The federal government helps your clients be philanthropists with tax incentives that greatly reduce the out-of-pocket cost of charitable gifts and in many cases enable donors to contribute much more than they originally imagined.

To assure clients' tax benefits, advisors need to know every jot and tittle. So here's a rundown of the major rules, together with the relevant Internal Revenue Code sections, Treasury regulations, revenue rulings and court cases. Unless otherwise stated, it's assumed that an individual is making the gift to a public charity (for example, to a school, church, hospital, or community foundation) or a private operating foundation (for example, a museum or library).

Currently, only itemizers can deduct their charitable gifts. At press time, Congress was considering bills that would allow a limited non-itemizer charitable deduction. Other increased tax benefits would be available. Congress was also considering proposals that would reduce the tax benefits for some charitable gifts.

But for now, here are the rules:

OUTRIGHT CHARITABLE GIFTS

Gifts of money

Deductible up to 50 percent of donor's adjusted gross income. IRC Section 170(b)(1)(A); Reg. Section 1.170A-8(b). Five-year carryover allowed for any “excess.” IRC Section 170(d)(1); Reg. Section 1.170A-10(b).

Securities and real estate held long term

Deductible at the full present fair market value, with no tax on appreciation. Campbell, 209 F.2d 331 (5th Cir. 1954). Deductible up to 30 percent of adjusted gross income. IRC Section 170(b)(1)(C)(i); Reg. Section 1.170A-8(d)(1). Five-year carryover allowed for any “excess.” IRC Section 170(b)(1)(C)(ii).

Ceiling election

Under an election, a donor can increase the ceiling to 50 percent of adjusted gross income (with a five-year carryover for any “excess”) by making the same gift, but:

  • reducing the amount deemed contributed for all long-term property gifts during the year by 100 percent of the appreciation, and

  • similarly reducing the deemed contribution for long-term property gifts being carried over from earlier years. IRC Section 170(b)(1)(C)(iii); IRC Section 170(e)(1); Reg. Section 1.170A-8(d)(2).

Securities and real estate held short term

Deduction is for cost basis or current fair market value, whichever is lower. IRC Section 170(e)(1)(A); Reg. Section 1.170A-4(a)(1). Deductible up to 50 percent of adjusted gross income. IRC Section 170(b)(1)(A). Five-year carryover for any “excess.” IRC Section 170(d)(1); Reg. Section 1.170A-10.

Ordinary income property (sale would result in ordinary income)

Reg. Section 1.170A-4(b)(1). For gifts of inventory, IRC Section 306 stock, collapsible-corporation stock, crops, artworks created by the donor and other “ordinary income” property gifts, deduction is allowed for property's cost basis or current fair market value, whichever is lower. IRC Section 170(e)(1)(A); Reg. Section 1.170A-4(a)(1). Deductible up to 50 percent of adjusted gross income. IRC Section 170(b)(1)(A). Five-year carryover allowed for any “excess.” IRC Section 170(d)(1); Reg. Section 1.170A-10(b).

Tangible personal property (works of art, antiques, books, etc.) held long term.

Reg. Section 1.170A-4.

Related gifts — Deduction is full present fair market value, with no tax on the appreciation, if use of the property is related to donee's exempt function (for example, a gift of a painting to an art museum or to a school for its art gallery). Deductible up to 30 percent of adjusted gross income. IRC Section 170(b)(1)(C)(i). Five-year carryover allowed for any “excess.” IRC Section 170(b)(1)(C)(ii). Deductible up to 50 percent of adjusted gross income (with five-year carryover for any “excess”) if same election made as for gift of long-term securities or real estate. See “Ceiling election,” this page.

Unrelated gifts — Reg. Section 1.170A-4(b)(3). If gift is unrelated to donee's exempt function, deduction is for the cost basis or current fair market value, whichever is less. IRC Section 170(e)(1)(B)(i). Deductible up to 50 percent of adjusted gross income. IRC Section 170(b)(1)(A). Five-year carryover allowed for any “excess.” IRC Section 170(d)(1).

Gift of work of art without the copyright — Gift or bequest of work of art qualifies for gift and estate tax charitable deductions (but not income tax deduction) even though copyright itself isn't transferred to charity, when:

  • the donee is a public charity described in IRC Section 501(c)(3) that is not a private foundation (under IRC Section 509), and

  • the use is related to the donee's charitable purpose. IRC Section 2055(e)(4); Reg. Section 20.2055-2(e)(1)(ii); IRC Section 2522(c)(3); Reg. Section 25.2522(c)-3(c)(1)(ii).

Tangible personal property held short term.

Same as gifts of short-term securities and real estate.

Autos when claimed value exceeds $500

If a charity sells an auto worth more than $500 without “any significant intervening use or material improvement by the charity,” the deduction can't exceed gross proceeds received from the sale. The deduction is not allowed unless taxpayer substantiates contribution by contemporaneous written acknowledgment by the charity. IRC Section 170(f)(12). Effective in 2005.

Patents

Initial deduction is limited to the lesser of the taxpayer's basis in the patent or its fair market value. An additional charitable deduction allowed in year of contribution and subsequent years based on a specified percentage ranging from 100 percent and reduced to 10 percent over 12-year period of the “qualified donee (charity) income” received or accrued by the charity on the patent. IRC Section 170(e)(1), (m). Effective June 4, 2004.

