Charitable Planning - 2014 & Beyond

The Power of Trust. The Power of Growth. The Power of Teamwork.
Charitable Giving Techniques:
Overview of Alternatives
Presented by: Amy Joyce
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Charitable Giving Options: Simple to Complex
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Simple
• Outright Gifts During Life
• Outright Gifts At Death
Moderate
• Donor Advised Fund
• Charitable Gift Annuity
• Pooled Income Fund
Complex
• Private Foundation
• Charitable Remainder Trust
• Charitable Lead Trust

Questions for Donors to Ask Them Themselves:
 What causes do I feel strongly about?
 When do I want to give money/property – now, after a term of years, or at the
end of my life?
 When do I want my charity to be able to spend the money/property that I give –
now, after a term of years, or at the end of my life?
 How engaged in the process do I want to be? Am I comfortable with more record
keeping, annual tax filings and consultations with professionals (attorneys,
accountants, financial advisors)? Or would I prefer to just give money to a cause I
believe in (now or at my death) as simply and economically as I can and forego
the potential additional tax savings afforded by more complex methods of
charitable giving?
 What economic and other advantages are there to me in giving away
money/property through one of the more complex methods as compared with
the outright gift or bequest?
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Outright Gifts
1. Outright Transfer During Life – Write a check, transfer stock, deed property,
etc. Can be done quickly and with minimal or no cost.
 How much is deductible for income tax purposes?
The income tax deduction, generally measured by FMV of gifted
property, for the year of transfer is limited to either 20%, 30%, or 50%
of the donor’s adjusted gross income (AGI), depending on: (1) type of
property given and (2) type of charity. The gift tax deduction is
measured in the same manner except that there is no AGI limitation.
2. Outright Transfer at Death – Provided for by will or by beneficiary
designation in a trust, life insurance contract, or retirement account.
Executor of estate oversees transfer of property to charity.
 How much is deductible for estate tax purposes?
The estate tax charitable deduction is based on value of the assets
actually passing to charity, reduced by death taxes payable out of estate
assets allocable to the charitable bequest.
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Outright Gifts (cont’d)
Tax advantage to donating during life rather than at death.
A charitable bequest takes advantage only of the estate tax charitable deduction and
not the income tax charitable deduction. Making a lifetime donation to a charitable
organization takes advantage of the income tax charitable deduction and the gift tax
charitable deduction, as can be illustrated with a simple example:
The estate of John, who is unmarried, is valued at $10 million. John's will provides
for a $1 million bequest to charity. If John dies in 2014, his estate's federal estate tax
liability will be reduced by about $400,000 ($1 million x 40% estate tax rate). But if
John had donated the $1 million prior to his death, not only would the $1 million be
removed from his gross estate, but also a charitable income tax deduction would
have been available, subject to the AGI percentage limitations.
Quid pro quo: A lifetime gift takes with it any cash flow that might otherwise be
available to the donor from the gifted property.
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Donor Advised Fund
How does it work?
 A donor advised fund is sometimes referred to as the “poor man's private foundation.”
 Donor contributes cash/marketable property to a specific public charity or community foundation (or
a commercial donor advised fund).
 Donor receives immediate income tax deduction (up to 50% of AGI) for FMV of property contributed.
 The public charity or community foundation typically receives grant requests from those charities
seeking distributions from the advised fund, and the donor suggests which grant requests should be
honored.
 Although the he donor cannot make a binding directive, the fund will typically make grants to the
charities recommended by the donor.
 In return for a fee, the fund manager: (1) Makes distributions to charities recommended by the
donor; (2) Seeks to maximize positive returns on the assets; and (3) Handles administrative duties
such as paperwork.
 Note: The donor does not obtain a tax deduction when the charity receives a distribution from the
fund.
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Charitable Gift Annuity
How does it work?
 Combines the benefits of an immediate income tax deduction and a lifetime income
stream. The donor makes a gift of cash or other property to a charity in exchange for a
guaranteed fixed income annuity for life. Annuity amount is set by the issuer.
 The charitable deduction is less than the total value of the donor’s annuity purchase
price because the deduction can only be claimed for the present value of the property
that the charity will keep after the donor’s death. The deduction takes into account:
1. FMV of assets donated
2. Life expectancy income beneficiary
3. IRS Discount Rate (annual rate of return that the IRS assumes the gift assets
will earn during the gift term – currently 2.0%).
 A portion of each annuity payment is: (1) tax-free – the donor is entitled to recover his
original investment over his life expectancy), (2) capital gain & (3) ordinary.
 Upon donor’s death the nonprofit gets to keep whatever is left of the original sum. The
issuer typically sets the annuity rate so that 50%of the donor's initial goes to charity.
 Gift annuities often are used because the typical agreement is fairly short and easy for
donors to understand. There is no need for a trust instrument or a trustee.
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Pooled Income Fund
How does it work?
 The fund is formed by a charity and is managed by trustees appointed by the charity.
 The donors gives money or property to the fund in exchange for units of interest, which
entitle the donors to a lifetime ratable share of the fund's actual income. PIFs are often
described as charitable mutual funds or the “poor man’s charitable remainder trust.”
 Each donor receives a charitable deduction for the actuarial value of the charitable
remainder interest in the pooled income fund. The tax deduction is based on the
following factors:
1. FMV of assets donated
2. Life expectancy income beneficiary
3. Highest investment return of the fund (NOT the IRS discount rate) during the
three preceding years.
 Although donors are entitled to income and gift tax deductions, their annual income
distribution from the fund is taxable (and the PIF cannot invest in tax-exempt securities).
 At the donor’s death, his share of the fund's assets pass outright to the charity.
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Pooled Income Fund (cont’d)
 Although popular in the 70s and 80s when interest rates were very high, PIFs have fallen
out of favor due to declining interest rates, which result in lower income payouts to donors.
 By contrast, Charitable Gift Annuities have become popular because they make payments
from both income and principal, at a specific and fixed dollar amount, determined upon
