder trust (CRT) with a twist. We’ll call it the “Give-Back CRT”. First let’s explain the CRT technique, and then we’ll show you how you can use it to continue substantial support of your favorite charity, even while feeling economically insecure.
  • Classic CRT Example: You establish a charitable remainder trust (“CRT”). A CRT is a special trust which requires a payment be made at least annually, to you for a set number of years or life. This payment can be made to you and your spouse (or in some instances other beneficiaries). So the trustee of the CRT could be required by the terms of the trust document to pay you and your husband a 7% annuity every year for your joint lives. If you contribute $1 million to this CRT, the trustee must pay $70,000 each year until the last of you dies. At that time, after the final $70,000 payment, the remaining balance of the trust will be distributed to the charitable beneficiary you named. Your trustee is not only authorized, she is required, to make this charitable distribution. The charity doesn’t receive any current funds, but it has a substantial future commitment it can rely upon (but see below).
  • CRT versus No Donation: So Richie Rich had a set back on some of his comic book ventures and is feeling a bit pinched on donating to his favorite charity. But Richie knows he needs to show leadership during these tough economic times to motivate others to give. Richie had been planning a $1 million contribution, but isn’t comfortable giving anything now. However, Richie is also aware that if he doesn’t lead the way, the charity will have even a tougher time soliciting others. So Richie opts to give $1 million, but in a way he can feel comfortable doing so. He gifts $1 million in a 7% CRT. Richie discussed this with the planned giving professionals from the charity and believes that authorizing the charity to announce this large gift will show a major long term commitment that will motivate other donors. For Richie personally, the fact that he will receive $70,000/year from the CRT makes the “gift” comfortable. If the economy continues to worsen, he’ll have cash flow coming from the CRT. That assurance gets Richie over the big gift hurdle. So Richie will help lead the charitable fund raising effort through tough times while simultaneously securing his financial future so he’s able to make the commitment. The only piece missing is that the charity still needs current dollars for its laudable efforts.
  • Give-Back CRT: The real impediment to Richie making the $1 million outright gift he initially intended was his financial worries. The CRT got Richie past that, but what about the charity? Richie can donate whatever portion of the $70,000 annual payment he receives each year back to the charity. This approach gives Richie comfort, but also the encouragement and moral obligation to donate as much as he can each year. At some point, Richie can terminate the CRT so that the charity will receive the then current value of its remainder interest. If a CRT is terminated early, Richie as the non-charitable beneficiary will report capital gain based on the value of the assets distributed to him as a taxable exchange under IRC Sec. 1001. PLR 200314021 and 200733014. Richie would be effectively treated as selling his interest in the CRT to the charity as remainder beneficiary. At that time Richie could also donate as much or all of the proceeds from this settlement to the charity.

Charitable Remainder Trusts in the Current Tax/Economic Environment

Economic turmoil has affected many of the foundations of CRT planning. CRTs had been a standard charitable planning technique. The drill had been: Donate highly appreciated and concentrated securities to charity (do you remember the concept of appreciation?). The charity would sell the appreciated security for no capital gains tax (you probably won’t pay those for years with the loss carryover’s you have). The charity would then invest in a well diversified portfolio (remember how well diversification has helped over the past 18 months?), and pay you an annuity amount for a term of years or life (the latter, especially for the joint lives of a husband and wife, was the most common). When you (or you and your spouse if a joint annuity) check out, the charity would receive the remaining assets. Example: Ira Investor purchased 100,000 shares of a start up research company Fake, Inc. for $1.00 per share. The company has developed a new gizmo that has just received FDA approval and the stock price has shot up to $57.00 per share on an unadjusted basis. Ira’s gain is huge, $5.6 million. The stock pays almost no dividends. Ira is retiring and needs more income to cover living expenses. He also wishes to diversify his investment holdings because they have become such a substantial portion of his estate. However, to sell his Fake, Inc. stock would trigger substantial capital gains. Ira works out a more comprehensive plan. Ira will contribute 40,000 shares, worth $2,240,000 to an exchange fund sponsored by a major investment firm. This will enable him to receive income tax free limited partnership interests, diversify his portfolio, and have an asset that is ideally suited for other family estate tax planning transactions (well, until the Pomeroy bill is enacted repealing discounts on passive assets). Ira will sell 20,000 shares at $1,120,000 and pay capital gains tax. This will provide him with a cash pool to use as he wishes. Ira will retain 20,000 shares because he still likes Fake’s prospects. Ira will donate 20,000 shares to a CRT which he will structure to provide a 5% payout. The CRT shares will be sold income tax free by the trust and the proceeds reinvested by the trust in a diversified portfolio. Ira will receive back a quarterly payment of $14,000 for the rest of his life. Ira will realize a charitable contribution deduction of $555,236, which will help offset the gain on the sale of shares of Fake, Inc. he sold. Most importantly, Ira will be sharing some of his windfall with his favorite charity. Because of his charitable goals, Ira structured the CRT with only a 5% payout to himself. He anticipates that his wealth manager will earn at least 6.5% on the CRT investments. Thus, at the end of Ira’s life expectancy, the Charity should receive in excess of $1.7 million. The financial and charitable benefits are significant.

