IRS Information, Regulations and Commentary on Charitable Legal Issues

PPA 2006 ~ Charitable Gifts from Individual Retirement Accounts

PPA 2006 ~ Charitable Gifts from Individual Retirement Accounts

PPA 2006 ~ Charitable Gifts from Individual Retirement Accounts


The Investment Company Institute reported the nation’s retirement assets topped $14.5 trillion in 2005, and of those dollars set aside in tax-deferred accounts, Individual Retirement Accounts (IRA) made up about 25% of the total.  For years, charitable organizations have been lobbying Congress to let donors make gifts from retirement accounts since almost everyone has cash saved in these highly regulated accounts. Until the Pension Protection Act of 2006  (PPA 2006) signed August 17th, charitable gifts from retirement accounts required that the donor take a taxable distribution, pay tax on the proceeds, write a check to the charity of choice and then take an income tax deduction on the tax return, assuming the donor actually itemized deductions. All along the way hurdles and traps discouraged donors from making this gift since the taxpayer’s charitable deduction was limited to 50% of his/her adjusted gross income (AGI), and some states taxed IRA distributions but didn’t offer a charitable deduction, so it actually cost money to give it away.  


As older retirees approach the end of this year, those over 70½ have required minimum distributions that must be made or significant penalties will be assessed.  For this reason, as older donors assess their tax situation, both charities and financial services companies will need to spool up quickly in order to make these gifts a reality.  The good news is that charitable contributions made through the IRA will be available to satisfy minimum required distribution requirements


Under the PPA 2006, charitable gifts from IRAs are now possible and encouraged.  While there is no income tax deduction for most donors unless gifts are made from a Roth IRA or an IRA with non-deductible contributions, those situations probably won’t be common.  However, because the donor will not have to recognize income, the net effect is the gift from an IRA becomes completely tax-efficient.  By keeping the AGI lower, the donor won’t be penalized with higher self-employment or social security taxes, the taxpayer won’t have to deal with the 3% phase-out of charitable deductions, there are fewer concerns about alternative minimum tax (AMT), and a donor can reduce taxes without having to itemize.


The major points of this planning opportunity are:


  • Up to $100,000 from each donor’s IRA is eligible for charitable giving.
  • Distributions are made by the IRA custodian, in a trustee to charity transfer (few financial services firms will be prepared to accommodate donors in 2006, so start early and plan for delays). The donor should not take possession of the distribution.
  • Gifts may be made from an IRA (a Roth IRA qualifies too) only, no SEP, 401(k), 403(b), SAR-SEP, SIMPLE accounts will qualify.
  • IRA giving is only available in 2006 and 2007.
  • The donor must be 70½ by the date of gift, unlike typical IRA required distributions that are made in the year in which IRA plan participants reach 70½.
  • IRA gifts may be made only to public charities, no split interest gifts (e.g., gift annuities, charitable remainder trusts), and no use of supporting organizations or donor advised funds is allowed.
  • Gifts from IRA assets, to the extent required, will qualify for required distributions.


This new law applies to lifetime gifts, andis especially beneficial for those who don’t itemize, or who have Schedule A limitations due to previous gifts, or AGI limitations because there’s not a large enough adjusted gross income to fully make use of charitable deductions.  For donors uncomfortable with the idea of invading their retirement nest egg now, testamentary gifts of retirement plan assets and income in respect of a decedent (IRD) still make good sense for those with charitable intent in their estate plans.



IRS Information, Regulations and Commentary on Charitable Legal Issues

Gift Annuities – Malpractice XIV

Billie and George Huntley have had a longstanding and supportive relationship with their church.  Both serve on various boards, and Mrs. Huntley recently joined the church’s new fundraising and endowment committee.  Billie’s background in life insurance has given her a good understanding of the financial importance of long-term retirement planning, and she introduced some of the congregation to the idea of charitable gift annuities (CGA).  The reason Billie knew something about gift annuities is that she had recently attended a program where life insurance producers were encouraged to “sell” these annuities to their clients and reap handsome commissions for their efforts.


Gift Annuities are Excellent Charitable Tools


In an effort to protect charities from registration and oversight by the SEC, the Philanthropy Protection Act of 1995 (PPA/HR 2519) stipulated that a CGA is to be treated as a charitable gift, not as a regulated security.  Further insulating the charity from registering as an investment company, the PPA also prohibited the payment of a commission in the sale of a gift annuity. Recently, the National Association of Securities Dealers (NASD) issued a statement that called on registered representatives to avoid offering any gift annuity by labeling it an unregistered product.*  Additionally, the National Committee on Planned Giving (NCPG) and the American Council on Gift Annuities (ACGA) have both gone on record to denounce the “sale” of gift annuities and the payment of commissions by any charities implementing them.


The gift annuity is generally a creature of state law, essentially acting as a bargain sale agreement between a charity and the donor.  Since gift annuities closely resemble insurance company single premium immediate annuities (SPIA), states generally have insurance departments oversee or regulate the contracts.  The payments from both the CGA and SPIA are both reported to the IRS on a 1096, then the donor reports the income on a 1099-R.  Unlike the SPIA, part of the gift annuity payment may be part capital gain (if funded with a contributed capital gain asset), part ordinary income, and part return of principal.  The CGA also differs from the commissionable SPIA sold by insurance producers because, as a planned gift, it provides a charitable income tax deduction, and it is limited to providing only lifetime payments to just one or two annuitants.  Unlike charitable remainder trusts, there is no need for the donor to pay for annual trust accounting, compliance, or document drafting services, and the gift annuity issuing charity is financially liable for the ongoing stream of payments.


Many seniors “shop” annuity rates, seeking a higher rate of return on their savings, and may be mislead by advertising claims when they overlook the charitable component of a CGA.  Too often, an overenthusiastic marketer will compare a gift annuity to a bank’s certificate of deposit (CD) or to a commercial insurance company’s SPIA.  Unfortunately, it is not an apples and apples comparison.  Medically underwritten commercial annuities offers more options beyond one and two life only guaranteed payments, and often pay a higher annuity payment.  When promoters pitch a CGA as a product in a way that puts it in a comparative situation to regulated commercial products, they confuse donors.  This is especially true when CGA rates are compared to bank CD rates. 

Commercial Annuity vs. the Gift Annuity


Hypothetically, a $100,000 CGA for a 70-year-old would produce $6,700 annually (paid monthly) and a concurrent income tax deduction of $32,204, but a comparable one life SPIA for a 70-year-old man produces $9,060 annually.  Obviously, one cannot make money by giving it away, but donors need to remember that a CGA is primarily a charitable gift, not a purchased money making tool.  Since the premise behind a CGA is that there should be a 50% residual value after the annuity terminates, there’s no way a charitable gift annuity can (or should) compete dollar for dollar as an investment tool; only when the philanthropic goals of the donor are factored in does it make financial sense. 


In light of historically low fixed income interest rates and recent gift annuity defaults by insolvent charities, it makes sense for donors and their advisors to look carefully at the financial strength of any charity offering split-interest gifts before making an irrevocable transfer to a nonprofit organization.  Prior to signing any gift annuity agreement, ensure disclosures required by state law are clear and all the parties to the transaction understand their responsibilities.


*NASD Regulatory & Compliance Alert, Regulatory Short Takes — Charitable Gift Annuities, Summer 2002.

IRS Information, Regulations and Commentary on Charitable Legal Issues

10 Reasons to Review Your Planning

Ten Charitable Planning Mistakes to Avoid


by Vaughn Henry and Johni Hays


This article highlights specific areas of the charitable planning process where mistakes seem to re-occur based on the authors’ combined experiences as charitable planning consultants.  Newcomers to the field of planned giving aren’t the only ones making mistakes because as you read through the article, you’ll see that all types of planners, from the seasoned professional to the charitable planning novice, show up in the following examples.  By sharing real-life situations, the authors hope to provide practical experience and knowledge from the trenches, not from the painful school of hard knocks, but via the less painful old cliché, “learn from the mistakes of others.”


1.         Not Putting the Donor’s Interests Ahead of All Others


As planners work together as a team to recommend a charitable plan for clients, it is imperative to always put the client’s interests ahead of the charity, the attorney, the CPA, and the agent.  It seems like a statement of the obvious, but sometimes a plan can seem so good, the planner doesn’t want to throw water on the proposal by bringing up the possible downsides.  Here’s a case where the planners went a step further down the wrong path by intentionally omitting relevant information the donors needed. 


In the case of Martin v. Ohio State University Foundation (Ohio App., 10th App. Distr., 2000), the donors of a NIMCRUT sued their life insurance agent, the life insurance company, and the charity that also acted as their NIMCRUT’s trustee.  An attorney and an insurance agent proposed a charitable plan to a couple that included the donation of $1.3 million of undeveloped farmland to a NIMCRUT.  The donors would use income from the NIMCRUT to purchase a $1,000,000 life insurance policy costing $40,000 per year for wealth replacement for the donor’s children.


 The donors received several proposals over the course of a few months.  Each and every proposal showed the NIMCRUT paying the donors income immediately after the execution of the NIMCRUT.  Since the donor’s annual income prior to the transaction was only $24,000, the donor was counting on the trust income to pay the insurance premiums.


