HOW to GIVE WISELY a Donor’S Guide to Charitable Giving

HOW TO GIVE WISELY A Donor’s Guide to Charitable Giving

By Marla Brill

ECONOMIC EDUCATION BULLETIN Published by AMERICAN INSTITUTE for ECONOMIC RESEARCH Great Barrington, Massachusetts About A.I.E.R. MERICAN Institute for Economic Research, founded in 1933, is an independent scientific and educational organization. The A Institute’s research is planned to help individuals protect their personal interests and those of the Nation. The industrious and thrifty, those who pay most of the Nation’s taxes, must be the principal guardians of American civilization. By publishing the results of scientific inquiry, carried on with diligence, independence, and integrity, American Institute for Economic Research hopes to help those citizens preserve the best of the Nation’s heritage and choose wisely the policies that will determine the Nation’s future. The Institute represents no fund, concentration of wealth, or other special interests. Advertising is not accepted in its publications. Financial support for the Institute is provided primarily by the small annual fees from several thousand sustaining members, by receipts from sales of its publications, by tax-deductible contributions, and by the earnings of its wholly owned investment advisory organization, American Investment Services, Inc. Experience suggests that information and advice on economic subjects are most useful when they come from a source that is independent of special interests, either commercial or political. The provisions of the charter and bylaws ensure that neither the Institute itself nor members of its staff may derive profit from organizations or businesses that happen to benefit from the results of Institute research. Institute financial accounts are available for public inspection during nor- mal working hours of the Institute.

Economic Education Bulletin (ISSN 0424–2769) (USPS 167–360) is published once a month at Great Barrington, Massachusetts, by American Institute for Economic Research, a scientific and educational organization with no stockholders, chartered under Chapter 180 of the General Laws of Massachusetts. Periodical postage paid at Great Barrington, Massachusetts. Printed in the United States of America. Subscription: $25 per year. POSTMASTER: Send address changes to Economic Education Bulletin, American Insti- tute for Economic Research, Great Barrington, Massachusetts 01230. Contents

I. GIVING 101 ...... 1 How Much Should You Give? ...... 1

II. SELECTING AND EVALUATING A CHARITABLE ORGANIZATION ...... 5 Avoiding Scams...... 6

III. IRS GUIDELINES FOR CHARITABLE CONTRIBUTIONS ...... 9 Contributions of Property ...... 9 Timing Your Deductions ...... 10 Recordkeeping ...... 10 Cash Contributions ...... 11 Noncash Contributions ...... 11 Automobile Expenses ...... 13

IV. CHARITABLE BEQUESTS ...... 15 Types of Bequests...... 15 Benefits of Making a Bequest ...... 17

V. METHODS OF CHARITABLE GIVING ...... 19 Pooled Life Income Funds...... 19 Charitable Remainder Trusts ...... 20 Charitable Gift Annuities ...... 23 Charitable Lead Trusts ...... 24 Private Foundations ...... 26

VI. SPECIAL CONSIDERATIONS FOR GIFTS OF REAL ESTATE, STOCK, RETIREMENT ASSETS, AND INSURANCE ...... 27 Gifts of Real Estate ...... 27 Gifts of Retirement Assets...... 28 Charitable Bargain Sales ...... 29 Gifts of Appreciated Stock ...... 30 Gifts of Closely-Held Stock ...... 31 Gifts of Life Insurance...... 32

VII. THE IMPACT OF THE 2001 TAX ACT ON GIVING DECISIONS ...... 33 APPENDIX: COORDINATING PLANNED GIVING WITH LIFETIME GIFTS TO FAMILY MEMBERS ..... 35 Family Giving: The Basics ...... 35 I. GIVING 101

“Make all you can, save all you can, give all you can.”—John Wesley

HE word “philanthropy” is derived from the Greek words that trans- late into “to love mankind.” Indeed, many individuals feel there is Tno better way to express their passion for the causes that matter most to them than through a commitment of their time and financial resources. People support nonprofits for a variety of reasons that extend beyond altruism. Having one’s name on a donor list provides a side benefit of signaling altruistic intentions and largesse. Others value the tax benefits associated with charitable giving, or use a planned giving program in conjunction with estate planning. Whatever your reason for giving, it is important to combine your good intentions with practical business sense. This means contributing in ways that minimize taxes to the greatest extent possible, investigating how the charitable organizations you favor are being run and how your donations will be used, and coordinating charitable donations with other aspects of your financial life. How Much Should You Give? The easy answer is “as much as you feel comfortable with.” That amount varies from person to person. If you grew up in modest surroundings and your family needed to budget carefully to get by, you may well have reservations about giving away a large share of your wealth, especially during your lifetime. On the other hand, if you have lived comfortably for most of your life, are satisfied with your standard of living, and have taken care of family obligations, you may feel more comfortable with donating generously. Statistics show that the amount people donate to charities does not necessarily keep pace with increases in assets or income. Affluent income- tax filers under age 65 are only half as generous as their more modestly situated peers, according to a recent report by NewTithing Group (www.newtithing.org), a philanthropic research organization and devel- oper of donor education tools. If affluent young and middle-aged filers had donated as high a proportion of their investment asset wealth to charity in 2003 as did their less affluent peers, concludes the report, total individual charitable donations could have been as much as $25 billion higher that year, an increase of at least 17 percent. Interestingly, the report found no 1 Families’ Wealth and Their Contributions to Charity According to the Congressional Budget Office’s analysis of the Survey of Consumer Finances, about 40 percent of the people surveyed contributed at least $500 to charity in 2000. Families giving at least that much donated an average of $4,400. Not surprisingly, wealthier families were both more likely to contribute and contributed more. About a third of families with less than $500,000 in net worth contributed $500 or more. But about three-quarters of families worth between $500,000 and $1 million contributed at that level, and more than 90 percent of families with more than $3 million in net worth did so. Average contributions also increased from $2,300 for families with less than $500,000 in net worth to almost $400,000 for those with $50 million or more.

Percentage Average of Families Contribution from Millions of Giving Families Giving Net Worth Families at Least $500 at Least $500 Less than $0.5 Million 90.79 32 $2,300 $0.5 Million to $1 Million 8.26 73 $3,000 $1 Million to $3 Million 5.21 82 $5,900 $3 Million to $5 Million 0.93 90 $19,200 $5 Million to $50 Million 1.28 95 $37,500 $50 Million or More 0.02 95 $391,400 Source: Congressional Budget Office based on Board of Governors of the Federal Re- serve System, Survey of Consumer Finances (prepared by National Opinion Research Center, University of Chicago, 2001). such generosity gap among seniors of different wealth levels. A number of factors go into gauging how much you can comfortably afford to give, including your income level, health, job security, financial obligations, and investment assets. As a “broad brush” benchmark, NewTithing suggests that someone with assets of $500,000 (excluding a personal residence, retirement accounts, and possessions) and salary and non-investment income of $300,000 could comfortably allocate 0.6 percent of the $500,000 in assets toward annual donations, or $3,000. An additional $2,000 could be donated from income, bringing the total gift to $5,000. After the deduction for charitable contributions, the out-of-pocket cost to the donor would be approximately $3,000. (These estimates are not unbiased; NewTithing is an advocacy group that favors more charitable giving. But the figures are worth considering.) Suggested guidelines such as the one above will probably not be quite as relevant for those considering a planned giving program. “Planned giving” refers to the process of arranging a charitable gift of estate assets to a 2 nonprofit organization as part of an overall estate plan. Planned gifts have become popular because of the many choices and the flexibility available in deciding on a method of giving as well as the tax incentives offered. Potential donor and beneficiary benefits include increasing current income, reducing income taxes, avoiding capital gains tax, diversifying an investment portfolio, passing assets to family members at a reduced tax cost, and securing the financial future of a charitable organization. Regardless of whether you are donating as part of a planned giving program or are simply interested in making charitable contributions during your lifetime, this booklet will help you: 1. Explore the tax and other financial advantages of charitable donations and planned gifts to charitable organizations. Specific examples are given to illustrate how each option can be applied to actual situations. By learning about the various giving options, you can find the most appropriate and advantageous strategy for yourself and your beneficiaries; 2. Select a worthwhile, well-run charity whose mission resonates as one that is important to you; 3. Avoid the ever-increasing number of charitable “scams,” especially those promoted through the Internet after Hurricane Katrina and other natural disasters; 4. Understand the impact of the 2001 Tax Act on planned giving decisions; and 5. Coordinate strategies for making gifts to family members with a planned giving program.

