Gift Planning Tips

Challenges with Gifts of Intellectual Property

Donors of patents, trademarks, copyrights, trade names and other intellectual property –
so-called qualified intellectual property – are allowed to deduct only their cost basis (or fair market value, if less). However, such donors are entitled to deduct a certain amount of “qualified donee income” charities receive from donated patents or other property for a period of 12 years [IRC §170(m)].

Donors must inform the charity that they are making qualified intellectual property contributions and the donee charity must prepare an annual return showing the amount of income received.

Obviously, charity may continue to benefit from the patent long after the initial 12 years.  Patents and other intellectual property formerly were treated as capital assets and deductible at fair market value, not cost basis, until passage of the American Jobs Creation Act of 2004. Some commentators suggested that the 2004 law changes may have killed off gifts of intellectual property, but Congress nonetheless provided a mechanism for donors to deduct payments actually received by charity on a sliding (declining) scale over 12 years, ranging from 100% to 10% of charity’s “qualified donee income.”  (See the table on page 2-8(c) of the Charitable Giving Tax Service.) Reg. §1.6050L-2, provides computation examples and sets out information that donors must provide to recipient charities, as well as reporting requirements of charities, which include furnishing of Form 8899, “Notice of Income from Donated Intellectual Property” to the donor and IRS.



Nonqualified Charitable Remainder Trusts Worth a Look

Most donors and their advisers want to ensure that charitable remainder trusts satisfy all the requirements of IRC §664 and thus qualify for charitable deductions and tax-exempt status.  CRTs must be in the form of a charitable remainder annuity trust [IRC §664(d)(1)], charitable remainder unitrust [IRC §§664(d)(2) and (3)] or a pooled income fund [IRC §642(c)(5)] to entitle the donor to an income tax, gift tax or estate tax charitable deduction. Failure of a trust to qualify means lost tax deductions and loss of tax-exempt status, and the IRS could also impose gift tax on the charitable remainder interest.

In the case of a testamentary trust, an estate tax charitable deduction may not be necessary – if the client’s estate is sheltered by the estate tax exclusion ($5.34 million for 2014).  Consider Larry, who has an estate of $4,000,000. He wants to establish a trust that benefits his only sister, Karen, and have the assets eventually pass to his favorite charity. But Larry doesn’t want Karen’s payments to be limited to a specified dollar amount or percentage, as would happen with an annuity trust or unitrust.  He would like her to have all the income generated by the trust assets, and also give the trustee the right to distribute corpus to Karen if she needs additional funds. 

Larry could create a nonqualified testamentary CRT that achieves the above goals.  At Karen’s death no part of the trust will be included in her gross estate, unless she held a general power of appointment. Charity is entitled to as much or little as is left in the trust at Karen’s death. Because the trust is not a charitable remainder trust, it is not subject to the private foundation rules [IRC §§4941, 4943, 4944, 4945].

Drawbacks to a nonqualified trust?  Larry’s trust is not a tax-exempt entity. Therefore, the sale of assets within the trust will not avoid capital gains tax or net investment income tax. This may not be much of a concern with a testamentary trust, where the assets funding the trust would receive a stepped-up basis at Larry’s death. Taxes may be a problem, however, if the trust is funded with U.S. savings bonds, IRAs or other income in respect of a decedent. In addition, the trust will be subject to income tax on income that is not distributed to Karen – at steep rates.  In 2014, trusts reach the top 39.6% tax bracket when taxable income exceeds $12,150.



Who Gets Custody of the Unitrust When a Couple Splits?

Helen and Bob created a net-income with make-up charitable remainder unitrust, naming themselves as trustees and life-income beneficiaries. Sometime later, they judicially converted the trust to a straight unitrust. They are now in the process of divorcing and want to divide the unitrust into two separate trusts. Assets of the original trust will be allocated and divided equally, on a pro rata basis, between the two new unitrusts. Terms of the unitrusts will be the same, except that Helen will be the sole unitrust beneficiary of one trust during her lifetime. At her death, the payments will continue for Bob’s lifetime. Bob will be the primary beneficiary of the second unitrust, with Helen the successor beneficiary if she survives him. Each will serve as trustee of his or her own trust and have the right to designate the remainder beneficiaries.

The IRS ruled that the division of the original trust and distribution of the assets to the two new trusts will not cause the original trust or either of the new trusts to be disqualified under IRC §664. The basis and holding period of the assets in the new trusts will be the same as they were prior to the division of the original trust. The IRS also ruled that, provided the expenditures are reasonable, the payment by the trust of legal and other costs associated with the trust division will not be self dealing under IRC §4941 and will not be a taxable expenditure under IRC §4945 (PLR 200301020).


Co-investing Charitable Trusts with Remainder Beneficiary’s Endowment

Some organizations are reporting increased interest among donors in establishing charitable remainder trusts and charitable lead trusts that are co-invested with the charity’s endowment funds.  In 2003, the IRS gave the green light to Harvard University to invest the assets of charitable remainder and lead trusts along with the school’s endowment. The ruling (PLR 200352017) noted that the endowment was invested in a widely diversified portfolio, including public equities, bonds, private equity and real estate.

Although much of Harvard’s endowment income is in the form of passive dividends, interest and long- and short-term capital gains, some is debt-financed or otherwise treated as unrelated business taxable income. The university indicated that many donors had expressed interest in having their trusts match the return on the school’s endowment, which had significantly outperformed the trusts that the university manages as trustee.  Harvard’s plan was to enter into contractual obligations with interested donors under which it would issue a contract right to each participating trust for “units.” The value of the units would be nominally tied to the value of the endowment and would entitle the trusts to receive periodic payments based on the number of units owned.

The IRS ruled that the issuance of units to the trusts, the making or receipt of payments with respect to the units and the holding or redemption of the units was not a “commercial venture” that would generate unrelated business taxable income to Harvard.


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