The charity’s representative wrote a comment on the last proposal shown to the donors that a net income trust funded with non-income producing land can’t make any income payments until after the land is sold.  When the insurance agent saw the comment on the proposal, he deleted it before giving it to the donors. Unfortunately, the land was not sold until two and one-half years later and no income was paid to the donors during that time.  In the meantime the agent tried to loan the clients enough money to pay the insurance premiums, but in the end the policy lapsed.  The donors sued for fraud, negligent misrepresentation, breach of contract and breach of fiduciary duty asserting they had never been told the truth about income not being payable from the NIMCRUT until after the land was sold.


In the Martin case, the advisors failed to give the donors accurate and complete information as to how the charitable gift would work in their situation.  They intentionally deceived the clients for what appears to be their own financial gain.  At all times and in all aspects of planning with clients, the goal must be to provide advice that is in the clients’ best interests, not the planners. Clients deserve the best and accurate advice from their planners even if it prevents the gift from occurring.


2.         Recommending a Charitable Gift Without a Full Understanding of the Donor’s Financial Needs and Goals


A few planners tend to sell a charitable gift like a financial product.  A charitable gift is not a product; it’s part of an integrated estate and charitable planning process. To illustrate, one planner wanted to set up a CRAT for an older client funded with farm-land. The planner had a fixed annuity he wanted to sell to the trustee using the proceeds from the land.  The planner was under the impression the trust was required to purchase an annuity since it was a charitable remainder “annuity” trust. The planner was then counseled on how a well-balanced mutual fund might be a more suitable vehicle for the proceeds.  Unfortunately, the planner responded he wasn’t licensed to sell mutual funds. 


Upon further learning that the annuity would produce tier one ordinary income at the client’s marginal income tax bracket of 42%, the planner replied that since his client would be obtaining a large income tax deduction he could afford to pay more in income taxes.  


Sadly, this situation represents a product-selling planner who isn’t mindful of the downside of recommending the CRT. The planner did not ascertain his client’s charitable interests, instead he recommended the concept as a means to avoid or even evade capital gains taxes when in fact, it would potentially increase his client’s tax liabilities.  The recommendations made for this plan weren’t in the client’s best interests and could be considered malpractice on the part of the planner.


3.         Serving As Trustee


Another misstep can occur during the charitable planning process when the advisor serves as the trustee for either the client’s life insurance or charitable trust.  Financial planners, brokers and insurance agents need to be careful when asked by their clients to serve as the trustee.  The best answer to give a client is “No, thank you.” Serving as trustee can create a serious conflict of interest if the trustee benefits by the transaction, not to mention SEC problems if the agent or broker has a securities license.


 If the life insurance agent is selling the policy to the trustee when he also serves as trustee, he is selling a product to himself for which he earns a commission using someone’s else’s money.  It’s a conflict of interest and it is best to leave the trustee’s duties to a trust professional.


Generally, non-legal advisors are not well trained in the duties imposed on the trustee as a fiduciary.  Moreover, non-legal advisors are generally not trained to understand the language used in trust documents and what each paragraph means in layman’s terms.  Moreover, most insurance companies will not allow their agents to act as trustees for trusts funded with their own insurance policies.  Additionally, most E&O coverage does not cover acts by an insurance agent acting as a trustee.


For many reasons even attorneys are reluctant to serve as trustees because attorneys know all too well the complex duties involved when acting as a fiduciary and following the prudent investor rules.  One trust officer, who found out too late what the trustee’s duties are, served as the trustee of a testamentary CRAT.  He asked how long he could wait to begin making payments to the income beneficiaries as the land inside the CRAT hadn’t sold and there were no other assets inside the trust.  Three years later, the income beneficiaries still hadn’t received their first income payment from a trust that has no legal recourse but to distribute income or assets annually, whether it’s liquid or not.


4.         Donating Inappropriate Assets


A charitable planner can find himself in an uncomfortable position when he is unfamiliar with the consequences making gifts using various assets.  The tax rules covering charitable deductions for different kinds of assets can be complex, so the best way to prevent these types of mistakes from happening is to know the rules for each type of asset. 


To illustrate, one planner suggested a client donate $3,000,000 of art to a CRUT using a 10% income payment.  Even though the client properly executed the CRUT, the client continued to display the artwork in his home.  The planner mistakenly thought the charity would advance the 10% income payment to the trust each year, and he did not know the artwork couldn’t be kept indefinitely on display at the client’s home.  To make matters worse, the charitable deduction was not based on the artwork’s fair market value like the planner told the donor, but instead the deduction for tangible personal property that has no “related use” to the trust was based on the donor’s lower cost basis.


Another planner was working with a client whose only other asset beyond $75,000 of mutual funds was a $350,000 IRA.  The planner didn’t realize the entire IRA would be subject to income taxes if the client donated it to charity in exchange for a charitable gift annuity.  Adding to the misunderstanding was the offending charity’s IRA Donation “proposal” which failed to adequately disclose the disadvantages of using an IRA for a charitable gift under current tax laws.  (Note:  proposed legislation, if enacted into law, may allow IRAs to be given to charities during the donor’s lifetime without incurring a taxable event.  See Senate Bill S-1924.)


A financial planner, who also wasn’t aware of the consequences of donating the specific asset he recommended, knew his client was coming into a large sum of money soon from the sale of his business.  The planner recommended that his client quickly donate the business to a CRT to help his client avoid taxes.  Upon discovery, however, the client had actually sold his entire business five years ago and this large sum of money was the final payment in a series of installment payments for the buyout.


Donating Various Types of Assets


These assets need extra special handling:

·       Encumbered real estate

·       Closely held “C” corporation stock

·       Restricted (Rule 144) stock

·       Stock with a tender offer in place

·       Sole proprietorships, partnerships and on-going businesses

·       “S” corporation stock


These assets should generally be avoided in charitable gift planning:

·       Property with an existing sales agreement

·       Installment notes

·       Stock options (both qualified Incentive Stock Options and nonqualified stock options)

·       Lifetime transfers of IRAs and Qualified plan dollars

·       Lifetime transfers of commercial deferred annuities

·       Lifetime transfers of savings bonds


5.         Reinvesting CRT Assets Improperly


Often times a charitable trust is put together by a financial advisor or insurance agent with the hopes that the donor, who generally serves as trustee, will look to the advisor or agent to reinvest the proceeds of the gifted asset once it’s sold.  While there is nothing wrong with this plan, advisors need to be educated on the complexities associated with prudent investor rules, charitable trust accounting, tax deductions, etc., before they can fully understand the consequences of their recommendations.


An example of improperly invested CRT assets occurred when a planner recommended his middle-aged donor establish a CRAT.  Inside the CRAT the donor-trustee bought a “life-only” single premium immediate annuity to “guarantee” the annuity income payable to the income beneficiary.  The flaw underlining this transaction is that the charity’s remainder interest would be left without any assets when the trust terminates, as a single premium immediate annuity for “life only” will end upon the death of the client with no principal balance leftover. This recommendation could make the trust subject to oversight by the state’s Attorney General for imprudent investment and all its advisors are potentially liable to the charity  Remember, a CRT is a split interest gift, and there are two beneficiary groups with a legal interest in these tools, so the trustee often must wear two hats, one as an income beneficiary and one looking out for the charity’s well being.


To compound an already unpleasant situation, when the planner was counseled regarding the flaw in his proposal, he and the lawyer argued that the trustee’s purchase was valid because the trust “passed the 10% test.”  The planner and lawyer were then counseled on the difference between the 10% test in terms of the charitable deduction and subsequently investing CRT assets improperly.


Another planner, who also recommended a similar plan, suggested his trustee purchase a life insurance policy to pay the charity its portion when the immediate annuity payments end.  However, this plan was similarly destined for failure as the CRAT cannot accept ongoing contributions to pay a lifetime of insurance premiums 


Improper investing occurred with a stockbroker who chose to invest his client’s CRT funds with several partnerships (creating UBTI) in the first year of the CRT’s existence.  This choice created a taxable CRT that does not avoid the capital gains liability when the appreciated asset that funded the CRT was sold.  In addition, there was no income tax deduction to offset the reinvestment error, compounding the broker’s poor advice.  Other mishaps have occurred when the trustees were given access to a charge card on a money market account held inside a CRT.  Trustees with charge cards on CRT assets open up self-dealing and debt financed problems similar to trading on margin accounts and charging the CRT interest on the loan when the trades do not materialize as expected.


If a planner “sells a CRT”as a way to take assets under management or sell wealth replacement, it isn’t unethical but it sure can be short sighted.  It’s also likely to result in unhappy clients who find themselves stuck with an irrevocable plan that doesn’t meet their needs.  Agents and planners who recommend charitable gifts must be knowledgeable of charitable gift laws and be prepared to pull in a team of experts to implement a plan in the donor’s best interests.


Learn from the mistake of an insurance company that allowed a commercial deferred annuity to be removed from inside a CRT.  The CRT’s trustee was the owner and beneficiary of the annuity and the husband was the annuitant.  At the husband’s death, the death claim papers were sent to the surviving spouse who checked the box on the claim form allowing the surviving spouse to change the ownership of the annuity to her own name as an individual.  She then withdrew all the interest earnings in the annuity.  The error wasn’t caught until the spouse complained of the large IRS Form 1099 she received the following January for the interest income she received. This is often a problem in a NIMCRUT using a deferred annuity when the insurance company incorrectly sends out a 1099 to the annuitant, instead of to the tax-exempt CRT, while the CRT is properly issuing a K-1 for the same income distributions, thus doubling the income tax exposure.