How has the current tax and economic environment affected the above planning model:

The exchange fund may not qualify for discounts. The $14,000 cash flow may prove inadequate if the substantial expenditures for the bail outs, stimulus plans, etc. trigger significant inflation. It might prove more prudent to structure CRTs with unitrust payments (CRUTs) instead of with annuity payments (CRATs). A CRUT pays a uni-trust payment based on the value of the CRT assets each year. If significant inflation pushes up the price of monetary assets, the distribution will similarly grow. CRTs generally assumed stable tax rates. However, most pros believe income tax and capital gains rates will likely grow in future years to meet federal budget deficits. If that is the case, then the net results of a CRT plan will prove less favorable. This is because the CRT avoids current income tax but taxes are paid at a later date. The limitations on charitable giving deductions, 50% AGI at the max (30% for long term capital gains, etc.), rarely affected donor’s in the past. However, the economic devastation has slashed earnings and passive income for many. The various tiers of limitations may in fact affect donors now. Might now be NIMCRUT time? A Net Income Make-up CRUT pays the lesser of a set percentage of the CRT’s annual value (the uni-trust percentage) or the trust's income for the year. That’s the “NI” portion of the NIMCRUT, next comes the “M” portion. The NIMCRUT pays beneficiaries more than the percentage unitrust amount when income exceeds the percentage uni-trust amount in one year, to “make-up” or compensate for the failure to have met the required percentage unitrust amount in earlier years. If you think the markets will lag for a while but eventually will recover, the make up amount may be a great way to capture this.

Charitable Remainder Trusts Divisions

Economic turmoil has wreaked havoc with everything, including marriages. If you and your spouse had set up a CRT, but have decided to pitch separate tents, what happens to your CRT? A recent revenue ruling describes two situations (one a divorce) when the prorata division of a CRT into two or more separate trusts does not cause the trusts to fail the CRT requirements under IRC Sec. 664(d) . Furthermore, these divisions: 1. are not considered to be a sale, exchange, or other disposition producing gain or loss; 2. do not terminate the trust's status under the Section 4947(a) (2) split-interest trust rules; 3. do not result in the imposition of an excise tax under IRC Sec. 507(c); and 4. do not constitute an act of self-dealing under IRC Sec. 4941 or a taxable expenditure under IRC Sec. 4945. Rev. Rul. 2008-41, 2008-30.