Bargain sales

Charitable contribution is the difference between fair market value and sale price of long-term securities and real estate. IRC Section 170(e)(2); Magnolia Dev. Corp., 19 TCM 934; Waller, 39 TC 665 (Acq.); Gladstein, (DC) 68-1 USTC para. 9197; Gamble, (DC) 68-1 USTC para. 9393.

Capital gain implications — Cost basis of property must be allocated between portion of property “sold” and portion of property “given” to charity, based on the fair market value of each. Appreciation allocable to sale is subject to capital gains tax; appreciation allocable to gift is not. IRC Section 1011(b); Reg. Sections 1.1011-2 and 1.170A-4(c)(2).

Caveat — Outright gift of mortgaged property is considered a bargain sale. Reg. Section 1.1011-2(a)(3); Guest, 77 TC 9 (1981).

Partnership gifts

Contributions are not deductible on partnership return, but are deductible by individual partners. IRC Section 702(a)(4); Reg. Section 1.170A-1(h)(7).

Corporate gifts

Ceiling on deductibility is 10 percent of corporation's taxable income. IRC Section 170(b)(2). Five-year carryover for any “excess.” IRC Section 170(d)(2). Corporation on accrual basis may elect to deduct a gift on this year's tax return even though payment made in next tax year, if gift authorized by board this tax year and payment made within two months of the close of this tax year. IRC Section 170(a)(2); Reg. Section 1.170A-11(b).

Corporations meeting certain tests get enhanced deductions for gifts of inventory (used by charity for the ill, needy or minors), or scientific equipment (used by colleges, universities or qualified scientific research organizations for research, experimentation or research training). Deduction is for:

  • the property's basis plus half of the appreciation, or

  • twice the property's basis, whichever is lower. IRC Sections 170(e)(3) and (4); Reg. Section 1.170A-4A.

Gifts of computer technology and equipment for educational purposes from kindergarten through 12th grade and for public libraries can qualify for the larger deduction (when tests are met), provided the gifts are made before 2006.

OUTRIGHT GIFTS TO PRIVATE FOUNDATIONS
(OTHER THAN PRIVATE OPERATING FOUNDATIONS)

Securities, real estate and tangible personal property held long term

Deduction is for cost basis or current fair market value, whichever is lower. IRC Section 170(e)(1)(B)(ii).

Exception for “pass-through” foundations

Deduction allowed for full present fair market value when the private foundation, within two and a half months after the year of receipt, gives an amount equal to all such gifts to public charities (schools, churches, etc.) or private operating foundations. IRC Sections 170(b)(1)(A)(vii), (E)(ii) and (iii); Reg. Section 1.170A-9(g)(2)(iv), (v). Note: Unless tangible personal property is put to a “related” use, deduction is nevertheless limited to the lesser of current fair market value and cost basis. IRC Section 170(e)(1)(B)(i).

Long-term appreciated publicly traded securities (special rule)

A deduction for the full fair market value is allowable for contributions of stock for which, as of the contribution date, market quotations are readily available on an established securities market. This special treatment is available to the extent that the contribution — along with all prior contributions of stock in the same corporation by the donor and the donor's family — do not exceed 10 percent of the value of the corporation's outstanding stock.

Caution — Appreciated publicly traded stock subject to Securities and Exchange Commission Rule 144 is deductible at cost basis. Private Letter Rulings 9247018, 9320016, 9734034, 9746050. But SEC Rule 145(e) stock (allowed to be sold under that rule) is deductible at present market value. PLR 9320007.

Ordinary-income and short-term property gifts

Deduction is for the lesser of cost basis and current fair market value. IRC Section 170(e)(1)(A).

Ceilings on deductibility — Thirty percent of adjusted gross income for cash and ordinary-income property. IRC Section 170(b)(1)(B). Twenty percent of adjusted gross income for gifts of capital gain property. IRC Section 170(b)(1)(D)(i).

Exception for “pass-through” foundations — If certain distribution requirements are met, ceiling may be 30 percent or 50 percent of adjusted gross income, with five-year carryover for any “excess.” IRC Sections 170(b)(1)(A)(vii), (C)(iii).

Carryover — Five-year carryover for “excess” gifts. IRC Section 170(b)(1)(B).

REDUCTION FOR SOME ITEMIZERS

Taxpayers must reduce their itemized deductions (except medical expenses, casualty and theft losses, and investment interest) by 3 percent of adjusted gross income over $145,950 (over $72,975 if married, filing separately) in 2005. This amount is adjusted annually for inflation. In any event, the 3 percent rule won't take away more than 80 percent of the itemized deductions subject to that rule.

DELIVERY DATE

The delivery date determines valuation and year of deduction. Reg. Section 1.170A-1(b). Here are the rules:

Gifts of securities

If mailed, date of mailing is the delivery date; if delivered by other means or if hand delivered, date received by charity is the delivery date. To be effective, the delivery must be unconditional and the stock certificate must be properly endorsed. If the stock certificate is not endorsed, the donor should give the charity a properly endorsed power and the stock certificate. If securities delivered to the donor's bank or broker (as donor's agent) or to the issuing corporation (or its agent) instructing corporation to reissue in charity's name, the delivery date is the date securities transferred to the charity on corporation's books (date on new stock certificate having charity's name).

For Depository Trust Corporation (DTC) electronic transfers, the gift is “delivered” when the transfer to the charity's account is completed.

Gifts by check

If mailed, date of mailing is delivery date; if delivered by other means, date received by charity is delivery date.

