For high net-worth individuals and couples, there are a variety of transfer techniques in order to minimize exposure to death taxes. These include, but are not limited to Disclaimer Trusts, Credit Shelter Trusts, Applicable Exemption Trusts (a/k/a Credit Shelter Trusts), and Q-TIP Trusts. These Trusts, effective for use with married couples, can be utilized in Wills and Revocable Living Trusts. To further minimize potential payment of estate and inheritance taxes, a variety of other techniques may be employed. These techniques focus on major lifetime gifting. They include, but are not limited to:
A. Annual exclusion gifts. Each year, an individual may currently give $13,000.00 per donee and, with the consent of a spouse, $26,000.00 per donee; B. Lifetime exemption gifts. Substantial gifts, over the annual exclusion amount, may be made if a donor pays gift taxes and survives three years although an exclusion of $1,000,000 for aggregate lifetime gifts may be used; C. Gifts to Remove Appreciation. Gifts may made to remove appreciation from a donor’s estate; D. Education. Unlimited payments of qualified tuition expenses may be made if paid directly to the educational institution; E. Medical. Unlimited payments of medical expenses may be made so long as said payments are made directly to the provider and to the extent they are not covered by insurance; F. Spousal. Inter-spousal gifts using the unlimited marital deduction; G. Leveraged Gifts. Gifts may be made through Trusts which include, but are not limited to, a Qualified Personal Residence in Trust (QPRT) and Grantor Retained Annuity Trusts (GRAT); H. Life Insurance to Others. Gifts of existing life insurance outright to owners other than the insured; I. Life Insurance to Trust. Gifts of life insurance premiums through the use of an Irrevocable Life Insurance Trust; and J.Charitable gifts. The focus of this guide will be the utilization of charitable giving in estate planning. Charitable planning has a variety of benefits including personal satisfaction, lifetime income tax minimization and post-death estate and inheritance tax minimization. Charitable planning takes a variety of forms ranging from simple lifetime checks to charitable organizations through the utilization of more complex Charitable Lead Trusts or Charitable Remainder Trusts.
Various sections of the Internal Revenue Code apply to transfers to charitable organizations. Unless otherwise indicated, all citations within this article will be to the Internal Revenue Code of 1986 and the regulations issued thereunder. The most notable sections, in understanding and implementing charitable planning, include:
A. Section 170 – Income Tax Deductions for Charitable Transfers; B. Section 2055 – Charitable Transfers Deductible for Estate Tax Purposes; C. Section 2522 – Charitable Transfers Deductible for Gift Tax Purposes; D. Section 501 – Defining Tax Exempt Organizations; E. Section 509 – Defining and Describing Private Foundations; and F. Section 664 – Describing Charitable Split Interest Transfers.
A. OVERVIEW OF THE WEALTH TRANSFER CHARITABLE TAX DEDUCTION
Transfers that qualify for a charitable deduction can be utilized for income, estate and/or gift tax purposes. Generally, transfers, that qualify for the charitable deduction, are made to a tax exempt organization. These organizations are described in detail in Section 501. The most relevant provision is Section 501(c)(3), which describes what is commonly thought of as a charitable organization: a corporation, community chest, fund or foundation organized and operated for religious, charitable, scientific, testing for public safety, literary or educational purposes or to foster a national or international sports competition or for the prevention of cruelty to animals or children, no part of the net earnings of which inure to the benefit of any private shareholder or individual, or substantial part of which is carried on propaganda or attempting to influence legislation and which does not intervene in or participate in any political campaign. In addition to public charities, the charitable deduction can be employed by entities commonly known as private foundations. These entities, defined in Section 509(a) are those which are not included in the definitions covering public charities. See Section 509(a)(1)-(4). Rev Rul 59-310, 1959-2 CB 146 sets forth the prevailing definition for charity in determining whether a private or public organization qualifies as an appropriate recipient by which a donor can request or assets a charitable deduction. This ruling states, in relevant part “charity in the legal sense of the term includes benefits which are for an indefinite number of persons and are for the relief of the poor, the advancement of religion, the advancement of education, for erecting or maintaining public buildings or works or otherwise lessening the burdens of government."
Charitable deductions are allowed for transfers to qualified and identifiable recipient organizations. In general, there are four types of these organizations:
- Charitable Corporations and Associations – if they are to or for the use of corporations/associations “organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes," See Section 2055(a)(2). 2. Government – if said transfers are to or for the use of the United States, any of its states, the District of Columbia, counties, cities, towns and other political subdivisions so long as the transfers are solely and exclusively for public purposes. See Sections 2055(a)(1), 2522(a)(1) and 178(c)(1). 3. Trusts/Fraternal Organizations – if the transfers are used “exclusively for religious, charitable, scientific, literary, or educational purposes or for the prevention of cruelty to children or animals…" See Section 2055(a)(3). It is important to note that these organizations are disqualified for purposes of charitable deductions if they participate in propaganda, lobbying, or participation in political campaigns. It should also be noted that said organizations may undertake activities above and beyond that for charitable purposes. However, deductible transfers must be exclusively used for charitable purposes. 4. United States Veterans Organizations – if there is no use of the net earnings for the benefit of a private shareholder individual. See Sections 2055(a)(4) and 2522(a)(4).
In order to qualify for a charitable deduction, a charitable interest must meet certain criteria:
- It must be or an ascertainable interest; 2. It must comply with proper reporting requirements; and 3. There must be substantiation of the transfer.
An interest is certainly ascertainable and simple to recognize of an outright gift or a donor’s or decedent’s interest in property. However, when property is transferred in Trust or for both a private and charitable purpose Reg Sections 20.2055-2(a) and 25.2522(c)-3(a) state that the deduction will only be allowable if the charitable interest is ascertainable at the time of the contribution and can be severed from the private interest. Examples of deductible and ascertainable interests include: undivided portions of a donor or decedent’s entire interest in a type of property, remainder interest in residence and farms, qualified conservation contributions and a remainder interest in a Trust, a charitable lead interest or a charitable gift annuity.
As to reporting, charitable transfers during lifetime must be reported for income tax purposes on an individual’s personal income tax return provided that the individual taxpayer itemizes his or her deductions. Charitable transfers for decedents are reported on Schedule O of the federal estate tax return, known as the Form 706.
Proper reporting entails proper substantiation. Proper substantiation follows the following set of rules:
A. As to charitable contributions of money, a taxpayer is required to maintain a canceled check, receipt or letter acknowledging the contribution from the donee. B. For contributions of property other than money, a taxpayer must keep a receipt or letter from the donee noting the date of the donation, the location of the donation and a description of the contribution. In the event the donor wishes to claim a deduction greater than $500.00, he or she must also keep written records regarding the acquisition of the property including the date and manner of its acquisition as well as the cost or other basis of property held for less than twelve months before the contribution. If the claim deduction exceeds $5,0000.00, a donor must also obtain a qualified appraisal as well.