1 Introduction: THE SECRET TO UNDERSTANDING PLANNED GIVING

1 Introduction: THE SECRET TO UNDERSTANDING PLANNED GIVING

Article posted in General on 15 June 2015| 3 comments
audience: National Publication, Russell N. James III, J.D., Ph.D., CFP | last updated: 23 June 2015
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VISUAL PLANNED GIVING:
An Introduction to the Law and Taxation
of Charitable Gift Planning

By: Russell James III, J.D., Ph.D.

1 INTRODUCTION:
THE SECRET TO UNDERSTANDING PLANNED GIVING

Click here to read the preface.

Sophisticated planned giving can be intimidating for professional fundraisers, financial advisors, and donors.  It seemingly offers complex terms, complex calculations, and the risk of serious penalties if done incorrectly.  It is no wonder that many simply turn away from the field to stick to the easier approaches they already know.  Yet, this fear leads to enormous lost opportunities for the donor, the fundraiser, and the financial advisor.  This book is intended to make the concepts of planned giving friendlier and more intuitive.  When advisors and fundraisers understand the core capabilities of planned giving, they are able to provide dramatically increased value to their clients, donors, and nonprofit organizations.  That starts not with mastering the vast complexity possible in planned giving, but with understanding the underlying simplicity common to almost all of planned giving

Planned giving and simplicity don’t normally go together.  The perception of planned giving is that it can be enormously complex.  This perception is accurate.  Planned giving transactions can be among the most complex transactions.  They can involve Charitable Remainder Trusts, foundations, Charitable Lead Trusts, capital gains taxes, income taxes, estate taxes, gift taxes, special business entities, a four-tiered income accounting system, life insurance, arcane documentation requirements, and more.  When facing this forest of rules and regulations, it makes perfect sense that many simply throw up their hands and retreat.  Yes, planned giving can become quite complicated.  Yet, amidst this forest of details, a core simplicity motivates nearly all planned giving transactions.

Behind all of the complexity lies this simplicity.  Gift planning can do two things.  Fundraisers should use it for two main reasons.  Financial advisors should use it for two different main reasons.  That’s it.  If you remember these sets of two, you will understand the basic what and why of planned giving.

It’s not that complicated.  Gift planning can do two things, lower taxes and trade a gift for income.  Regardless of how massively complex a planned giving transaction can become, it will do only these two things.  If you understand this simple reality, you understand what planned giving structures can accomplish.

So, if planned giving can only do these two things, why do we need an entire book – indeed many, many books most of which are far more sophisticated than this one – to cover planned giving?  It is true that planned giving can only do two things (lower taxes and trade a gift for income), but there are a wide variety of ways in which these two things can be accomplished.

Let’s begin with trading a gift for income.  The first question to answer is, “Where should the income come from?”  Does the donor want the income payments to come from, and be guaranteed by, the charity?  If so, then she would consider a Charitable Gift Annuity (CGA).  Does the donor instead want the income payments to come from, and be backed by, the assets contributed by the donor?  If so, then she would consider a Charitable Remainder Trust (CRT).  Perhaps the donor would prefer to have the income payments come from, and be backed by, a large pool of assets contributed by many donors.  If so, then she might consider the, relatively rare, Pooled Income Fund (PIF).  Instead of having one option (trading a gift for income, yes or no), the donor now has three options.  The menu of options does not stop with these three choices.

First, the donor can choose where the income payments should come from.  Next, the donor can choose what kind of payments she would prefer.  If the payments are coming from the charity, she can choose to take fixed dollar payments for one or two lives where the payments begin immediately following the gift.  This is the standard Charitable Gift Annuity.  The donor may instead prefer to delay the start of the payments until some future point, such as retirement.  This is a deferred Charitable Gift Annuity.

   

If the payments are coming from a Charitable Remainder Trust holding the donor’s assets, there are even more options for the income.  Just as with a Charitable Gift Annuity, a Charitable Remainder Trust can make fixed dollar payments for life or multiple lives.  Alternatively, the Charitable Remainder Trust can make fixed dollar payments for a set period, up to 20 years.  Or, the Charitable Remainder Trust can pay a fixed percentage of its assets, either for one or more lives or for up to 20 years.  This means that if the value of the assets in the Charitable Remainder Trust increases or decreases, so do the payments.  This may be attractive as a way to combat the effects of inflation through investment performance, especially because the donor often can continue to manage or select the manager of the assets.  In yet another variation, called a Net Income Charitable Remainder Unitrust or NICRUT, the payments may be capped at the income received from the trust investments.  This may be helpful to prevent a forced sale when the trust holds only an asset that generates no income.  Even this alternative has two additional variations.  In the Net Income with Make-up Charitable Remainder Unitrust (NIMCRUT), any payments reduced due to low income in one year can be made-up in later years when income is high.  Finally, the flip-CRUT combines two types of Charitable Remainder Trusts, starting as a NIMCRUT or NICRUT and then “flipping” to a standard CRUT upon the occurrence of an event such as the donor reaching retirement age or the sale of a difficult-to-market asset.  Through creative asset management, this can allow the assets to grow rapidly with no taxation or payouts until the donor desires to start receiving them at some later point.