Understanding the four-tiered system of accounting in a CRT can seem complex.  Often planners may not fully comprehend all the issues involved and this leads to mistakes.  For instance, one attorney counseled his client to fund a CRT with farmland.  He had the trustee purchase tax free municipal bonds after the land sold to obtain tax-free income from the CRT.  However, what the professional didn’t realize, is how the capital gain income from the sale of the real estate is higher on the 4 tier accounting system than any new tax free income generated by the municipal bonds.  Understandably, the client was quite unhappy when the income wasn’t “tax-free.”


6.         Not Monitoring the Wealth Replacement Sale


A charitable planning case can be effectively implemented with the appropriate professionals including the client’s attorney, CPA, planned giving officer, and the life insurance agent.  However, in charitable plans where life insurance is a part of the overall plan, the purchase of life insurance inside an irrevocable life insurance trust (ILIT) should be monitored by the donor’s estate planning attorney.  Attorneys should direct the process and clearly indicate to the donor, the trustee, and the life insurance agent how the process should work and in what order each step should occur.  Otherwise, what can happen is the insurance sale can be implemented in a way that undermines the donor’s estate plan. The following are life insurance missteps that can cost clients hundreds of thousands of dollars in estate or gifts taxes. 


1)     The insurance policy is issued prior to the life insurance trust’s implementation.  This occurs when the insurance agent issues the policy before the irrevocable trust is executed and funded.  If the policy is applied for before the trust is executed, it is commonly applied with the insured as the policy owner.  If the ownership is thereafter transferred to the irrevocable trust, the threeyear in contemplation of death rule occurs causing the policy to be pulled back into insured’s estate if he dies within three years of the transfer.

It’s a preferred practice to have the donor’s insurability determined using “trial” applications, but once insurability is approved, the policy should not be issued until the ILIT is executed, funded, and withdrawal power letter have been sent to trust beneficiaries and the Crummey powers lapse.  At that point the agent submits completely new applications with the trustee as the owner and beneficiary. The trustee then pays the premium to the agent and the policy is then officially issued.


2)     The insurance agent accepts the premiums directly from the insured and applies those premiums to the policy owned by the ILIT  The proper procedure requires that the agent obtain the premium check from the trustee’s funds, not from the insured’s personal funds, when the trust beneficiaries have withdrawal powers.  The goal is to have the trust funded and the withdrawal beneficiaries notified and their right to those annual exclusion gifts lapse prior to the trustee paying the premium. 


If, on the other hand, the agent obtains a premium check directly from the donor’s personal funds, the premium amount is not considered a gift of present interest since the trustee never had the funds, nor have the beneficiaries been notified of their withdrawal rights and therefore, their gifts cannot fall within the annual exclusion gift amount.  The insured must file a gift tax return for these gifts and use part of his estate tax exemption equivalent of the unified credit (currently $1,000,000) to cover the premiums.


7.         Selling the Numbers on a Charitable Illustration.


The various illustrations from charitable planning software vendors are generally provided to prospective donors to give them diagrams or flowcharts to describe the type of charitable gift being presented.  The mistakes made when presenting these illustrations arise from a misunderstanding of the variables behind the illustration. For example, a common mistake is to create a CRT with a non-spouse as an income beneficiary, e.g., mom, dad and child, and the illustrations are cranked out without any cautionary words about the loss of the unlimited marital deduction and the effect of taxable gifts with a CRT being included in the trustmaker’s estate.  The software produces the correct “income tax deduction,” but does not address the more complex gift or estate tax issues.


The charitable planner must know the variables that produced these calculations and numbers.  The planner must know and understand the footnotes and assumption behind every proposal.  With a charitable remainder trust, for example, the planner needs to know what interest rate is being used to assume the future growth of the CRT assets.  In addition, the interest rate must be a reasonable number. In turn, the planner must inform the client of the variables used in the illustration.  The client must know what numbers he can rely on and those he cannot.  It’s simply an education process, and the more the client knows and understands, the better and happier the client will be.


8.         Selling Charitable Gift Annuities


Planners new to the field of charitable giving frequently have a misconception surrounding a charitable gift annuity.  Since planners may sell commercial annuities to clients for commissions, they sometimes assume that a charitable gift annuity is an annuity offered for sale to the public from their insurance company. 


However, a charitable gift annuity is not a commercial annuity offered by a life insurance company.  It can only be offered by a charity and is an agreement between a donor and a charity in which the donor gifts an asset to a charity in exchange for lifetime income for the donor.  The income provided to the donor from the charitable gift annuity is always paid by the charity.


The young planner who was asked to work with a particular charity’s donors to conduct seminars and help establish charitable gift annuities best illustrates this misconception. The planner thought the insurance company had an annuity for him to sell at the seminar and that he would be earning a commission on each charitable gift annuity “sold.” The agent asked if these donors would be bringing their checkbooks to the seminar and if these gift annuities are mostly “one-interview sales.”


To make the confusion even worse, a few charities are under IRS scrutiny for their practice of paying advisors a “finder’s fee” for bringing clients to establish a charitable gift annuity with them. Not only are these practices considered highly unethical by some professional advisors, but also it may be a violation of the Philanthropy Protection Act of 1995. An advisor cannot help fulfill the donor’s charitable mission and values by giving donations to causes in which the client feels strongly if the advisor steers all potential donors to only one charity – the one that will pay him a finder’s fee.


9.         Unknowingly Practicing Law Without A License


The unauthorized practice law is generally thought to be committed by a non-lawyer when that person provides legal advice to another either verbally or through the drafting of legal documents.  The unauthorized practice of law can occur in charitable and estate planning through the misuse of computerized legal documents also known as “specimen” documents.


The reason for providing specimen documents is so the planner can bring something to the planning process as a “value added service” for the client’s attorney. These sample documents are intended for use by the client’s attorney when that attorney may not be an expert in the field and could use a “starting point” in drafting.  It’s a way for the agent to be professional and helpful in the planning process.


Unfortunately, the planner or the client can misuse these specimen documents.  Some non-lawyers have asked if they can “just fill in these blanks” because their client doesn’t want to pay an attorney. Whether it is a specimen life insurance trust or a charitable remainder trust, many costly errors have been made when a non-lawyer or donor takes the position that one document fits all and fills in the blanks of a specimen document. Further, many of these specimen trust agreements are ineffective as they are based on IRS prototype documents that are too rigid and don’t provide donors with the flexibility to create a legitimate planning tool that meets their unique needs. 


 Form books can also get a professional in trouble.  One attorney who hurriedly drafted a trust for his client found this out the hard way after inserting boilerplate language from a forms book.  The language gave the trustee of the CRT the power to pledge trust assets and to borrow funds;those powers put the exempt status of the CRT at risk.


Charitable gifts are complex and the laws with respect to charitable giving as well as property law can and will vary by the donor’s particular state law.  Specimen documents do not take into account any state law nuances.  In fact, for this very reason, the practice of providing specimen documents to planners has caused enough litigation to stop some insurance companies from supplying these documents


10.       Recommending Aggressive Charitable Techniques


Planners could scuff their professional reputations when they are involved in aggressive planning techniques and later the IRS or the courts condemn the plan they once recommended.  One of the most recently promoted aggressive charitable planning arrangements was charitable split or reverse split dollar.  This was an idea whereby the donor purchased a policy and had the death benefit split between the charity and the donor’s family.  However, the donor took a charitable deduction for the entire premium knowing that the donor’s family would personally benefit from this transaction. Sure enough, in 1999 charitable reverse split dollar arrangements were shot down by Congress [H.R. 1180, the Tax Relief Extension Act of 1999] and the IRS handed down some severe penalties in IRS Notice 99-36, 1999-26 I.R.B. 1.


Some life insurance companies refused to accept or underwrite business from their agents if this concept was behind the life insurance sale.  Other companies accepted the life insurance premiums without passing judgment on how that business came to the insurance company or how the agent advised their clients on tax deductibility.


Even though Congress has passed legislation stopping this charitable tax technique, its promoters are still using this concept.  The latest version of the technique uses a charitable remainder trust that owns life insurance under the disguise that the donor-income beneficiary is an “employee” of the charitable remainder trust.  The trust is employing the donor-income beneficiary and hence the charitable plan now falls within the “employment” context of split dollar funded life insurance and thus, outside of the prohibiting legislation However, this plan may raise self-dealing issues that will be sure to capture the attention of the IRS.




        The above article demonstrates the pitfalls that planners want to stay clear of as they work to help clients in the area of charitable planning.  Take this as a great opportunity to learn from the mistakes made by others and avoid the pitfalls in your practice.


Clients need complete disclosure of the advantages and disadvantages of the plan being proposed.  Wellinformed clients tend to be appreciative of the extra effort and it is an important factor in client satisfaction surveys.  Take the extra time and make sure the clients’ charitable plan is proposed with the client’s best interests first.


Vaughn Henry’s consultancy, Henry & Associates, specializes in gift and estate planning services, wealth conservation and multi-generational family entities. Vaughn also owns, a frequently updated wealth planning resource Web site, and resides in Springfield, IL.


Johni Hays is the Director of Advanced Markets for AmerUs Life Insurance Company in Des Moines, Iowa.  She is also the co-author of the book The Tools and Techniques of Charitable Giving, published by The National Underwriter Company. She can be reached at [email protected]




Vaughn W. Henry


Vaughn Henry provides training and consulting services on the charitable estate planning process.   As an independent advisor to charitable organizations on planned giving, Vaughn’s clients include some of the Forbes 400 and large U.S. corporations. His consultancy, Henry & Associates, specializes in gift and estate planning services, wealth conservation, and domestic and international financial services.


