Planned charitable giving officers, attorneys, and other professionals who advise individuals who make significant charitable gifts often encounter obstacles related to charitable planning around giving.
“Significant gifts” are large gifts and often include trusts, such as charitable remainder trusts (CRTs), and naming rights, such as the donor's right to place their name on some physical structure.
It is well known that federal tax law provides “carrots” to individuals who make such gifts, such as the ability to claim a charitable federal income tax deduction. Less well known is that federal tax law imposes “sticks,” such as denying a charitable deduction, to donors who don't comply with a very complex set of rules.
Using a few examples, I will focus on sticks.
Pledge risks
Let us consider Husband (H) and Wife (W), a wealthy couple living in a large American city. Their lead lawyer is a senior partner in a white-shoe law firm in their hometown, and they have set up a private foundation (PF). This statement of facts may seem innocuous, but it is fraught with tax risk for H and W who want to donate a 7 or 8 figure sum to a great charity in their hometown.
This pair will deal with one or more individuals who are very vested in the particular charity – for example, the charity's high-profile president or board chairman, who probably calls H and W by their first names. and belongs to the same clubs. On the surface, there's nothing wrong with this photo. But I see a few quibbles, considering that: (1) a gift of the kind in question is likely to be one in which H and W get their names on something in charity (a naming gift); (2) the gift is likely to be made by the PF of H and W; and (3) the gift is likely to be made pursuant to a written commitment that H and W make to the charity.
The catch in this situation is that paying the mortgage can be an act of self-treatment. A pledge is either enforceable (as a contract) or unenforceable. Enforceability is determined under the law of the state governing the lien. At least three states, Iowa, New Jersey, and Pennsylvania, require neither consideration nor injurious reliance for a pledge to be enforceable.1 A pledge or a large amount must always be in writing and the writing must contain a legal provision. The promise made by H and W will be enforceable under the law of contract (promise to deliver supported by consideration of designation). This means that any payment of the pledge by the PF of H and W would be a prohibited act of self-dealing. It's a big, bad stick, for sure.2
Let's look at another situation involving promises that can result in a stick. In Revenue Ruling 81-110, Party A made a legally binding (enforceable) commitment. Party B has paid the pledge. The Internal Revenue Service determined that Party B's payment was a transfer to Party A and that Party A was deemed to be paying the lien (and could take the corresponding charitable deduction).
To avoid (most) pledge problems, a charity must: (1) determine in advance the source or sources of payment for the pledge; and (2) ensure that the development office verifies all pledges prior to signing the pledge agreement. In one case involving an 8-figure pledge, I learned that this was not done and a bad outcome ensued for both the charity and the wealthy donor couple.
Qualified valuation rules
Assume that the donor is a fairly wealthy individual who wishes to use $250,000 worth of highly appreciated marketable stock to create a CRT for the eventual benefit of Charity A, which will serve as the CRT's trustee.
Until January 1, 2019, when the new qualified valuation rules came into effect, tax advisors generally believed that no qualified valuation was needed for the KRRT the donor intended to create. Changes in Treasury regulations changed everything. The new rules provide that if a fractional interest (such as a residual interest in a KRRT) is given to a charity, the fractional interest (not the asset used here to fund the KRRT) is subject to the qualified valuation rules.3 The only exception is that such an assessment is not required for a cash-funded CRT.4 Appreciated assets, however, not cash, are typically used to create a CRT described here.5
Gift Gift
Tax law requires a concurrent written acknowledgment (CWA) of a charitable gift for the donor to be entitled to a charitable deduction.
Charitable gift officers are generally aware of the tax law requirement that for a donation of $250 or more, the donor must be able to substantiate the gift with a CWA that states: (1) if the charity has provided any goods or services to the donor in consideration of the gift, and (2) if made, the monetary value of those goods or services.
In fact, gift officers are so aware of this requirement that they occasionally misuse it. Misapplication occurs when the charity issues a standard CWA with no goods or services to a gift annuity donor. Annuity payments made by the charity to the annuitant (who is most often the grantor) are “goods” that can have significant monetary value. The tax law in this situation expressly requires the CWA to declare whether the pension recipient has received anything of value other than the pension from the charity.6
Other common sticks
Here are some other sticks that prevent donors from taking a charitable deduction:
The donor does not know the basis and has no data to establish the basis. In this situation, the basis is zero. This is because the taxpayer has the burden of creating a favorable tax position and the donor cannot do so.7
An intermediary sends shares to charity from the donor's individual retirement account as a qualified charitable distribution (QCD). This is problematic because the IRS has not said when QCD is considered to have been incurred or how to calculate its amount. So the donor may not be able to qualify for a charitable deduction. No federal income tax charitable deduction is allowed for a QCD.
The donor has the stock tied to the charity to create a gift annuity, and the stock depreciates in transit. It is unclear what value should be used to calculate the annual pension payment. The answer can be found in the Charitable Gift Acceptance Policy (GAP). If the GAP remains silent on this issue, there is a potentially messy fight ahead.
PF pays for gala dinner tickets. This is a recurring problem for one reason: the IRS has said that the buyer's PF may not pay the “charitable portion” of the ticket price.8 To determine what the charitable portion is against the cost of the dinner, the cost of the dinner is determined by finding out what a comparable commercial venue would pay.
IRA money is left to a charity after the donor's death. This presents a recurring problem because some IRA custodians want charitable beneficiaries to set up legacy IRAs. The problem here is that charities have generally found it difficult or impossible to take their beneficiary distributions from an inherited IRA. Gift officers at charitable organizations generally believe this is because the custodian wants to keep the IRA assets. I am inclined to believe that they are correct.
Endnotes
1. As to New Jersey, SEE Jewish Federation of Central New Jersey v. Barondesa234 NJ Super. 526 (1989) (spoken promise held to be enforceable). As for Iowa, SEE Salsbury v. Northwestern Bell Telephone221 NW2d 209 (1974). As for Pennsylvania, a written pledge in which donors (a married couple filing a joint federal income tax return) state that they intend to be bound by their promise to donate is enforceable with law (SEE 33 PS Section 6).
2. LOOK Treasury Regulations Section 53.4941(d)(2(f).
3. Treasures. The rules. Section 1.170A-6(b)(2).
4. Treasures. The rules. Section 1.170A-15(g).
5. Appreciated assets (in particular, securities and real estate) are typically used instead of cash to create a charitable remainder trust (CRT) because the transfer of a CRT-rated asset does not trigger the appraisal to be realized as capital gains. This is because the transfer is not a sale or exchange.
6. Treasures. The rules. Section 1.170A-13(f)(16).
7. Regarding the basic rules in general, SEE IRS Publication 561.
8. LOOK Decision Private Letter 9021066 (March 1, 1990).