Deduct 100% of Income With a 2020 Charitable Gift Annuity? Yes (but not likely with a CRT)
By Professor Russell James, J.D., Ph.D., CFP®, Texas Tech University
The CARES Act allows individuals to deduct up to 100% of income in 2020 using charitable gifts of cash.1 To get this treatment, the deductible charitable gift must be a “qualified contribution.”
What is a qualified contribution? First, the taxpayer must elect this treatment for the gift.2 Also, the gift can’t go to a donor advised fund or a supporting organization.3 Finally, a qualified contribution requires:
- (i) such contribution is paid in cash during calendar year 2020 to an organization described in section 170(b)(1)(A)
To break it down, a qualified contribution is a deductible contribution that is:
- “paid in cash”
- “during calendar year 2020”
- “to an organization described in section 170(b)(1)(A))” (i.e., a public charity)
Let’s consider some examples:
Gift 1 – Cash
I donate a $1,000 check to a public charity on December 1, 2020. I deduct $1,000.
Is this $1,000 deductible contribution a qualified contribution?
Yes. All three elements are there.
Gift 2 – Quid pro quo cash
I donate a $1,000 check to a public charity on December 1, 2020, in exchange for admission to a gala dinner worth $100 according to IRS guidelines. I deduct $900.
Is this $900 deductible contribution a qualified contribution?
Yes. The $900 is a contribution paid in cash during calendar year 2020 to a public charity. The $100 is not a contribution. It is just payment for the dinner. In other words, the $100 part was a sale not a gift. Of course, we don’t have specific guidance here, but there is no reason to expect that such a gift would be treated differently. (There are areas where we can’t have benefits going to the donor, but those relate to private foundations, donor advised funds and certain charitable trusts, so they are not an issue here.)
Gift 3 – Charitable Gift Annuity
I donate a $100,000 check to a public charity on December 1, 2020, in exchange for a lifetime annuity worth $60,000 according to IRS valuation guidelines. I deduct $40,000.
Is this $40,000 deductible contribution a qualified contribution?
Yes. This is the same idea as the quid pro quo cash gift in the last example. Is this $40,000 a gift of cash? Yes. Does this cash go to a public charity? Yes. Is this gift of cash paid to the public charity during calendar year 2020? Yes. As with the previous example, the $60,000 part is not a contribution. It is simply payment for the annuity. Again, we don’t have specific guidance here, but this gift meets the rules exactly as the last gift did.
Gift 4 – Charitable remainder trust
I donate a $100,000 check to a charitable remainder trust (CRT) on December 1, 2020. I receive a lifetime annuity from the property in the CRT worth $60,000, according to IRS valuation guidelines. I deduct $40,000. At its termination, the trust will pay anything left over to a public charity.
Is this $40,000 deductible contribution a “qualified contribution”?
Probably not. Is cash paid to a public charity during calendar year 2020? No. What the public charity gets in 2020 is not cash, but rather a future interest.4 Cash is paid in 2020 to a CRT (an entity described in section 664), not to a public charity (“an organization described in section 170(b)(1)(A)”).
The counterargument here is that the statute might be construed to require only that “a contribution” goes to a public charity in 2020, not the actual cash itself. To follow this argument, let’s first add some parentheses. The statute now reads, “a contribution (paid in cash during calendar year 2020) to an organization described in section 170(b)(1)(A).” The argument continues. A contribution need only be “paid in cash” by the donor. It need not actually be “paid in cash” to an organization described in section 170(b)(1)(A). This argument holds that we can have a qualified contribution where no cash goes to a public charity in 2020. Before getting too lost in a discussion of the grammatical plausibility of such syntactical gymnastics, it helps to consider legislative intent.
Policy and practice comment:
The purpose of the law: get cash to public charities now.
Beyond the text itself, it helps to understand the intent of the law. The purpose here is to get cash to public charities they can use immediately. That is why gifts to donor advised funds and supporting organizations are excluded.
