Falling discount rates may spell opportunity for gift planners
The applicable federal mid-term rate (AFMR) used to calculate certain charitable gifts has been steadily declining over the past year. The November and December 1998 AFMR of 5.4% marks the all-time low since the floating rates took effect in 1989 and is now lower than the fixed statutory rate of 6% that was in effect until 1983.
What do such low discount rates mean for gift planners and donors? Low rates can mean that charitable lead trusts will hold greater appeal once again. With the AFMR at record lows, the charitable lead trust offers gift and estate tax planning opportunities not seen in recent years. For example, at a 5.4% discount rate, a charitable lead annuity trust paying 8% for 20 years will result in a gift and estate tax deduction that serves to eliminate 98% of the tax liability that would otherwise be due on assets transferred to loved ones via this gift planning vehicle.
For those donors who are interested in life income plans such as charitable remainder trusts and gift annuities, however, low discount rates can in some cases reduce the attractiveness of a gift from a pure tax planning perspective. Now more than ever it is critical that gift planners utilize the most favorable AFMR for their donors–choosing from either the current month’s rate or the rate from one of the two months preceding the current month. For example, in a gift annuity calculation that is prepared for a donor today (at press time of this Give & Take), the gift planner could process the calculation with December’s AFMR of 5.4%, November’s rate of 5.4%, or October’s rate of 6.2%. Each calculation will show a slightly different tax deduction available to the donor depending upon the discount rate that was used. The higher the AFMR, the larger the tax-deductible gift value for the donor of a gift annuity. By determining the most beneficial discount rate among the three most recent rates, gift planners can help their donors make the most tax-wise gifts possible.
For gifts such as gift annuities and charitable remainder annuity trusts that can return a portion of payments received as tax-free or capital gain income that is taxed more favorably than regular income, falling discount rates can result in a larger percentage of income being taxed on a more favorable basis when received, thereby reducing or largely offsetting the reduced tax savings as a result of the lower tax deduction at the outset. The exact results will depend on the age of the donor and the cost basis of property used to fund a gift.
Another point to keep in mind: as the discount rate falls the maximum payment possible from a charitable remainder trust for life must also fall in order to avoid running afoul of the 5% probability test and the 10% minimum charitable remainder value rules. For this reason, trusts that pay higher rates of income for limited terms of years will be increasingly popular, especially when dealing with younger persons who would otherwise not be able to qualify for higher payment rates they may prefer. In other cases donors may simply lower their “rate expectations,” thereby increasing their income tax deductions.
The subject of discount rates and how they affect gift planning objectives is discussed in more detail in the Sharpe seminar “Major Gift Planning II.” For more information on this and other Sharpe training opportunities, click here. You may also want to see the article on page 1 for tips on dealing with lower interest rates this year.
Magazine ranks top 100 charities
In a recent comprehensive article, Consumers Digest discussed how much money American charities raise and give away. The article also produced a list of the top 100 charities according to total expenses. Here are the 10 charities in terms of total income that topped the Consumers Digest list:
- American Red Cross $1,737 (million)
- Memorial Sloan-Kettering Cancer Center $739
- American Cancer Society $418
- Easter Seals $402
- Salvation Army– Southern Territory $402
- Salvation Army– Eastern Territory $355
- Shriners Hospital for Children $334
- Salvation Army– Central Territory $325
- Salvation Army — Western Territory $319
- American Heart Association $318
Source: Consumers Digest, November/December, 1998