Life Insurance to Fund Gifts or Bequests

If you had planned a large bequest but are now concerned that the reduction in your estate will undermine the funding of personal bequests, life insurance may provide an option. You may be able to have the charity purchase a permanent life insurance policy on your life and fund the charitable gift outside of your will, thereby preserving your estate assets for non-charitable heirs. If you believe that the estate tax is likely to be strengthened with future legislation under President Obama, seeking to bridge the budget deficit and fund enhanced governmental programs, then the opposite approach might be beneficial. In these situations, use an ILIT and new insurance to fund additional bequests to the non-charitable heirs and retain the existing charitable bequest under your will to preserve your estate’s charitable contribution deduction. Using insurance to fund a large deferred gift for a charity is a common technique. If you want to make a large commitment, but fear it may not be viable because of market conditions, don’t reduce your commitment, fund it with life insurance. Have an insurance consultant evaluate the performance of the policy and whether funding adjustments need to be made (perhaps you were able to stop premium payments several years ago, but the recent market declines again require annual gifts until the value of the policy is rebuilt).

Charitable Lead Trust in Lieu of Outright Gifts

You had planned to make a large charitable gift, but your daughter’s business has declined considerably. Although you are confident she’ll “be okay,” you are concerned for her in the long term. In lieu of an outright gift, set up a CLT. What is a CLT? A typical approach to using a CLT is for a parent to establish a trust for a charity for a term of years, say 20. During the term, an annuity payment is made to a designated charity or charities. At the end of the 20-year term, the remainder goes to the parent’s children. Sometimes the term of a CLT is designed not only to minimize gift tax consequences but to coordinate with the child’s estimated retirement age. A CLT can be tailored to meet your specific concerns for your daughter. Example: Your daughter is age 40. Because of the impact of the recession on her business, you are more worried about her providing for her future retirement. You establish a 25-year term charitable lead annuity trust (CLAT). The intent is to nearly zero out the value of this transfer for gift tax purposes, grow assets in the CLAT above the payout rate during the long 25-year term, and then provide a nest egg to your child. With security values still substantially below market highs, and interest rates at historic lows, this should prove to be a very advantageous time to fund a CLAT. At the end of the CLAT term, your child will be 65, retirement age. Thus, the CLAT can provide a form of retirement benefit to your child. If the growth of the CLT portfolio is more than the payout rate to the charity, over the term, the trust assets can grow significantly. However, the recent market meltdown may have derailed the target investment results in older CLTs so substantially that you, as the parent, may need to review the retirement assistance the child might need because the CLT may provide much less than anticipated. If the CLT were only recently formed, a substantial decline in value (especially if it had been invested to maximize the growth for the child/beneficiary) may be so severe that the CLT’s annual charitable payments may burnout the trust so that it will end before the intended term with nothing left for the child. The recent market meltdown may have derailed the target investment results for your CLT so substantially that you, as the parent, may need to review the retirement assistance the child might need because the CLT illustrated in the preceding example may provide much less of a remainder than anticipated. If the CLT were only recently formed, a substantial decline in value, (especially if it had been invested to maximize the growth for the child/beneficiary) may be so severe that the CLT’s annual charitable payments may burn out the trust so that it will end well before the intended term with nothing left for the child. Consider other steps to accomplish your previously intended but not unrealizable goals. For example, if you had intended to use a CLT to provide an heir a benefit at some future date, and the CLT will burnout, you should evaluate the use of GRATs, life insurance, or other approaches to meet that goal.

Classic CLT Example:

  • Debby Donor has a substantial estate. Her son and only heir, David, is age 40 and has a chronic illness. He continues to work and is self supporting. Debby wants to reduce the potentially substantial estate tax she faces especially in light of the many proposals now in Congress to make the estate tax permanent. Further, given that interest rates used in calculating the tax consequences of CLATs are at historic lows, and equity values remain depressed, Debby believes that from a financial perspective this is an optimal opportunity to use a CLAT to leverage value to her heir. She also wants to assure her son’s financial future.
  • Debby establishes a CLAT for her son. Debby has her attorney prepare a trust agreement and obtain a tax identification number. The trustee sets up an account with the wealth management firm Debby has used for many years.
  • Debby then donates $1 million dollars to the CLAT. The designated charity will receive $60,000 per year for the next 20 years. Debby directs that this be used to address genetic research relating to chronic illness, as long as the charity deems a need for this.
  • She does not receive an income tax charitable contribution deduction (she could if the CLAT were a grantor trust).
  • Assume that Debby has made prior gifts totaling $800,000 to her son David to help him in light of recent economic strains and job losses. These gifts used up $800,000 of the $1 million gift tax exclusion available (the amount any taxpayer can gift without a current gift tax). However, if Debby gave the gift directly to David, the $1 million gift could generate nearly $400,000 in gift tax cost [($1 million gift - $200,000 remaining exclusion) x 50% assumed tax rate]. However, because of the annuity payment of $60,000/year for 20 years, the value of the eventual gift to her son David is reduced to only about $56,000 and no gift tax will be due on the transfer.
  • From a personal perspective, not only has Debby provided substantial benefit to her chosen charity, but she has provided a retirement plan for her son to assure his financial security when he is forced to retire at an early age because of his health issues. In 20 years, when David reaches age 60, the CLAT will end and he will receive a distribution of the trust assets.
  • Debby’s wealth manager believes that it is reasonable for her to realize a 7.5% return on the CLAT portfolio given the 20 year time horizon. As such, her son David will receive not the original $1 million she gave to the CLAT, but $1,650,000 when the trust terminates. Debby is confident that this amount will more than adequately fund her son’s retirement years.
Backend CLAT Example: CLATs work best in a low interest rate environment. Interest rates remain at historic lows, but have been inching upward. Asset values remain depressed. So now is an optimal time to structure a CLAT to remove low interest rate assets to heirs with the minimal amount paid in the interim to charity, and hopefully with the future substantial appreciation outside your estate. However, idyllic the current CLT planning environment, many are worried about the potential impact of short term volatility or declines undermining the effectiveness of the CLT. There might be a planning twist that enables you to lock in the low interests rates, remove assets at current low values, but still protect against a possible downdraft in values. The provisions in Regulations permit the CLT annuity payments to change over the CLT term. You can start CLT paying a low CLT amount in the current year, and slowly step it up in each later year of the CLAT and in last year pay the charity whatever you have to in order to reduce value of gift to CLT to nearly zero. With this backend CLAT you needn’t worry that poor performance in the early years will undermine the plan. In contrast, if you loose significant investment value in the early years of a traditional level term CLAT the planning mechanism simply will not succeed. A backend CLAT should be structured as an inter-vivos grantor trust. If you don’t use a grantor trust structure, the trust could be decimated by income tax in the early years when income may significantly exceed the lower stepped payments to charity, meaning a lower contribution deduction to offset CLT income. Charity will get same amount of money, but the increased likelihood of success for long term is significant.

Defer Current Gifts, Don’t Cancel Them

You had hoped to donate $100,000 to your favorite cause, but your earnings have been severely affected by recent developments. Don’t cut your commitment. Pledge the same $100,000 but commit to pay it over, say, 3 years. If circumstances improve, you can just pay it earlier. Paying a pledge over time, or making a new commitment to be paid over a number of years, can provide a positive boost to the fund raising efforts of a charity that can acknowledge or even promote the deferred gift. If economic recovery occurs quickly enough, you can always accelerate the deferred gifts.

New Endowments

You wanted to endow a perpetual gift that would support college scholarships for needy students whose parents are unable to pay for college as a result of chronic illness. You had determined a target funding amount with the charity. However, in light of recent market performance, is that amount still sufficient to meet your goals? Review the status of the fund and the assumptions initially used regarding what percentage could be paid out of that fund without depleting it (so it would, in fact, last in perpetuity). Increased funding may be necessary to achieve your goals.

Underwater Endowments

An issue facing many endowment funds is that the values of the funds have fallen below the dollars initial given to establish the fund (they are said to be “underwater”). The actions that the charity should take will depend on applicable state law and the terms of the agreements governing the fund. If an endowment is below its historical cost or value, in certain circumstances, the charity may be able to continue to spend the income earned on the fund. Capital gains are unlikely to be included in the definition of spendable income for this purpose and will generally have to be added to the fund value until the initial dollar value is again attained. Income, however, might only be available to spend if the endowment fund is below its initial fund value as a result of market declines, not appropriations. It is not clear whether a charity may have to use unrestricted funds to replenish endowment funds which have dropped below their initial value. The answer may, in part, depend on whether appropriations or market declines were the cause. Charities with underwater endowment funds are advised to investigate the appropriate actions that should be taken.