II. SELECTING AND EVALUATING A CHARITABLE ORGANIZATION

OUR selection of a charitable organization starts with evaluating your unique values and preferences, which are often shaped by Ypersonal experiences. There is certainly no shortage of causes and missions that want your support. From animal welfare, to education, to political causes, the ranks of philanthropic organizations are vast and growing. Once you determine the causes that are most important to you, the next step is deciding which organizations are best equipped to carry out their missions. When it comes to how efficiently and effectively they use your money, not all charities are created equally. Like Enron and other scandal- ridden companies highlighted in news reports of a few years ago, charitable organizations have their share of wasteful executives who might prefer to spend money on lavish fund-raising events or unreasonably high salaries, rather than direct the lion’s share of contributions to the people you wish to help or the causes you wish to promote. With a little digging, however, it is possible to evaluate charitable organizations and determine whether they are spending money in ways you consider useful and benefi- cial. An excellent resource is the Better Business Bureau’s Wise Giving Alliance (formerly the BBB Philanthropic Advisory Service). The web site, listed at the end of this chapter, provides guidance for evaluating how an organization spends donations by breaking expenses into three catego- ries: programs, administration, and fund-raising. Program services, the heart of an organization and the reason most people donate, might cover things such as research grants, educational programs, or food or medical supplies and field personnel. Administration includes expenses such as accountants’ or attorneys’ fees, rent, employee salaries, and other general expenses. Fund-raising costs include creating and printing brochures, fund- raising events, and advertising. In general, the Council of Better Business Bureau standards call for (1) at least half of the charity’s total income to be spent on programs; (2) at least half of public contributions to be spent on programs described in appeals; (3) no more than 35 percent of contributions to be spent on fund- raising; and (4) no more than half of the charity’s total income to be spent on administrative or fund-raising costs. In applying these standards, consider special circumstances that might 5 make a charity’s expenses reasonable even though they do not meet the percentage guidelines. For example, a new organization understandably will have higher fund-raising costs than an established charity. And be sure to compare charities that do the same kind of work, since the type of work can affect operating costs dramatically. While the Wise Giving Alliance can provide some insight into an organization’s finances, the information may be outdated if the charity does not respond to the organization’s inquiries about finances in a timely manner. And because the BBB list focuses on national charities, you may not find information on many nonprofits that have a more local or regional emphasis. Another useful resource is GuideStar (www.guidestar.org). All nonprofits listed on GuideStar are either registered with the IRS or have provided the organization with proof of their status as legitimate nonprofits that meet IRS criteria for tax-exempt organizations. You can see at a glance if your contribution will be deductible. If the charity is not on GuideStar, ask to see its “letter of determination” from the IRS to verify its tax-exempt status. The IRS also offers guidance in Publication 78, Cumulative List of Organizations, a list of organizations eligible to receive tax-deductible charitable contributions. The online version, located at www.irs.gov, can help you conduct a more efficient search of these organizations and determine whether your contribution is fully deductible. The list of questions below will help you research the charitable organizations you are interested in: 1. What is the organization’s mission? Has it changed over the years? 2. What were its annual expenditures and revenues for each of the last three years? Are they expanding, contracting, or stable—and why? 3. How are costs controlled? 4. How does it differ from similar nonprofits? 5. In the last full year, what percentage of donations came approximately from individuals and private foundations, public foundations, government agencies, or corporate foundations? 6. What percentage of total expense is spent on program activities that directly advance the organization’s mission? Avoiding Scams Most charities are reputable and worthy of your financial support. Chari- 6 table fund-raising is a big business these days, however, and just like any big business, it has its share of questionable operators. In recent years, e-mail scams claiming to be from charities have been targeting unsuspecting donors with alarming frequency. Many of them play on public sympathy generated by floods, hurricanes, and natural disasters. One scheme sends phony messages purporting to be from the American Red Cross. When you click on the link provided in the message, it takes you to what appears to be a Red Cross website. It is actually a copycat site set up by thieves who pocket your donation. Of course, telemarketing, postal mail, and door-to-door solicitations were thriving business long before the advent of cyberspace. While all of these are legitimate ways for reputable charities to contact you, they also provide an entry point for unscrupulous scammers posing as nonprofit organizations. Below are some guidelines from the Massachusetts Attorney General’s office for investigating a charity. Know your charity. Never give to a charity you know nothing about. Ask for printed materials that clearly and specifically state: the name, address and telephone number of the charity; a specific description of how and where the charitable funds will be used; whether your donation is tax- deductible as a charitable contribution; and the name, address and telephone number of the professional fund-raiser, if any, the charity uses. Find out where your money goes. Beware of statements such as “all proceeds go to charity;” the “proceeds” may not be very much after expenses are deducted. Also ask for financial statements that tell you how much of your charity dollar goes to fund-raising or administrative and general expenses, and how much is left for the program you want to support. Don’t be fooled by a name. Some phony charities, including for-profit companies, have sympathetic sounding names, or names that closely re- semble those of respected, legitimate charities. Don’t fall for a “sob story.” The hard-luck tale is a favorite ploy of the phony operator. A legitimate charity will tell you how it is using your money to make a difference for the better. Don’t succumb to pressure. Take time to decide. The need is always there; make sure the organization will be there, too. Don’t give cash. Pay by check, and make it out to the charity (use its full name; do not use initials), not the fund-raiser. Never give your credit

7 card number to a fund-raiser over the telephone. If the fund-raiser comes to your door, always ask to see identification. Better yet, mail your check directly to the charity. Don’t be lured by “goodies.” Household products and tickets to shows can be legitimate fund-raising tools, but they do add extra costs. If you receive unordered items in the mail, do not feel obligated to make a donation. Verify the information given. Call your local police department; some require organizations to register before soliciting; they may be able to tell you if they have received complaints about the solicitation. Call the beneficiaries of the charitable funds—local schools, shelters, workshops, etc. Find out whether they are aware of the solicitation and have authorized the use of their names. Keep records. Receipts and canceled checks come in handy when you file your income tax returns or in case you later have a complaint. If you suspect that an e-mail solicitation may be a scam, you may wish to report it to the Internet Crime Complaint Center, a partnership between the FBI and the National White Collar Crime Center (a federally-funded nonprofit group of law enforcement agencies), at www.ic3.gov. Your state attorney general’s office is also a good place to report a charity solicitation that has the markings of a scam.