Does a charitable gift annuity (CGA) accomplish this purpose? Yes. If I give $100,000 in cash to a charity for an annuity worth $60,000, can the charity spend the $40,000 deductible gift portion immediately? Yes. If the IRS valuation is correct, then setting aside the $60,000 will, on average, take care of the annuity obligation.
Of course, this freedom can vary in some states. In some states, the charity could actually spend the entire $100,000 immediately and just let the next administration worry about the annuity obligation. In some states, the charity would need to show that they had set aside the $60,000. In some states, they would need to set aside even more or use the money to buy an annuity from an insurance company to make these payments.5
What if the charity chooses not to spend the gift portion immediately? Many charities follow this practice. But the purpose of the statute was to get cash to public charities immediately. It was not to direct what those public charities did with that immediately available cash.
What if the charity wants to spend the entire gift portion immediately but local law requires it to hold some back (or purchase an annuity from an insurance company)? Consider this analogous gift.
Gift 5 – Quid pro quo endowment cash
I donate a $1,000 check to a public charity on December 1, 2020, in exchange for admission to a gala dinner worth $100. The event raises money for a permanent scholarship fund. I deduct $900.
Is this $900 deductible contribution a qualified contribution?
Yes. The explanation is identical to Gift 2. The fact that the gift is designated for a permanent scholarship fund (endowment) doesn’t change the tax result.
It is true that the charity isn’t going to immediately spend all of those funds. In this case, the donor restriction actually prevents them from doing so. (The gift is restricted to a permanent scholarship fund, a type of endowment.) This gift is likely even more restrictive than a charitable gift annuity in a jurisdiction where the charity must hold excess reserves or purchase a private annuity. But the scholarship gift appears clearly to fit within the statute.
In some past examples where a temporary 100% income limitation for charitable deductions was allowed in response to a national disaster, there was some guidance for the use of those gifts. For example, in the Taxpayer Certainty and Disaster Relief Tax Act of 2019, the 100% deduction was available only for gifts made for disaster relief efforts.6 However, even that minimal level of direction is absent from the CARES Act legislation. The intent appears to be simply getting cash to public charities now rather than directing the use public charities may choose to make of the cash once it’s received. The closest comparison may be to the Katrina Emergency Tax Relief Act of 2005 which also allowed 100% income limitations for individual taxpayers without restricting the gifts to disaster relief usage. This legislation also was compatible with charitable gift annuities, but likely not charitable remainder trusts.7
This same policy goal also fits with why a cash gift to a charitable remainder trust would likely not be a qualified contribution. That gift does not get cash to public charities now. It may be decades before the public charity even knows that the CRT exists.
This points out an important distinction between CRTs and CGAs that gift planners sometimes miss. A charitable remainder trust is a split-interest gift. A charitable gift annuity is a form of quid pro quo gift. With a charitable remainder trust, the public charity receives only a future interest in the gift. With a charitable gift annuity, the public charity receives 100% of the entire transfer immediately. This distinction is sometimes lost because charities often manage their gift annuity pool similar to the ways they manage a charitable remainder trust, waiting until the death of the annuitant to use any of the funds. But this isn’t the nature of the gift itself; it’s the choice of the charity (sometimes limited by local laws) on the appropriate use of the funds. Thus, even if we call a CGA a “deferred gift,” this is not actually an inherent feature of the gift, it is true only if the charity chooses to manage it in that way.
Abusive? No. In fact, it might actually be bad planning.
Beyond simply complying with the text of the statute and the underlying legislative intent, it is always good to think through whether the application feels abusive. Is taking a 100% deduction in 2020 for a charitable gift annuity abusive? No. Certainly, it could be beneficial. But it could also be detrimental. Indeed, the statute itself recognizes this. It requires that the taxpayer must elect to treat the gift in this way.
How could taking more deduction be harmful? Because the alternative is usually taking the deduction later. Any deduction not used in 2020 will be carried over for up to five additional years. Those deductions may be more valuable because they can apply at a higher tax bracket.
