Dedon on Estate Planning

Charitable Contribution Deductions

Many donors are confused whether they can claim a charitable income tax deduction for gifts directly to individuals. Even if the donee is poor and in need, a contribution directly to that individual does not necessarily result in a charitable contribution deduction.

Some background: Generally only contributions to charities are tax deductible. The IRS determines whether an organization is a qualified charity. Charitable organizations are generally two kinds: (1) public charities, such as universities, churches, relief organizations such as the Red Cross and the United Way, and most hospitals, or (2) private foundations. While public charities receive much of their support from many donors, private foundations are typically created by individuals and receive support from a limited number of people, such as from one family. So if Mom and Dad create a charity and they are the sole contributors that charity will be private foundation.

Although contributions to both public charities and private foundations are tax deductible, public charities enjoy more advantages. For example, a private foundation must distribute 5% of its assets annually. If 5% of its assets are not distributed, then taxes are imposed.

So back to my earlier point: if Mom and Dad create their own private foundation and it is approved by the IRS, that foundation cannot make distributions directly to individuals unless the foundation receives IRS approval for such specific grants. Thus, it is not sufficient to receive IRS approval for the foundation; the IRS also must bless the contributions directly to the donee-individuals. Mom and Dad must tell the IRS they intend to offer scholarships or grants directly to individuals. Mom and Dad must tell the IRS the criteria for selection, the potential grantees, who will do the selection, and other information. The IRS wants to make sure the donees are not, for example, Mom and Dad’s family. On the other hand, if Mom and Dad’s IRS approved private foundation distributes directly to a public charity, no prior IRS approval is required for the distribution.

In sum, when you donate to your church or your university and don’t receive anything in return, you obtain a charitable contribution deduction. However, if you create your own charity you need to obtain IRS approval as a private foundation and additional IRS approval if your private foundation intends to give directly to individuals. No contribution deduction is allowed for contributions directly to individuals that do not flow through qualified charities.

Charities And Their Investments

To add insult to injury, not only have numerous charities seen their endowments plunge, but now the charity Board members may find themselves facing civil lawsuits and IRS penalties. The potential liability applies to both public charities and private foundations.

Public charities are always under scrutiny because of their higher profile. The State Attorney General offices can hold Board members responsible for failure to exercise proper oversight over charity employees. In recent years, some major public charities have had problems with officers using charitable funds for personal purposes. Also, if assets are not properly diversified or managed, the Board members could be personally liable.

For private foundation Board members, there are these same fiduciary concerns, plus more stringent IRS rules. For example, Internal Revenue Code Section 4944 imposes a personal tax on a private foundation’s Board and officers if the foundation holds investments that "jeopardize" the charity’s purpose. The liability is joint and several among all the Board members and officers.

Although Section 4944 is not new, what is recent is United States Senate Finance Committee member Charles Grassley’s comments to the BNA Daily Tax Report that a foundation’s Board that invested primarily with Bernard Madoff should examine why they put "all their eggs in one basket." With endowments down, Board members will need to be particularly diligent to protect their charity’s assets and themselves. Grassley’s comments establish that charities – both public and private – continue to be on Congress’ radar, and when it comes to investments the Board would be well-advised to consider a widely diversified and prudently managed portfolio.

Monitoring Tax Exempts

The November 21, 2008 Daily Tax Report published by BNA, reported on IRS Commissioner Steve Miller’s comments at the annual Western Conference on Tax Exempt Organizations held in Los Angeles on November 20^th.  Miller’s theme was full disclosure and transparency regarding tax exempt organizations’ operations.

According to Commissioner Miller, the revised Form 990, which is the annual tax return filed by tax exempt organizations, and greater information required at the creation of the organization, as required by Form 1023, will facilitate the IRS monitoring these organizations. Miller was quoted as saying "[w]e intend to let the sun shine" on governance issues. Thus, it will become increasingly important to have the board of directors actively review key decisions and document those decisions in Minutes.

The Daily Tax Report quoted Miller as saying the IRS will focus on the following:

• The composition and independence of the board

• Internal financial controls

• Compensation

• Conflict of Interest policies

Planned Giving: The 2008 Charitable Remainder Annuity Trust

The November/December issue of Advancing Philanthropy, the bimonthly magazine dedicated to ideas and strategies pertaining to fundraising which is published by the Association of Fundraising Professionals, contains an article I wrote regarding Charitable Remainder Annuity Trusts combined with life insurance. As charities struggle to maintain gift levels, the article illustrates how CRAT's can help charity and the individual. The article contains case studies applying the concept to particular client situations. It is reproduced here.  (It will take a minute to download.)

Estate And Charitable Planning Using A Life Estate

Charitable planning often plays an important role in a donor’s estate plan. The following PowerPoint shows the advantages of using a life estate to help charity and also to help the donor’s estate planning. As illustrated in the PowerPoint, the donor contributes a primary home or vacation home to a public charity during his lifetime. However, the donor continues to reside in the house as long as he and his spouse are living. Upon the second of their deaths, the home belongs to the charity. The charity can use the home for its own purposes or sell it.