Since 1977, Vaughn has been a widely recognized and popular presenter to charitable groups, business owners, accountants, attorneys and financial services providers. He specializes in deferred gifting and the Economic Citizenship concept, and creative gifting for the Reluctant Donor. He helps charities learn how to develop larger gifts from difficult prospects and to work more cooperatively with donor advisors.

Vaughn received his BS in Agricultural Science and MS in Animal Science from the University of Illinois and is completing work toward a Ph.D. in management. Prior to consulting, he taught at the college level where he generated entrepreneurial funding for college programs. He continues to consult farm, ranch and closely held family businesses in operational and management techniques, specializing in small business communication technology, human resources training, operations, management and multi-generational estate planning. He is a licensed insurance and securities practitioner. Vaughn owns, a frequently updated wealth planning resource Web site, and resides in Springfield, IL.

In addition to serving on the board of the National Association of Philanthropic Planners, Vaughn’s affiliations include the Sangamon Valley Estate Planning Council, Central Illinois Planned Giving Council (NCPG) and numerous trade and professional financial services organizations. He has been featured in many professional publications, including The Wall Street Journal, Worth, Forbes, Investors Business Daily, Journal of Practical Estate Planning, Planned Giving Design Center, Leimberg Services Newsletters, Planned Gifts Counselor, and Planned Giving Today.


Johni Hays, JD, CLU


Johni Hays is Director of Advanced Markets for a Midwest life insurance company.

Johni has extensive experience in estate and business planning, life insurance planning, charitable giving, retirement planning, annuities, and federal taxation.  She has lectured extensively on estate, business and retirement planning in addition to publishing articles nationally on charitable giving.  Johni is a co-author of the book The Tools and Techniques of Charitable Giving, published by The National Underwriter Company and is the charitable giving commentator for Steve Leimberg’s electronic newsletter service, Leimberg Information Services, Inc., (LISI). 


Johni was previously Advanced Markets Counsel for ManuLife Financial in their U.S. headquarters in Boston.  In addition, Johni served as an estate planning attorney with Myers Krause & Stevens, Chartered law firm in Naples, Florida, where she specialized in life insurance as a part of the overall estate plan.  She also was with Principal Mutual Life Insurance Company for nine years as a marketing consultant in the Mature Market Center in Des Moines.


Johni graduated cum laude with a Juris Doctor degree from Drake University in Des Moines, Iowa in 1993.  She also holds a Bachelor of Science degree in Business Administration from Drake University where she majored in insurance, and graduated magna cum laude in 1988.


            Johni is a member of the National Council on Planned Giving, the Mid-Iowa Planned Giving Council, the Mid-Iowa Estate & Financial Planners Council, and the State Education Council for “Leave a Legacy – Iowa.”  Johni is a Chartered Life Underwriter (CLU) and a Fellow of the Life Management Institute (FLMI), and she has been a member of both the Iowa Bar and the Florida Bar since 1993. She can be reached at [email protected]


IRS Information, Regulations and Commentary on Charitable Legal Issues

Making Your Charitable Trust Mimic a Pension – Vaughn Henry & Associates

Making Your Charitable Trust Mimic a Pension – Vaughn Henry & Associates

Make that Charitable Trust Act like a Pension

Vaughn W. Henry © 1999

If you think Patrick Henry’s, “taxation without representation” is meaningful, imagine how he’d feel about our “taxation with representation”.

Once upon a time, pension experts promoted tax deferred retirement plans as a way to grow an estate. Their sales pitch was, “whatever you don’t use in retirement will be available for your kids.” Then, when it became apparent business owners were setting aside too much for themselves, the Department of Labor and ERISA/IRS regulations mandated a whole list of rules that made discriminatory retirement planning a thing of the past. To heap further problems on the pension owner, Congress changed the estate tax treatment of retirement accounts in 1981 to eventually make them completely taxable at both the income and estate tax level by 1986. In some areas of the country, it was possible for a family to owe more than 100 cents tax on every inherited dollar, so in today’s planning environment, a different approach to retirement planning has become more popular. Enlightened estate planning promotes the concept of regaining control over dollars that otherwise are lost to the tax system.

Depending on the performance and nature of the investments used, a charitable retirement unitrust might make use of new flip trust regulations and have more income with capital gains treatment on the deferred income stream. The alternative approach is to use a specially designed deferred annuity inside a §664 charitable remainder trust (CRT) to more precisely control the timing and recognition of distributable net income (DNI) and make it a spigot trust. WIFO* (worst in, first out) four tier trust accounting can be manipulated if there is a complete understanding of the investment choices inside CRT funded with cash.

Gerald (50) and Susan Warren (49) have a successful partnership as business brokers and consultants. While they have a fully funded profit sharing and pension plan, they decided to look into other retirement planning tools that offered a different sort of control. The Warren’s dissatisfaction with their existing plan became apparent after they saw how the required minimum distributions would force out income when they wouldn’t need it and the eventual confiscation of their savings. Originally designed to provide security in retirement and create an estate for their heirs, instead after a series of legislative changes, it looked like the IRS is the major beneficiary of their retirement planning.

With a degree in law, Gerald looked into using a charitable trust to mimic his pension plan and decided to make use of a net income/make-up charitable remainder unitrust (NIMCRUT). Although not every contributed dollar is 100% deductible, the flexibility and personal satisfaction of knowing their social capital dollars will be redirected was motivating. Once they acknowledged that taxes are a form of involuntary philanthropy, the §664 CRT made more sense within their master plan and they proceeded with the trust. Since Gerald plans to work full-time at least through age 68, the Warrens decided to set aside $50,000 a year for contributions to their retirement unitrust. Over the next 18 years, a total of $900,000 will be saved inside a tax-exempt trust that generates $163,012 in tax deductions. When the retirement CRT or spigot trust opens up in the 19th year, the Warrens can expect to receive $4.33 million (based on past investment performance) in after-tax income during their retirement. After Gerald and Susan pass away, at their joint life expectancy, the trust will transfer $7.81 million to their community foundation’s donor advised account for their children to manage and distribute. This trust, combined with a wealth replacement trust for their heirs, will leave the family in control of the Warren estate and produce a “Zero Estate Tax Plan” that suits their planning goals with a family financial philosophy of wealth preservation and charity.

For those who would prefer to use a conventional pension plan, if the same NIMCRUT input assumptions are used, the tax liability at life expectancy would be a staggering $5.899 million and the total spendable income would not be significantly different. Clearly, a charitable trust as a retirement planning tool is worth consideration for individuals with charitable intent and a desire to retain control of family wealth.

Pension §664 Trust
Deductibility Full Partial
Tax Advantaged Growth Yes Yes
§415 Limitations Yes No
Assets Subject to Estate Tax Yes No
Non-Discrimination Rules Yes No
Early & Late Retirement Penalties Yes No
Required Minimum Distributions Yes No
Taxation of Distributions Ordinary Income WIFO* Acctg.
Benefits to Heirs Yes Optional
Heirs’ Benefits Taxed Yes No
IRS Information, Regulations and Commentary on Charitable Legal Issues

Charitable Trust Continuing Education Seminar – Vaughn Henry & Associates

Charitable Trust Continuing Education Seminar – Vaughn Henry & Associates

CRT and Charitable Planning Continuing Education Programs

VWH – some programs provide up to 15 CPE or CE, also PACE/CLU, CTFA credits are available for accountants, financial planners, insurance producers and trust officers. For further information or scheduling, contact Vaughn Henry at 800.879.2098.

Charitable Trust Continuing Education Workshop

Workshop topics include CRT design and implementation, new tax laws affecting estate & gift planning, computer software and establishing family influenced philanthropy. Practical applications will be stressed and tools provided to explain to clients how and why they should preserve their social capital. Besides benefiting advisors who have clients with demonstrated charitable intent, there will be materials presented to help motivate the reluctant or latent philanthropist. Learn about ways to maximize family wealth and influence for entrepreneurs, family business owners and clients involved in pending transactions. Not for profit development officers and fund-raisers may also find the program helpful as they establish planning partnerships and strategic alliances to assist their donors be tax-efficient with planned gifts.

Name _______________________________ Firm ____________________

Address ____________________________ City/State/Zip ______________

Telephone (___ __________) Fax (___ ___________ ) e-mail _____________

SSN or license __________________ Attorney__ CPA__ CFP__ Ins. Prod. __ CTFA __

Other Associates Attending __________________________________

The program will cover:

How to convey options to maximize family wealth

Developing enlightened self-interest with your clients

Why even non-charitably inclined clients should look at §664 and §170 Trusts

Creating strategic alliances with communities, clients and charities

Financial planning tools for clients interested in controlling social capital

How to conserve the $10 -140 trillion due to change generational hands

Why the changing political and economic climate will make developing community resources more important for your clients

Integrating charitable remainder and lead trusts, ILITs or Dynasty Trusts and family foundations into your estate planning activities

Developing a family financial philosophy

Tools to gather and reposition assets and how to maintain control, influence and relationships for several generations

Redirecting tax deferred and qualified retirement plans so I.R.D. and estate taxes do not dissipate the influences of family wealth