funding. As a result, the payments will not decline regardless of market interest rates.
 However, it is because of the current low interest rates that PIFs might be attractive to
some donors. Remember, the up front charitable deduction is equal to the FMV of the
property given to charity minus the present value of the income stream retained by the
donor. When interest rates are low, the present value of the donor’s retained interest is
lower and the present value of the charity’s remainder interest is higher, resulting in a
higher charitable income tax deduction.
 As interest rates rise, which is expected by most economists, the net income from PIFs will
increase as well.
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Private Non-Operating Foundation
How does it work?
 A private foundation is a charitable organization supported by a single source (e.g., a family).
 Non-operating foundations do not engage in charitable activities directly, but accumulate and disburse
funds for charitable purposes. By contrast, operating foundations (e.g., museums) use their funds for
their own charitable activity, including purchasing and maintaining assets. Individual donors typically
establish non-operating foundations.
 The primary tax benefit of establishing a private foundation is that contributions to it are deductible
(subject to of AGI limitations), even though most of the contributed funds may be held by the foundation
(and controlled by the donor) for many years.
 The foundation need only distribute 5% of its net asset value, redetermined annually.
 A private foundation does not pay regular income tax, but is generally subject to a 2% excise tax on net
investment income, resulting in more after-tax dollars to accomplish charitable objectives.
 Start-up and annual costs can be substantial (similar to running a small business).
 Generally, an individual must have fairly substantial wealth, a desire to make significant charitable
contributions, and long-term charitable objectives for the benefits to exceed the cost of establishing a
private foundation.
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Charitable Remainder Trust
How does it work?
 The CRT provides an annual stream of payments to one or more non-charitable beneficiaries for a
term of years (not to exceed 20) or for life. When the income interests terminate, the trust property
is distributed to the designated charitable organization.
 Since the remainder interest in the trust goes to charity, the donor is entitled to a current income tax
deduction equal to the present value of the charitable remainder interest. This arrangement provides
the donor with an up front tax deduction and a retained flow of income from the gifted property.
 The value of the remainder interest also qualifies for the estate or gift tax charitable deduction. This
is important when someone other than the donor or his spouse is the non-charitable income
beneficiary (e.g., grantor’s child). In either case, the deduction is reduced by the present value of the
remainder interest passing to charity.
 The CRT is exempt from income taxes. As a result, any income not distributed by the trust to the
income beneficiary will accumulate tax free and will ultimately revert to the charity.
 Due to the tax exempt status of the trust, the grantor can fund the trust with appreciated property,
which the trust can then sell without the imposition of capital gains tax at the trust level. Since assets
are not eroded by income taxes, the CRT has a higher asset base available for the production of
income.
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Charitable Lead Trust
How does it work?
 Essentially the mirror image of a CRT: (1) Provides an annual annuity stream (lead interest) to charity
and (2) Remainder reverts to the donor or other non-charitable beneficiary.
 The charitable lead trust arrangement permits the donor to make a charitable gift of income from
property while retaining ownership of the property for the grantor or grantor’s family. This technique
typically is used by families who are willing and able to forego income from the use of assets for a
period of time while they wait for their remainder.
 Two variations of CLTs, each with different objectives:
1. Grantor Lead Trust – Designed to produce an immediate income tax deduction for the value
of all the income that will be paid to the charity in future years. The grantor is deemed to
own the trust assets and, as a result, pays tax on any income generated by the trust assets.
For this reason, grantor lead trusts often hold tax-exempt securities.
Grantor lead trusts can only be created during the grantor’s lifetime. Typically the assets
revert to the donor after a term of years (e.g., at retirement age).
2. Non-Grantor Lead Trust – Designed to reduce gift and estate taxes while passing property to
family members. The grantor does not receive a charitable income tax deduction; however,
the trust’s income will be offset by charitable contribution deductions.
Non-grantor lead trusts may be created during life or at death, with the remainder interest
passing to the donor’s family members.
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Charitable Lead Trust (cont’d)
Example: Non-Grantor Charitable Lead Annuity Trust
 John has the following profile: (1) charitably inclined, (2) $15 million gross estate, and (3) wants his
children to inherit most of his assets but understands that the amount can be significantly reduced by
estate taxes.
 John creates a non-grantor CLT as follows:
• Trust Term: 20 years
• Funding Amount: $5 million of securities
• Annual Growth: 8%
• Annuity Payout Rate: 5% ($250,000 to charity annually)
• IRS Discount Rate: 2%
• PV of Income Interest: $4,087,850 (charitable)
• PV of Remainder Interest: $912,150 (non-charitable)
 This example shows that:
• The charity will receive $5 million ($250,000 for 20 years).
• The trust assets will grow to $11,864,294, taking into account 8% annual growth less the 5%
annual payments to charity. IRS assumes growth of only 2%!
• John will have a taxable gift of $912,150 (covered by lifetime gift tax exemption) but John’s
children will receive nearly $12 million at a gift tax cost of about $1 million!
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Donor Advised Fund vs. Private Foundation
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Donor Advised Fund Private Foundation
Deduction – cash gifts: 50% of AGI 30% of AGI
Deduction – L/T cap gain prop: 30% of AGI 20% of AGI
Donor control (*key*): Donor can recommend investments
& grants, but fund makes final
decisions.
Donor retains control over investments
and grant making, limited only by IRS
rules.
Entity’s minimum annual
payout requirements:
None, except by fund’s policy. Must pay out 5% of asset value
regardless of income.
Ease of Creation: Established by simple contract
between donor and fund.
Nonprofit corporation or trust
organized as private foundation.
Start-up costs: No cost to donor. Substantial legal, accounting, and
operational costs.
Tax-exempt status: Shares public charity status with
fund.
Must establish separate tax exempt
status (IRS approval).
Entity’s annual taxes: None. Generally tax-exempt but subject to 2%
excise tax on investment income.
Annual tax filing responsibility: None for donor; reported by fund. Donor responsible for Fed/state filing.

