Planned giving officers for charities, lawyers and other professionals who advise individuals who make significant gifts to charity often encounter stumbling blocks regarding the charitable planning around the donation.
“Significant gifts” are large gifts and often involve trusts, such as charitable remainder trusts (CRTs), and naming rights, such as the donor’s right to have their name placed on some physical structure.
It’s fairly well known that the federal tax law affords “carrots” to individuals who make such gifts, such as the ability to claim a federal income tax charitable deduction. Less well known is that the federal tax law imposes “sticks,” such as denial of a charitable deduction, to donors who don’t comply with an array of highly complex rules.
Using some examples, I’ll focus on the sticks.
Perils of the Pledge
Let’s consider Husband (H) and Wife (W), a wealthy couple who live in a large American city. Their primary lawyer is a senior partner at a white-shoe law firm in their city, and they’ve established a private foundation (PF). This statement of facts may seem innocuous but is filled with tax-related peril for H and W, who want to donate a 7- or 8-figure sum to a major charity in their city.
This couple will deal with one or more individuals who are highly placed in the particular charity—for example, the charity’s high profile president or board chair, who perhaps calls H and W by their first names and belongs to the same clubs. On the surface, there’s nothing wrong with this picture. But I see some sticks, taking into account that: (1) a gift of the kind in question is likely to be one for which H and W get their names on something at the charity (a naming gift); (2) the gift is likely to be made by H and W’s PF; and (3) the gift is likely to be made pursuant to a written pledge that H and W make to the charity.
The stick in this situation is that the payment of the pledge may be an act of self dealing. A pledge is either enforceable (as a contract) or unenforceable. Enforceability is determined under the law of the state governing the pledge. At least three states, Iowa, New Jersey and Pennsylvania, don’t require either consideration or detrimental reliance for a pledge to be enforceable.1 A pledge or a large amount should always be in writing, and the writing should contain a governing law provision. The pledge made by H and W will be enforceable under contract law (the promise to give is supported by the consideration of naming). This means any payment of the pledge by H and W’s PF would be a prohibited act of self-dealing. It’s a big, bad stick, to be sure.2
Let’s look at another situation involving pledges that may result in a stick. In Revenue Ruling 81-110, Party A made a legally binding (enforceable) pledge. Party B paid the pledge. The Internal Revenue Service ruled that Party B’s payment was a transfer to Party A and that Party A was deemed to pay the pledge (and could take the corresponding charitable deduction).
To avoid (most) problems with pledges, a charity should: (1) determine up front the source or sources of payment for the pledge; and (2) make sure the development office vets all pledges before signing the pledge agreement. In one case involving a pledge of an 8-figure amount, I learned this wasn’t done, and a bad outcome ensued for both the charity and the wealthy donor couple.
Qualified Appraisal Rules
Assume the donor is a fairly wealthy individual who wants to use highly appreciated marketable stock worth $250,000 to establish a CRT for the eventual benefit of Charity A, which will serve as trustee of the CRT.
Until Jan. 1, 2019, when new qualified appraisal rules took effect, tax advisors generally believed that no qualified appraisal was needed for the CRT the donor intended to create. Amendments to the Treasury regulations changed all that. The new rules provide that if a partial interest (such as the remainder interest in a CRT) is given to a charity, the partial interest (not the asset used here to fund the CRT) is subject to the qualified appraisal rules.3 The only exception is that such an appraisal isn’t required for a cash-funded CRT.4 Appreciated assets, however, not cash, are typically used to create a CRT described here.5
Gift Receipt
The tax law requires a contemporaneous written acknowledgment (CWA) for a charitable gift for the donor to be entitled to a charitable deduction.
Charity gift officers are aware, by and large, of the tax law requirement that for a donation of $250 or more, the donor needs to be able to substantiate the gift with a CWA that states: (1) whether the charity provided any goods or services to the donor in consideration of the gift, and (2) if it did, the monetary value of those goods or services.
In fact, gift officers are so aware of this requirement that occasionally they misapply it. The misapplication occurs when the charity issues a standard no-goods-or-services CWA to a gift annuity donor. The annuity payments made by the charity to the annuity recipient (who’s most often the donor) are “goods” possibly having significant monetary value. The tax law in this situation expressly requires the CWA to state whether the annuity recipient received anything of value in addition to the annuity from the charity.6
Other Common Sticks
Here are some other sticks preventing donors from getting a charitable deduction:
The donor doesn’t know the basis, and there are no records to establish basis. In this situation, the basis is zero. That’s because a taxpayer has the burden of establishing a favorable tax position, and the donor can’t do this.7
A broker wires stock to the charity from the donor’s individual retirement account as a qualified charitable distribution (QCD). This is problematic because the IRS hasn’t said when the QCD is deemed to have been made or how to calculate its amount. So the donor may not be able to meet the requirements for a charitable deduction. No federal income tax charitable deduction is allowed for a QCD.
The donor has stock wired to charity to establish a gift annuity, and the stock drops in value while in transit. It’s unclear what value to use to compute the annual annuity payment. The answer may be found in the charity’s gift acceptance policy (GAP). If the GAP is silent on the matter, there’s a potentially messy fight in store.
PF pays for gala dinner tickets. This is a recurring problem for one reason: The IRS has said the purchaser’s PF may not pay the “charitable part” of the ticket price.8 To ascertain which is the charitable part versus the cost of dinner, the cost of dinner is determined by finding out what a comparable commercial venue would charge.
IRA money is left to a charity at the donor’s death. This poses a recurring problem because some IRA custodians want charitable beneficiaries to set up inherited IRAs. The problem here is that charities generally have found it difficult or impossible to receive their beneficiary distributions from an inherited IRA. Gift officers at charities generally believe it’s because the custodian wants to hold on to the IRA assets. I’m inclined to believe they’re correct.
Endnotes
1. As to New Jersey, see Jewish Federation of Central New Jersey v. Barondess, 234 N.J. Super. 526 (1989) (spoken pledge held to be enforceable). As to Iowa, see Salsbury v. Northwestern Bell Telephone, 221 N.W.2d 209 (1974). As to Pennsylvania, a written pledge in which donors (a married couple who file a joint federal income tax return) state that they intend to be bound by their promise to donate is enforceable statutorily (see 33 P.S. Section 6).
2. See Treasury Regulations Section 53.4941(d)(2(f).
3. Treas. Regs. Section 1.170A-6(b)(2).
4. Treas. Regs. Section 1.170A-15(g).
5. Appreciated assets (in particular, securities and real estate) are typically used instead of cash to establish a charitable remainder trust (CRT) because transferring an appreciated asset CRT doesn’t cause the appreciation to be realized as capital gains. That’s because the transfer isn’t a sale or exchange.
6. Treas. Regs. Section 1.170A-13(f)(16).
7. As to basis rules generally, see IRS Publication 561.
8. See Private Letter Ruling 9021066 (March 1, 1990).