Struggling Private Foundations

The cost of administering a foundation can be substantial. If the administrative costs, management, and operational burdens, coupled with recent market declines, have made it impractical to continue to maintain a private foundation, one approach might be to transfer the foundation to a community foundation. A community foundation is a group of individual charitable funds, each generally bearing its own name (unless privacy is a concern). A community foundation can provide for more economical and professional management, and because it is a public charity, the excise taxes that can apply to a private foundation do not apply.

Prior Real Estate Donations

You donated appreciated real estate to a charity and received a substantial income tax deduction for the fair value of the property when donated without ever having to recognize the capital gain on the appreciation. The charity was going to sell the property. Review the status of this with the charity. If the charity was caught in a bad local real estate market crash, it may be stuck holding a property it cannot sell while it is paying carrying costs. You might need to make additional donations to defray this cost or perhaps otherwise help the charity in its efforts to sell the property to prevent a good deed from becoming a financial detriment. If the real estate donation was made through a charitable remainder trust, as discussed previously, the decline in the value of the property might make it impossible for the charity to sell the property. Revisit the plan.

New Real Estate Donations

You own real property that you would like to donate to a favorite charity in a charitable remainder trust CRT. There are several approaches that can be used to structure a CRT. While these have been discussed above, they are noted briefly here to show their application for real estate planning.
  • Charitable remainder annuity trust (“CRAT”). In a CRAT, the annuity percentage is multiplied by the initial trust value, and that fixed amount is paid to you each year (or quarter or month depending on how you set up the CRAT) over your life (or the period of years for which you set up the CRAT to run).
  • Charitable remainder unitrust (“CRUT”). A CRUT provides that the fixed percentage is applied to the value of the assets each year so that the annuity amount paid to you each year will fluctuate with the value of the assets in the CRUT. An advantage of a CRUT in the current environment is that if inflation picks up substantially in future years as a result of the tremendous sums being paid for the bailout and economic stimulus packages, a CRUT will provide you with protection over future years. If the underlying assets in the CRUT increase in value (real estate rentals increase in future years, or more likely, the real estate is liquidated and the proceeds invested in marketable securities), you will be paid a greater dollar amount.
  • Net income make charitable remainder unitrust (“NIMCRUT”). A NIMCRUT is a spin on the CRUT described previously that may be the optimal CRT approach in the current economy. Say you have non-income producing real estate that you want to donate to charity (for example, raw land). The CRT will not produce much income until the charity sells the property. In a NIMCRUT, if the income in any year is less than the unitrust amount for that year, the shortfall is made up in future years in which trust income exceeds the unitrust amount in those later years. It’s as if the payments due to you are accrued and will be paid in a future year. The maximum payout in later years is the sum of the CRUT amount due to you in each of the prior years, and the amount necessary to make up for any shortfalls in prior lean years. A NIMCRUT may be the ideal CRT for economic turmoil because it addresses the issue of a time lag in selling property and provides upside protection against potential (perhaps likely) future inflation.

Depreciated Securities

Don’t donate depreciated securities. Those dogs in your portfolio should be sold, not donated. Donating securities that have appreciated to a charity is a great tax deal (you get a deduction based on the full fair value of the securities donated and don’t have to recognize the otherwise taxable gain). However, donating securities that have declined in value is a lousy deal. You only get to deduct the fair value of the stock donated. You’d generally be better off selling losers at a loss, taking whatever tax benefit you can from those losses, and then donating the net cash from the proceeds.

