PHILIP T. TEMPLE
McCarthy Fingar LLP
Friday, September 23, 2005
Committees on Health
Law and Non-Profit
I. CHARITABLE GIFT ANNUITIES
A. In Brief. Donor transfers money or property to charity in exchange for promise to pay fixed amount annually to donor (and survivor, if desired) for life. Transfer is part gift and part purchase of annuity. Annual income (rate of return) paid by charity depends upon beneficiary's (annuitant's) age at time of gift. Annual rate of return remains constant for life. Annuitant is considered to be his age at his nearest birthday.
B. Most institutions use rates suggested by American Council on Gift Annuities, 2401 Cedar Springs, Dallas, Texas 75201.
C. The Texas lawsuit -- Ritchie vs. “All.”
1. Lawsuit alleged that charities’ investment of gift annuity proceeds
created “investment companies” subject to registration and other
requirement of federal securities laws.
2. Lawsuit also alleged that charities were engaging in price fixing by
choosing to use recommended annuity rates published by the
3. Congress responded to the threat posed by the case and enacted the
Charitable Gift Annuity Antitrust Act of 1995 and the Philanthropy
Protection Act of 1995.
Antitrust claims were then dismissed.
D. Income Tax Contribution Deduction:
1. Donor entitled to immediate charitable contribution deduction on his income tax return for year of gift. Amount established by official U.S. Treasury tables.
2. When funded with money, donor's contribution deductible up to 50% of adjusted gross income. Any "excess" deductible over five following years -- up to 50% of adjusted gross income each year until exhausted.
3. When funded with long-term appreciated property, contribution deductible up to 30% of adjusted gross income, with five year carryover for any "excess." Possible to increase ceiling to 50% -- with five year carryover -- in some instances by electing to reduce amount of deduction by 100% of appreciation allocable to gift element.
E. Tax-Free Income. Significant portion of each annuity payment annuitant receives is tax-free. Tax-free amount each year for life (but not to exceed life expectancy -- after investment in contract is recovered, payments fully taxable) is fixed by
annuitant's age at time of gift. Determined by official Treasury tables. Called the exclusion ratio.
F. Capital Gains Implications On Transfer Of Appreciated Property:
1. Transfer of appreciated property is deemed to be bargain sale.
2. In computing amount of gain, cost-basis of transferred property must be allocated between gift portion and "investment in contract" (value of annuity received).
3. Amount of capital gain is difference between investment in contract and allocated basis.
4. Gain so determined is taxed to donor over his life expectancy, if annuity is nonassignable. Capital gain divided by annuitant's life expectancy and reported over his life expectancy, but only from that portion of annual payments which is return of investment in contract. Still not bad deal.
5. Gain reported ratably over life expectancy only if donor is sole annuitant or is one of annuitants in two-life annuity.
G. Estate Tax Benefits:
1. Annuity for donor's sole life completely excludable from his estate.
2. In two-life annuity, estate of first annuitant (purchaser) not subject to estate tax if second annuitant does not survive. If second annuitant survives: Includable in estate of first annuitant (purchaser) is only value of survivor's annuity -- what it would cost to purchase annuity paying survivor same annual amount that was paid to annuity purchaser. This value based on survivor's age at annuity purchaser's death. If no gift annuity purchased, entire amount used to purchase annuity subject to estate tax. If survivor annuitant is spouse, can qualify for marital deduction.
3. Survivor receives same amount tax-free each year as first annuitant did. In addition, survivor gets income tax deduction spread over his life expectancy for any Federal estate tax paid by first annuitant's estate on value of survivor's annuity.
H. Gift Tax Implications of Two-Life Gift Annuities. Donor who funds annuity with own property and provides annuity payments first to himself and then to survivor,
makes gift to survivor. However, proper drafting of annuity agreement -- donor retains right to revoke survivor's interest -- can make gift to survivor free of gift tax.
II. DEFERRED PAYMENT GIFT ANNUITIES
A. Many donors with sufficient current income from employment or other sources would like to make sizable charitable gift of capital now, but are concerned that on retirement they will need income their capital earns. They would also like to reduce their current income taxes. Deferred payment gift annuity often
answer. It provides retirement income and saves income taxes now -- and lets donor make important charitable gift. Now sometimes called the IRA substitute.
B. In Brief. Donor makes gift to charitable institution in exchange for charity's promise to pay him guaranteed life income starting at retirement (or any other date specified).
1. Satisfaction of making significant charitable gift.
2. Donor gets sizable charitable deduction now when he is in higher tax bracket than he will probably be after retirement. Charitable gift now (rather than after retirement) generates greater tax savings. Reason: Higher the tax bracket, larger are tax savings generated by charitable gift.