Recognizing planning opportunities during client transactions

Software options and presentation materials for deferred giving clients

Avoiding malpractice traps

Investment concerns in the CRT after TRA ’97

Seminar Presentations

Educational Program Outline for Charitable Remainder Trust Continuing Education

I. Family Wealth Preservation and Motivation

II. The Magnitude of the Charitable Marketplace

_A. The History of Charitable Giving in the United States

_B. The Size of the Market

_C. Benefits of Charitable Remainder Trusts

_D. Why Charitable Gifts

_F. Charitable Gifts and Income Taxes

_G. Charitable Gifts and Gift Taxes

_H. Charitable Gifts and Estate Taxes

III. The Charitable Trust

_A. The Charitable Trust Defined

_B. Charitable Remainder Trusts – Basic Types

_C. Charitable Remainder Annuity Trusts

_D. Charitable Remainder Unitrusts

…… 1) Standard unitrust

…… 2) Net income unitrust

…… 3) Net income with makeup unitrust

_E. Examples of Each Type of Charitable Remainder Trust

_F. Tax Accounting for Charitable Remainder Trust

…… 1) Income tax deduction

…… 2) Gift tax deduction

…… 3) Estate tax deduction

…… 4) Income tax exemption of trust

…… 5) Capital gains tax exemption

…… 6) Generation skipping tax

…… 7) Income tax reporting

_G. Suitable Assets for Gifting

…… 1) Securities

…… 2) Real estate

…… 3) Closely held stock

…… 4) Retirement plan benefits

…… 5) Hard to value assets

_H. Funding the Charitable Remainder Trust

…… 1) Investment philosophy

…… 2) Investment options

_I. Charitable Remainder Trust Income Beneficiaries

…… 1) Sole and spousal beneficiaries

…… 2) Non-spousal beneficiaries

_J. Charitable Remainder Beneficiaries

…… 1) Public charities

…… 2) Community foundations

…… 3) Private foundations

_K. Wealth Replacement Trusts

IV. Charitable Trust Case Studies

Our Sites


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Vaughn W. Henry

Henry & Associates


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IRS Information, Regulations and Commentary on Charitable Legal Issues

Excess Accumulations in a Qualified Plan

Excess Accumulations in a Qualified Plan

Pension Traps for the Well Heeled

Excess Accumulations in a Qualified Plan — Why Some Participants May Want to Opt Out

It’s been said that the rich are not like other people. In fact, they have a whole set of problems that many of us cannot fully appreciate. Tax simplification and reduction may be popular political goals, but historically, Congress has nibbled away at the wealthy and their right to control personal wealth. A good example of this double standard is the excise tax trap in which many of the prosperous find themselves at retirement. Too much of a good thing obviously had to be penalized somehow.

While Congress dreams up new ways to wring more dollars out of the well to-do, the IRS has special regulations available right now to make life for wealthy savers more taxing. Conventional wisdom holds that the rich already have too many special tax breaks. In reality, for the well heeled, previous changes in laws have completely destroyed many of the same shelters and techniques that still benefit poor and middle class taxpayers. Income tax deductions are consistently eliminated, and net tax rates moved up without much opportunity to squawk from taxpayers. It is these gradual changes that have had such a big impact on the bottom line for many people looking to minimize tax hits on their assets. Even though published tax rates are lower now than in earlier years, without their old deductions, the taxes paid are higher and spendable income for many is actually much less. When politicians talk about tax relief, they cut in one area and increase in others.

The recently passed Taxpayer Relief Act of 1997 has eliminated the 15% excise tax on distributions during life as well as in estates. However, normal income and estate tax liabilities were kept in place. Since few estate tax breaks were passed in this legislation providing relief for professionals with significant estates, keeping a close eye on uncontrolled appreciation remains important. With the loss of §664 Trusts as a tool to pass down retirement plan assets for young beneficiaries, extra care needs to be taken with plans for some families with wealth.

As an example of the incremental hike in tax rates, the pension tax laws are a classic example of ways the government creatively generates new revenues. Pension savings were fully exempt from estate taxes as late as in 1981. Over the next five years, those qualified retirement savings plans (QRP) were gradually exposed to estate taxes and by 1986 were completely subject to tax liabilities, now at 55% for many estates. All of these backdoor tax increases occurred while big income tax cuts were simultaneously passed and promoted for general public consumption.

Once promoted as an ideal way to safeguard the future, qualified retirement plans may not work as originally intended for the top 5 – 10 percent of plan participants. Highly compensated pension participants, urged by their advisors to defer salary into qualified plans, may have put themselves into a trap with few options to control those funds. Savings, they were told, could be withdrawn as needed and theoretically used in a lower tax bracket. It was also assumed that flexible use in retirement would allow the retiree discretion in how those funds were exposed to tax. Today, it turns out that most wealthy retirees still pay taxes at the highest marginal income tax rates. Since 77 per cent of the nation’s wealth is held by those over 50 years of age, tax rates have stayed high to reflect that reality. Other planning assumptions about unused retirement savings being available to create an estate for heirs have also been proven wrong. The oft-heard advice to defer more income into retirement plans may be exactly the wrong thing to do today for many affluent savers. Not that saving in a tax-deferred environment is bad, it just may need to be repositioned for more efficiency.

When is this threshold for new taxes going to be an issue? The biggest problem exists if there is any potential for estate taxes and there are already significant assets in a qualified plan. Instead of the family receiving those unused retirement plan funds, about 75% will pass to the IRS upon the taxpayer’s death (income in respect of a decedent or IRD). Capital punishment in every sense of the word, estate and income taxes effectively confiscate almost all of the sheltered savings. These exposed funds include money in pensions, profit sharing and 401(k) programs, as well as 403(b), IRA and HR-10 (Keogh) plans. At greatest risk of loss are the self-employed, professionals and small business owners who maximized their plan contributions every year and now have accounts that will approach $1 million by retirement. For most savers, that seems like an unreachable goal, but compounding interest and maximum contributions may make it commonplace for those with good programs.

Where did it all go wrong? To fill a social need, Congress created legislation to encourage taxpayers to set aside funds for retirement. Nobody disputed that saving for the future was a desirable goal and should be encouraged with favorable tax treatment. As a result, motivated company owners used qualified plans in a tax deductible environment to grow their nest egg without the burden of current taxation. Unfortunately, for the IRS, too much money was withdrawn from the tax collection system and it reduced needed tax revenues. So new laws were drafted to make it harder to save in retirement shelters. Today the IRS can effectively penalize a taxpayer if they save too much, withdraw savings too early or too late, and if they take distributions that are too large or too small. Mortimer Caplin, former director of the IRS, summarized it well, “There is one difference between a tax collector and a taxidermist — the taxidermist leaves the hide.”

Congressional budgeters view the huge pool of deferred savings as a cash cow to be milked for future revenue enhancements. For example, when federal unemployment benefits needed to be lengthened in 1992, Congress financed the program by changing the tax treatment on rollovers from qualified plans. They projected that most taxpayers would not jump through all of the hoops creating new tax revenues and penalties to produce the needed funds. Unfortunately, they were right.

If you think you might be one of those exposed to unnecessary taxation. There is specialized computer software available to project tax problems and liabilities for retirement plans, and qualified tax and financial advisors should be consulted to minimize any potential for losses. With creative planning, new strategies recently granted IRS approval could also eliminate many of the obstacles for successful savers. However, action needs to be taken early and the program monitored carefully. Properly done, the value of a qualified plan can be used to fund retirement, and still pass any remainder of the estate to heirs without penalties.

© Vaughn W. Henry, 1995 and 1997

IRS Information, Regulations and Commentary on Charitable Legal Issues

Charitable Split Dollar Plans – Vaughn Henry & Associates

Charitable Split Dollar Plans – Vaughn Henry & Associates

An open letter on Charitable REVERSE SPLIT DOLLAR – AND ITS PROGENY

by Stephan R. Leimberg, JD CLU


  • There have been five key claims for Charitable Reverse Split Dollar arrangements and their progeny:
  • First, funding of life insurance will be – in essence – income tax deductible.
  • Second, no party will be subject to income or gift tax liability (and it may also be possible to beat the estate tax).
  • Third, the donor will be able to use tax deductible dollars to provide for his or her own retirement income.
  • Fourth, this is a “no cost”, “nothing to lose”, “sure thing” with substantial benefits for charity, and
  • And fifth, this is a very, very good financial opportunity for the agent who is able to convince the client-donor and the charity to implement the plan and split the insurance.

Let me make my viewpoint very clear:

First, either all – or a significant portion of the check the donor-insured – or his or her corporation – writes – will not be deductible.

Second, the donor will incur significant income or gift tax liability – or both. And the person who prepares and signs the donor’s tax return will also likely face legal as well as ethical challenges.

Third, this is not a good deal for the charity. In fact, it may potentially be a New Era level public relations, economic, and legal disaster. The overpayment of premiums and the loss of interest on the “unearned premium account” may be deemed an imprudent course of action, probably a violation of the charity’s state charter, and a risk of its tax exempt status. In fact the charity may be sued by the donor on the grounds that he or she relied on the charity’s counsel checking out the viability of the plan.

Fourth, although the agent who sells this concept may realize a very short term gain, in the long-run, my prediction is that selling this concept will prove very expensive to both the wallet and the reputation of that agent.

Let me explain why I feel that donors, charities, tax preparers, insurance agents, as well as plan promoters will all loose from the marketing of charitable reverse split dollar and the “I’m different” schemes that make the same promises:

In examining CRSD – just as in any tax transaction, the IRS and the courts will look at both the formal written documents – and the substance – the totality and reality – of the transaction as a whole. The IRS and the courts can ignore your words can be ignored if they don’t comport to your actions.

Seemingly unrelated pieces of a puzzle can be re-assembled by the IRS when it’s clear that the parties intended from the start that each piece was intended to be part of a whole and no part of the puzzle works without the other parts.