Resources for Evaluating Charitable Organizations

BBB Wise Giving Alliance (www.give.org; 703-276-0100) American Institute of Philanthropy (www.charitywatch.org; 773-529- 2300) Guidestar (www.guidestar.org; 757-229-4631)

8 III. IRS GUIDELINES FOR CHARITABLE CONTRIBUTIONS

AX benefits can significantly reduce the actual cost of a gift. For example, if you are in a 35 percent federal tax bracket, a gift of T$1,000 does not actually cost you $1,000 since the charitable deduction will generate $350 in tax savings. Additionally, if you donate a long- term appreciated asset rather than first convert that asset into cash, avoiding the tax on capital gains may make the donation even more tax advantageous for you. Generally, you can deduct contributions of money or property that you make to a qualified organization. If you give property, you can deduct the fair market value of the property at the time of the contribution. You can deduct contributions to charity only if you itemize your deductions. If you receive or expect to receive a financial or economic benefit as a result of making a contribution to a qualified organization, you cannot deduct the part of the contribution that represents the value of the benefit you receive. For example, if you pay $100 for tickets to a charity event and the fair market value of those tickets is $25, you may only deduct $75 as a charitable contribution. For cash donations, your maximum deduction for charitable contributions is generally limited to 50 percent of your adjusted gross income. In addition, the total of your charitable contributions deduction and certain other itemized deductions may be limited. Contributions of Property If you contribute property to a qualified organization, the amount of your charitable contribution is the fair market value of the property at the time of the contribution. According to the IRS, “Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts.” If you need to get an appraisal to ascertain the value of donated property, the appraisal fee is not deductible as a contribution. However, you can claim the fee, subject to certain limitations, as a miscellaneous itemized deduction. The limit on tax deductions for charitable contributions is lower for property than for cash. For gifts of property, the limit is 30 percent of adjusted gross income. Contributions of cash or property that exceed the respective limits for one year can be carried over into subsequent years, up to a maximum of five years. These carryover contributions are subject to 9 the same percentage limits in the year to which they are carried. When you contribute property with a fair market value that is less than your cost basis in it, your deduction is limited to its fair market value. You cannot claim a deduction for the difference between what you paid for the property and its fair market value. This rule is important to note for types of property that decrease in value, including cars, clothing, and appliances. The rules for contributions of cars (and boats and airplanes) have changed recently and are worth noting. Beginning in 2005, the deduction for a car is limited to the gross proceeds from its sale by the organization. This rule applies if the claimed value of the donated vehicle is more than $500. When you donate property that has increased in value, you can generally deduct the fair market value of the gift. However, there are some exceptions to this rule. The deduction for donations of capital assets (such as stocks, bonds, jewelry, or coins) held one year or less is the item’s fair market value minus the amount that would have been ordinary income or a short-term capital gain had you sold the item for its fair market value. This rule limits the deduction to your basis in the property—generally, what you paid for it. For example, if you buy some stock for $800 and donate it to a charity eight months later when its fair market value is $1,200, your charitable deduction is limited to $800. You may deduct the full value of property held more than one year, including any appreciation. Thus, in the previous example, the donor would have been able to deduct the fair market value of $1,200 if the stock had been held for more than one year. Thus, to obtain the maximum tax benefit from a stock donation, donate appreciated stock that you have held for over one year. In certain situations, you must reduce the fair market value of property by any amount that would have been a long-term capital gain if you had sold it. The IRS publications listed at the end of this chapter outline these exceptions in more detail. Timing Your Deductions You can deduct your contributions only in the year you make them in cash or property. Usually, the contribution is considered complete at the time of its unconditional delivery. A check that you mail to a charity is considered delivered on the day you mail it. Contributions charged to a credit card are deductible in the year you make the charge. Recordkeeping You must keep records to prove the amount of the cash and noncash 10 contributions you make during the year. The kind of records you must keep depends on the amount of your contributions and whether they are cash or noncash contributions. An organization must give you a written statement if it receives a payment from you that is more than $75 and is partly a contribution and partly for goods or services. Keep the statement for your records. It may satisfy all or part of the recordkeeping requirements explained in the following discussions. Cash Contributions Cash contributions include those paid by cash, check, credit card, or payroll deduction. They also include out-of-pocket expenses incurred when donating your services. For a contribution made in cash, the records you must keep depend on whether the contribution is less than $250, or $250 or more. For each cash contribution that is less than $250, you must keep either (1) a canceled check, or a legible and readable account statement that shows the check number, amount, date posted, and to whom paid if payment was by check; the amount, date posted, and to whom paid if payment was made by electronic funds transfer, or the amount, transaction date, and to whom paid if payment was charged to a credit card; or (2) a receipt (or a letter or other written communication) from the charitable organization showing the name of the organization, the date of the contribution, and the amount of the contribution. To claim a deduction for a contribution of $250 or more you should have an acknowledgement of your contribution from the qualified organization or payroll deduction records. If you made more than one contribution of $250 or more, you must have either a separate acknowledgement for each or one acknowledgement that shows your total contributions. The acknowledgement must be written, and include the amount you contributed, whether you received any goods or services as a result of your contribution, and a description and valuation of those goods or services. Noncash Contributions For a contribution not made in cash, the records you must keep depend on whether your deduction for the contribution is: less than $250; at least $250 but not more than $500; over $500 but not more than $5,000; or over $5,000. Deductions of less than $250. If you make any noncash contribution, you must get and keep a receipt from the charitable organization showing the name of the charitable organization, the date and location of the chari- 11 table contribution (e.g., the place where you donated your car), and a reasonably detailed description of the property. A letter or other written communication from the charitable organization acknowledging receipt of the contribution and containing this information will serve as a receipt. You are not required to have a receipt where it is impractical to get one (for example, if you leave property at a charity’s unattended drop site). Deductions of at least $250 but not more than $500. If you claim a deduction of at least $250 but not more than $500 for a noncash charitable contribution, you must get and keep an acknowledgement of your contribution from the qualified organization. The acknowledgement must con- tain the same information required for deductions of less than $250. Addi- tionally, it should include whether you received any goods and services as a result of the contribution, and a description and value of those goods and services. Deductions over $500 but not over $5,000. If you claim a deduction over $500 but not over $5,000 for a noncash charitable contribution, you must have the same acknowledgement and written records required for deductions of at least $250 but not more than $500. Your records must also include (1) how you got the property—for example, by purchase, gift, bequest, inheritance, or exchange; (2) the approximate date you got the property or, if created, produced, or manufac-

Deductible As Charitable Contributions Money or property you give to: • Churches, synagogues, temples, mosques, and other religious organizations • Federal, state, and local governments, if your contribution is solely for public purposes (for example, a gift to reduce the public debt) • Nonprofit schools, educational institutions, and hospitals • Public parks and recreation facilities • Salvation Army, Red Cross, CARE, Goodwill Industries, United Way, Boy Scouts, Girl Scouts, Boys and Girls Clubs of America, etc. • War veterans’ groups Expenses paid for a student living with you, sponsored by a qualified organization. Out-of-pocket expenses when you serve a qualified organization as a volunteer. As an example, you can deduct unreimbursed out-of-pocket automobile expenses, such as the cost of gas and oil, that are directly related to the use of your car in giving services to a charitable organization. Or, you can use a standard mileage rate of 14 cents a mile to figure your contribution.

12 tured by or for you, the approximate date the property was substantially completed; and (3) the cost or other basis, and any adjustments to the basis, of property held less than 12 months and, if available, the cost or other basis of property held 12 months or more. This requirement, however, does not apply to publicly traded securities. If you are not able to provide information on either the date you got the property or the cost basis of the property and you have a reasonable cause for not being able to provide this information, attach a statement of expla- nation to your return. Deductions over $5,000. If you claim a deduction of over $5,000 for a charitable contribution of one property item or a group of similar property items, you must have the acknowledgement and written records described above for deductions over $500 but not over $5,000. Generally, you must also obtain a qualified written appraisal of the donated property from a qualified appraiser. Automobile Expenses If you claim expenses directly related to use of your car in giving services to a qualified organization, you must keep reliable written records of your expenses. Records are considered reliable if you made them regularly and at or near the time you had the expenses.

Not Deductible As Charitable Contributions Money or property you give to: • Civic leagues, social and sports clubs, labor unions, and chambers of commerce • Foreign organizations (except certain Canadian, Israeli, and Mexican charities) • Groups that are run for personal profit • Groups whose purpose is to lobby for law changes • Homeowners’ associations • Individuals • Political groups or candidates for public office Cost of raffle, bingo, or lottery tickets. Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups. Tuition. Value of your time or services, including the value of income lost while you work as an unpaid volunteer. Value of blood given to a blood bank.

13 Your records must show the name of the organization you were serving and the date each time you used your car for a charitable purpose. If you use the standard mileage rate, your records must show the miles you drove your car for the charitable purpose. If you deduct your actual expenses, your records must show the costs of operating the car that are directly related to a charitable purpose. For more information on IRS guidelines for charitable contributions, consult IRS Publication 526, Charitable Contributions, and Publication 561, Determining the Value of Donated Property. Because the tax rules for charitable contributions may be complex, you may also wish to consult a tax professional, particularly if you plan to make a substantial gift.

