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Chico Marx once gave his check to writer Heywood Broun to pay off a gambling debt, but warned him not to cash it before noon. The following day, Broun called Chico, complaining that the check bounced.
“What time did you go to the bank?”
“You said noon; I got there at twelve-o-two.”
“Too late!”
Charities and advisors tell donors about the income tax reporting to substantiate charitable gifts—e.g., the “$250-and-over” receipt rules, rules for cash gifts under $250, rules for gifts of used clothing, household items and vehicles and qualified appraisal requirements.
Sometimes, however, there’s not even a peep about the gift tax implications or the gift tax reporting rules for charitable gifts. Or, they tell the donors after it is too late to avoid taxes and penalties.
Here’s the short gift tax story for outright charitable gifts—when gift tax reporting is and isn’t required. Unfortunately, this is followed by the long story, because it gets complicated for split-interest charitable gifts.
The short story on the gift tax:
• Gifts that qualify for the $13,000 annual-per-donee exclusion aren’t reportable, whether made to an individual or a charity.
• Outright charitable gifts of cash (including IRA rollovers), regardless of the amount, and property gifts (regardless of the value) qualify for the unlimited gift tax charitable deduction and generally aren’t reportable.
• An outright charitable gift of a partial interest (for example, an undivided one-fifth interest in Greenacre) is reportable. But, no gift tax is payable, because it qualifies for the unlimited gift tax charitable deduction.
• “If you are required to file a return to report noncharitable gifts and you made gifts to charities, you must include all your gifts to charities on the return.” [emphasis added] Instructions for Form 709 United States Gift (and Generation Skipping Transfer) Tax Return. (This is from the instructions for 2011. The instructions for 2012 haven’t been issued yet and won’t be until this Autumn. However, the annual instructions have been saying this for a number of years). Presumably, “all” means outright charitable gifts to any charity during the year totaling more than $13,000.
• Gift tax reporting is required for gifts to charities of remainder and lead interests. Offsetting gift tax charitable deductions are available for those gifts resulting in a wash. Taxes may, however, be incurred on a non-charity’s interest in those arrangements if the gift is not offset by the $13,000 annual exclusion and the unified gift and estate tax exemption of $5,120,000 in 2012 and an allowable maritable deduction. If Congress doesn’t act, the unified gift and estate tax exemption will be $1 million in 2013.
The rules differ—depending upon whether the gift is a charitable remainder unitrust, charitable remainder annuity trust, pooled income fund, gift annuity, deferred payment gift annuity, remainder interest in a personal residence or farm or charitable lead trust. And, different rules often apply when the beneficiaries are spouses.
To keep things interesting, different rules apply for citizen and alien spouses. Remember, there's a difference beween an alien spouse and an alienated spouse. The latter may well be an American citizen.
And, to make things even more complicated, how the property is owned (separate property, joint ownership, tenancy in common or community property) and whether an income beneficiary is the first, joint or successor beneficiary must be taken into account.
Now for the rest of (and the long) story:
CHARITABLE REMAINDER UNITRUSTS AND ANNUITY TRUSTS
● One-life unitrust or annuity trust for donor's life. The value of the charitable remainder interest in a unitrust or annuity trust is not subject to gift tax. However, the donor must report the remainder gift, regardless of size, because it's a future interest. Then, the donor takes an offsetting gift tax charitable deduction resulting in a wash.
● One-life unitrust or annuity trust for beneficiary other than the donor. A donor who creates a charitable remainder unitrust or annuity trust calling for payments to another (for example, a spouse or child) for life, with the principal to be delivered to charity on the life beneficiary's death, makes two reportable gifts: one to the beneficiary (the value of his or her life interest) and one to charity (the value of its remainder interest). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then, it's deductible as a charitable contribution, resulting in a wash.
Life beneficiary's interest when the beneficiary is not the donor's spouse. The donor makes a gift to the life beneficiary of the beneficiary's life interest. The life interest has—over the years—been treated as a present interest and qualifies for the $13,000 annual exclusion. If the value of the interest exceeds the $13,000 annual exclusion and the gift is not offset by the donor’s $5,120,000 (for 2012) unified gift and estate tax exemption, gift tax will be due.
Life beneficiary's interest when the beneficiary is the donor's spouse. A citizen-spouse's life interest qualifies for the unlimited gift tax marital deduction. Gifts to a non-citizen spouse should qualify for the $139,000 2012 annual exclusion. (Indexed annually for inflation).
● Two-life unitrust or annuity trust funded with the donor's separate property and the donor is the first beneficiary. A donor who creates a unitrust or annuity trust using his or her own property that pays income to the donor for life, and then to a survivor beneficiary for life, makes two reportable gifts: one to charity (the remainder interest) and one to the survivor beneficiary (the right to receive payments if he survives the donor). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then, it's deductible as a charitable contribution, resulting in a wash.
Second life beneficiary's interest when the beneficiary is not the donor's citizen-spouse. The donor makes a gift to the beneficiary of the value of the survivorship life interest. The gift is of a future interest, so it doesn't qualify for the $13,000 annual exclusion or the special $139,000 2012 annual exclusion for a non-citizen spouse. If the gift is not offset by the donor’s $5,120,000 unified gift and estate tax exemption, gift tax will be due.