Gifts of artworks and other tangible personal property

Date charity receives the property is the delivery date.

Real estate gifts

Date charity receives the properly executed deed is the delivery date (unless state law requires the deed to be recorded for title to pass; in that case, recording date is delivery date).

Pledges

Deduction is taken in year fulfilled — not when made. IRC Section 170(a)(1). Satisfying pledge with property does not give rise to taxable gain or deductible loss. Rev. Rul. 55-410, 1955-1 CB 297.

DETERMINING FAIR MARKET VALUE

Securities.

When there is a market for securities on a stock exchange or over the counter — Fair market value is the mean between high and low on date of delivery (bid and asked prices on date of delivery if quoted selling prices not available). Reg. Section 20.2031-2. Same rule for closed-end investment company shares.

Valuation of mutual fund shares (open-end investment companies) — Fair market value is the redemption price (bid). Cartwright, 411 U.S. 546 (1973).

Real estate, works of art and other property not traded on an exchange or over the counter

Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Reg. Section 1.170A-1(c)(2). Valuation is substantiated by expert appraisals. (See “Substantiating Deductions,” this page.) Cost of appraisal is an IRC Section 212(3) deduction (subject to 2 percent floor on miscellaneous itemized deductions). Percent of adjusted gross income ceiling on charitable contributions is inapplicable. Rev. Rul. 67-461, 1967-2 CB 125. For guidelines on appraisals, see Rev. Proc. 66-49, 1966-2 CB 1257 and Reg. Section 1.170A-13(c).

SUBSTANTIATING DEDUCTIONS

Strict appraisal, appraisal summary and information reporting requirements are imposed when property gifts (other than marketable securities) are claimed as income tax charitable deductions. The rules apply to property contributions claimed at over $5,000 per item or group of similar items, whether or not donated to the same charity ($10,000 for closely held stock, but appraisal summary is required if claimed value is over $5,000).

Easier (but still detailed) reporting rules apply for property gifts valued at $5,000 or under. Reg. Section 1.170A-13; see Form 8283.

To deduct any gift of $250 or more, a donor must have written substantiation from the charity (including a good faith estimate of the value of any goods or services given to the donor in exchange for the gift). IRC Section 170(f)(8). C corporations must now meet the substantiation requirements that have long been required of individuals, closely held corporations, personal service corporations, partnerships and S corporations. IRC Section 170(f)(11), effective June 4, 2004. For quid pro quo gifts over $75, charity must inform donor that gift deduction is limited to excess of amount (or value of property transferred) over value received by donor. IRC Section 6115; Regs. Sections 1.170A-1(h); 13(f); 1.6115-1; IRS Pub. No. 1771.

REPORTING BY DONEES AND PENALTIES

Charities, charitable remainder trusts and charitable lead trusts disposing of donated property (subject to the appraisal requirements) within two years of receiving the gift must report its disposition to the IRS and the donor. IRC Section 6050L; Reg. Section 1.6050L-1; see Form 8282.

Penalties

Penalties imposed for failure to comply. IRC Sections 6721, 6722 and 6724. Civil and criminal penalties imposed for negligence, fraud and valuation overstatements. IRC Sections 6662, 6663, 7206 and 7207. The ultimate penalty is called Leavenworth.

PERSONAL SERVICES

No charitable deduction for value of personal services rendered free for charity. Grant, 84 TC 809 (1985), aff'd, (4th Cir. 1986) (unpublished opinion). Reg. Section 1.170A-1(g); Rev. Rul. 57-462,1957-2 CB 157; Rev. Rul. 1967-2 CB 103.

UNREIMBURSED VOLUNTEER EXPENSES

Deductible when incurred in rendering services for charity. Rev. Rul. 55-4, 1955-1 CB 291. Optional standard mileage rate of 14¢ per mile for unreimbursed automobile expenses. IRC Section 170(i). Ceiling is 50 percent of adjusted gross income, with a five-year carryover. Rockefeller, 76 TC 178, aff'd 676 F.2d 35 (2d Cir. 1982); Rev. Rul. 84-61, 1984-1 CB 39. No deduction is allowed for charitable travel expenses if “there is a significant element of personal pleasure, recreation or vacation” in the travel. IRC Section 170(j).

Unreimbursed babysitting expenses incurred to render volunteer services are not deductible. Rev. Rul. 73-597, 1973-2 CB 69.

PATRON'S GIFTS

Contribution is amount transferred by donor minus value of theater ticket, meal or other privilege donor is entitled to receive. Rev. Rul. 67-246, 1967-2 CB 104; Rev. Rul. 86-63, 1986-1 CB 88. See Rev. Proc. 92-49, 1992-1 CB 987 and Rev. Proc. 98-61, 1998-2 CB 811 for special de minimis rule.

Payments for right to purchase athletic tickets. A special rule applies when a donor makes a charitable contribution to or for a college or university and is thereby entitled to purchase tickets to athletic events. IRC Section 170(l); Reg. Section 1.170A-13(f)(14).

INSTALLMENT OBLIGATIONS

Gift of installment obligations (gain reported under IRC Section 453) accelerates remaining deferred gain in year of gift. Rev. Rul. 55-157, 1955-1 CB 293.

CHARITABLE LOANS

No income, gift or estate tax deductions for interest-free loan or rent-free use of property. IRC Section 170(f)(3)(A); Reg. Section 1.170A-7(a); IRC Sections 2522(c)(2) and 2055(e)(2).