14 IV. CHARITABLE BEQUESTS

CCORDING to the American Association of Fund-raising Counsel’s Trust for Philanthropy, nearly 90 percent of giving oc- A curs during donors’ lives. Such gifts are termed charitable contributions. The balance of gifts, made from donors’ estates, are charitable bequests. Gifts bequeathed by will have become the financial cornerstone of Ameri- can charitable organizations. Whether it is for moral principles or financial planning, thousands of individuals each year make the choice to include benevolent giving in their estate planning. One of the most straightforward ways you can make a deferred gift is to incorporate a bequest in your will. A bequest is a statement you make in your will or trust designating that a portion of your assets be used for the benefit of a charitable organization. This can be accomplished by creating a new will, modifying an existing will, or naming the charity as a beneficiary of a revocable trust, retirement plan, or life insurance policy. You can give almost any kind of asset to a charity through a will, including cash, securities, real estate (such as a residence), and personal property (such as works of art or antiques). You can also donate funds from an IRA, Keogh, tax-sheltered annuity, pension plan, profit-sharing plan, or funds from a life insurance policy at death. In addition to the variety of assets that can be used to make a bequest, there are also many ways to structure a bequest. It is not necessary to notify a charity that you plan to make a bequest. Indeed, a recent national survey of donors found that most bequest donors do not notify the chosen charity. (The same survey found that nearly a third of donors who made bequests had never made a cash contribution to the charity that would benefit.) The decision is yours. Some donors prefer to remain anonymous until the gift takes effect. However, if you have very specific intentions regarding the use of your bequest, discussing your gift with the charity can clarify your wishes. Types of Bequests Specific Bequest. The charitable organization receives a specified dollar amount, percentage, or asset, such as securities, real estate, or personal property. Residual Bequest. After estate-related taxes, debts, expenses, and specific gifts are paid, a residual bequest provides for the charitable organization to receive all or a percentage of the remainder of the estate. 15 Contingent Bequest. This type of gift allows you to leave all or a percentage of your estate to a charitable organization, but only under certain circumstances. For example, if your primary beneficiary does not survive you, then those assets will be given to the charitable organization. When drafting a will, it is important to anticipate such an occurrence to ensure that your assets will be given to a charity of your choice rather than to unintended beneficiaries. Restricted Bequest. In some cases, you may feel strongly that the money or assets you plan to donate be used for a specific purpose. A restricted bequest will allow you to designate how your gift will be used within the charitable organization. For example, you can establish a fund that would memorialize a family member by providing financial support to a specific program. It is important to remember that when you draft a restricted bequest, you should use the broadest terms possible to ensure that your gift is not made obsolete. Many organizations encourage donors to include a clause that allows the trustees to override the restrictions of the bequest if the gift can no longer be used in a way that is consistent with the donor’s wishes. (See box on “Examples of Bequest Language.”) Testamentary Trusts. This is a trust you establish through your will. Trust beneficiaries receive income for life or for a specified number of

Examples of Bequest Language The following examples can be tailored to your interests. Please consult an attorney for assistance in making a bequest.

For an Unrestricted Bequest “I hereby give and bequeath to the (Charitable Organization), a nonprofit corporation organized and existing under the laws of the State of ______, _____ dollars ($___) [or ____ percent (___%), or all of the rest, residue, and remainder of my estate] to be applied to the general uses and purposes of the said charitable organization.”

For a Restricted Bequest “I hereby give and bequeath to the (Charitable Organization), a nonprofit corporation organized and existing under the laws of the State of______, _____ dollars ($___) [or ____ percent (___%), or all of the rest, residue, and remainder of my estate], the income and/or a reasonable portion of the principal to be used for the following purpose: ______. If in the opinion of the Trustees of the (Charitable Organization) my gift cannot be usefully applied for such a purpose, this bequest may be used for another purpose that the Trustees believe is most in keeping with my expressed wishes and intent.”

16 years, and at the end of the trust term or after both you and your income beneficiary have died, the charity receives the remainder. You may also combine different types of bequests. For example, a benefactor can leave a specific bequest to a charity as well as provide for a residual bequest. Be aware, however, that if restrictions are being placed on a bequest or if the gift is a non-traditional asset, you should discuss such restrictions and details with the charitable organization to ensure that your objectives can be fulfilled. Benefits of Making a Bequest A bequest can provide substantial tax savings if your estate is large enough to be vulnerable to estate or inheritance taxes. Assets that are left to charitable organizations are deductible for Federal estate tax purposes, and there is no limit on the amount of that deduction. Furthermore, bequests are not usually subject to state inheritance or estate taxes. Bequests are especially rewarding in a large estate, where the assets are often subject to a high Federal estate tax. In that case, the savings may be more than half the value of the bequest. Additionally, bequests allow you to have full access to your assets during your lifetime, while giving you the satisfaction of knowing that you will be making a significant contribution to a favorite charity.

V. METHODS OF CHARITABLE GIVING

NDER the Internal Revenue Code, several different types of contributions qualify for a charitable deduction, each with its own Ubenefits and drawbacks to consider. Pooled Life Income Funds A pooled life income fund is a particular type of trust that operates like a mutual fund. You make a gift to a charitable organization, and for investment purposes, the assets are “pooled together” with gifts from other donors. You will be assigned “units” in the fund that has been chosen, and the fund pays you (and any beneficiaries you designate) a proportionate share of the fund’s net income, either quarterly or annually. When your last named beneficiary dies, his portion of the fund is then bestowed to the charitable organization. Pooled income funds thus provide income to you and to any named beneficiaries, while also providing a significant gift to a charity. Most charities specify a minimum initial contribution, but it is usually relatively small (say, $5,000), and often there is no minimum for additional contributions. Some charities allow you to name only one or two income beneficiaries, while others allow you to name more. It is important to realize that different pooled income funds have different investment objectives. Typically the trustees of such funds manage them with the goals of providing an income return and preserving or increasing the principal. But they have a lot of leeway in pursuing these objectives. It is imperative that you understand your own investment goals and research each individual fund to ensure that it fits your financial needs, as well as your charitable objectives. Benefits of putting money in a pooled life income fund. There are many reasons to place funds in a pooled life income fund, not the least of which are the tax benefits. You will be eligible to deduct from your federal income tax a portion of the gift in the year you make it, with five additional years to take any unused deduction. You will also avoid capital gains tax on any appreciated assets contributed. Additionally, the charitable remainder value of the assets contributed to the pooled life income fund will no longer be considered as part of your estate, thus reducing your total estate tax exposure. The advantages for the incomes beneficiaries (including you, if you choose) are modest but lifelong. They will receive income for life. While 19 Example of a Pooled Life Income Fund A 45-year-old benefactor donates $30,000 in appreciated stock, originally purchased for $3,000, to a pooled life income fund. The donor is the sole beneficiary. In this example, the rate of return is 4 percent, and the capital gains tax rate is 15 percent.