CGAs, PIFs & CRTs
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Char. Gift Annuity Pooled Income Fund Char. Remainder Trust
~ Min. investment: $5,000 $20,000 $200,000
Set up time, costs &
complexity:
Immediate, No cost, Simple
Contract
Immediate, No cost, Simple
Transfer Document
Weeks/Months, Prof. Fees,
Formal Trust Document.
Charitable income
tax deduction:
PV of charitable remainder
(based on 7520 rate).
(based on fund performance).
(based on 7520 rate).
Taxation of Annuity
Payment:
Tax-free return of inv’t,
capital gain & ordinary.
Ordinary income. Tier System: Ordinary, Cap
Gain, Exempt & Rtn of Prin
Type of Income
Payout to Donor:
Fixed income payout;
potential inflation risk.
Fluctuates according to
investment returns.
Fixed annuity (CRAT) or
fixed % of assets (CRUT).
Control over
investment choices:
No Control – Charity controls
how assets are invested.
Some Control – Donor
chooses allocations to various
investment pools.
Complete Control –
Trustee controls how
assets are invested.
Remainder charitable
beneficiaries:
Typically only the sponsor
charity; can’t be changed.
Flexible and may be changed. Flexibility provided for in
trust document.
Income beneficiaries: Up to 2 Up to 2 Unlimited
Non-charitable term: Lifetime Lifetime Lifetime or term of years
(not to exceed 20)

Importance of Interest Rates for
Split-Interest Arrangements
 Generally, when calculating tax deductions involving charitable and non-charitable beneficiaries, you
use the IRS discount rate for the month in which the gift is made (or either of the prior two months, if
lower).
 Also know as the Section 7520 rate, the IRS discount rate equals 120% of the annual mid-term rate,
rounded to the nearest 0.2%. The annual mid-term rate is the average annual yield over the past 30
days of Treasury instruments that have remaining maturities of 3-9 years.
 December 2014 Sec. 7520 rate = 2.0%.
 In a nutshell – the lower the IRS discount rate:
• The lower the tax deduction for charitable gift annuities & charitable remainder trusts.
(PV of donor’s retained income interest is not heavily discounted and is therefore larger, which
translates into a smaller interest for the charitable beneficiary)
• The higher the tax deduction for charitable lead trusts.
(PV of donor’s remainder interest is less valuable because charity’s interest is not heavily
discounted, thereby creating a larger interest for the charitable beneficiary)
 Pooled income funds are unaffected by IRS discount rates.
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Importance of Interest Rates (cont’d)
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Illustration: Charitable Remainder
Annuity Trust
Charitable Lead
Grantor Trust
Trust Term 20 years 20 years
Sec. 7520 Rate
(November 2014)
2.2% 2.2%
FMV of Trust Assets $1,000,000 $1,000,000
Percentage Payout 5% 5%
Type of Interest
Retained by Donor
Income Remainder
Effect of Low
7520 Rate
PV of Annuity to Non-Charitable
Beneficiary is Higher
PV of Annuity to Charitable
Beneficiary is Higher
Donor’s Income Tax
Charitable Deduction
$191,414 $808,586

Charitable Planning - 2014 & Beyond

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