Suppose a donor transfers $1,000,000 of cash for a charitable gift annuity worth $600,000 in 2020. The sale part is $600,000, and the gift part is $400,000. Suppose the donor would otherwise have $400,000 of taxable income in both 2020 and 2021. If the donor takes a $400,000 deduction in 2020, the donor saves $114,795.00 in federal taxes. If the donor deducts $200,000 in each year, the donor saves $139,595.00 (or $300 less if the donor splits the deducted $240,000—60%—and $160,000—40%). Why does the donor save more by not deducting 100% of income in 2020? Because the last of the 2020 deductions are applying against a 10% tax bracket. The first of the 2021 deductions are applying against a 35% tax bracket. Pushing those 2020 deductions worth 10 cents on the dollar to the following year, when they are worth 35 cents on the dollar, makes sense.
For most donors, deducting 100% of income doesn’t affect the size of the useable charitable deduction, only the timing of when that deduction will be used. For many the tradeoff will be now vs. later, where later may be better. Thus, using this strategy isn’t necessarily beneficial to the taxpayer (or harmful to the Treasury).
The real benefit comes when a donor makes gifts so large as to be above the combined income limits for both 2020 and all of the following five years. This typically arises when the donor is making, has made or will make large gifts from assets while declaring relatively little taxable income. Nevertheless, the idea of paying “no taxes in 2020” may be an attractive headline for donors who might otherwise be contemplating a charitable gift annuity as a way to support charity, avoid market volatility and protect against longevity risk.
But, wait, where is the on-point case regulation or PLR? One downside of new legislation that lasts only nine months is that we don’t get to have one of these. In fact, everyone agrees that the new 60% limit for gifts of cash from the Tax Cuts and Jobs Act that started in 2018 is in desperate need of clarification.8 But, so far, we’ve got nothing, despite some compelling pleas for guidance.9 In such cases, we have to do our best to look at the (1) text of the statute, (2) the intent of the legislation and (3) the reasonableness of the application. An immediate gift of cash in exchange for an annuity passes all three.10
Professor Russell James, J.D., Ph.D., CFP® of Texas Tech University is responsible for the university’s on-campus and online graduate program in charitable financial planning.
2 “(ii) the taxpayer has elected the application of this section with respect to such contribution.”
3 “(B) EXCEPTION. — Such term shall not include a contribution by a donor if the contribution is — (i) to an organization described in section 509(a)(3) of the Internal Revenue Code of 1986, or (ii) for the establishment of a new, or maintenance of an existing, donor advised fund (as defined in section 4966(d)(2) of such Code).”
4 Treas. Reg. 1.170A-8(a)(2) “…A contribution of a remainder interest in property, whether or not such contributed interest is transferred in trust, for which a deduction is allowed under section 170(f)(2)(A) or (3)(A), shall be considered as made to the charitable organization…”
5 One might argue that if the charity couldn’t actually purchase a comparable annuity from an insurance company for $60,000, then the IRS valuation method is somehow incorrect. But that practical issue is different from the conceptual discussion here, especially given that these extra requirements are not part of the federal tax law.
6 See, e.g., Taxpayer Certainty and Disaster Relief Tax Act of 2019.
7 See, Martin Hall, Carolyn M. Osteen, & A. L. (Lorry) Spitzer (2005). Katrina Emergency Tax Relief Act of 2005, https://www.ropesgray.com/en/newsroom/alerts/2005/10/katrina-emergency-tax-relief-act-of-2005.aspx.
8 See Katzenstein, Lawrence P. (2020) A Potpourri of Charitable Planning Tricks and Traps, p. 5-8, https://www.wdcepc.org/assets/Councils/Washington-DC/libraryCharitable Planning Tricks and Traps.Katzenstein.pdf.
9 See AICPA latter referenced in Katzenstein (2020).
10 See also Willis, R.A. (April 4, 2020) Jack Straw Fortnightly, 3(3), p. 3, https://www.plannedgiftdesign.com/uploads/2/4/6/6/24661337/volume_three_number_three.pdf for a brief discussion.