Charitable Deduction (see note below) $9,155 Estimated First Year Income $30,000 * 4% $1,200 Capital Gains Tax Savings ($30,000-$3,000) * 15% $4,050

Note: The charitable deduction is based on the remainder value of the gift, which is calculated on the life expectancy of the donor(s)/beneficiary(s) and the expected rate of return on the trust fund investments. The IRS publishes remainder factor values in IRS Publication 1458. Most charitable organizations own software that will automatically download up-to-date remainder factors to make this calculation for you. Donors may deduct an amount equal to 30 percent of their adjusted gross income in year one and carry forward the excess, applying the 30 percent rule for up to five years. these payments tend to be small, and will vary with the fund’s investment performance, they typically surpass the dividend payments on most publicly traded securities. A pooled life income fund provides a steady stream of income as well as an opportunity for long-term growth of both income and principal. In this way, it allows you to provide lasting financial support to the beneficiaries and charities of your choosing, while relieving a portion of your own tax burden. Charitable Remainder Trusts Charitable remainder trusts (CRTs) are another option for giving. Simi- lar to a pooled life income fund, a charitable remainder trust provides you and any beneficiaries a stream of income for life or for a period of years. Contributing to a pooled income fund is simpler than establishing a charitable remainder trust, since the donor incurs little or no setup costs. However, pooled income funds may be less adaptable to individual needs than a charitable remainder trust because they are usually organized under a standard agreement for a group of donors. In exchange for making irrevocable donations to the trust, donors receive an immediate tax deduction and can still earn income from the donated assets. After the trust terminates, the accumulated principal, or “remainder interest,” goes to the charitable beneficiary. Unlike other life-income invest-

20 ments, charitable remainder trusts are invested separately as managed trusts with their own Federal tax identification number. Income payments from the trust are typically made at the end of each calendar quarter. CRTs require a trust agreement that outlines specific terms and condi- tions. To save time and expense, charities will typically provide donors with an initial draft agreement for review by an attorney. Once the trust agreement is signed, you can fund the trust by transferring assets. Several varieties of CRTs are described below. Charitable Remainder Unitrust (CRUT). A CRUT pays a variable income based on a fixed percentage of the net fair-market value of the trust assets, which are revalued annually. The percentage is determined at the inception of the unitrust. The rate must be at least five percent and typically does not run higher than 10 percent. If your goal is to increase your charitable deduction, a lower rate is in your best interest; on the other hand, a higher rate will provide you and your beneficiaries with higher income. Each year, the charity distributes a fixed percentage of the unitrust’s current value, as revalued annually. One additional advantage of a CRUT is that income can increase as the trust principal grows over time. Also, you may make additional (annual) contributions to a CRUT at any time. Flip Unitrust. A Flip Unitrust allows even greater flexibility than a charitable remainder unitrust, because it makes it possible to change your income payments based on your circumstances. When a Flip Unitrust is created, income payments are limited until a designated event takes place. The event can be the sale of a house, a child entering college, or the decision to retire. At that time, the trust “flips” and income payments increase based on a higher percentage of the trust assets. An incentive to extending the limited income payment period is that the trust assets accu- mulate tax free until the date of the “flip.” Charitable Remainder Annuity Trust (CRAT). A charitable remainder annuity trust pays you and any beneficiaries that you name a set dollar amount, either for life or for a fixed number of years. The amount of the annual income is based on either the net income of the trust or a fixed percentage of your contribution specified in the agreement, whichever is less. The annuity trust is popular because it incorporates the security of a constant return and provides a current income tax deduction. Additions cannot be made to a charitable remainder annuity trust. CRTs are the most flexible life income plans available. As a result, you can shape a CRT to achieve almost any financial or estate planning goal. You have the option of receiving a variable or fixed income, receiving

21 Example of a Charitable Remainder Trust A 70-year-old benefactor establishes a CRUT with $500,000 of appreciated stock originally purchased for $55,000. The donor is the sole beneficiary of the trust. The trust distributes five percent of the trust assets each year for the life of the donor. In this example, the IRS discount rate is 4.8 percent and the current capital gains tax rate is 15 percent.

Charitable Deduction (see note below) $268,660 Estimated First Year Income 5% * $500,000 $25,000 Capital Gains Tax Savings ($500,000-$55,000) * 15% $66,750

Note: Also known as the Applicable Federal Rate (AFR), the IRS discount rate is used to determine the charitable deduction for many types of planned gifts. The rate is the annual rate of return that the IRS assumes the gift assets will earn during the gift term. The IRS discount rate is published monthly. It is announced on about the 20th of the month that precedes the month to which the rate will apply. It equals 120 percent of the annual mid-term rate, rounded to the nearest 0.2 percent. The annual mid-term rate is the annualized average yield of treasury instruments over the past 30 days that have remaining maturities of 3-9 years. The higher the IRS discount rate, the higher the deduction for charitable remainder trusts and gift annuities, and the lower the deduction for charitable lead trusts. Fluctuations in the IRS discount rates affect unitrust deductions far less than annuity trust and gift annuity deductions. IRS discount rate fluctuations do not affect pooled life income fund deductions. payments that continue for a certain period of years or for life, or deferring larger income payments until a certain point when you will need more money. Thus, CRTs are an efficient and adaptable mechanism for support- ing yourself, your beneficiaries, and your charity in one inclusive agreement. Most CRTs can be funded with a variety of assets, including closely held stock, real estate, and, in some instances, personal property. CRTs also have the distinct advantage of incurring no capital gains tax liability on appreciated property placed in them. You receive a charitable income tax deduction in the year you make the gift, with an additional five years to carry over any unused deduction. You and/or your designated beneficiaries can receive income for life or for a period of up to 20 years. While a number of charities have no limitation on the number of beneficiaries, IRS rules effectively limit how young they can be. Through reinvestment within the trust, you can further achieve diversi- fication of a previously concentrated asset by establishing a CRT. You also have the option of adding to a CRT at any time, with the exception of a CRAT. And, any assets contributed to a CRT are removed from your 22 estate, thus reducing your estate tax exposure. Charitable Gift Annuities Of life-income arrangements, the Charitable Gift Annuity is one of the oldest and simplest arrangements for making a deferred charitable gift. It is essentially a contract between you and the charitable organization, in which the charity agrees to pay up to two recipients (including you, if you choose) a fixed annuity in exchange for a gift of cash, marketable securities, or real estate. If effect, the charity promises to pay a stream of income for life— financed and guaranteed by the resources of the charity. The American Council on Gift Annuities (www.acga-web.org) recom- mends rates of return for the annual income payments, which are based on the age of the beneficiary as well as his life expectancy. While these suggested rates are not competitive with commercial annuities, many charities use them. Like charitable remainder trusts, there are several types of charitable gift annuities, each described below. Immediate Payment. With an immediate payment gift annuity, beneficiary payments begin at the end of the quarter in which the gift was made. Annuitants must be at least 60 years old. This plan caters to the needs of older investors who may need immediate income payments and tax deductions in order to achieve their estate planning goals. Deferred Payment. A deferred payment annuity is a new form of charitable gift annuity that is designed to attract younger investors who currently have a high income and are planning for their retirement years. The deferred payment plan is essentially the same as the immediate payment plan except that payments do not begin until a future date, usually the time of retirement. By deferring the payments, the plan guarantees that when the income payments begin, they will be substantially larger than those of the immediate payment gift annuity plans. The deferred payment plan also appeals to younger donors because they are able to take a charitable tax deduction in the year that they make the gift. This type of investment strategy resembles a tax-deductible IRA, where you can take deductions in your high-earning years and are then guaranteed income sometime in the future when your working income begins to diminish. Flexible Payment. Choosing this less structured annuity allows you to retain some flexibility regarding the timing of annuity payments. Depending on your needs, payments can begin as early as one year after the gift is made, or they can continue to be deferred until later dates (specified in the gift annuity agreement). Since it is difficult to determine what your financial needs may be down the road, the appeal of the flexible payment annuity is that

23 Example of a Charitable Gift Annuity Mr. James, who is 70-years-old, donates $15,000 of appreciated stock, originally purchased for $2,500, to a Single Life Charitable Gift Annuity with quarterly payments that begin immediately. The annuity rate is 6 percent and the current IRS discount rate is 4.8 percent.