Future Income Tax Benefits of Charitable Giving

A planned gift may be the charitable giving answer for you during economic turmoil. Planned or deferred gifts are donations which you agree to pay over a number of future years. Here’s why they might be the best approach to your contributions in the current circumstances:
  • Most importantly, if you make a deferred gift, the charity will receive a large commitment now that can provide incentive to other donors and enable the charity to continue programs.
  • If you cannot afford to make the gift you want, make a pledge for the amount you hoped to donate, and just pay it over a reasonable number of years so that on a cash flow basis, it is affordable. If your economic situation improves, or your worries simply decline, you can always accelerate and pay the gift now.
  • If you believe that income tax rates will rise in the future (how else will the bailouts and stimulus packages be paid for), and your charitable contribution deductions are of limited value presently because of an unfortunate abundance of tax losses, a deferred gift might be advantageous. Your contribution can be structured to take advantage of the increased tax benefits of future tax increases to the extent that payments are made in those future years.

IRAs and Charitable Giving

The best thing to give to charity is Income in Respect of a Decedent (“IRD”) since the charity, unlike an individual beneficiary, won’t recognize taxable income on its receipt. Best way to do it with a retirement plan account is to name the charity directly and not run it through an estate or trust. So you’re intent on leaving your old alma mater the bequest sufficient to fund the purchase of modern abstract welded steel 2-story high beer can sculpture you vowed to fund when you were a pledge at Beta Epsilon Epsilon Rho. Times are tight because of the economy so you add BEER as a beneficiary of your IRA. Being frugal you handle the beneficiary designation on your own, why pay a lawyer? You self-inflicted beneficiary designation could be as well planned as your original BEER commitment. Here are a few thoughts on leaving some or all of your IRA to charity. Consider leaving retirement asset to charity because of IRD issues, and no IRD assets to individual heirs. Name the charity as direct beneficiary of your IRA, don’t pay the pledge through a revocable living trust. If not done properly, you could inadvertently trigger current taxation. Other beneficiaries cannot use stretch IRA if a charity is a beneficiary. Your designated beneficiaries must be determined by September 30 of the year following your death. For an IRA, if there are multiple beneficiaries, your heirs can split that account into separate shares for each beneficiary by December 31 of the year after your death. If this is done, then each beneficiary can use his or her own life expectancy to calculate payouts, which must be started no later than that December 31. There are three ways to address these issues
  • For a charity, you have to cash them out before this date if IRA names both charitable and non-charitable beneficiaries.
  • Separate accounts by September 30 will work. Divide IRA into separate accounts one for the charity and one for the Charity so that charity doesn’t impact daughter’s ability to stretch.
  • Separate IRAs, i.e., one IRA for humans and one for charities.
Example: What can go wrong? An estate or trust has taxable income from receiving IRA distribution, but maybe there is no offsetting charitable income tax deduction when the IRA check is given to charity. 2008 Chief Counsel Memorandum 200848020 illustrates the problems that can be faced for improper IRA/charitable planning. Assume the following: 800,000 assets, six kids and two charities. The IRA was made payable to a trust which will have to pay off the two charities and six kids. The estate eliminated the charities by paying their interest out. Since the trust paid off the charities it was left with $600,000. The trust was held to have realized $200,000 of income from the distribution of the IRA, but was not found to have a charitable deduction since no instructions were provided in the governing instrument to donate IRA funds to charity. The moral of the story is don’t combine charitable and human beneficiaries in same trust. Another solution to the mixed IRA beneficiaries (i.e., charitable and non-charitable) is to draft the governing document to obtain an offsetting charitable income tax deduction in the case the estate or trust has IRD income. A trust's or estate's payment to charity must be made "from gross income" and "pursuant to the governing instrument" to be deductible. This result is not assured however. See Proposed Regulations § 1.642(c)-3(b) (2) and § 1.643(a)-5(b). Sample Language: “I instruct that all of my charitable gift bequest and devises shall to extent possible be made from IRD.” Recent proposed regulations provide that instructions to distribute specific types of income to a charity or another type of beneficiary won’t be respected unless there is an economic effect other than tax consequences. Will this affect the directions as to how to use IRA funds? If all IRD goes to charity will the proposed regulations undermine the intended result? Tip. If your goal is to assure that the trust qualifies as a “designated beneficiary” consider naming a special fiduciary, called a trust protector, who is not a trustee or beneficiary. This person could be given the power to modify the trust to correct drafting errors, typos, or ambiguities, or to take steps required to qualify the trust as a designated beneficiary. A charity or your estate are not designated beneficiaries. So if either is listed as a beneficiary, perhaps the trust protector can be given the power to distribute out their share by September 30 of the year following your death to avoid the minimum required distributions (“MRDs”) being calculated as if there were no beneficiary. Treas. Reg. 1.401(a)(9)-4, Q/A-3. You might want to have this latter power automatically lapse on the beneficiary determination date which is September 30 of the year following your death as the plan participant. The rationale for that limitation is that the tax benefits of having a designated beneficiary must be set by that date so that changes after that date would not affect the tax results of plan distributions. Note, although the designated beneficiary has to be determined by September 30 of the year following your death, those beneficiaries are given until December 31 of that year to actually make the first distributions.