Exceptions — Although uncharged interest is generally imputed to lender of interest-free loan, regulations exempt charitable loans up to $250,000 per charity. Temp. Reg. Section 1.7872-5T(b)(9). Rent-free loan of artwork to public charity for a related use is exempt from gift tax. IRC Section 2503(g).

DEPRECIABLE PROPERTY

Deduction for depreciable property is reduced by what would have been taxed as ordinary income (under IRC Sections 1245 or 1250) if property had been sold. IRC Section 170(e)(1)(A).

LIFE INSURANCE GIFTS

Donor names charity beneficiary of his insurance policy and irrevocably assigns incidents of ownership to it.

Caution — State law must permit a charity to have insurable interest in donor's life. PLR 9110016.

Gift of policy on which premiums remain to be paid

Income tax deduction is slightly above cash surrender value. Reg. Section 25.2512-6(a). However, if that amount exceeds policy's cost basis, deduction is for cost basis. IRC Section 170(e)(1)(A). Continued payment of premiums gives donor deduction for annual premiums. Awrey, 25 TC 643 (1955).

Gift of fully paid policy

Income tax deduction is generally replacement cost. Reg. Section 25.2512-6(a). But if that amount exceeds policy's cost basis, deduction is for cost basis. IRC Section 170(e)(1)(A).

Endowment policy

Charitable deduction for value minus amount that would be taxed as ordinary income on a sale. IRC Section 170(e)(1)(A). But see Reg. Section 1.170A-4(a).

Caveat — Donor has ordinary income of difference between cost and maturity value in year charity receives proceeds. Rev. Rul. 69-102, 1969-1 CB 32; Friedman, 41 TC 428, aff'd 346 F.2d 506 (6th Cir. 1965).

CHARITABLE REMAINDER TRUSTS

New development

Inter vivos charitable remainder unitrusts and annuity trusts are disqualified if a spousal right of election exists under state law. The IRS gives safe harbor procedures for avoiding disqualification by obtaining waivers. For trusts created before June 28, 2005, the Service will disregard the right of election, even without a waiver, but only if the spouse does not exercise the right of election. Rev. Proc. 2005-24, 2005-16 IRB 1.

Charitable remainder unitrust (CRUT)

Specifies that the income beneficiary will receive annual payments determined by multiplying a fixed percentage (at least 5 percent but not more than 50 percent) by the net fair market value of the trust assets determined each year. For each contribution to the trust, the value (determined under IRC Section 7520) of the remainder interest must be at least 10 percent of the net fair market value of the property as of the date the property is contributed. IRC Section 664(d)(2)(D). On the death of the beneficiary (or survivor beneficiary, if there is more than one), the charity gets the remainder. IRC Section 664(d)(2).

A variation, net income with makeup charitable remainder unitrust (NIM-CRUT), calls for the trustee to pay only trust income if actual income is less than stated percentage. Deficiencies in distributions (when trust income is less than stated percentage) are made up in later years if trust income exceeds the stated percentage. Under another variation, net income charitable remainder unitrust (NI-CRUT), deficiencies are not made up. IRC Section 664(d)(3); Reg. Section 1.664-3(a)(1)(i)(b). The regulations prohibit pre-contribution capital gain as NIM-CRUT and NI-CRUT income. (TD 8791.)

Regulations authorize “flip” unitrusts, a NICRUT that switches to a standard (fixed percentage) CRUT on an allowable triggering event (for example, sale of closely held stock) specified in the trust agreement.

Appraisal requirements on CRUTs funded with “unmarketable assets” are imposed when the donor, the donor's spouse, a beneficiary or a related or subordinate party is the trustee.

Charitable remainder annuity trust (CRAT)

Specifies a fixed dollar amount (at least 5 percent but not more than 50 percent of the initial net fair market value of transferred property) paid annually to the income beneficiary for life. The value of the charitable remainder interest (CRT), determined under IRC Section 7520, must be at least 10 percent of the initial net fair market value of all property placed in the trust. IRC Section 664(d)(1)(D). On the death of the beneficiary (or survivor beneficiary, if there is more than one), charity gets the remainder. IRC Section 664(d)(1).

For CRTs, the 50 percent maximum annual payout requirement applies to transfers to trusts after June 18, 1997. The 10 percent minimum remainder interest requirement is effective for transfers to trusts after July 28, 1997. The 10 percent requirement doesn't apply to transfers in trust under a will executed before July 29, 1997 if the decedent died before 1999 without having republished the will or, on July 28, 1997, was under a mental disability to change the disposition of his property and didn't regain competence to dispose of the property before he died.

Regulations give a host of rules for CRUT and CRAT payments after year-end (by April 15) to satisfy the prior year's required payout. (TD 8791; TD 8926.) Caveat — In Atkinson, 309 F.3d 1290 (11th Cir. 2002), cert. denied, 540 U.S. 946 (2003), a CRAT's failure to comply with the required annual payment regulations resulted in complete loss of the estate tax charitable deduction where seven quarterly payments weren't made. (An additional estate tax of $2,654,976 was incurred.) That certainly got everyone's attention.

How payments are taxed to recipient

For CRUTs and CRATs, amounts paid to the recipient retain the character they had in trust. Each payment is treated as follows: first, as ordinary income to the extent of the trust's ordinary income for the year and undistributed ordinary income for prior years; second, as capital gain to the extent of the trust's capital gain for the year and undistributed capital gain for prior years (which can be offset by any capital losses the beneficiary may have from other investments); third, as tax-exempt income to the extent of the trust's exempt income for the year and undistributed exempt income for prior years; fourth, as a tax-free distribution of principal. Ordering rules also apply for classes of income within first and second categories. IRC Section 664(b); Reg. Section 1.664-1(d).

