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When Clients Wish to Restrict Charitable Gifts

Philanthropic clients sometimes have an interest in making gifts or bequests to specific projects or programs of a charity, rather than for the general purposes of the organization. Gift restrictions have practical implications for the donee organization, and may present tax issues for the donor’s estate. Several issues arise: (1) How will the restriction be enforced? (2) Does a bequest restriction risk disqualification from the estate tax charitable deduction (assuming the estate is subject to state or federal estate taxes or inheritance taxes).

As to enforcement, a bequest can be drafted as a conditional bequest that would fail upon the occurrence or nonoccurrence of some event. A conditional bequest to charity is deductible for estate tax purposes if, at the time of the decedent’s death, the possibility that the bequest will fail is so remote as to be negligible [Reg. §20.2055-2(b)(1)]. It is important to emphasize that the remoteness of the possibility is determined as of the date of death, without regard to what actually happens subsequently. Thus, a bequest to an orphanage conditioned upon the orphanage’s not moving from the county where it was located was ruled to be deductible, because the possibility that the orphanage would move was found to be highly improbable as of the date of the testator’s death [Rev. Rul. 67-229, 1967-2 C.B. 335]. Other examples:

• Even where a museum could be divested of ownership of artwork in the event it attempted to sell or dispose of the pieces, the donor would nevertheless be entitled to an estate tax deduction for the fair market value of the collection. Ownership would pass instead to a private foundation established by the donor. Because the works will always be held by an exempt organization, the deduction would not have to be reduced (PLR 200418002).
  
  
• A charitable deduction was allowed for a bequest to a school to establish a scholarship where the principal amount of the bequest would revert to the decedent’s children or grandchildren if the school ceased to exist or lost its state accreditation. The IRS ruled that, under the facts and circumstances of the case, the possibility of reversion was so remote as to be negligible (TAM 9443004).
  
  
• The IRS found that a charitable deduction would be available for an estate that left several bequests to charity on the condition that the charitable beneficiaries not initiate a will contest. The IRS said that the chances that a charity would contest the will were so remote as to be negligible (PLR 200505008).

 

 

Avoiding Confusion in Charitable Bequest Planning

Lucille Kramer’s inter vivos trust provided that, after her death, 15% of the remaining property was to pass to “Maryknoll, in Maryknoll, NY.”  Another 10% went to her church, and the balance was to be distributed to her children.  Although there is no organization known simply as Maryknoll in Maryknoll, NY, there are three charities – Maryknoll Lay Missionaries, Maryknoll Sisters and Maryknoll Fathers and Brothers.  The three charities, with the consent of the state’s attorney general, filed a stipulation under which the 15% share would be divided equally.  The Surrogate’s Court noted that where the identity of the charity cannot be determined, cy pres may be applied, provided a general charitable intent is evident.  The court found that Kramer had a charitable intent and that the court had jurisdiction to determine matters relating to inter vivos trusts, concluding that the proposed distribution would best effectuate Kramer’s intent (In the Matter of the Application of Lucille C. Kramer, 2008 N.Y. Slip Op 28184).

The Kramer case makes it clear that several inquiries may need to be made beyond simply ascertaining a charitable legatee’s correct legal name and location:

• Is this an organization with a single location?
• If this is a charity with multiple locations (such as a nonprofit healthcare system), is it possible or desirable to restrict the client’s bequest to use in a particular geographic area?
• Is the organization a national charity with affiliates?  Does the client wish to restrict the bequest to the activities of a local affiliate?
• Is this a national charity with wholly owned or controlled subunits?  How will the organizational structure affect the application of bequest monies in the absence of restrictive language in the will?
• What will provisions are appropriate to clarify geographical designations and other bequest restrictions?
• What are the client’s alternatives if the charity is unable or unwilling to use bequest funds locally, or in the manner desired by the testator?

 

The “Kiddie Tax” and CRTs for College Education

The 2007 Small Business and Work Opportunity Act extended the kiddie tax to children age 18 and below (formerly 17 or younger) and to full-time college students under age 24, unless a student’s earned income exceeds half of his or her support (H.R. 2206).  The “kiddie tax” threshold increased to $1,900 for 2009 (investment income over that amount is taxed at the kids’ parents’ tax rates).  Can a unitrust designed to provide funds for students while in college still work?  The answer should be yes, if the trust is invested to provide favorably taxed income.  A college unitrust, invested to generate primarily long-term capital gains and qualified dividends, can be tax-efficient even where the beneficiaries’ parents are in a 33% or 35% federal tax bracket.   Such a plan would enable beneficiaries to enjoy income taxed at a 15% rate, under current law.  In some cases, part of the beneficiaries’ payout may be tax-free return of corpus, reducing tax rates on the unitrust amount to below 15%. 

Suppose a grandfather transfers a $200,000 stock portfolio with an aggregate basis of $100,000 to an 8%, 20-year college unitrust, with a “flip” provision.  The stocks earn 1% dividends and grow at an annual rate of 8%, so that after nine years the trust has expanded to $400,000 (dividends are paid out annually but capital gains are not).  The trust flips to become a standard payout unitrust in Year 10, when the oldest grandchild, now age 18, starts receiving 8% of $400,000.  The stocks pay 1% dividends ($4,000) annually, so the trustee must sell $28,000 of stock the first year to pay the grandchild the remaining $28,000 due him (a $32,000 total unitrust amount).  The sale results in $21,000 of long-term gain and $7,000 tax-free return of corpus (basis).  Under 2009 law, $1,900 of capital gains/dividends would be tax free, assuming the grandchild is in a 15% tax bracket; $7,000 would be tax-free return of corpus and the remaining $23,200 of payout would be taxed at the 15% rate applicable to capital gains and dividends . . . an average 10.9% tax rate.  It should be mentioned that the donor also receives a charitable deduction of about $40,000 in the year the trust is created.

Is it reasonable to expect such large distributions of capital gain income from the unitrust?  Based on the IRS’s Winter 2009 Statistics of Income, the answer seems to be yes.  IRS statistics on split-interest trusts indicated that unitrust distributions from “Tier Two” (long-term capital gains) accounted for 51% of all payouts to beneficiaries.

Note: This discussion presupposes that the grandparent who funds a “college unitrust” has the twin goals of helping charitable organizations and supplementing grandchildren’s college education.  There are many other plans for funding college educations that provide more funds for college but do not benefit worthwhile causes. 

 

 

Maximizing the Value of Savings Bonds in an Estate

Mr. P has been a patriotic saver all his life and is proud that he has accumulated $230,000 of U.S. savings bonds during his lifetime.  He plans to leave the bonds to Mrs. P in his will, to provide for her security, but was surprised to learn that Mrs. P will have to pay substantial income taxes on every bond she cashes.

Gift planning solution:  Mr. P decides to leave the bonds to a tax-exempt charitable remainder trust in his will.  The trustee can cash the bonds without owing income tax, reinvest the proceeds and pay Mrs. P a good income for life.

 

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