Pointer: The donor can avoid making a gift to the survivor by retaining the right exercisable only by will to revoke the survivor's life interest. If the donor exercises that right, the trust terminates on the donor's death. The trust principal is then delivered to charity. The donor need not actually exercise the right, but retention of the right avoids the donor's making a completed gift to the survivor beneficiary.
Second life beneficiary's interest when the beneficiary is the donor's citizen-spouse. A citizen-spouse's future interest qualifies for the gift tax marital deduction. Alternatively, gift tax concerns can be avoided if the donor reserves the right to revoke the surviving spouse's life interest by will.
● Two-life unitrust or annuity trust funded with joint, tenancy in common or community property and the donors are spouses. The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then it's deductible as a charitable contribution, resulting in a wash. The actuarially older spouse makes a gift to the actuarially younger spouse of the difference in value of their survivorship interests. However, the gift qualifies for the gift tax marital deduction if the actuarially younger spouse is a U.S. citizen. Alternatively, the spouses can each reserve the right—exercisable only by will—to revoke the other spouse's survivorship interest in one half of the life-income gift. That right need not be exercised. Non-citizen spouses should each reserve that right to avoid gift tax concerns.
POOLED INCOME FUNDS
● One-life pooled income fund gift for donor's life. The value of the charitable remainder interest is not subject to gift tax. However, the donor must report the remainder gift, regardless of size, because it's a future interest. The donor then takes an offsetting gift tax charitable deduction, resulting in a wash.
● One-life pooled income fund gift for beneficiary other than donor. A donor who creates a pooled income fund gift for another individual makes two reportable gifts: one to the income beneficiary (the value of the life interest) and one to the charity (the value of the remainder interest). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then, it's deductible as a charitable contribution, resulting in a wash.
Life beneficiary's interest when the beneficiary is not the donor's spouse. The donor makes a gift to the life beneficiary of the value of the life interest. The life interest is a present interest and, thus, qualifies for the $13,000 annual exclusion. If the value of the interest exceeds the $13,000 annual exclusion and the gift is not offset by the $5,120,000 (for 2012) unified gift and estate tax exemption, gift tax will be due.
Life beneficiary's interest when the beneficiary is the donor's citizen-spouse. If the qualified terminable interest property (QTIP) election isn't made, the rules are the same as in the preceding paragraph. But, if the QTIP election is made, the entire amount transferred by the donor to the pooled income fund—not just the spouse's life interest—is eligible for the unlimited gift tax marital deduction. If the donor elects to treat the gift on a gift tax return as a qualified terminable interest, the full value of the assets in the fund (attributable to the beneficiary's units) on the surviving spouse's death will then be included in the survivor's gross estate. But, the surviving spouse's estate will be entitled to an offsetting charitable deduction, resulting in a wash. If the spouse is a non-citizen, the gift should qualify for the special $139,000 2012 annual exclusion.
● Two-life pooled income fund gift made with the donor's separate property when the donor is the first beneficiary. A donor who uses his or her own property to make a pooled income fund gift—paying income to the donor for life and then to a successor for life—makes two reportable gifts: one to charity (the remainder interest) and one to the successor beneficiary (the right to receive payments if he or she survives the donor). The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then, it's deductible as a charitable contribution, resulting in a wash.
Second beneficiary's interest when the beneficiary isn't the donor's spouse. The donor makes a gift to the beneficiary (the value of the survivorship life interest). Because the gift is a future interest, it doesn't qualify for the $13,000 annual exclusion. If the gift isn't offset by the $5,120,000 unified gift and estate tax exemption in 2012, gift tax will be due.
Pointer: The donor can avoid making a gift to the survivor by providing that he or she retains the right—exercisable only by will—to revoke the survivor's life interest. Should the donor exercise that right, payments will terminate not on the death of the survivor of the donor and the second beneficiary, but on the donor's death. The donor need not actually exercise the right, but the retention of the right avoids the donor's making a completed gift to the survivor beneficiary.
Second life beneficiary's interest when the second beneficiary is the donor's spouse. A citizen-spouse's future interest in a pooled income fund gift can't qualify for the gift tax marital deduction as a QTIP, because the spouse's life interest starts in the future. But, gift tax concerns can be avoided if the donor reserves the right to revoke the surviving spouse's life interest by will, as described in the preceding paragraph. The right to revoke should also be retained when the survivor beneficiary is a non-citizen spouse.
● Two-life pooled fund gift funded with joint, tenancy in common or community property when donors are citizen spouses. The charitable remainder interest is reportable, regardless of size, because it's a future interest. Then, it's deductible as a charitable contribution, resulting in a wash. The actuarially older spouse makes a gift to the actuarially younger spouse of the difference in value of their survivorship interests. The spouses’ survivorship interests can't qualify for the marital deduction as a QTIP. But, gift tax concerns can be avoided by each spouse reserving the right—exercisable only by will—to revoke the other spouse's survivorship interest in one-half of the life income gift. That right need not be exercised. That right should also be retained for non-citizen spouses.
To be continued next month: Rules for charitable gift annuities; charitable remainder interests in personal residences and farms; and charitable lead trusts. Also, stay tuned for filing deadlines, adequate disclosure and penalties.
© Conrad Teitell 2012. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.