Charitable Giving with Roth Conversions – Line up Gifts Now

Many wealthy prospective donors will consider converting to Roth IRAs in early 2010 when the income limit on conversions is lifted. The optimal way to convert is to use funds outside the IRA to pay the income tax due on the conversion. One means of reducing the income tax on the conversion is to generate charitable contribution deductions. If a donor makes donations this year that cannot be used because of the income limitations then the carryover losses could be absorbed next year with the conversion. Example: It’s January 1, 2010. Dr. Feelgood is quite worried about malpractice issues although at present he has no issues, cases or claims. He cherry picks all the stocks that he was asset allocated into in 2009 that have appreciated, and donates them to a CRUT at his favorite charity, “Lonely Lawyers Fund”. The assets donated generate a current income tax deduction. Dr. Feelgood goes to temple and converts his IRA into a Roth IRA, safeguarding (depending on state law) more of his IRA (a converted Roth IRA is full dollars, not pre-tax dollars so more is really protected if the Roth post conversion has the same level of protection of a pre-conversion IRA). The tax cost of the conversion has been to a meaningful extent eliminated by the CRT he formed for the charity. Example: Dr. Feelgood still feels he has a few good years of money making before the new health care system undermines his financial base. So when he funds the CRT in the above example he funds it with investment real estate and structures it as a NIMCRUT. No income is earned so none is paid now, but in later years when his income is expected to drop the CRT will sell the land and pay him a make-up payment. Example: Dr. Feelgood’s accountant is very cute and clever. Cindy CPA knows that it really pains Dr. Feelgood to pay income taxes so she recommends that when he converts his IRA to a Roth, that he create four separate Roth IRAs: international equities Roth #1, small cap stock Roth #2, S&P 500 Roth #3 and an automobile/bank stock Roth #4. In 2011, before the due date for Dr. Feelgoods 2010 tax returns, Cindy, Dr. Feelgood and his investment adviser Wally Wealthmanager evaluate the asset class Roths and re-convert back to regular IRAs all the Roths that did not increase considerably in value post-conversion. The result is a lower tax on the conversion that is completely offset by the CRT that Dr. Feelgood set up. Example: To complete the circle of planning Dr. Feelgood set up a SLAT (spousal access life insurance trust) that owns insurance on his life to fund the payment to their children of the assets to be removed from their estate in the CRTs to charity. This not only protects the children, but since Dr. Feelgood’s spouse is a beneficiary she can access the cash value of the policies to fund retirement needs if necessary. Finally, to keep the charity happy since the charity suggested the entire plan, Dr. Feelgood buys an insurance policy from AXA using their new Charitable Legacy Rider. This enables Dr. Feelgood to benefit any charity of his choice at no incremental cost. The charitable benefit is 1% calculated based on the base policy death benefit between $1-$10 million. [Thanks Steve Fishman, Norwood Financial for this tidbit!].


Charitable giving is a key component of everyone’s financial, tax, estate, and related planning. Giving back is one of the most rewarding things any of us can do. Your economic situation undoubtedly was affected by the recession. Economic turmoil continues. Using some creative spins on basic charitable giving building blocks can enable you to continue some or even the same level of giving and tailor your planning to fit current circumstances.

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