In my opinion, both the “substance-over-form” doctrine and the “step transaction” doctrine – will be applied here – vigorously!

Charitable Reverse Split Dollar and the “progeny” I’ve examined – let’s be honest – is an integrated inter-dependent series of steps attempting to obtain a very good result for the donor and his family with relatively little of the client’s dollars for the charity.

Let’s address the law: We’ll start with the obvious. To get an income tax deduction for a gift to charity, you must both intend to make a gift – and – in fact – make one. If there’s no donative intent, in other words if you really don’t intend to make a gift, the entire deduction may be disallowed.

And for gift tax purposes, a transfer is not a gift – where the transferor’s primary impetus is the anticipation of personal economic benefits in return for that transfer.

Yet, that’s exactly what we have here – a donor anticipating hugh amounts of cash values flowing to his or her children’s trust. No Gift – no deduction. Strike one!

Even if you can show you intended to make a gift, to the extent you get something of value back from the charity, a “this for that”, the deductible amount of your gift must be reduced. This is called the quid pro quo rule.

So to the extent your contribution to charity is offset by a material economic benefit from charity, your deduction is only the excess of what you give over what you get back.

It is the reasonable expectation of a benefit in return for your gift – and not the legal right to get it – that’s important here.

The IRS takes this quid pro quo rule seriously: In fact, a representative of the charity – probably the president or director – will have to sign a legal document attesting – under penalty of purgery — how much – if anything – you’ve received in return for your gift.

Ask yourself how you would testify – in court and under oath – to the following questions:

Mr. Donor, what did you expect to get from this arrangement?

Did you know that the charity is laying out amounts substantially greater than it should for the term insurance coverage it actually receives – maybe five or six times as much as it should be paying?

Did you know that – because the charity is overpaying its share of the premium – a substantial benefit is flowing – through the split dollar arrangement – to your family’s trust?

Do you think the promissed amount of cash values would be in your children’s trust – if it didn’t get substantial economic help – in the form of overpayments of premiums – from the charity’s participation?

Did you know that the charity is also laying out even more money if the plan calls for a “unearned premium” account? Did you know that interest or growth on that money doesn’t go to the charity – it’s diverted to your family’s trust?

Did you know this unearned premium account is the equivalent of a long term interest free loan from the charity to your children’s trust? Can you give us any reason why Section 7872 shouldn’t be imposed – to impute several hundred thousand dollars of taxable interest to the trust over the plan’s span?

By the way, would you ask your counsel to provide the court with the legal authority for levelizing P.S. 58 costs – what’s the citation?

Were you aware that your cash contributions each year were part of an integrated plan designed mainly to put money in the hands of the charity – only so that it could turn around and use all or the bulk of those dollars to make all these great things possible – for you and your children?

You said you knew all these things – and in fact all these things reflected the plan and the promises that were explained to you by the agent who set this arrangement up.

Yet you took a tax deduction for the entire $100,000 check you wrote. Care to justify that? Would you care to explain why you didn’t reduce that $100,000 deduction on your income tax return by the value of the benefit your family received?

Quid Pro Quo – That’s strike two.

If all else fails, the IRS could allow the deduction – and then argue that, to the extent the children’s trust was enriched through the charity’s participation, the taxpayer has recovered the benefit for which he was allowed a deduction.

That recovery of his tax benefit is taxable income under Code Section 111. And then it’s a constructive taxable gift from the donor to his children.

What about the argument that there is no taxable economic benefit from the reverse split dollar arrangement? After all, isn’t there a revenue ruling that allows the taxpayer to choose to use – or not use – the insurer’s published rates rather than P.S. 58 rates?

The answer is, No, there is no ruling – with respect to reverse split dollar. In fact, this is what PLR 9604001 is all about – wealth generated by one party and shifted to and received by another may be taxable income to the recipient. The IRS could treat the increases in cash value in the children’s trust as currently taxable income – not under Section 83 – but under Code Section 61 – which subjects to tax “all income from whatever source derived”.

Let’s move to the partial interest rule:

The partial interest rule has a very simple purpose. Congress intended that a charitable gift be used exclusively for charitable purposes.

Let me repeat. The Code (Sec. 170(f)(3)(A) makes it very clear that you get an income tax deduction – only if the transfer isn’t going to be diverted back to – or for the benefit of – the donor. That’s why the Code denies a deduction for anything less than an unrestricted gift of the donor’s entire interest in the cash or asset contributed. A real honest to goodness – no strings attached, nothing up my sleeve – contribution.

If you give anything less than your entire interest, you don’t get a deduction.

And to make sure no games are played, the Regulations state, “if you divide the the property up in order to beat this partial interest rule, we’re still not going to allow a deduction. Don’t try to do by indirection what we have told you you can’t do directly.

In reality, the charity really ever owns the whole $100,000 check it receives each year from the donor. In fact, it knows – even before it receives each year’s check – that it will never receive next year’s check – if it doesn’t do what the donor intends it to do – use all or the bulk of the money for the split dollar premium payment.

So the pretense that the contribution is total and unrestricted and that the charity has full, absolute, and unrestricted use of the money flies in the face of the uncontraverted intentions of the parties – and the facts. That clearly violates the spirit – as well as the letter – of the Congressional intent in the Code that a charitable gift be used exclusively for charitable purposes.

Clearly, the parties intend that the charity will never get to use the entire check. They agree to that the first day they shake hands. The best the charity gets is a tenuous and temporary and in some cases diminishing piece of a small part of what the charity could buy on its own.

So, there’s no way the IRS or a court will believe an argument – no matter how couched – that the donor has given his entire interest, an unrestricted gift of cash – when both the facts and the promotional literature of the proponents of CRSD say otherwise.

Think About It: The end and intended result of CRSD is no different than if your client gives the cash value of an existing life insurance policy to a trust for his children and then assigns a portion of the death benefit to the Boy Scouts. There, it’s just a little more obvious – but no less certain that a gift of only a partial interest has been made to charity.

True, it was designed to make it look like the corporation or the donor gave – and gave all – with no strings attached – and with nothing expected in return.

But everyone knows the purpose of the client’s corporation writing the check was to create the appearance of separate and independent events and therefore the appearance of a gift of the check writer’s entire interest.

But the separate parties are a magician’s trick. The end result is circular. Dollars flow from the donor (or an entity controlled by the donor) through the charity and back – if not to the donor – to a party related to or controlled by the donor. Clearly, a violation of the partial interest rule. Simplistic subterfuge:

So again we put the donor back on the stand and the IRS attorney asks,

You never expected the charity to take the entire $100,000 each year and purchase crutches or wheelchairs, did you? You had an understanding with the charity – a pre-arrangement – that the charity would use the money – all or almost all – each year – to help your children’s trust pay for the life insurance?

In essence the charity’s role in this plan was to serve as your conduit – your funnel – your agent – to move the bulk of the money you give it each year to your children – and not to the crippled children it is chartered to serve. Is that correct?

There is clearly a pattern of timing, conduct, and expectations by all of the parties to CRSD that effectively assure the donor and his or her family of substantial economic benefits – and none of these benefits would be possible if the charity had – in reality – been given a total and complete – rather than a partial interest.

Nor will the argument that the charity has no legal obligation to pay premiums win the day. The law doesn’t require a legal contract to apply either the quid pro quo or the partial interest rule. If there’s a reasonable expectation of a quid pro quo, the law does not require that the charity be legally obligated to pay the economic benefit. It’s enough that the parties expect that result.

Partial interest rule – Strike three!

Now let’s look at the terms, private inurement and private benefit.

Both of these Code provisions are highly technical. But both echo the same purpose as the partial interest rule: When you make a gift to charity, that money belongs to the charity. It is to be used by the charity – EXCLUSIVELY – for charitable purposes. There should be no diverting of the charity’s dollars to any person or entity that’s not a legitimate recipient of the charity’s tax-exempt objectives.

That’s why Section 501(c)(3) of the code states that to remain qualified, no part of the charity’s earnings – broadly defined – can go to a private shareholder or individual. That’s the private inurement rule. The same code section further prohibits charitable money passing to private interests. The private benefit rule encompasses transfers of benefits from charities to almost anyone – other than the appropriate objects of the charity’s bounty.

Let’s go back on the stand:

When the charity entered into this CRSD – it essentially agreed to pay the highly inflated P.S. 58 rate – rather than the actual cost of insurance. And it may also agree to levelize its payments for the term insurance it’s getting – meaning that it pays – up front – in the early policy years – even more – than the admittedly inflated P.S. 58 rates. And your family’s trust will not pay the charity interest on the use of its money or reimburse the charity for any overpayments.

So in all these ways, the charity was helping you meet your personal insurance needs with death benefits and increasing cash values in your children’s trust’s policy, wasn’t it?

Certainly, this is a private benefit. And providing a private benefit violates the intent of the rule requiring exclusive use of a charity’s money and resources for charitable purposes. This violation is exactly what the code was intended to prohibit.

By the way, one of the claims made by promoters was that this arrangement would provide substantial benefits for the charity. But if – for any reason – the CRSD plan ends before the insured dies – just what does the charity get?

Can it be argued that – even if there is some benefit to the donor or his family – it’s incidental? Yes, you could argue that – but it appears the promotional literature promises just the opposite – big deductions for the client and big cash values plus a substantial death benefit for the client’s family. Compare those two with what the charity gets.

Private Benefit – Strike Four!