Charitable Deduction $6,507 Annual Payment $25,000 * 6% $900 you do not have to predict your financial future at the time you make the gift. The risk in establishing a charitable gift annuity is relatively low, as income payments are fixed and guaranteed by the assets of the charity. Moreover, charitable gift annuities pay relatively high rates. Currently, rates go as high as 10 percent for immediate payment gift annuities and even higher for deferred gift annuities. There are also tax benefits to creating a charitable gift annuity. You are entitled to take a charitable income tax deduction in the year you make a gift, with up to five additional years to take any unused deduction. In addition, a portion of the annuity income will be tax-free. When using appreciated securities to make a gift, you will not incur capital gains tax liability at the time of the gift. Instead, some of the annuity income that you would ordinarily receive tax-free will be taxed at the capital gains rate. Under this scenario, you will pay less capital gains tax than you would have if you simply sold the assets. Charitable Lead Trusts A Charitable Lead Trust (CLT) provides current income to a charitable organization during your lifetime for a designated number of years; the assets remaining at the end of the trust term (including any increase in the principal) are then bequeathed to a non-charitable beneficiary (typically an heir) or reverted back to the donor. Thus, a CLT allows you to give immediate income to a charitable organization while also providing for the financial future of you and your heirs. Additionally, this arrangement, which is typically appropriate for large gifts, allows for a lower gift and estate tax cost than if the assets were donated at the end of your life. However, there is no income tax deduction when you first establish the trust. A charitable lead trust can be established as a testamentary trust through your will, although it can also be established during your life. You can fund a lead trust with cash, closely held stock, publicly traded securities, partnership interests, income-producing real estate, or a combination of the above.

24 There are two types of charitable lead trusts, the non-grantor lead trust and the grantor lead trust or reversionary lead trust. Both are described below. Non-Grantor Lead Trust. The non-grantor lead trust is the most com- mon of the lead trusts, and will allow you to provide a temporary gift of financial support to a charitable organization. At the end of the trust term, the trust assets and any additional growth earned revert to your children, grandchildren, or other heirs. A non-grantor lead trust provides a gift tax and potentially an estate tax deduction on the gift interest earned in addition to minimizing intergenerational transfer taxes and ultimately passing ownership to family members. Grantor Lead Trust or Reversionary Lead Trust. At the end of the trust term, a grantor charitable lead trust allows the assets to revert to you or your spouse, rather than to other non-charitable beneficiaries. A grantor lead trust is designed to provide a large and immediate income tax deduction for the present value of the income stream that is paid to the charitable organization during the term of the trust. This strategy may be particularly useful if you need to shift future tax deductions into the current year in order to relieve an immediate tax burden. While there is no income tax charitable deduction available for the annuity interest of a charitable lead trust, if you have significant assets, a non-grantor lead trust will provide significant gift and estate tax relief. The key reason that many investors choose to establish a non-grantor lead trust is to pass property and other assets to family members in a way that shelters them from exorbitant gift and estate taxes. You receive a charitable gift tax deduction for the present value of the annual trust payments to the charity. The amount of this gift tax deduction is typically a large percentage of the total assets contributed to a lead trust, leaving only a small portion of the amount subject to the gift tax. Since the gift tax deduction and the amount subject to gift tax is determined at the time assets are contributed to a CLT, any appreciation of the assets that takes place during the term of the trust is not subject to additional gift or estate tax. As a result, the amount you ultimately transfer to your heirs may be much larger than the amount on which the gift tax is imposed. Furthermore, the income earned by a non-grantor CLT is excluded from your gross income and is therefore not taxable. In effect, this results in a reduction of taxes over the trust term. The assets contributed to a CLT are removed from the taxable estate, reducing estate tax exposure. Grantor CLTs will at some point revert back to the grantor of the trust, and thus you are considered the owner of the trust. As a result, you are taxed on all income generated by the trust, but the present value of that 25 Examples of a Charitable Lead Trust A donor establishes a Non-Grantor Charitable Lead Annuity Trust with a 15-year term and a payout rate of five percent. The trust is funded with appreciated property valued at $1,000,000 with a cost basis of 25 percent. When the trust terminates, the trust principal will pass to the donor’s children. The current IRS discount rate is 4.8 percent

Gift Tax Deduction $535,430.00 Annual Annuity to Charitable Organization $1,000,000 * 5% $50,000.00 Amount Subject to $1,000,000 – Gift Tax Gift Tax Deduction $464,570.00 Gift Tax Paid by Donor Gift Tax Exemption $0 (if no prior taxable gifts) interest is immediately deductible from your income taxes. And, since you legally remain the owner of the trust, there are no gift taxes applied to the principal investment. Private Foundations Affluent individuals with a philanthropic bent might want to consider a private foundation as a way for themselves and other family members to fund worthy causes, while maintaining maximum control over how the money is invested and which organizations receive grants. Private foundations offer maximum control because contributions are invested and managed separately. Most private foundations enlist trust companies to invest the money and handle administration and tax-reporting requirements. Some also hire outsiders to decide how and where to allocate grants. There are approximately 70,000 private foundations in the United States today. To establish a private foundation you must create the organization, establish a board, and get tax-exempt status from the IRS. Once approved the foundation is subject to certain requirements, including payment of an ex- cise tax on net investment income and meeting IRS reporting requirements. The foundation must also distribute at least five percent of net investment assets to qualified charities and other charitable purposes each year. Because establishing and running a foundation can be expensive and time-consuming, the Council on Foundations advises against funding a private foundation with under $10 million, although other groups suggest lesser amounts. The Council on Foundations (www.cof.org) and the Asso- ciation of Small Foundations (www.smallfoundations.org) can provide further information on establishing a private foundation.

26 VI. SPECIAL CONSIDERATIONS FOR GIFTS OF REAL ESTATE, STOCK, RETIREMENT ASSETS, AND INSURANCE

Gifts of Real Estate

FTEN a significant portion of a person’s wealth is in the form of real estate. If you need a new stream of income without selling off, O for example, depreciated stocks, you may want to consider gifts of real estate, including personal residences, commercial buildings, farms, and parcels of land. You may deed the property directly to a charity, establish a life-income arrangement, or negotiate a Retained Life Estate. The last option transfers ownership to the charitable organization while you reside on the property for life or for a period of time, after which the charitable organization receives clear title to the property. Testamentary gifts of real estate through a will are also possible. There are important regulations and procedures that must be followed when a piece of real estate is given to a charitable organization. For example, an appraisal and an environmental review need to be completed. Additionally, there are transfer costs that you are responsible for before a gift can be executed, such as taxes, broker fees, title insurance or review, repairs, rezoning, deed preparation, etc. Gifts of real estate can involve complex issues of valuation, environmental liability, pre-arranged sale, and real estate ownership interests; hence, it is crucial that real estate transfer documents be carefully reviewed by legal and tax counsel and discussed with the charity before any final arrangements are made. For real estate owned and occupied as a primary residence, a married couple can exclude up to $500,000 from capital gains tax upon the sale of the property ($250,000 for an individual). For gains in excess of the exclusion amount, you can use all or a portion of the proceeds to fund a charitable remainder trust fund and avoid all capital gains tax. Unlike a primary residence, for which the IRS provides capital gains exclusions, the sale of a second home may be subject to heavy taxes. By making a gift to a charitable trust, you can receive a charitable tax deduction, avoid capital gains tax, generate income, and remove the property from your estate. Donating real estate can be a strategic financial move. A piece of property or residence can greatly appreciate in value, and the sale of such property can trigger substantial capital gains tax. By choosing to donate real estate, you can avoid some of these taxes. Specifically, you can avoid