A life estate gives the donor a current income tax deduction and also removes the asset from the donor’s estate. The tax deduction can be used to fund an insurance policy which could be owned in an Irrevocable Life Insurance Trust. At the end of the day, the donor has supported his favorite charity, removed a valuable asset from his estate, and taken advantage of the current income tax deduction to purchase life insurance which can pass to his family tax free. It provides a "win win" for all involved.

Download 91508_blog.PPT

Annual Compliance for Public Charities

In its continuing effort to better police and monitor tax exempts, the IRS in August issued the instructions to the newly revised Form 990. For the first time since 1979, the IRS changed Form 990, which is the compliance return public charities file each year. The Form 990, as well as a charity’s organizational documents, are public documents available to anyone who desires to review them.

Charities will begin using the new Form 990 for the 2008 year. The form was released in December 2007, and can be found at the IRS web site, www.IRS.gov/eo.com. It consists of 11core pages and 16 schedules. According to the IRS, the initial draft garnered 3,000 pages of written comments that were considered before the final draft.

From the IRS’ perspective, "the revised form will give the IRS and the public a much better view of how exempt organizations operate." IRS Commissioner Doug Shulman continued, "the improved transparency provided by these changes will also benefit the tax-exempt community."

From the charitable community’s perspective as well as its return preparers, new Form 990 adds detail and complexity to an already thorough return. However, this is the price to pay in response to abuses that had developed in the charitable area after a period of relative IRS neglect. The IRS is now devoting more resources and greater attention to tax exempts, and the revised Form 990 is one illustration of that new policy.

Tax Deduction Under Section 170

Section 170 of the Internal Revenue Code allows income tax deductions for charitable contributions. The typical donations are cash or property. If property is donated, a deduction is clearly allowed provided the fair market value is determined.

However, not all contributions are deductible. What about the contribution of services? How about the contribution of air time by a radio station or space in a newspaper? Or with the internet becoming the preferred choice of communication, how about free advertising by an internet service provider to a charity?

The Internal Revenue Service has made a distinction between contributions of property and contributions of services. Though the difference is enigmatic in certain instances, generally, a contribution characterized as a service, unlike those which are determined to be a gift of property, will not be tax deductible.

Tax Exemption Under Section 501(c)(3)

Internal Revenue Code Section 501(c)(3) affords organizations tax exemption if certain requirements are satisfied.  These organizations must accomplish a charitable purpose. Such purposes include conducting scientific, religious, educational, or literary activities. At least one of these purposes must be set forth in the organization’s Articles of Organization. This post focuses on educational and scientific purposes.

An educational purpose includes not only "instruction or training of individuals for the purpose of improving or developing his capabilities" but also "the instruction of the public on subjects useful to the individual and beneficial to the community." Treas. Reg. Section 1.501(c)(3)-1(d)(3). For example, the IRS has determined that an organization whose purpose was to educate the public about the accuracy and fairness of news coverage was eligible for tax exemption. Rev. Rul. 74-615, 1974-2 C.B. 165.

Supporting Organizations

Supporting Organizations ("SO") are charities created under Section 501(c) (3) of the Internal Revenue Code. Donations are deductible as charitable contributions. SO’s have been utilized by wealthy individuals who otherwise would be limited by creating a private foundation. These well-advised individuals (or their advisors) mastered the arcane and complicated tax provisions authorizing SO’s, and thereby created SO’s to obtain greater tax advantages compared to private foundations. The advantages arise because SO’s are treated as public charities. (The February 25, 2008 Post discussed these advantages.)

As often the case in other areas of the tax law, creative but misguided taxpayers and advisors used SO’s to obtain tax benefits beyond those intended by Congress. Congress pushed back with substantial changes to SO’s. These changes affect primarily "Type III" SO’s, which are the type most often used by individuals seeking the greatest autonomy and control over their charity. In contrast to Type I and Type II SO’s, where the supported public charity effectively controls the SO, Type III SO’s resemble private foundations with greater control for the taxpayer. It is for this reason that Type III SO’s were targeted by Congress as requiring the greatest reform.

Not All Tax Exempts Are Created Equal

Many clients are interested in creating a charity to accomplish their charitable objectives. However, there is much confusion over charities and tax exempt entities in general.

First, a tax exempt entity is not necessarily a charity, and not all charities are created equal. A tax exempt entity simply means that income generated by the entity is not subject to income tax. The tax exempt entity could be a charity or, for example, a trade association, a labor union or a fraternity. These organizations are described in Section 501 of the Internal Revenue Code.

Charities are distinguishable from other tax exempt entities because they satisfy a charitable purpose (i.e., "501(c)(3) organizations"). Charitable purposes are varied, but they include, for example, religious, health, educational and scientific purposes, and more general purposes such as helping the poor. The advantage of being a charity compared to other tax exempt entities is that contributions to charities are tax deductible. However, as alluded to above, not all charities are treated the same. Charities can be public charities or private foundations. As the chart at the end of this Post illustrates, there are advantages to being a public charity. Contributions to public charities are deductible at 50% of adjusted gross income ("AGI") versus 30% of AGI for a private foundation. Further, the general rule for contributions of stock to a public charity is that deductions are at fair market value at 30% of AGI, versus the stock basis and 20% of AGI for private foundations. Public charities also are not subject to various excise taxes that apply to private foundations.