Now let’s turn to the Uniform Management of Institutional Funds Act. Again, back on the stand – only this time the president of the charity is now in front of the court:

Mr. President, USA today – – reported on Friday – June 5th that the Dow Jones Industrial Average was up 13% from 6 months ago. Why didn’t you invest the $100,000 a year you received from Mr. Donor in the market?

Wouldn’t it have made more sense for you to have used the entire check you received from Mr. Donor over each of the last three years – as a premium on a policy your charity owns and is the beneficiary of – than to enter into this split dollar plan where your charity only gets a small fraction of what the donor’s contribution could have purchased?

Why didn’t you use the entire check you received this year to buy term insurance on the donor’s life?

Mr. President: How do you justify the use of your charity’s money to enrich a private individual and/or his family? What defense do you have against a charge that you knowingly overpaid – significantly – for insurance – no less a crime than if you deliberately overpaid a truck dealer for a truck the charity bought?

Mismanagement of the charity’s funds – Strike five!

Let’s talk about the COMPLICITY ISSUE:

Mr. President: did you send Mr. Donor a letter each year for the last three years stating that he received nothing of economic value in return for his $100,000 checks? But you were aware that Mr. Donor’s family trust would be getting thousands of dollars of cash values and death benefits – because of your charity’s participation in the plan?

The President of the charity is either guilty of gross investment negligence – or of complicity to fraud. I’m talking about the patently untrue statement he signed under penalty of purgery that the charity provides the donor nothing of economic value in return for his or her contribution. Where are all these great benefits coming from – if not from the charity?

Complicity to fraud. Strike six!

Finally, compliance exposure:

I can see the lawsuits now by clients claiming they were never fully informed about the tax exposure. Some of them may sue the charity – as well as you.

No gift, quid pro quo, partial interest rule, private benefit, mismanagment of charitable funds, signing official documents the parties know contain incomplete and untruthful information.

If you still think charitable reverse split dollar works – call me. I’ll defend you – down to your last dollar.

Steve Leimberg

Leimberg Associates, Inc.

610 527 4712

E-mail: Leimberg


How will the IRS catch me? I’ve got a cancelled check for – say $100,000 – that shows the date the charity cashed it. How will they ever find out?

Every tax attorney I know has heard this question a thousand times.

The answer here is simple. The IRS finds the promoters – the marketers. And I don’t think that finding the promoters will be hard.

The IRS then requires them to submit a list of the names of all the people who have set up a CRSD plan. Bingo. You’re it.

What will it cost if they catch me? Well, for openers, aside from the tax and interest, there’s a 20% accuracy-related penalty.

Guess who has the burden of proving that the underpayment of tax was not negligent? Then there are possible civil fraud penalties – 75% of the tax.

What about the opinion letters?

They are worthless – unless there’s substantial reliable authority for the position. And there isn’t.

Certainly, you can’t use the existing private rulings on reverse split dollar. Even if you could, the taxation of reverse split dollar itself is without substantial reliable authority.

And you certainly can’t claim reliance on marketing promises as a defense.

Here’s the bottom line:

We don’t need to place our clients, our community’s charities, and ourselves in harms-way. We don’t need to use an idea so risky and so uncertain that a legal defense fund is required to promote it.

Read the book, Tax Planning With Life Insurance or read the Tools and Techniques of Life Insurance Planning and you’ll find dozens of alternative ways life insurance can be used creatively – to legitimately – and without risk – accomplish charitable as well as personal goals.

As an author and lecturer, it’s my job to encourage creativity and stimulate fresh thinking. But it’s also my responsibility to let you know when I think you – my reader or listener – can get into trouble – even if – as in the case of equity split dollar – you may not really want to hear it.

If this thing winds up on the front page of the Wall Street Journal, it will hurt all the agents in the U.S. who are selling any form of split dollar arrangements – since the press and the public really can’t or will not distinguish between one form of split dollar and the other. The result could very well be the impetus for adverse rulings, regulations, or even legislation that would harm both legitimate split dollar sales and the legitimate uses of life insurance in charitable planning.

The Maybe It’s Me article tells it like it is – in lay terms. I urge you to read it – and share it – with those contemplating a charitable reverse split dollar arrangement and their counsel.

I also urge you to read the scholarly and incisive article by Doug Freeman, who I consider one of the leading experts in Charitable Planning in the U.S. I also suggest you read the excellent May and June two-part Financial Planing Magazine commentary by John Scroggin and Kara Fleming that are also cited in my article. The later two attorneys state, “Effectively, the program is a sham and will collapse of its own weight in a thorough audit.”

Determining the edge of the split dollar envelope is much like the study of geometry. They both start with theorems of pristine simplicity and gradually progress into the dark caverns of complexity.

The trick in analyzing any complex tax transaction, however, is to reduce it to its basic components and then attempt to reconcile the results with fundamental principles.

If dollars seem to move in circles or if benefits appear to shift without tax consequence, one had better illuminate the transaction with traditional tax tenets and common sense because, if for no better reason, this is the crucible that the Service and the courts will apply.”

In an article in the Spring, 1996 Benefits Law Journal article entitled, The Evolving Edge of the Split Dollar Envelope, the authors said:

“G. Quintiere & G. Needles, The Evolving Edge of the Split-Dollar Envelope, Benefits Law Journal, Vol. 9, No. 1, Spring 1996.

In the movie, the Devil’s Own, Brad Pitt plays an Irish terrorist against the good guy cop played by Harrison Ford.

Pitt sets the stage for the ending when he explains to Ford the difference between an American fairy tale and an Irish fairy tale. In an American fairy tale, the ending is always “happily ever after”. CRSD is not an American fairy tale – and it will end badly.

Let your brain – and your conscience – be your guide.

For another look at the same topic, see: Maybe It’s Me

IRS Information, Regulations and Commentary on Charitable Legal Issues

MAYBE IT’S (NOT JUST) ME – % Vaughn Henry & Associates

MAYBE IT’S (NOT JUST) ME – % Vaughn Henry & Associates

I’m not alone – at least about the dangers of CRSD (Charitable Reverse Split Dollar) and its progeny, what some people are calling charitable split dollar. Here are some recent comments:

Eric Dryburgh: In the highly respected Charitable Gift Planing News, August 1998, Pg. 5 ( 972-386- 8975) the author states,

“There are many variations on the theme, involving insurance trusts, partnerships, and other legal entities. Nevertheless, the basic legal concepts and legal risks are the same.”

“The charity must issue a receipt which accurately reflects what it receives. If the funds are not used to pay the policy premium, the receipt can appropriately reflect an unrestricted gift of cash. If the charity pays the policy premium, however, the receipt should reflect a nondeductible gift.”

NCPG: The Executive Committee of the National Committee on Planned Giving (NCPG) has reviewed a number of these plans and has concluded,

“Life Insurance “Quid Pro Quo” Poses Risks to Donors, Charities” and stated, “Notwithstanding the promoters’ claims to the contrary, NCPG strongly suggests that donors and charities not proceed with the kind of gift arrangement described above without first obtaining a private letter ruling from the IRS on the “quid pro quo” and partial interest issues

Its position paper states “CRSD is a high-risk venture that may expose donors to adverse income tax and transfer tax consequences and may endanger the tax-exempt status of charities that participate.” “Failure to note on receipts a charity’s intention to participate in the CRSD plan could violate both federal tax law and the Model Standards of Practice for the Charitable Gift Planner, adopted by NCPG May 7, 1991. Furthermore, participation by the charity in a CRSD program could put the charity at risk of loss of tax exempt status under the private inurement rules, which the IRS has interpreted broadly, in other contexts, to include contributors to organizations.”

Horowitz Scope Goldis: In “The Myths of Charitable Split Dollar and Charitable Pension”, Journal of the American Society of CLU & ChFC, September 1995, Pg. 98 the authors state on the subject of CRSD:

This is not merely aggressive tax planning, it is egregious and borders on tax fraud…”

Douglas Freeman: Planners should also carefully read the objective, balanced, and scholarly “CHARITABLE REVERSE SPLIT-DOLLAR: BONANZA OR BOOBY TRAP?” by well known and highly respected Los Angeles attorney Douglas K. Freeman in the Journal of Gift Planing, 2nd quarter, 1998 (317 -269 – 6274). Freeman states in a recent ALI-ABA Course of Study on Charitable Giving Techniques given May 7th and 8th in San Francisco,

The reverse split-dollar technique is aggressive planning without substantial reliable authority”, “charitable reverse split-dollar is an attempt to stretch an aggressive program further”. “Charities should never use their influence and reputation to promote a risky program that could influence donors to engage in an arrangement that could result in adverse economic or tax consequences to such donors.”

Scrogin and Flemming: Attorneys John J. Scrogin and Kara Flemming of Roswell, Georgia wrote two excellent and well reasoned discussion articles in the May 1998, Pg. 2 and June issues of Financial Planning Magazine entitled, “A Gift With Strings Attached?” and “One Gift, Many Unhappy Returns” in which the authors state that charitable reverse split dollar plans may suffer the same fate that befell tax shelters in the 1980’s and that donors, charities, tax preparers, and plan promoters are all vulnerable if the IRS cracks down on charitable reverse split dollar plans.

Frank Minton: Frank Minton, the Ethics Chairman of the National Committee on Planed Giving, has stated that,

“Overcharging charities for premiums by using actuarial tables that exaggerate the true cost of life insurance benefit the donor by reducing the amount the donors must pay.”

