New IRS Ruling Gives Donors More Options
August 22, 2016
by Don Gottesman, JD, LLM (Tax)
Donors who create gifts to benefit their favorite charity and themselves often prefer the amount they receive to be of the same amount, on a regular basis. Thanks to an IRS ruling this month, donors now have an additional option when making their gift. Identical payments allow donors to budget their funds, and give donors peace of mind that they will receive the same amount of money regardless of how the markets perform. To meet those dual goals, advisors recommend that donors create either a charitable gift annuity (a “CGA”) or a charitable annuity trust (a “CRAT”).
In this low-income rate environment, CGAs have fared somewhat well. CRATs, however, have not. The major problem for CRATs has been meeting what is commonly known as the “5% test” when combined with the minimum payment percentage. Under the 5% test, there must be a 5% or lower chance that the assets of the trust will be exhausted after (i) making the payments to the income beneficiary (usually the donor), and (ii) considering that beneficiary’s life expectancy.
To determine the value of the income payments, one performs a present value calculation using an applicable rate – called “the 7520 rate” – which the IRS changes monthly. To determine the beneficiary’s life expectancy, one refers to a certain mortality table at the time the CRAT is funded. In addition to the 5% test, the minimum payment percentage from a CRAT, per the IRS, is 5% of the value of the assets determined at the time the trust is funded.
And herein lies the rub: the 7520 rate has not been higher than 5% since December 2007. In fact, this year, the 7520 rate has ranged from 1.4%-2.2%. Consequently, it’s been very difficult to create a CRAT that meets the 5% test. If the CRAT does not meet this test, then:
- the CRAT is not exempt from income; and
- the donor is not eligible for an income, gift or estate tax deduction.
Fortunately, this month’s new ruling gives donors who seek to benefit their favorite charity and themselves an additional option by breathing new life into CRATs.
The ruling creates a safe harbor for CRATs that are payable for life and cannot meet the 5% test. The safe harbor requires CRATs to contain a specific provision stating that it terminates when its assets fall below 10% of the value of the assets used to fund the CRAT, after reducing the current value of the trust assets by the annuity payment and then multiplied by a specific discount factor. The burden falls on the trustee to conduct the calculation annually. This qualified contingency applies to CRATs:
- created by donors either during their lifetime or at death; and
- where the payments are made to the beneficiary or beneficiaries for life.
The exact language required by the IRS can be found in Revenue Procedure 2016-42.
As discussed, this new ruling is helpful for all donors who have recently had difficultly qualifying for a charitable deduction when they would also like their payments to always be the same amount of money. This ruling may be of particular interest to donors who, besides preferring identical payments, would like to use appreciated real estate to fund their charitable gift. Many charities will not permit a CGA to be funded with real estate. Some charities that do, however, will reduce the rate payable to the donor because the charity does not know what the net proceeds on the sale of the property will be. For donors considering making a gift to charity of appreciated real estate, a CRAT that has the qualified contingency provision found in this recent ruling (a “QC-CRAT”) might provide the best solution.
OPTIONS FOR DONORS SEEKING CHARITABLE DEDUCTION & IDENTICAL PAYMENTS
|Annuity Rate||Asset’s value multiplied by beneficiary’s life expectancy||Asset’s value multiplied by 5-50%||Asset’s value multiplied by 5-50%|
|Create at life||Yes||Yes||Yes|
|Create at death||Yes||Yes||Yes|
|Duration of Payment||For beneficiary’s life||For beneficiary’s life or|
Maximum of 20 years
|For beneficiary’s life, but may terminate early|
|At least 10% to charity test||No||Yes||Yes|
|Chance of exhausting assets is greater than 5% test||No||Yes||No, but must terminate when assets fall below 10% after payment to beneficiary|
|How created||Contract with charity||Attorney drafts||Attorney drafts|
Don Gottesman is Senior Development Officer at the California Community Foundation, where he partners with donors and their advisors to craft solutions for giving to charity in an impactful and efficient way.
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