Cutting Your Tax Bill

Cutting Your Tax Bill

Cutting Your Tax Bill?

A New Approach to Old Tools

Vaughn W. Henry


Looking for ways to:

  • provide more retirement income
  • generate tax deductions
  • minimize unnecessary estate taxes

Charitable Gift Annuities have been offered by nonprofit organizations for nearly 150 years and are considered safe, stable and about as “plain vanilla” a planned giving program as one could imagine. After the recent uproar and changes in tax laws, a number of planners have begun to take a new look at an old tool to accomplish a wide variety of estate and financial planning needs. Unlike the more heavily promoted Charitable Remainder Trust (CRT found in IRC §664), the gift annuity is capable of accepting assets that might “poison” a typical remainder trust. For example, client/donors with Sub-S stock or debt financed real estate may find a receptive place to park those problem assets inside their Gift Annuity. When the charity wants to sell the contributed asset, there’s no prohibition against family members of the donor purchasing the asset back. Normally, self-dealing restrictions prevent many owners from contributing family business assets, so the CGA is a viable option and with proper planning, there are powerful reasons to use this little known tool.

Not only does the CGA avoid the new CRT requirement of a 10% charitable remainder (§1089 in TRA ’97), it isn’t limited to 5% minimum payouts either. The gift annuity may also be used to provide income to retirees who want to remain in their farm residence and receive a retirement income stream before passing the real property to their favorite charity. Besides generating tax deductions much like the CRT, a well-designed and custom drafted gift annuity can be created to accomplish the following:

  • provide either immediate or deferred income to the donor/beneficiary and still allow the charity access to funds to meet its current charitable missions
  • improve risk management by smaller charities when using a commercial insurance product to provide adequate protection for the donor
  • if income is deferred, it may be delayed or accelerated, according to beneficiary needs
  • inflation protection may be incorporated to accommodate cost of living adjustments
  • capital gains recognition on donated appreciated assets may be spread over life expectancy
  • some income may be passed back to the beneficiary as a tax-free return of principal
  • an easily understood transaction benefiting the donor and the nonprofit organization

An example of how this might work for John and Gail O’Hara, aged 68 and 65, who decide to contribute $300,000 of appreciated stock ($130,000 cost basis) to a local charity. In return, the charity agrees to pay them a steady annuity income over both of their life expectancies. The transfer also generates the O’Haras a tax deduction of $94,445. This frees up cash that may be used in part to offset the wealth they’re giving away through a wealth replacement trust. In this way, their kids won’t be disinherited by the gift. John and Gail will receive a fixed income stream of $20,400 every year that will be taxed under three tiers. $5,416.67 is tax-exempt, $7,083.33 is taxed at lower capital gains rates and only $7,900 is taxed as ordinary income. Based on IRS averages, they will receive these funds over the 24 years of their life expectancy and this meets their living expenses comfortably without tapping into their other assets. If medical emergencies or long term care issues pop up later on, retirement income can be adjusted with income from their other assets. Should John or Gail outlive the statistical averages, they will still receive their annual annuity, but by then payments would be recognized as ordinary income, since the capital gains and tax-free portions would have been used by then. Their tax deduction, if not used in the first year to offset their other income tax liabilities, may be carried forward and used over an additional five years. Coupled with the increased income security from the gift annuity and the cash saved from their charitable deduction, the O’Hara family can easily offset the gift by funding a wealth replacement trust to pass more assets to their children and grandchildren free of both income and estate taxes.