Maybe it’s Me – More on Charitable Split Dollar Plans – brought to you by Vaughn W. Henry & Associates

Maybe it’s Me – More on Charitable Split Dollar Plans – brought to you by Vaughn W. Henry & Associates

Maybe it’s Me

by Stephan R. Leimberg, Esq.

My father always said (when he was sure he was right and the other person was wrong), “Maybe it’s me. Maybe I just don’t get it”.

Well, maybe it’s me.

But when people ask my opinion of Charitable Reverse Split Dollar, I have a hard time understanding why it’s so difficult for them to see what I see.

So let’s forget all the Code sections and legal jargon. Forget the technical terms like “quid pro quo”, “partial interest rule”, “step transaction” doctrine”, “private inurement”, and “private benefit”. Let’s forget – for a moment – the Uniform Management of Institutional Funds Act.

Let’s just take an honest – and common sense – look at what is really happening:

Picture in your mind that you are the president of a charity. The Attorney General of your state and the head of the local IRS office pay you a visit. During that brief chat, you happen to mention that last year, your charity was given a check for $100,000 by donor X.

Your two visitors ask: “Did you send donor X a letter thanking her for that gift?”.

You reply: “Yes, of course I did”.

They then ask: “In your letter, did you state that she received nothing from your charity in return for that gift”?

You reply: “Yes, I stated that the donor, X, received nothing of value in return for her $100,000 check.”

They ask: “No quid pro quo whatsoever?”

You answer: “Nothing! I stated in the letter that she got nothing in return for her charitable contribution.”

A few minutes later your visitors ask: “How did your charity use the $100,000 outright gift of cash? Was the money used to buy new wheelchairs? Did you purchase exercise equipment for the children? Did you buy new orthopedic braces? Just how was the $100,000 used?”

You reply: “We are putting the money toward an insurance policy on the life of the donor of the $100,000 gift”.

Your visitors ask: “What portion of the $100,000 a year are you putting toward that policy?”

You reply: “Pretty much all of it.”

Your visitors remark: “Must be a very large policy,” “Was donor X a frequent contributor to your charity in prior years?”

You reply: “No. This was her first gift. But she plans to make a gift of about the same amount year after year for a number of future years.

Your visitors ask: “Are you under a legal obligation to use each year’s $100,000 gift to make the annual premium payments?”

You (honestly) reply: “No. Our charity is under no legal obligation to turn around and use that money each year to pay premiums. We could use the money to purchase wheelchairs.”

Your visitors ask: “But you’re not buying wheelchairs or exercise equipment or braces?”

You reply: “Well, no. We’re putting the money into this insurance policy”.

Your visitors ask: “Can we see the schedule of the build-up of cash values from the policy which your charity owns on X’s life?”

You reply: “Oh, We don’t own the cash values. We only have the right to some of the death benefit – if the insured dies while the policy is still in force”.

Your visitors ask: “So who owns the policy’s cash values?”

You reply: “Our understanding is that the cash values are owned by a trust on behalf of the children and grandchildren of the donor – insured. We’re just splitting the death benefit with that trust- but the trust actually purchased the policy. It owns the contract and it gets all the cash values.

Your visitors then ask: “So you are really just purchasing term insurance with the money you are paying toward the premiums?”

You reply: “Yes. We are essentially getting the equivalent of one year term insurance coverage every year. But if Ms. X dies, we’d get a lot of money”

Your visitors ask: “Are you are paying more, less, or the same as a competitive one year term policy you could have purchased on your own?”

You reply: “We never really checked.”

But when you do check – you find you could have purchased the term coverage on X’s life for significantly less than the money – the portion of the $100,000 a year your charity is actually paying toward the premium.

Your visitors ask: “What’s happening with the difference between what you could and should be paying for term insurance (assuming your charity had an insurable interest and the outlay was an appropriate expenditure of the charity’s money)? In other words, how large will the cash values – owned by the trust your client created for her children and grandchildren – grow to in Y years?

You reply: “It’s not really our business. The cash values don’t belong to our charity. But in Y years, the cash values will grow to about $6,000,000.”

Your visitors (particularly the state’s Attorney General) ask: “You said that your charity was receiving a check from Ms. X for $100,000 a year – no strings attached. Assuming a justifiable reason for insuring Ms. X’s life and assuming reasonable premiums for the type of one year term insurance your charity is receiving, what happened to the rest of your charity’s money? Why is the cash value growing in the hands of your contributor’s trust – for her children – rather than being invested or used for the crippled children and adults your charity is supposed to be caring for?

Come up with a good answer to any of these questions? I couldn’t.

Now picture yourself as the donor. Every year you file your tax return and claim a contribution to charity of $100,000. The charity has sent you a letter saying that you received no “quid pro quo” – you got (directly or indirectly) nothing in return for your contribution.

What do you say when the IRS auditor asks you: “Is that true? You received nothing back from the charity – directly or indirectly – in return for your $100,000 check?”

You say: “Oh, no” “Look, nothing up this sleeve. Nothing up that sleeve. I got nothing back from the charity in return for my $100,000 a year contribution.” “It even says in the promotional literature I consulted that “cash contributions are unconditional.”

What do you say when the IRS auditor asks you: “You know, don’t you, that the Code would not allow you any income tax deduction – if you personally purchased a policy on your life and split the premium dollars with the charity? And you know it’s a sin to tell a lie – that you gave a no-strings attached gift of $100,000 – and received nothing back in return – if in fact you got back something of great value?

You’d say, “Of course I do. I know no deduction is allowed for a contribution to charity of less than my entire interest.

