The Better Testamentary Response to the ... | Sharpe Group blog
Posted December 18th, 2020

The Better Testamentary Response to the SECURE Act: Charitable Remainder Trust or Gift Annuity? Part 2

Many commentators believe funding a testamentary charitable gift annuity with an income in respect of a decedent (IRD) item, like an IRA, means the annuity will be taxed in full immediately, with no recovery in basis. But is that, in fact, the correct result given the purpose of the IRD rules?

When this IRD item passes to the charity, the payments consist of ordinary income. However, since the charity is tax-exempt, it pays no income taxes on it. It almost certainly converts the IRA into cash to be the source of funds to pay the annuitant. From this perspective, the annuitant should receive a tax-free return of principal for their payment received during their life expectancy.

If this is the correct interpretation of the taxation of annuity payments, then the charitable gift annuity would be superior to a charitable remainder trust because of the partial tax-free nature of the payments. Contrast the taxability of payments coming from the charitable remainder trust, which will almost certainly be taxed in full as ordinary income under the tier accounting rules.

If this is not the correct interpretation, then the taxation of the gift annuity is at least as favorable as a charitable remainder trust.

Furthermore, there are additional advantages of the testamentary gift annuity over the remainder trust. The gift annuity has much more flexibility for deferral planning than a testamentary remainder trust. The gift annuity may be structured as a deferred or even a flexible gift annuity.

Coupled with the much smaller amounts required to fund and the avoidance of the expense of drafting and administering a trust, the gift annuity will be more appealing to the majority of donors not exposed to the federal estate tax.

The one complication occurs for those anticipating exposure to the federal estate tax. My future blog post will identify them and their solutions.

By Professor Christopher P. Woehrle

Click here to read Part 1 of this series.


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