New regulations, which apply retroactively, revise IRC Section 643(b)'s definition of income for NIM-CRUTs, NI-CRUTs and FLIP-CRUTs (before they flip) to take into account changes in how a state's laws define trust accounting income Reg. Section 1.643(b)-1.

CRUTs and CRATs are exempt from taxation

But a trust is not exempt in any year it has income that would be taxable unrelated business income if the trust was an exempt organization, IRC Section 664(c), and must make quarterly estimated payments of unrelated business income tax. IRC Sections 6654(l), 6655. Payments to income beneficiary are still taxed as described in “How payments are taxed to recipient,” this page. Bills before Congress would modify the unrelated business income tax rules for CRTs by imposing a 100 percent excise tax on unrelated business income — but the CRTs wouldn't lose their exemption.

Governing instrument requirements

To assure charitable deductions and avoid adverse tax consequences, a governing instrument must contain specific provisions. See Reg. Sections 1.664-1 through 1.664-3; IRC Sections 508(e) and 4947(a)(2); Rev. Rul. 72-395, 1972-2 CB 340; Rev. Rul. 82-128, 1982-2 CB 71; Rev. Rul. 82-165, 1982-2 CB 117; Rev. Rul. 88-81, 1988-2 CB 127; Rev. Rul. 92-57, 1992-2 CB 123; Rev. Proc. 89-20, 1989-1 CB 841; Rev. Proc. 89-21, 1989-1 CB 842; Rev. Proc. 90-30, 1990-1 CB 534; Rev. Proc. 90-31, 1990-1 CB 539; Rev. Proc. 90-32, 1990-1 CB 546; Rev. Proc. 98-56, 1998-2 CB 667.

The IRS has issued new specimen annuity trust agreements. Rev. Proc. 2003-53 through Rev. Proc. 2003-60. The Service is still in the process of updating its specimen unitrust agreements.

Income tax charitable deduction

Allowed for value of remainder interest; computed using Treasury tables. IRC Section 170(f)(2)(A).

Unitrusts — Reg. Sections 1.664-3(d) and -4; IRS Pub. 1458.

Annuity trusts — Reg. Sections 1.664-2(c) and 20.2031-7; IRS Pub. 1457.

Caveat — Annuity trusts must meet “5 percent probability test” of Rev. Rul. 77-374, 1977-2 CB 329. But see Moor, 43 TCM 1530 (1982). A 1978 General Counsel's Memorandum (GCM 37770) proposed a ruling to the IRS (but was not issued by IRS) that would in limited circumstances, depending on the facts of each case, apply Rev. Rul. 77-374 to CRUTs.

Capital gain

No capital gain incurred on transfer of unmortgaged appreciated assets to trust. Rev. Rul. 55-275, 1955-1 CB 295; Rev. Rul. 60-370, 1960-2 CB 203. Similarly, there's no capital gain to donor on a sale by trust, except as taxable under four-tier system (See “How payments are taxed to recipient,” p. 11).

Exception — Gain taxable to donor if trust assets sold and invested in tax-exempt securities pursuant to agreement between donor and trustee. Rev. Rul. 60-370, 1960-2 CB 203.

Caveat — Don't fund unitrusts or annuity trusts with mortgaged property or donor-created undivided interests. PLRs 9015049 and 9114025.

Estate tax

IRC Section 2055(e)(2)(A). One-life (donor is beneficiary). Fair market value of trust principal at death included in gross estate and then deductible as charitable contribution, resulting in a wash.

Two-life (funded with donor's separate property; donor is first beneficiary; another is the survivor beneficiary). The fair market value of trust principal at donor's death is included in his gross estate, but is then fully deductible as charitable contribution if second beneficiary does not survive. If second beneficiary survives, charitable remainder (based on the survivor's age at the donor's death) is a deductible charitable contribution.

Gift tax

IRC Section 2522(c)(2)(A). Value of the charitable remainder is fully deductible, so charitable gift is immune from gift tax. When there is a life interest other than donor's, there is a gift by donor to non-charity beneficiary of value of beneficiary's life interest. Value of that gift depends on type of property ownership and when other beneficiary's payments are to begin. It's often possible for donor to avoid gift tax (when donor is one of the beneficiaries) by reserving right to revoke life beneficiary's interest by will only. Reg. Section 1.664-3(a)(4); Rev. Rul. 74-149, 1974-1 CB 157.

Gift and estate tax marital deductions

When donor's U.S. citizen spouse is the only other beneficiary, a marital deduction is allowed for the spouse's life interest. IRC Sections 2056(b)(8) and 2523(g). And a charitable deduction is allowed for the remainder interest. IRC Sections 2055(e)(2) and 2522(c)(2). Thus, there is no transfer tax. For 2005 gifts to alien spouses, gift tax $117,000 annual exclusion (adjusted annually for inflation) may be available and estate tax marital deduction may be available if qualified domestic trust (QDOT) rules are met. Reg. Section 20.2056A-2(b).

Substantiating charitable deductions

To deduct a gift of $250 or more, a donor must have written substantiation from the charity (including a good faith estimate of the value of any goods or services given to the donor in exchange for the gift). If no goods or services were provided, the acknowledgment must so state. IRC Section 170(f)(8); Reg. Section 1.170A-13(f)(2). The substantiation rules don't apply, however, to CRUTs or CRATs. Reg. Section 1.170A-13(f)(13).