Michael Huft:In the November 1998 issue of Trusts & Estates, Michael Huft states,

“The problems faced by the charity are potentially more serious than those faced by the donor, for in addition to the possibility that the charity will fail to realize the expected benefits of CRSD, the charity may lose its tax exempt status and its trustees or directors may face liability for breach of fiduciary duty.”

Billitteri and Stehle: In “Brilliant Deduction?”, The Chronicle of Philanthropy, August 13, 1998 the authors quote Marc Owens, director of the I.R.S. Exempt Organizations Division:

“The service is examining whether donors improperly violate federal tax laws by participating in these deals, which currently are being offered by a small number of estate planning companies and their representatives….Charities are supposed to be doing charitable things, not acting as a clearing house for one’s life insurance premiums.”

The service is “actively looking at charitable split-dollar plans in pending cases that include both audits of existing charities and applications by new groups seeking tax-exempt status.”

The article quotes Attorney Douglas K. Freeman as saying

“This thing has some fatal flaws, and the worst part of this is, it puts the charitable institutions at risk.”

Conrad Teitell: Teitell noted in the Oct. -98 edition of his TaxWise Giving that charities and their representatives that give inaccurate information to donors about a gift’s fair market value or incorrectly tell donors that a quid pro quo gift is fully deductible are subject to the abusive tax shelter penalties of IRC Sec. 6700 and 6701. This is the civil penalty imposed on promoters, salespeople, and their assistants who organize or sell a “plan or arrangement” constituting an “abusive” tax shelter.

Abusive is defined as a statement concerning a tax benefit that the person knew – or had reason to know – were false and “gross” valuation overstatements of the property’s value. Both the false or fraudulent statement and the gross valuation overstatement must relate to a material matter. Teitell points out that “a person furnishing a gross valuation overstatement need not have knowledge of the overvaluation to be penalized.” He notes that “an aiding and abetting provision imposes a penalty on persons (such as the president or treasurer of a charity) who help prepare false or fraudulent tax documents that could result in a tax underpayment provided the person knew or had “reason to believe” that the document is material to the tax law. Under the reason-to-believe standard, a person has knowledge if he or she deliberately remains ignorant of what otherwise would have been obvious.” No plan or arrangement is required.” See Exempt Organizations Continuing Professional Education (CPE) Technical Instruction Program for FY 1999. Teitell notes that “It may be a kinder and gentler IRS, but it wasn’t born yesterday.” Will these rules apply to those who make the five key claims listed below? (Is it worth making your client famous to find out?).

The Bottom Line(s) Up Front:

Promoters make five key claims for Charitable Reverse Split Dollar arrangements and their progeny:

(1)Funding of life insurance will be – in essence – income tax deductible.

(2)No party will be subject to income or gift tax liability (and it may also be possible to beat the estate tax).

(3)The donor will be able to use tax deductible dollars to provide for his or her own retirement income.

(4)From the charity’s perspective, this is a “no cost”, “nothing to lose”, “sure thing” with substantial benefits, and

(5)This is a very, very good financial opportunity for the agent who is able to convince the client-donor and the charity to implement the plan and split the insurance.

Let me make my viewpoint very clear on any plan that makes all these promises – no matter what it’s called:

First, in my opinion, in every one of these CRSD or CSD plans I’ve examined, either all – or a significant portion of the check the donor-insured – or his or her corporation – writes – will not be deductible. Deductions already taken in open tax years are likely to be disallowed.

Second, the donor will incur significant income or gift tax liability – or both. There may, therefore, be an understatement of gift as well as income tax with accompanying additional tax, interest, and if the understatement is large enough and substantial authority for the taxpayer’s position can’t be shown, penalty provisions may apply. The person who prepares and signs the donor’s tax return may also likely face legal as well as ethical challenges.

Third, this is not a good deal for the charity. In fact, it may potentially be a New Era level public relations, economic, and legal disaster. If there has been overpayment of premiums and a loss of interest on the “unearned premium account,” the arrangement may be deemed an imprudent course of action by the board of directors and officers of the charity, probably a violation of the charity’s corporate charter, and a risk of its tax exempt status. It is even possible that the charity may be sued by the donor on the grounds that he or she relied on the charity’s counsel checking out the viability of the plan.

Fourth, although the agent who sells this concept may realize a very short term gain, in the long-run, my prediction is that selling this concept will prove very expensive to both the wallet and the reputation of that agent.

Fifth, I realize that attorneys I personally like and respect from prestigeous law firms (e.g. Michael Goldstein of Husch & Eppenberger) have issued favorable opinion letters or spoken on behalf of these arrangements and have voiced their view that these plans are “a planning technique suitable for consideration by informed taxpayers who are not risk adverse.” If they and their law firms are comfortable with these arrangements, fine. As long as the client and the charity are both FULLY appraised of the risks and the discussion is protected by the attorney-client privilege, there is no limit to what tools or techniques may be considered. I’m saying both that the CRSD and CSD plans I’ve examined will not work as commonly described – and potential IRS and/or Congressional over-reaction may result in harming – not only the players – but others (and other planning tools and techniques) as well.

I am conservative – as charged by at least one promoter. As an author and advisor, the last thing I want to do is to make my client – or yours – famous. And it’s also true that I still believe the IRS will not back down on its position in TAM 9604001. I said it when the TAM was first issued in my Miami (Heckerling) Tax Institute address cited below – and I still believe the IRS will win if the underlying principles are tested in the courts. It’s 1999, three years have passed, and there has been no sign the IRS has seen the error of its ways – or will. If anything, the IRS might push Congress to eliminate all its aggrevation over the issue by mandating interest-free loan treatment.

Let me explain why I feel that donors, charities, tax preparers, insurance agents, as well as plan promoters will all loose from the marketing of charitable reverse split dollar and the “I’m different” schemes that essentially make the same promises to the donor:

In examining CRSD and its progeny – just as in any tax transaction – the IRS andthe courts will look beyond the formal written documents – to the substance – the totality and reality – of the transaction as a whole. The IRS and the courts can ignore your words if they don’t comport to your actions and clear intent. Transactions will be characterized for tax purposes according to their overall economic substance rather than the terms used to describe them.

Seemingly unrelated pieces of a puzzle can be re-assembled by the IRS and the courts when it’s clear that the parties intended from the start that each piece was intended to be part of a whole and no part of the puzzle works without the other parts. In my opinion, both the “substance-over-form” doctrine and the “step transaction” doctrine – will be applied here – vigorously!

Charitable Reverse Split Dollar (and the “progeny” I’ve examined to this point) – let’s be honest – is an integrated inter-dependent series of steps attempting to obtain a very good result for the donor and his family with relatively little of the client’s annual “charitable donation” ending up in the hands of the charity.

Advisors should ask themselves how a promoter – with a straight face – can – both verbally and in writing – tout any arrangement that provides “tax sheltered accumulation, creditor protection for family wealth, an option for tax free retirement income, substantial death benefits for the client’s family, the potential for estate tax free life insurance proceeds at no gift or GSTT cost, and plan values that can be owned individually, or by an irrevocable or revocable trust (or an FLP or LLC) and help those who want to make deductible deposits in excess of qualified plan contribution limits – and at the same time say to the IRS (and then possibly under oath in court) that the neither the client nor the client’s family received anything (directly or indirectly) of value

At best, promoters can honestly claim only that the charity has a present expectation of future reward and has not received “an empty bag.”

And (even if true) those claims merely beg the question since the charity was supposed to have ALL of the money the client claimed as a deduction, not merely the dregs of a tattered rag.That the charity may not seriously overpay or that it may eventually really will get some thing out of the deal of some value is irrelevant

The ultimate test – no matter what the plan is called – is simple: One must merely ascertain the answer to these questions:

  • Is this really a case of detached disinterested generosity – or is it a deal the insured is making with the charity? Do the parties intend that the donor (or the donor’s family or family trust) will receive – directly or indirectly – anything of meaningful economic value from the charity in return for the check the donor wrote? If so, the plan is an invitation to litigation. At best, the deduction must be reduced by the value received.
  • Is life insurance really needed by the charity, can this need be documented, and if so, is the insurance under the arrangement appropriate in amount and type? If not,the charity faces fame but not fortune. Remember Leimberg’s Third Law of Tax Planning: “The Last Thing You Want to Do Is Make Your Client Famous.
  • Was the transaction as a totality good for charity? Did the charity pay more than a reasonable amount for what it received? If yes, the president and board of the charity will soon become familiar – on a first name basis – with the state’s Attorney General who is charged with making sure charitable dollars are charitably used (and not abused, misused, or diverted to private noncharitable hands).
  • What benefits would the donor – insured’s trust have received had the charity not participated? In other words, is there even a small amount in the donor-insured’s trust attributable to the charity’s money? Any wealth in the donor-insured’s trust at any time or manner generated by dollars that were claimed to be the charity’s money is too much.

A rose’s thorn by any other name is still a rose’s thorn. You can’t expect to disguise a pig as a peacock and expect to beat the butcher!

REFERENCES: (Vaughn Henry’s CRT Information Web Site (Vaughn Henry’s CRT Information Web Site (NCPG, “Position Paper) (ABA searchable discussion archive)

Tax Planning With Life Insurance: 2nd Edition (800 -950-1210) Associates, Inc. Web Site)

Split Dollar Life Insurance: Rip, Split, or Tear? 31st Annual Philip E. Heckerling (Miami) Institute on Estate Planning, Chapter 11.

Audio Tape Discussion between Michael Goldstein and Stephan R. Leimberg, Manulife Financial (Available from any Manulife Agent or by calling Advanced Markets at 617 854 4323.)