Posted September 1st, 1997

How Do You Spell Relief? Continued… Impact of the TRA on Planned Gifts

In a last minute and surprise move, the Congressional conferees joined the IRS in its current initiative to eliminate the use of certain types of charitable remainder trusts as tax avoidance devices in ways they believe were never intended by lawmakers in the past. Buried in the details of this law is a provision that restricts the use of charitable remainder trusts to situations where the anticipated charitable remainder is worth at least 10% of the amount used to fund the gift. This will have the practical effect of eliminating the use of charitable remainder trusts by young persons seeking to avoid capital gains tax, and older persons seeking very high payouts or to provide a life income for children in their twenties or thirties. Put another way, Congress has decided to disallow charitable remainder Congress has decided to disallow charitable remainder trusts where more than 90% of the anticipated economic value of the trust will accrue to the benefit of noncharitable beneficiaries.

For example, in the case of a couple, 71 and 68, with four children ranging in age from 47 to 38, a 5% charitable remainder unitrust will barely generate a 10% remainder factor. A trust with younger children or higher payout, for example, would no longer qualify for tax benefits. In any event, many charities, driven by concerns based in gift accounting and crediting guidelines, already require minimum remainders of 10% or more. Expect much debate in coming months over the wisdom of this provision. The IRS had already proposed new regulations in May of this year that would effectively eliminate many of what the Treasury perceived to be abusive planned gifts, and this law appears to lend support to that move.

From the viewpoint of prospective trust donors, the new capital gains tax rate may be considered a “privilege” tax, not a “penalty” tax, and rather than seeking to avoid capital gains tax, they will be seeking to realize gains at 20% rather than other income at 40%. The TRA and other related environmental factors do not add up to good news for those looking to promote planned gifts as ways for financially motivated persons to “come out ahead” while possibly doing good in the long run.

On the other hand, most planned gifts will be more attractive than ever under the provisions of this law, but for new and different reasons. Due to other tax accounting rules, charitable remainder trusts and gift annuities can actually result in helping donors increase the amount of income they will realize at capital gains tax rates as low as 8% in future years. This will be especially attractive to older donors who wish to make larger gifts while increasing their income in retirement years, precisely the group for whom many planned gifts were intended in the first place. For these and other reasons, this bill should accelerate the process of shifting the emphasis in gift planning more to the “gift” element of the planned gift. Those institutions and advisors who realize this and proceed accordingly will continue to raise significant funds utilizing planned gift methodologies.

In 1986, the maximum capital gains tax rate was raised by as much as 100% for some middle income taxpayers, and the maximum rate of 28% began for persons with earnings that were in the average house-hold income range. This has had a dramatic impact on fund-raising over the past decade. One way to view the TRA is that it is one more step in reversing the Tax Reform Act of 1986. From a charitable gift planning standpoint, it means we may now return to the way things were prior to 1986. A challenge lies in the fact that many development officers in America were not in the field in those days and thus haven’t functioned in an environment that featured a maximum capital gains tax rate of 20%.

There are pitfalls in this law for those who ignore it, and opportunities for those who embrace its provisions and use them for maximum benefit. The key will be to act swiftly to assure that major donors, in particular, are not confused or misled regarding the impact of this law on their philanthropic plans in this and future years.

 A Case in Point

The following example illustrates the planning process many donors will need to pursue when considering gifts of appreciated property in light of the new tax act.

George and Mary Blake are planning to make a charitable gift of $10,000. In the past they have written checks to complete their gifts, but this year they have been advised to consider a gift of securities. They have two different investments that have increased in value since purchased. Both have a cost basis of $4,000.

In the case of Investment A, they have held the asset for three years. This property would qualify as long-term property under the new tax act and be taxed at the new maximum capital gains tax rate of 20% for property held more than 18 months.

In the case of Investment B, they have owned the property for just 14 months. This property falls into the new “mid-term” gain property category for property held between one year and 18 months. Mid-term property is still subject to a maximum capital gains tax rate of 28%. The Bakes are in the 39.6% tax bracket for each additional dollar of ordinary income. Which property should they give?

If they give the mid-term property, Investment B, they will bypass a larger amount of capital gains tax than if they give the long-term property, Investment A. The after-tax cost of their gift will thus be $480 lower if they decide to donate Investment B. In choosing properties for charitable gifts, therefore, the Bakes and others in their position should give priority to appropriate assets they have owned between one year and 18 months.

This example is excerpted from the recently released booklet “A Guide To Charitable Giving after the 1997 Tax Act.”

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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