When tests are met, income and gift tax charitable deductions are allowable for a charitable gift of all, or part of, a beneficiary's life interest in a charitable remainder trust. PLRs 9409017; 9550026; 9721014; 200205008.

A charitable remainder trust can be collapsed and its assets divided between the donor-beneficiary and the charitable remainder organization. But there are capital gains implications. PLRs 200127023; 200310024. And the beneficiary must be in good health. PLRs 200208039; 200252092; 200304025. The beneficiary's health is irrelevant, however, if the trust is measured by a term of years and the payments are to be made to the beneficiary's estate if the angel of death calls before the end of the term. PLR 200127023. A donor also can swap a remaining CRUT interest for a charitable gift annuity. PLR 200152018.

Multiple grantor trusts

The IRS has ruled that multiple grantor CRTs aren't trusts. PLRs 9547004 (involved husband, wife and six grandchildren); 9547004 (involved S corporation and shareholder.)

POOLED INCOME FUNDS

Donor transfers money or securities to public charity

(Only charities described in IRC Section 170(b)(1)(A)(i), (ii), (iii), (iv), (v) or (vi) can have pooled income funds). Charity adds donor's gift to its separately maintained pooled income fund, where it's invested together with similar gifts of other donors.

Each donor gets his pro rata share of pooled income fund earnings each year for life. Income the beneficiary receives is taxed as ordinary income. On the income beneficiary's death, the charity removes assets from the fund equal to his share and uses them for its charitable purposes.

Donor's pooled fund gift also can provide life income for a survivor (for example, spouse). IRC Section 642(c)(3), (4), (5); Reg. Sections 1.642(c)-5 and -6. For the rules governing pooled income funds maintained by community foundations, see Rev. Rul. 96-38, 1996-2 CB 44.

Governing instrument requirements

To assure charitable deduction and avoid adverse tax consequences, governing instrument must contain specific provisions. See Reg. Sections 1.642(c)-5 and -6; IRC Sections 508(e) and 4947(a)(2); Rev. Rul. 82-38, 1982-1 CB 96; Rev. Rul. 90-103, 1990-2 CB 159; Rev. Rul. 92-81, 1992-2 CB 119; Rev. Proc. 88-53, 1988-2 CB 712.

Income tax charitable deduction

Allowed for the value of the remainder interest, determined using Treasury tables. IRC Section 170(f)(2)(A); Reg. Section 1.642(c)-6(d); IRS Pub. 1457. (See “Treasury Tables for Split-Interest Gifts,” p. 15, for a discussion of Treasury tables).

Capital gain

No capital gain incurred on transferring unmortgaged appreciated assets to pooled income fund. (See “Capital Gain,” p. 12.) Fund takes over donor's basis and holding period in assets. Reg. Section 1.642(c)-5(a)(3). No capital gain to donor or fund if fund sells long-term assets. IRC Section 642(c)(3). (But see Reg. Section 1.643(b)-1, revising IRC Section 643(b)'s definition of income to take into account how a state's laws define trust accounting income.) Gain on sale of short-term assets is taxable to fund.

Estate tax

IRC Section 2055(e)(2)(A).

One-life plan (donor is beneficiary) — Value of donor's share in fund at death includible in gross estate, but then fully deductible as charitable contribution, resulting in a wash.

Two-life plan (funded with donor's separate property, donor is first beneficiary and another is to be survivor beneficiary) — Value of donor's share in fund at death includible in his or her gross estate, but then fully deductible as charitable contribution if second beneficiary does not survive. If second beneficiary survives, charitable deduction for remainder interest is based on survivor's age at donor's death.

Marital deduction

The general rules of IRC Sections 2056(b)(7) and 2523(f) apply (terminable interests qualifying for the marital deduction). Thus, the donor's units in the pooled income fund, pursuant to qualified terminable interest property (QTIP) election for a U.S.-citizen spouse, are eligible for the marital deduction. The property will be included in the spouse's estate at spouse's death but, because the spouse's life estate ends and the property passes outright to the charitable remainder organization, an estate tax charitable deduction is allowed to the surviving spouse's estate. See Reg. Section 20.2056(b)-7(h), Example 13. For alien spouse rules, see “Gift and estate tax marital deductions,” p. 12.

Gift tax

IRC Section 2522(c)(2)(A). Value of the charitable remainder is fully deductible, and thus charitable gift is immune from gift tax. When there is life interest other than donor's, there is gift by donor to non-charity beneficiary of value of beneficiary's life interest. Value of the gift depends on type of property ownership and when other beneficiary's payments are to begin.

It is often possible to draw a contract so that a gift is not deemed made to non-charity beneficiary by reserving the right to revoke life beneficiary's interest by will only. Reg. Section 1.642(c)-5(b)(2). Use this method when a donor's spouse is the second beneficiary in a two-life inter vivos pooled fund gift because the surviving spouse's future interest does not qualify for QTIP gift tax election, for U.S.-citizen spouse or $117,000 (in 2005) exclusion for alien spouse. This figure is adjusted annually for inflation.

