Gift Planning Tips

Escaping Tax on Excess Life Insurance

Workers whose employers provide group term life insurance are subject to income tax on the premiums for coverage in excess of $50,000 [Code §79(a)].  The amount included in income is not the actual cost of the coverage, but the uniform premiums of Table 1 in Reg. §1.79-3.  For example, the cost per month for $1,000 of life insurance protection for an individual age 35, is $0.09, ($1.08 annually) making the taxable cost of an additional $50,000 of insurance $54 ($1.08 x 50).  The tax does not apply to any amount paid by the employee toward his or her own coverage.

One way for the philanthropically inclined employee to avoid the tax is to designate charity as the beneficiary of insurance amounts in excess of $50,000.  Premiums attributable to the portion designated solely to charity for the entire year are not included in the employee’s income, although there is no income tax deduction [Reg. §1.79-2(c)(3)].

ESOP's Charitable Fables

One way for a business owner to postpone the recognition of capital gains tax on the sale of a company is through the establishment of an employee stock ownership plan (ESOP) — a form of retirement plan [Code §1042(b)(1)].  Proceeds from the sale must be reinvested in the stock of domestic corporations to qualify for the deferral.

The owner’s basis in the qualified replacement stock is the same as the basis of the shares transferred to the ESOP, but no capital gains tax is due until the replacement stock is sold.  Recapture of the capital gains tax can be avoided if the shares are given away, including to charity [Code §1042(e)(3)(C)].  The IRS has ruled that an outright gift of qualified replacement property to charity falls within the recapture exception (Letter Ruling 9533038) and qualifies for a charitable deduction for the fair market value.  The replacement shares can also be used to fund a charitable remainder trust that provides lifetime income to the owner and eventual benefit to charity (Letter Rulings 9438012, 9438021 and 9533038).  In a variation on funding the remainder trust with replacement property, the business owner can fund the trust instead with shares in the C company stock and allow the trustee to sell the shares directly to the ESOP, provided there is no requirement that the trustee sell the shares to the ESOP.  This bypasses the Code §1042 requirements entirely.

Leading Donors to Bigger Deductions

Philanthropic clients who plan to retire within a few years might not realize that lowered retirement income means reduced charitable deduction limits (50% or 30% of AGI for gifts of cash or appreciated assets, respectively).  A good strategy is to maximize the income tax deduction during high-income years.  One way a client can accomplish this goal is by funding a reversionary charitable lead trust with municipal bonds prior to retirement.  The donor receives an income tax deduction, offsetting some tax on earnings.  Because trust assets will return to the donor at the end of the trust term, the donor is subject to tax on the trust’s income each year.  However, the income generated by the municipal bonds will be tax free.  Under currently low §7520 rates, deductions for charitable lead trusts are higher.  For example, a $50,000 charitable lead annuity trust that pays charity 2% annually for ten years generates a deduction of $40,923 using May’s 1.8% §7520 rate.  At the end of ten years, the assets return to the donor.

How Long Can Trusts Last?

The payment of a charitable remainder annuity trust or unitrust may not extend beyond the lives of one or more named individuals and a term greater than 20 years.  For example, the governing instrument may not provide for a payment to Adam for life, then to Ben for a term of years, with Ben’s share payable to his estate in case he does not survive Adam for the full term, because the period of the payment may extend beyond both the lives of Adam and Ben and a term more than 20 years.  On the other hand, the governing instrument may provide for a payment to Adam for life, then to Ben for life or a term less than 20 years, whichever is shorter, since it is not possible for the period of payment to extend beyond the lives of Adam and Ben [Reg. §§1.664-2(a)(5)(i), 1.664-3(a)(5)(i)].  This may be an attractive option for an older donor who wants a family member or friend to benefit in the event the donor dies shortly after establishing the trust.  However, it’s important to remember that the value of the charitable remainder must be at least 10% of the net fair market value of the assets transferred to the trust on the date of the gift [Code §§664(d)(1)(D), 664(d)(2)(D)].


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