Thus, what starts as a simple concept – trading a gift for income – quickly becomes cluttered due to the many options available.  Instead of throwing up our hands when faced with the alphabet soup of CGA, deferred CGA, CRAT, CRUT, NICRUT, NIMCRUT, and flip-CRUT, the key is to remember that there is just one core idea – trading a gift for income.  Beyond this the options are simply variations available to better match the desires of the donor.

The second thing gift planning can do is lower taxes.  Lowering taxes can be great for the donor (gifts are cheaper), great for the advisor (providing serious value to the client and reducing the tax bite on assets under management), and great for the charity (making bigger gifts more affordable).  But, lowering taxes can be a complicated process.  In fact, most of the complexity in planned giving comes from tax laws and, consequently, most of this book deals with tax law.  Determining the best way to lower taxes first depends upon which type of taxes the donor is interested in lowering.  Planned giving can lower capital gains taxes, income taxes, and estate taxes, but the techniques differ depending upon which tax is the focus.

Lowering capital gains taxes occurs when the donor gives appreciated property, rather than cash, to the charity.  Because the charity – and not the donor – sells the appreciated property, no taxes are paid.  The donor can either give the property to the charity, or give the property to the charity in exchange for income – with all of the options available as discussed above.

Lowering income taxes can occur in a number of ways.  In the simplest form, the donor can take an income tax deduction for making a charitable gift of money or property.  Beyond this, there are several methods by which a donor can take an immediate income tax deduction in exchange for a transfer that will not be received by the charity for many years, often not until after the death of the donor.  These strategies include the Charitable Remainder Trust, the remainder interest deed in a home or farmland, the private foundation, the donor advised fund, and the grantor Charitable Lead Trust.  Additionally, the donor can still receive an income tax deduction when making a charitable gift in exchange for income, such as with a Charitable Remainder Annuity Trust (CRAT), Charitable Remainder Unitrust (CRUT), Charitable Gift Annuity (CGA), or Pooled Income Fund (PIF).  Not only can charitable giving lower income taxes for the donor, it can also lower income taxes for the donor’s heirs.  When deciding which assets to leave to charity at death, the donor may choose to leave money in traditional retirement accounts (IRAs, 401-Ks) to charity.  If the heirs receive these funds, they must pay income taxes when they withdraw the funds.  Charities, in contrast, do not pay income taxes.  Thus, wise planning leaves the tax-heavy assets to charity. This reduces the income taxes that would otherwise be owed by the heirs without diminishing the charity’s share.

Charitable planning can also lower estate taxes.  Of course, money or property left to charity at death is not subject to estate taxes.  Thus, money or property left to charity through a will, beneficiary designation, Charitable Remainder Trust, or remainder interest deed will escape estate taxes.  The Charitable Remainder Trust may also be combined with an Irrevocable Life Insurance Trust structured in such a way as to avoid estate taxation on life insurance received by the heirs.  A non-grantor Charitable Lead Trust allows the donor to pass any growth above the §7520 interest rate to heirs completely without taxation.

Of course, lowering taxes can be combined with the techniques of trading gifts for income.  Stacking the methods creates highly complex transactions.  For example, the donor could transfer highly appreciated corporate shares into a Charitable Remainder Unitrust paying 6% of all trust assets per year to the donor and donor’s spouse for life with payments limited to income (with makeup provisions) until the shares are sold, with part of the value of the income tax deduction and payments being used to fund an Irrevocable Life Insurance Trust to provide estate tax free inheritance to the children, where the Charitable Remainder Trust, at the death of the surviving spouse, transfers all remaining assets to the donor’s private family foundation managed by the donor’s children and grandchildren.  Yes, charitable planning can get complicated.  But, underneath this frightening mess of acronyms, trusts, foundations, and law, the basic concept is still the same.  Planned giving can do two things – lower taxes and trade a gift for income.  That’s it.

Planned giving can do two things, lower taxes and trade a gift for income.  That’s nice, but it doesn’t necessarily explain why a fundraiser should know about planned giving.  Planned giving has a real impact on nonprofits only when it leads to larger gifts.  These larger gifts don’t come simply because a gift might be slightly cheaper due to a tax benefit.  Instead, they come from two sources – asking for assets instead of cash, and addressing the donor’s other financial concerns.

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