3. Donor receives guaranteed annual income at retirement when his income will probably be lower than current income. Thus, receives income at time when it is needed and when it may be taxed in lower income tax brackets.
4. Part of each guaranteed payment will be tax-free.
5. Donor rids himself of management and investment worries.
6. Donor will save estate taxes and probate costs.
D. Determining Payments To Be Made:
1. Annual income charity pays (rate of return) depends upon (1) annuitant's age now, and (2) age annuitant will be when payments are to start.
2. American Council on Gift Annuities recommends this procedure:
(a) Take amount transferred and compound annually at 6% a year from date of transfer until six months before first payment. However, period of compounding is then rounded off to first even number of years six months before date of first payment.
Example: On February 1, 1995 donor transfers $100,000 for deferred payment annuity with first payment to be made on February 1, 2115. Period of compounding would be 19 years. That is, 20 years until first payment, reduced by six months and then rounded off to nearest whole year before first payment.
(b) Once amount transferred compounded as provided above, determine amount of annuity to be paid by multiplying rate of return charitable organization currently offers for immediate annuities for individuals who are now age annuitant will be when annuity payments are to start.
E. Income Tax Savings:
1. Donor receives income tax charitable deduction in the year he makes transfer. Amount of contribution established by official U.S. Treasury tables.
2. When funded with money, contribution deductible up to 50% of donor's adjusted gross income. Any “excess” deductible over five following years -- up to 50% of adjusted gross income each year -- until exhausted.
3. When funded with long-term appreciated securities, contribution deductible up to 30% of adjusted gross income, with five year - 30% of adjusted gross income carryover for any "excess." Possible to increase ceiling to 50% of adjusted gross income with five year - 50% of adjusted gross income carryover in some instances. Same transfer is made but amount deemed contributed reduced by 100% of appreciation allocable to gift part of annuity.
F. Favorable Taxation Of Annuity Payments. Substantial part of each payment received is tax-free until investment in contract is recovered. Tax-free amount depends on : (1) annuitant's age now, (2) age when payments start, (3) Treasury's life expectancy tables in effect when payments start, and (4) income tax laws in effect when payments begin. This information enables computation of "exclusion ratio."
G. Capital Gains Consequences:
1. There are capital gains implications when deferred payment gift annuity funded with appreciated securities. However:
(a) Gain is smaller than gain would be on sale of appreciated securities (instead of transfer for deferred payment gift annuity).
(b) Gain should not be reportable in year of transfer for deferred payment gift annuity (as it would be if securities sold). Should be reported ratably over donor-annuitant's life expectancy, starting when payments begin.
2. Treasury regulations give capital gains implications for "immediate" gift annuities (when payments start within one year of gift). Assumed that rules will be same for deferred payment gift annuities. Private letter ruling so holds.
H. Benefiting Family Member:
1. Donor can have deferred payment gift annuity pay income to him for life (starting when he chooses) and then to his wife (or other designated family member) for life.
2. How two-life annuities work: Payments made to one individual for life (starting at specified date) and then to survivor for life; or payments can be made jointly and then to survivor. Which way best depends on donor's wishes and how assets used to fund annuity are owned. Deferred payment gift annuities can generally be written so that family member's right to payments not subject to Federal gift tax.
3. Rate of return lower for two-life deferred payment gift annuity because period of payments is actuarially longer.
I. Estate Tax Benefits:
1. If donor is only annuitant (or, in two-life annuity, is not survived by second annuitant) annuity not taxed to estate at all.
2. If there is survivor annuitant, only amount includable in estate of first annuitant (purchaser) is value of survivor's annuity - what it would cost to purchase annuity, paying survivor same annual amount that was paid to annuity purchaser. This value based on survivor's age at annuity
J. Income Tax Benefits For Survivor. Survivor receives same amount tax-free each year as first annuitant did. In addition, survivor gets income tax deduction spread over his or her life expectancy for any Federal estate tax paid by first annuitant's estate on value of survivor's annuity.
III. Some More Recent Developments Regarding Gift Annuities
1. The flexible Starting Date Gift Annuity – see PLR 200449033.
2. Swap of crut life interest for Gift Annuity. See PLR 200152018.
3. New York State Changes:
(a) Investments of gift annuity reserve account. Prudent Investor Act.
(b) Charities no longer limited to cash or readily marketable
securities for gift in return for gift annuity.
IV. The Attack on Charities and Donations.
1. On Senate Finance Committee Front Burner.
2. Most important areas:
(a) The deduction for gifts of appreciated real estate, closely held
business interests and tangible personal property.
(b) Supporting organizations.
(c) Donor advised funds.
3. The Non-Profit Panel: the attempt not to throw out the baby with the bath water.