What do you say when the IRS auditor asks: “Isn’t the charity’s split dollaring with the trust – and the circular path of the money from you to the charity – back through the split dollar policy to the trust you created – in reality a back door way for you to funnel money to your family’s trust? And doesn’t that constitute a gift of (a lot) less than a full interest in the $100,000?

Haven’t you – indirectly – retained a means of reacquiring (and then making a gift to your family of) a significant portion of every $100,000 check you write? Haven’t you really subverted the charity’s interest in the money or the policy which it could have purchased and totally owned with that $100,000?

What do you say when that same IRS auditor asks: “Why and how did the trust you set up for your children and grandchildren – get richer every year – even though you claim for gift tax purposes that you made little or no contributions to that irrevocable trust?” “Can we see your gift tax returns?”

Please correct me if I’m wrong. But it appears to me that the president of the charity has engaged in a tacit conspiracy with the “donor” to defraud the IRS (no, make that every U.S. citizen) as well as the charity. He’s told the IRS (and implicitly the Attorney General of the State in which the charity is located) that it’s received a no-strings (or stings) attached donation in the net amount of $100,000. Yet, clearly, there’s a string and a sting. If there were none, there would be a lot more wheelchairs and exercise equipment – and less wealth in the hands of the insured’s children’s trust.

And it’s pretty clear to me that each year, Donor X is lying on her tax return – claiming a deduction for far more than the net value of what she’s really contributing to the charity. Money is merely circulating from the client to the charity to the client’s children’s trust via the guise of the charity split dollaring a life insurance policy.

And maybe it’s me – but shouldn’t Ms. X be filing gift (and perhaps generation-skipping) tax returns – for the real (albeit indirect) gifts she’s making to the irrevocable trust she set up for her children and grandchildren? After all, the money didn’t appear in the trust from thin air. And certainly it would be an act beyond – and in violation of – the charity’s charter to use money that should have used to purchase wheelchairs – to enrich Ms. X’s children and grandchildren. So if it wasn’t the charity’s money, how did the $6,000,000 get there?

The charity’s contribution toward the policy is not an amount equal to the insurer’s one year term costs. According to the promoter’s sales literature, the charity’s contribution will normally be P.S. 58 term rates – which we all know is substantially higher (maybe five or six times) than the real cost of the coverage the charity is getting. And who gets the benefit of that annual overcharge the charity is paying? And if the charity lays out a “prepayment”, will it be paid a reasonable rate of return for the use of its money – or does that too magically find its way to the donor’s children’s trust?

We’re not talking about aggressive planning here, gang.

In my opinion , it’s likely the IRS would view this as nothing less than (“Read my lips”) T A X F R A U D. This is exactly the type of tactic that brought about the stiff charitable rules in THE TAX REFORM ACT OF 1969: Congress was fed up with charitable contribution deductions that didn’t truly reflect the value of the ultimate benefit flowing to charity.

Tell me if I’m wrong:

The donor and the charity know from the get-go that next year’s donation from Ms. X will never occur – if the charity didn’t “split” the death benefit dollars (and shift all of the policy’s cash values and the earnings the charity should have enjoyed on any “unearned premium account” to the irrevocable trust the insured donor set up for her children and grandchildren).

Ms. X, the donor, never intended that the charity could keep – and use for its charitable purposes – anywhere near the entire amount she claimed as a “no-strings-attached “I get nothing from it” $100,000 donation.

Ms. X, the donor, knew from the promotional literature that the whole scheme was a ploy to get a largely undeserved income tax deduction and shift significant wealth to her children and grandchildren’s trust at what was touted to be no gift or generation-skipping tax cost.

And if that’s what the donor and president of the charity are, what’s that make the promoters of this shell game?

Yes, I know there are infinite variations on this theme and each promises that its version is “different from all the others” and “our plan rests on solid legal ground”. I also know that some of these promoters are very sharp characters who throw so much paper and so many code sections at you – and tell you how much you can make doing it – and how much others are already making – that you want to believe it will work. (Especially if you’ve paid them a lot of money for the idea).

But take a really honest look at the quality of the cloth garbing the emperor:. The bottom line of every one of these schemes I’ve seen (and I admit even I haven’t seen it all) is the old “something for nothing” trick.

“Everyone – the agent – the charity – the insured – the children – you all get a free lunch – and the IRS will buy and pay for it”.

Well guys and gals – it ain’t gonna work. The IRS ain’t gonna buy it. And it ain’t worth your home.

Worse yet, when this scheme hits the Wall Street Journal, every split-dollar arrangement – even the very conservative and legitimate arrangements by very honest and ethical agents and attorneys – will become suspect.

Or maybe it’s me? Clearly, the concept is no secret. So why are its promoters so reticent to obtain a private ruling with respect to each of the issues I have raised? Clearly, a PLR is the least assurance competent counsel would insist upon. (And I’ll be happy to eat crow – medium rare – if a donor can obtain such a ruling).

P.S. If you are promoting this time bomb, when the IRS and the Attorney General of your state starts asking you these questions, call one of the attorneys who has issued a “favorable opinion letter” on this. I’m sure he’ll be willing to defend you – right down to your very last dollar!

P. S. P. S. 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.

Neither I nor they are alone in our position: See S. Horowitz, A. Scope, and S. Goldis, “The Myths of Charitable Split Dollar and Charitable Pension”, Journal of the American Society of CLU & ChFC, September 1995, Pg. 98 where the authors state: “This is not merely aggressive tax planning, it is egregious and borders on tax fraud…” Planners should carefully read two excellent and well reasoned discussions on the subject. The first is 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 further 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”, and 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”. Attorneys John J. Scrogin and Kara Flemming of Roswell, Georgia recently published 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.