Substantiating charitable deductions

To deduct a gift of a remainder interest of $250 or more, a donor must have an acknowledgment from the charity stating that the gift was transferred to the charity's pooled income fund and stating whether any goods or services (in addition to the income interest in the fund) were provided in exchange for the transfer. If no goods or services were provided, the acknowledgment must so state. The acknowledgment need not include a good faith estimate of the income interest. Reg. Sections 1.170A-13(f)(2), (13).

GIFT ANNUITIES
(IMMEDIATE AND DEFERRED)

Donor transfers money or property to charity in exchange for its promise to pay fixed amount annually to donor (and a survivor, if desired) for life. Transfer is part gift and part purchase of an annuity.

Income tax charitable deduction

Computed using Treasury tables. Rev. Rul. 84-162, 1984-2 CB 200; IRS Pub. 1457. (See “Treasury Tables for Split-Interest Gifts,” p. 15, for a discussion of Treasury tables.)

How the beneficiary is taxed

Annuitant's income payment is part return of principal and part interest; only the interest portion is taxable.

Determining amount received tax free, the exclusion ratio

The exclusion ratio is a fraction, with the numerator being the value of the annuity (determined under Rev. Rul. 84-162) and the denominator being the expected return (determined using tables in Reg. Section 1.72-9).

The entire annuity payment becomes taxable if annuitant outlives his life expectancy. IRC Section 72(b)(2). If annuitant dies before reaching life expectancy, unrecovered investment in the annuity is an itemized deduction on last income tax return. IRC Sections 72(b)(3); 67(b)(10). Effective for annuities with starting dates after 1986.

Capital gain implications when appreciated property is used to fund a gift annuity.

There is capital gain when gift annuity is funded with appreciated property. Amount of gain is smaller than it would be on a sale.

Gain is not all reportable in year of transfer, as it would be on a sale of property. Gain is reported ratably over annuitant's life expectancy when annuity is non-assignable and donor is an annuitant. Reg. Section 1.1011-2(a)(4) and (c), Example 8.

Estate tax. IRC Section 2039.

One-life (donor is annuitant) — No estate tax.

Two lives (funded with donor's separate property; donor is first annuitant; second individual is the survivor annuitant) — If second annuitant doesn't survive donor, no estate tax. If second annuitant survives, included in donor's gross estate is value of annuity (determined by survivor's age on donor's death). Any estate tax paid by donor's estate attributable to annuity is deductible by survivor over his life expectancy. Reg. Section 1.691(d)-1(c).

Gift tax. IRC Section 2522(c)(2)(A).

One-life (donor is annuitant) — No gift tax.

Two-life (funded with donor's separate property; donor is first annuitant; another is the survivor annuitant) — Gift to survivor of future and terminable interest; hence, no annual exclusion or marital deduction.

Suggestion — Gift tax on survivor's interest can be avoided if donor reserves right to revoke survivor's annuity. Reg. Section 25.2511-2(c).

Marital deduction

One-life gift annuity for U.S. citizen spouse qualifies for unlimited gift and estate tax marital deductions. IRC Sections 2056(b)(7)(B) and 2523(f)(2), (3). Two-life spousal joint and survivor annuity qualifies for marital deduction as QTIP. IRC Sections 2056(b)(7)(C) and 2523(f)(6). A special rule allows a gift tax QTIP marital deduction for two-life spousal joint and survivor annuity for an alien spouse. See the last sentence of IRC Section 2523(f).

Deferred payment annuity (payments begin more than one year after gift)

Income tax charitable deduction. Rev. Rul. 84-162, 1984-2 CB 200. Exclusion ratio is not determined until payments begin; estate and gift tax implications same as for “immediate” annuities, see “Estate tax” and “Gift tax,” this page.

Flexible starting date deferred payment gift annuity

Donor is allowed during specified period in the future to choose when annuity payments are to begin. PLRs 200449033; 9743054; 9017071. Tax implications similar to “traditional” deferred payment gift annuity.

Substantiating charitable deductions

When the gift portion of a charitable gift annuity is $250 or more, a donor must have an acknowledgment from the charity stating whether any goods or services in addition to the annuity were provided to the donor. If no goods or services were provided, the acknowledgment must so state. The acknowledgment need not include a good faith estimate of the annuity's value. Reg. Sections 1.170A-13(f)(2), (16).

CHARITABLE LEAD TRUSTS

Trust makes payments to designated charity for term of years, with reversion to donor (or spouse) at end of term

To avoid income tax to donor on trust income, reversionary interest must be worth less than 5 percent of trust corpus. IRC Section 673(a).

Instead of reversion to donor or spouse, a lead trust can provide payments to charity for many years or for a term measured by a qualifying life, with remainder to family members — reducing (and sometimes eliminating) gift and estate taxes on passing property “down the line.” Only one or more of the following individuals may be used as measuring lives: the donor; the donor's spouse; an individual who, with respect to all remainder beneficiaries (other than charities) is either a lineal ancestor or the spouse of a lineal ancestor of those beneficiaries. The requirement that all non-charitable remainder beneficiaries are lineal descendants of the individual who is the measuring life, or that individual's spouse, is satisfied if there is less than a 15 percent probability that individuals who are not lineal descendants will receive any trust corpus.

Note — When the trust's duration is measured by a term of years, any individual in the world can be the remainderperson. (TD 8923.) Be sure to take the generation-skipping transfer tax into account.

Income tax charitable deduction — Only if:

  • income paid to charity is taxed to the donor; and

  • charity's interest is a guaranteed annuity or unitrust interest. IRC Section 170(f)(2)(B); Reg. Section 1.170A-6(c)(2).