27 Example of a Real Estate Gift Harry and Sally have owned their family summer house for 25 years. They are both 74-years old. They bought the house for $100,000 and it is now worth $500,000. If they sold the house, they would owe capital gain taxes of $60,000 (15 percent) However, if they transfer the ownership to a 5 percent Charitable Remainder Unitrust (CRUT) that pays them interest income for life, they avoid all capital gains tax, receive a charitable deduction equal to $242,145, and their projected annual income distribution would be $25,000. The property would also be removed from their estate, thus reducing their future estate tax burden. Transfer Ownership Sell the House to 5% CRUT Capital Gains Tax $ 60,000 $0 Charitable Deduction $ 0 $ 242,145 Projected Annual Income Distribution For Life $ 0 $ 25,000 capital gains tax. Furthermore, such gifts also qualify for a charitable income tax deduction for the current full market value of the property. If you are interested in donating real estate that has gone down in value, it might be more prudent to sell the property and realize the deductible loss. Then you can donate the proceeds to a charitable organization and be eligible to take an income tax deduction for your gift. Gifts of Retirement Assets Qualified Retirement Plan assets make up a substantial portion of many people’s wealth, and yet they are among the most tax-burdened assets one can own. These assets may be held in many different forms, including pensions, profit-sharing, stock bonus plans, IRAs, Keoghs, 401(k)s, and tax-sheltered annuities (e.g., 403(b)s). If a beneficiary of one of these plans dies before the payments end, the balance remaining is added to the decedent’s estate and is thus subject to Federal income tax (up to 35% in 2006), Federal estate tax (up to 46% in 2006), and potentially to the generation-skipping transfer tax (up to 46% in 2006) if the money is given to a person more than one generation removed from the decedent. Although it is possible to roll over the balance of the decedent’s qualified retirement plan to his spouse without paying any estate taxes, the same tax burden will be applied to the assets when the spouse dies. Taking all of this into consideration, donating these assets to a charitable organization can be a strategic tax decision. With all of the taxes levied on retirement assets, it is possible that only 20 cents on the dollar would be left for the decedent’s family, whereas if the assets are donated to charity, those taxes 28 may be avoided. The most straightforward way to make a gift of retirement assets is to name the charitable organization as the beneficiary of your retirement plan. You simply fill out a “Change of Beneficiary Form” provided by your plan administrator. Using such a strategy will help you and/or your beneficiary avoid Federal income taxes, estate taxes, and generation skipping transfer taxes. The tax benefits of naming a charitable organization as the beneficiary of a retirement plan include a charitable deduction on your estate at the time of your death. Unfortunately, no immediate deduction is allowed since a gift of this form is technically revocable. It may be possible in some situations and in conjunction with a current gift, to receive an immediate gift credit for the full amount of retirement plan assets that would be bestowed to the charitable organization at the time of your death. Another strategy is to withdraw money from a retirement plan. As early as age 591/2, participants in retirement plans are allowed to take withdrawals from their accounts with no tax penalty, and by 701/2, participants are generally required to start taking distributions. Making outright gifts to a charitable organization with these payments makes it possible for you to avoid taxes over the long-term while gaining the satisfaction of helping a charitable organization. You can also use withdrawals to fund a life income gift, although the tax incentives are not as great as making an outright donation to charity. Withdrawing funds from a retirement plan may provide more tax relief in the future. As of this writing, withdrawals from retirement plans may be subject to income tax. However, proposed legislation would allow people age 591/2 or older to take money from IRAs and donate it to charity without it being subject to income tax. Even under current law, which taxes such withdrawals, you are eligible to take a charitable income tax deduction for the entire amount of your gift (which is subject to the usual limitations on charitable deductions). Thus, the charitable deduction helps offset the tax on the withdrawal. If you choose to use your withdrawals to fund a life income gift, the charitable deduction will not equal the full amount of the gift. Thus, it is financially strategic to make an outright gift to a charitable organization with payments from retirement assets rather than set up a life income fund. Charitable Bargain Sales A Charitable Bargain Sale is a sale of a piece of real estate to a charity at less than its fair-market value. A bargain sale is often used when you would like to keep a portion of the value of the property you wish to 29 donate. Often that money is used as a down payment on a retirement facility or a new residence. In addition to the money from the sale, you will receive a charitable deduction for the discount taken from the market value of the residence. The process by which a bargain sale takes place is quite simple. You and the charity agree to a purchase price that is less than the property’s fair- market value, as determined by independent appraisal. The charity then has the option of paying the purchase amount upfront or issuing you an installment note for a mutually agreed upon term of years and interest rate. A bargain sale is inexpensive and adaptable to the needs of both you and the charitable organization. The agreement is usually a few pages long and there are no significant legal expenses in setting it up. The terms of the agreement include decisions about the interest rate, down payment, term, frequency of payments, gift portion, and tax deduction—all of which are negotiable and can be adjusted to fit the objectives of you and the charity. A sale of this kind is also tax efficient in that it often produces better tax results than a traditional life income gift (pooled life income fund, charitable gift annuity, etc.). There are a number of tax benefits. When the charity liquidates the property after the bargain sale, you qualify for a charitable income tax deduction and you also avoid capital gains tax on the gift portion of the transaction. You can receive a lump sum for a move to your next home or receive income for a determined number of years. Con- sidering all the complexities involved in the sale of real estate, all bargain sale agreements should be thoroughly examined by lawyers who specialize in real estate, taxes, and charitable giving before any final contract is signed. Gifts of Appreciated Stock More and more people are choosing to give highly appreciated securities to charity. Long-term appreciated securities are among the most popular type of non-cash gifts because these gifts allow donors to convert “paper” wealth into an income-producing asset. Long-term appreciated securities (assets that have been held for more than one year) include stocks, bonds, shares of mutual funds, and closely- held stock. A gift of appreciated stock can be given outright or used to form a life-income plan. You can often choose to give stock that has appreciated greatly in value. You can also use a gift of appreciated stock as a way to rebalance your investment portfolio. When donating shares of an appreciated stock, you receive a double tax benefit. A charitable deduction will be given to you based on the fair market value of the gifted securities, and you avoid all capital gains tax.

30 Example of a Gift of Appreciated Stock A 55-year-old donor held 400 shares of XYZ Technology stock, which he purchased for $15,000 in 1995. The shares are now worth $100,000. The stock pays no dividend. He would like to sell the stock but faces a capital gains tax of $12,750 (15 percent), leaving only $87,250. Instead, he decided to contribute his stock to a Charitable Remainder Unitrust (CRUT) with a payout of 10 percent for life. By doing so, he avoids paying the $12,750 capital gains tax, receives a charitable contribution deduction of $14,733, and pays an income of 10 percent of the value of the CRUT per year for life. For example, if the investment returns of the CRUT were 10 percent every year, the CRUT’s yearly payout would be $10,000. Charitable Remainder Sell the Stock Unitrust Capital Gains Tax $12,750 $0 Charitable Deduction $0 $14,733 Annual Income For Life $0 10 percent of the value of the CRUT

That means that no matter how much a stock has appreciated in value, none of that appreciation will be taxable if the stock is given as a charitable gift. If you use the stock to fund a pooled life income fund, charitable remainder trust, or an annuity fund, you also avoid capital gains tax while enjoying a new income stream and ultimately benefiting the charity. Gifts of Closely-Held Stock The potential for gifts of closely-held stock is continually growing, for a few different reasons. First, the number of individuals who own their own companies has grown substantially in the past decade. Second, owners of closely-held stock have little opportunity to take money out of their business and turn it into cash for their own use without incurring significant salary or dividend taxes. Finally, closely-held stock has a zero cost basis until capital gains tax is added into the equation. Closely-held stock can simultaneously be given to a charitable organization and avoid all capital gains costs, earn a charitable deduction for the fair market value of the stock, and change paper wealth into cash, which makes it appealing to many potential donors. The benefits of giving closely held stock are ample for both the charity and the donor, and there is a particular strategy used. First, the business owner will donate shares of closely held stock to a charitable organization. He is then given a charitable deduction on his income taxes for the fair market value of the donation and avoids all capital gains taxes on the

31 appreciated value of the stocks. Since the charitable organization has no real use for paper wealth, it has the option to sell the shares back to the donor’s company for cash. In this way, the donor receives a charitable deduction and avoids capital gains tax, the charity receives a cash donation, and the company retains full control of their stock. Gifts of Life Insurance Life insurance offers another way to donate. There are four conventional ways you can plan a gift of life insurance. First, you can give an existing life insurance policy directly to a charity, naming the charity as beneficiary and handing over all rights of ownership to the charity. Second, you may main- tain ownership of your policy while naming the charity as the beneficiary. Third, you can take out a new life insurance policy and name the charity as the original policy owner and beneficiary. Last, a life insurance policy can also be used to fund a life-income gift. A gift of a life insurance policy provides the charity with support while also qualifying you for a charitable deduction on your income tax. The amount of the deduction depends on whether the policy is paid up or whether further premiums are required. In order to receive any deduction, you must relinquish to the charity all rights of ownership in the policy and name the charity as the beneficiary. If you retain ownership of the policy but name the charity as the beneficiary, the gift is considered a gift of “partial interest,” which excludes you from receiving an immediate income tax or gift tax charitable deduction. An estate tax charitable deduction will be allowed for the value of the proceeds that pass to the charity at the time of your death. Making a gift of a new life insurance policy in which the charity is the applicant offers two major benefits for the donor. First, the entire initial premium amount donated to the charity is deductible, whereas if the donor had bought the policy and then made the donation, the market value of the premium would most likely decrease, thus affording only a partial deduction to the donor. Second, if the life insurance policy is not made in the name of the donor, it will not be considered a part of their estate. Thus, at death, the value of the policy will escape the taxes incurred on the estate of the deceased.

