Gifts That Give Back

Potential donors of charitable gifts are sometimes reluctant to make a substantial charitable contribution. It's not that they lack conviction in the good works of the charity or that they fail to recognize the tax benefits of making the contribution. The reason for the donor's reluctance to act may be a need for income. The donor may feel, often with some justification, that a substantial charitable gift may have an adverse impact on their cash flow. A charitable gift annuity is one technique that can help donors make the charitable gifts they want to make without giving up the income that they need.

Charitable gift annuities are really a combination of several widely used tax planning techniques; annuities, installment sales, and charitable contributions. Under a charitable gift annuity arrangement, the donor transfers to the charity cash or appreciated property. In exchange, the charity promises to pay to the donor a fixed payment over the donor's life (or the lives of the donor and another annuitant). The annuity payments can begin immediately or they can be postponed until a future starting date. In other words, charitable gift annuities can behave like commercially available immediate annuities or deferred annuities.

The key difference between a charitable gift annuity and a commercially available annuity is that the charitable annuity is usually less generous to the donor than a commercially available annuity. Therein lies the income tax charitable deduction aspect of the transaction. If the present value of the charitable annuity is less than the fair market value of the asset donated, the difference represents an income tax charitable deduction. The income tax deduction is immediate, even though the annuity payments are to be received over time.

If the asset contributed is cash, that's pretty much the end of the story. However, many potential donors would rather donate substantially appreciated assets. Frequently, these assets may also be low income producers. For example, the donor may be holding valuable raw land or low income stocks.

In the case of the purchase of a charitable annuity in exchange for the contribution of long-term capital gain property, the transaction is treated as a bargain sale. In a bargain sale transaction, the charity purchases an asset for less than its fair value. In order to compute the tax implications of a bargain sale, the amount realized (in this case the annuity) and the basis are allocated between the sale portion and the charitable contribution portion. If the amount realized on the sale portion exceeds the allocable amount of basis, gain is realized. However, because annuity payments are received in installments, the gain is recognized as annuity payments are received. The taxability of each annuity payment is computed by first dividing the payment between income and principal. The principal portion is then further divided between gain and non-taxable return of basis.

There are also two miscellaneous rules to keep in mind. First, like other present and future value calculations, the appropriate discount rate is published monthly by the IRS. Also, the Committee on Gift Annuities (a collection of officials of major charities) helps set the annuity payout rates.

Of course, this brief article is no substitute for a careful consideration of all of the advantages and disadvantages of this matter in light of your unique personal circumstances. Before implementing any significant tax or financial planning strategy, contact your financial planner, attorney or tax advisor as appropriate.