May 26, 2015 5:00 pm
Published by Michael
While gift planners understandably prefer the charitable remainder trust’s (CRT) flexibility in the design of the commencement and duration of payments, the charitable gift annuity (CGA) can be surprisingly effective as well.
Surrendering the Right to Payment
For those who established annuities years ago, the subsequent very low inflationary environment has preserved much of their purchasing power from the annuity payments. Internal Revenue Code Section 170(e)(1)(A) denies the charitable deduction for the gain; namely, the ordinary income element and any unreported capital gain.1
Commutation Tax Consequences
Let’s examine these tax consequences of a commutation with the following example:
In April 2010, a 72 year old contributed $100,000 in cash for the right to receive $5,900 for life. If there’s still more capital gains to be taxed, the 30 percent limitation will apply.5
Commuted Payment Gift Annuities
Unlike a CRT, whose duration may be for a term of years not to exceed 20, a CGA can be paid only as a single life annuity, a joint and survivor annuity or a two lives in succession gift annuity.6 Nevertheless, a number of PLRs and a General Counsel Memorandum clarified the tax consequences of a CGA agreement permitting the commutation of a deferred gift annuity for either: (1) installment payments for a number of years certain, or (2) a lump sum amount.7 The recipient of the payments may be either the donor or a donee selected by the donor.8 The recipient was entitled to a lifetime payout but had the ability to sell or assign the right to the CGA payments to the issuing charity or a third-party selected by the donor in exchange for either a lump sum or installment stream.
Let’s examine two circumstances when the commuted payment assists the philanthropically minded client to achieve priority financial planning goals, such as enhancing retirement income or financing the cost of higher education for a family member.
Improving Cash Flow in Retirement
In the first scenario, the donor seeks to improve her retirement income for a short period of time to tide her over until the commencement of a larger Social Security benefit (either at normal retirement age or later). These payments of $11,734 provide enough after-tax income so that Sarah can wait until age 70 and, thereby, maximize allowable Social Security benefits, which will be increased by 8 percent annually from age 67 to age 70.9
The net result is that Sarah has not only made a deductible charitable gift of $33,750 reducing her taxes by $9,450, but also received $82,138 in payments from the commuted payment annuity that enabled her to maximize her Social Security benefit.
Financing Professional Education
In the second scenario, a parent or grandparent would like to fund over time the college and professional education of a child or grandchildren. The annuity payments to Harry III are unearned income subject to the “kiddie tax” (that is, a tax applied to a child’s unearned income of more than $2,100) until Harry III becomes 24, as it’s highly likely he won’t be providing more than half his support during his undergraduate and professional training. Each has made a taxable gift to Harry III though each’s unused unified transfer tax exemption will be
sufficient to eliminate the need to pay a gift tax.
Gift and generation skipping transfer (GST) tax for Harry Sr. Because the trust would be acting as the agent for Harry III, there would be no immediate taxation of the deferred payment annuities.11
Commutations of CGAs can be a way to begin “charity at home” and end it (early) for charity!
Endnotes
1 Internal Revenue Code Section 170(e)(1)(A) and IRC Section 72(a).
2. General Counsel Memorandum, ibid, noted in its summary that the recipient of the annuity payments was contemplating use of the funds for college, but there was no requirement in the gift annuity for the funds to be so used.
9.