32 VII. THE IMPACT OF THE 2001 TAX ACT ON GIVING DECISIONS

OTENTIAL donors should consider changes to estate tax laws made by the Economic Growth and Tax Relief Reconciliation Act of P 2001 before making any giving decisions. For some people, the changes may alter giving plans because they reduce or eliminate estate taxes on some estates. An estate may be subject to taxes if it exceeds what is called the exemption equivalent—the amount someone can transfer free of federal estate taxes. The Act provides for phased-in increases in the most important exemption available against the estate tax from 2001 through 2009. The exemption equivalent in 2001 was $675,000, which meant that for a taxpayer dying in 2001 who made no taxable gifts during his or her lifetime, the first $675,000 of that taxpayer’s estate could pass free of estate taxes (leaving aside all other available credits and deductions). Under the 2001 law, the exemption equivalent increases to $2 million in 2006, and to $3.5 million in 2009. In 2010, the estate tax is eliminated for a single year under the “sunset provision.” But absent further legislation, the tax reform mea- sures under the Act will disappear and the applicable law at the time it was enacted will go back into effect. Before the Act, people with reasonably large estates took it as a given that estate taxes would be due upon their deaths, or in the case of a married couple, upon the death of the surviving spouse, and many concluded that it would be practical to reduce those taxes through charitable gifts. As a result of the larger exemption equivalents being phased in, the need to make large charitable gifts to reduce the size of an estate for tax purposes is less relevant for some people in the current environment, and they may wish to reconsider whether there is likely to be any need to make charitable donations to save estate taxes. While future legislation may keep some increases in the exemption equivalent under the new Act from coming into effect, the increases that become effective may not be rolled back. Accordingly, people need carefully consider whether they should make charitable donations to save estate taxes. An exception may be those with very large estates because unless estate taxes are eliminated altogether, their estates are likely to continue to owe estate taxes. At this point, the full impact of lowering or eliminating the estate tax on charitable contributions has yet to be determined. Reducing the estate tax 33 by exempting more wealth from the tax has two separate, opposite effects. By raising after-tax wealth, the lower tax may induce some people to give more to charity. At the same time, those individuals newly exempt from the estate tax have less incentive to give and may reduce their giving. According to an analysis from the Congressional Budget Office, perma- nently raising the amount of wealth exempt from the estate tax to either $2 million or $3.5 million would reduce charitable giving by less than three percent, as increased giving by the wealthiest donors would partly offset lower giving by donors with wealth below those cutoffs. However, perma- nently repealing the estate tax would cause a larger estimated decline in charitable giving—of six percent to 12 percent. For the federal government, reduced giving would directly raise income tax revenues by lowering the amounts claimed as itemized deductions for charitable contributions. That revenue gain would partially offset the loss in revenue caused by repealing the estate tax. These are merely projections. The issue of how much changes in the tax laws affect charitable contributions is far from settled. Tax rates have changed enormously over past century; the impact of these changes on charitable giving has often been weaker than economists predicted. (Giv- ing seems to fluctuate more in response to temporary tax changes than “permanent” changes; as currently written, the 2001 change in the estate tax law is a temporary change, but portions of it may yet be extended beyond 2010.) Taxes clearly affect the cost of giving, but for most people they are not the major reason to give.

34 Appendix COORDINATING PLANNED GIVING WITH LIFETIME GIFTS TO FAMILY MEMBERS

ANY individuals and families who make charitable contributions as part of a planned giving program are also in a position to Mmake lifetime gifts to children and other family members to accomplish basic estate planning and tax objectives. This chapter will cover basic information about gifting to family members, including “annual exclusion” gifts and gifts for college and related expenses. Family Giving: The Basics The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced interest loan, you may be making a gift. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts: (1) gifts that are not more than the annual exclusion for the calendar year; (2) tuition or medical expenses you pay directly to a medical or educational institution for someone; (3) gifts to your spouse; (4) gifts to a political organization for its use; and (5) gifts to charities. Gifts qualifying for the annual exclusion from gift tax—often called “annual exclusion” gifts—are completely tax free and you do not have to file a gift tax return. A separate annual exclusion applies to each person to whom you make a gift. For 2006, the annual exclusion is $12,000. Therefore, you generally can give up to $12,000 each to any number of people in 2006 and none of the gifts will be taxable. If you or your spouse make a gift to a third party, the gift can be considered as made one-half by you and one-half by your spouse. This is known as gift splitting. Both of you must consent (agree) to split the gift. If you do, you each can take the annual exclusion for your part of the gift. In 2006, gift splitting allows married couples to give up to $24,000 to a person without making a taxable gift. If you split a gift you made, you must file a gift tax return to show that you and your spouse agree to use gift splitting. “Annual exclusion” gifts can be particularly valuable in a second mar- 35 riage situation, where spouses can help each other make the full $24,000 per donee per year gifts without having to contribute to the other spouse’s gifts. A husband and wife can “split” the gifts that each of them makes in a year, even though each contributes the full amount of all the gifts to his or her donees. To do so, the couple must file a gift tax return whereby each spouse agrees to such “split” gifts. Alternatively, spouses could first transfer the funds into a joint account, with each spouse contributing $24,000 times the numer of donees he or she plans to make gifts to in the year. Then the spouses can make $24,000 gifts to their children and grandchildren from the joint account without the need to file a gift tax return, since each gift will then be considered made one- half by each spouse. Additional gift tax exclusions over and above the annual exclusions are available for gifts made (1) for tuition of a beneficiary if made directly to the educational institution involved, and (2) for payments of a beneficiary’s medical expenses, or for medical insurance for him or her, if made directly to the health care provider or insurer. Thus, under these exclusions, a grandparent could pay a grandchild’s college tuition each year and pay the grandchild $12,000 for room and board at college. When selecting property to be used for lifetime gifts, it is important to remember that if appreciated property is given away during one’s lifetime, the donee takes the donor’s basis for capital gains purposes. When the property is held until a person’s death, the individuals to whom the property passes get a stepped-up basis in the property—its fair market value at the decedent’s death. This means that in making lifetime gifts to individuals, the donor might wish to consider using money or other property with little or no appreciation to make the gifts, and retaining highly-appreciated assets so that they will get a “step up” in their bases at death. Note that under the 2001 tax Act, for the one year in which the estate tax is to be eliminated in 2010, the “step up” basis is limited. The estate of each decedent who is a U.S. citizen can elect to “step up” the basis on $1.3 million in property no matter who it passes to and on an additional $3 million if it passes to a surviving spouse. Property in an estate in excess of the amount that can be exempted no longer will receive a “step up.” Al- though these limitations may never actually come into affect, persons with large estates should be careful to keep detailed records of the bases of their assets. There are a number of other ways to make lifetime gifts to family members, including “sprinkle” trusts, funding a 529 college savings plan, or contributing to Coverdell Education Savings Accounts. Those inter-

36 ested in these options, and in making lifetime gifts to family members in general, should consult a tax professional for guidance. For more information about the American Institute for Economic Research’s charitable giving programs, please contact Shaun Buckler, Chief Financial Officer, by phone, mail, or e-mail: American Institute for Economic Research P.O. Box 1000 Great Barrington, MA 01230 413-528-1216 ext. 3146 [email protected]

Examples presented in this booklet are for illustration purposes only and are not intended as legal or tax advice. You should consult legal and tax advisors prior to making any decisions based on this book.

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