Ceiling on deduction is 30 percent of adjusted gross income, with a five-year carryover for any excess. IRC Section 170(b)(1)(B). Different rules may apply if the beneficiary of the lead interest is a non-operating private foundation. IRC Section 170(b)(1)(D).

Caution: The deduction is “recaptured” if donor ceases to be treated as owner before trust terminates (for example, donor dies). IRC Section 170(f)(2)(B).

Gift and estate tax

To avoid gift and estate tax implications on charity's income interest, the interest should be a guaranteed annuity or unitrust interest. IRC Sections 2522(c)(2)(B) and 2055(e)(2)(B); Reg. Sections 25.2522(c)-3(c)(2) and 20.2055-2(e)(2); Rev. Rul. 77-300, 1977-2 CB 352.

Computing value of a charity's lead unitrust and lead annuity trust interests

See “Treasury Tables for Split-Interest Gifts,” this page, for tables for computing value of charitable remainder interests; use those tables to calculate value of lead interests.

Caution: Rev. Rul. 82-128, 1982-2 CB 71, dealing with charitable remainder trusts, could apply to charitable lead trusts.

Capital gain

If donor has reversionary interest, he is taxed on gain in year realized by trust. If no reversionary interest, capital gain taxable to trust.

There's no generation skipping tax on remainder to grandchild whose parent isn't living at the trust's creation; nor for remainder to grandnephew or grandniece if parent is not alive at the trust's creation and the trust grantor has no lineal descendants. IRC Section 2651(e).

Substantiating charitable deductions

To deduct a gift of $250 or more, a donor must have written substantiation from the charity (including a good faith estimate of the value of any goods or services given to the donor in exchange for the gift). If no goods or services were provided, the acknowledgment must so state. IRC Section 170(f)(8); Reg. Section 1.170A-13(f)(2). The substantiation rules don't apply, however, to charitable lead trusts. Reg. Section 1.170A-13(f)(13).

GIFTS OF FUTURE INTEREST IN REAL PROPERTY
(WITH RETAINED LIFE ESTATE)

If property is a personal residence or farm, income tax deduction allowed for value of remainder interest, taking straight-line depreciation or cost depletion into account, discounted by Applicable Federal Rate (AFR). Need not take depreciation or depletion into account in computing estate and gift tax deductions, but still discount with AFR. IRC Section 170(f)(3)(B)(i); Reg. Sections 1.170A-7(b)(3) and (4); Reg. Section 1.170A-12(a); IRC Section 2522(c); Reg. Sections 25.2522(c)-3(c)(2)(ii) and (iii); IRC Section 2055(e)(2); Reg. Sections 20.2055-2(e)(2)(ii) and (iii); Rev. Rul. 76-473, 1976-2 CB 306. IRS Pubs. 1457, 1458 and 1459. See “Treasury Tables for Split-Interest Gifts,” this page.

Substantiating charitable deductions

To deduct a gift of $250 or more, a donor must have written substantiation from the charity (including a good faith estimate of the value of any goods or services given to the donor in exchange for the gift). If no goods or services were provided, the acknowledgment must so state. IRC Section 170(f)(8); Reg. Section 1.170A-13(f)(2). IRS substantiation regulations don't mention remainders in personal residences and farms. Reg. Section 1.170A-13(f). Pointer: Unless the IRS says otherwise, consider that the substantiation rules apply to those gifts.

GIFTS OF FUTURE INTEREST IN TANGIBLE PERSONAL PROPERTY
(WITH RETAINED LIFE ESTATE)

No federal income, gift or estate tax charitable deduction for gift of tangible personal property (for example, work of art, furniture, antiques) when donor or close family member retains life estate. IRC Sections 170(a)(3) and 2522(c)(2); Reg. Section 25.2522(c)-3(c)(1)(i); IRC Section 2055(e)(2); Reg. Section 20.2055-2(e)(1)(i).

REFORMING DEFECTIVE SPLIT-INTEREST CHARITABLE GIFTS

Many faulty split-interest charitable gifts may be reformed to qualify for tax benefits if certain requirements are satisfied and deadlines are met. IRC Section 2055(e)(3). Sometimes a trust that isn't otherwise reformable can be reformed under the doctrine of Scrivener's error. PLRs 200447033; 200441019; 200338006; 200251010.

TREASURY TABLES FOR SPLIT-INTEREST GIFTS

Interest assumption is pegged to 120 percent of federal mid-term interest rate based on average market yield of U.S. obligations. IRC Section 7520; Reg. Sections 1.7520-2, -3. AFR changes monthly, thus, donor's deduction for split-interest gift depends on rate in month transfer is made.

Two-month lookback — Donor generally has option to use rate for current month or either of two previous months. Special rules govern pooled income funds.

Treasury-issued actuarial tables are almost always used to value split-interest transfers. But the tables are disregarded when a terminally ill person is the measuring life or when the income beneficiary or remainder person won't get the expected benefit. Reg. Sections 1.7520-3(b); 20.7520-3(b) and 25.7520-3(b). Actuarial tables held to apply when terminal illness wasn't known on unitrust's creation. Burchell, 146 F. Supp. 2d 382 (S.D. N.Y. 2001).

Spotlight

The Faces of Generosity: The second largest donor in 2004 was Warren Buffet, chairman of Berkshire Hathaway, who with his wife Susan gave $2.6 billion through their Omaha-based foundations. Overall, Buffet has donated 1 percent of his total wealth.