Mr. and Mrs. Benefactor, who are ages 45 and 40, are the parents of two current students. Mr. and Mrs. Benefactor wish to make a gift to Bullis School of $400,000 in the form of stock which has significantly appreciated in value since they purchased the stock more than a decade ago for $100,000.
Mr. and Mrs. Benefactor make the gift as follows:
- They provide Bullis with a pledge of $400,000 to be paid over three years.
- They fulfill this pledge by transferring their shares of stock to Bullis School in three equal annual installments.
As a result:
- Bullis School receives $400,000.
- Mr. and Mrs. Benefactor avoid a federal capital gains tax of $45,000 which they would have incurred had they sold the stock and donated the proceeds.
- Mr. and Mrs. Benefactor are entitled to claim income tax charitable deductions totaling $400,000, resulting in federal tax savings of approximately $140,000 to someone in the top tax bracket.
Note: By spreading the gift over three years, Mr. and Mrs. Benefactor create an eight-year period (the initial three years plus five carry forward years) in which to claim the deduction thus minimizing the risk that they will lose a portion of the charitable deduction because of the annual 30% of adjusted gross income ceiling on the charitable deduction for appreciated property.
(The example above and the examples which follow are copy written by Helen Colson Development Associates.)
If a bequest is outright, i.e. the designated amount passes immediately and directly to the school without restrictions, that entire amount is effectively excluded from the donor's taxable estate and therefore from estate tax.
An outright bequest generally takes one of the following three forms:
- A pecuniary bequest, such as $100,000 in cash or securities valued at $100,000.
- A specific bequest, such as a home, a painting, or 100 shares of IBM stock.
- A residuary bequest, such as one-quarter of the decedent's estate remaining after all debts, expenses, and pecuniary and specific bequests have been paid.
Employee qualified plan benefits, IRA benefits, and life insurance proceeds also can be given to Bullis School upon death. These benefits pass by contract (the beneficiary designation form) rather than by will.
Leaving the benefits of a qualified plan or IRA to Bullis School is particularly attractive because the transfer avoids both an estate tax and an income tax which would be due if the benefits had been made payable to a non-charity. This offers a unique advantage to the donor. He or she can eliminate a significant tax burden by giving this asset to the school.
For example, if a donor wants to leave $100,000 to Bullis, he or she may have the choice of leaving that $100,000 in the form of cash or in the form of a qualified plan or IRA postmortem benefit. If he or she leaves the cash to the school and the qualified plan or IRA benefits to his or her family, the benefits will be subjected to income tax. However, if he or she leaves the qualified plan or IRA benefits to the School and the cash to his or her family, neither will be subjected to income tax.
In the case of a gift of a qualified plan or IRA benefits, the amount is affected by the date of death and thus there can be no assurance that a specific amount will be available. For example, the donor may die at an advanced age after he or she has consumed the bulk of his or her IRA or qualified plan benefits as a lifetime pension. The donor could avoid this unintended result by inserting a make-up provision in his or her will, i.e. "If my plan benefits payable to Bullis School at my death are less than $100,000, I give to the school a cash bequest in order to bring the total gift up to the $100,000 level."
In 2008 and 2009 only, a donor age 70-and-a-half and older can, during lifetime, give up to $100,000 per year from his or her IRA (but not from other qualified plans) directly to the School with favorable tax consequences.
Two advantages of giving life insurance proceeds to Bullis School are that the School will receive the proceeds immediately and that the school will not become party to the probate proceedings. If life insurance proceeds are transferred at death, an estate tax charitable deduction will be available if the policy was owned by the donor and was made payable to the school.
Transfers of a Split Interest
Sometimes donors wish to split benefits between Bullis and a family member. The charitable portion of such a split interest bequest will qualify for an estate tax charitable deduction if the bequest takes one of the following four forms:
A remainder interest in a residence. A donor might transfer his or her home to a surviving spouse for use during the rest of his or her life with full ownership of the house passing to the School upon his or her death.
A charitable lead trust. A donor might leave to the School by bequest an income interest (in the form of an annuity or unitrust) in a trust fund for 10 years with the principal passing to the donor's grandchildren at the end of the 10 year period. (An annuity is a specified amount payable annually. A unitrust provides for an annual payment of a specified percentage of the trust fund, re-valued annually.) In a depressed securities market, a charitable lead trust may result in extra gift tax or estate tax consequences.
A charitable remainder. A donor might leave an income interest (again in the form of an annuity or unitrust) in a trust fund to his or her child for life with the trust fund's principal passing to the School upon the death of the child.
These techniques may be initiated during a donor's lifetime and (with the exception of a charitable lead trust) would thereby also produce an income tax deduction. Any other form of split interest bequest will not qualify for the estate tax charitable deduction. If this split interest transfer is made in lifetime, similar rules apply under the gift tax and the income tax.
Mr. and Mrs. Loyal, ages 60 and 57, wish to give up their Florida vacation home because they prefer to spend their vacations in Arizona where they own a condominium.
The Florida vacation home was purchased 30 years ago at a cost of $75,000. Its present value is approximately $400,000.
Instead of selling the Florida home, Mr. and Mrs. Loyal donate it to Bullis.
As a result:
- Bullis School receives a house which it can sell for approximately $400,000.
- Mr. and Mrs. Loyal avoid a $49,000 federal capital gains tax which they would have incurred had they sold the vacation home themselves.
- Mr. and Mrs. Loyal achieve a federal tax savings of approximately $140,000 (35% of $400,000), as well as state tax savings of 6-9% of the value, by making a charitable contribution of their vacation home.
Mr. and Mrs. Generous are in their early 70s. Their life expectancy is approximately 15 years. They wish to transfer to their grandchildren a stock portfolio currently worth $2,000,000, approximately 15 years hence. The following are two alternatives. In Plan A, Mr. and Mrs. Generous transfer the $2,000,000 portfolio to a charitable lead trust. The trust pays an annuity of $160,000 per year to Bullis School for 15 years. At the end of the 15-year charitable term, the trust principal passes to the grandchildren. In Plan B, Mr. and Mrs. Generous retain and invest their $2,000,000 portfolio until the death of the survivor of them at which time the portfolio passes to the grandchildren by will.
Lead Annuity Trust
||Annual annuity to Bullis
||Gift tax and generation-skipping tax payable to grandchildren after unified generation-skipping tax credits
||- 0 -
||Projected principal after 15 years
@ 8% pre-tax return
||Projected estate tax and
|- 0 -
||Projected benefit to grandchildren
||Projected benefit to Bullis
||- 0 -
Mr. and Mrs. Charitable, ages 55 and 50, are the parents of two Bullis School alumni. Many years ago, Mr. and Mrs. Charitable invested in an unimproved parcel of land for which they paid $100,000. The land, which is now worth $500,000, is readily saleable, but produces no income.
Mr. and Mrs. Charitable want to increase their current income, make provision for their children, and make a substantial gift to the School.
To meet these objectives, the Charitables create a charitable remainder unitrust as follows:
- They transfer the parcel to a trust designating a bank or professional advisor as trustee.
- The trustee sells the land and reinvests the proceeds in a balanced portfolio of marketable stocks and bonds. Because a charitable remainder unitrust is not subject to income tax, the total $500,000 sale price is available for reinvestment.
- Each year the trustee pays to Mr. and Mrs. Charitable, and then to whichever of them survives the other, an amount equal to 7% of that year's value of the trust fund. The first payment is $35,000. (The payments will increase in future years if the trust principal increases in value.)
Mr. and Mrs. Charitable use $12,000 of their $35,000 increase in annual income to pay the premiums on a $1,000,000 life insurance policy on their lives. The policy is owned by their children who also are the beneficiaries. After 15 annual premiums, the policy is fully funded.
As a result:
- Mr. and Mrs. Charitable convert a non-income producing parcel of land into a portfolio of marketable securities generating $35,000 of income per year and continuing for life with the potential of an increase in the annual income as the portfolio grows in value. They do this without paying a capital gains tax on the sale of the parcel.
- In the year in which the trust is created, Mr. and Mrs. Charitable are entitled to an income tax deduction worth approximately $19,000 for the present value actuarially determined remainder gift to the School, approximately $55,000.
- Upon the death of the survivor of Mr. and Mrs. Charitable, Bullis School receives the trust principal which will be worth more than $500,000 if the trust earnings exceed 7% per year.
- Upon the death of the survivor of Mr. and Mrs. Charitable, their children receive $1,000,000. The children pay no income tax on the $1,000,000 because life insurance proceeds are not subject to income tax. Moreover, the $1,000,000 is not subject to estate tax because the children were the owners of the policy from its inception.