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Checklist: 1040 Planning Idea

mug martin shenkman√ MULTI-GENERATION CRT

Blended families are common, perhaps the norm (only about 20% of family units are comprised of traditional intact families). For many of these clients portability solves any estate tax concerns. The real issue is planning to protect children of a prior marriage, the current spouse and doing so when the primary estate asset is an IRA. A multi-life charitable remainder unitrust (CRUT) can provide an approach that addresses these planning challenges. The IRA can be bequeathed to a CRUT that initially benefits the surviving spouse and mandates a 5% payout. Following the death of the surviving spouse the CRUT continues for the named children of the prior marriage paying them 5% for life and on their demise the remainder passes to a qualified charity. Thus, the IRA provides for the spouse to support her for life, and then passes the benefits to the children after her death, all in an income tax efficient manner. Use of CRTs for IRAs of non-taxable estates was a concept probably many had not considered. This can provide a valuable and better approach than the traditional credit shelter trust when the primary asset is an IRA.

√ SINGLE MEMBER LLCS

Real estate values have grown substantially in recent years so it is likely practitioners will see more clients considering donations of appreciated real estate. An issue many real estate donations raise is the donee charity’s concern about potential environmental risks. In some cases appropriate due diligence can be done before the donation is contemplated, but this is not always feasible. What can be done? The donee charitable organization may accept the contribution of donated property in the name of a single member LLC. This will enable the charity to insulate itself from any potential environmental liability associated with the property by confining that risk inside the single member LLC. This will not jeopardize the donor’s income tax deduction. Notice 2012-52, 2012-35 IRB.

√ INVENTORY

Charitable contributions of inventory are only deductible up to the income tax basis of property. Clients, especially those with informally run closely held businesses, not realizing this limitation may donate unneeded business property and simply list it as another non-cash contribution. IRC Sec. 170(e).

√ BEQUESTS

Many clients do not face an estate tax so a bequest to charity will provide no tax benefit. Consider having the bequest paid in advance of death so that an income tax deduction may be realized. Be certain to have the charity sign a written acknowledgement that the gift is an “advancement” of the bequest to avoid the client being held responsible twice.

√ ADD CHARITY TO BYPASS TRUST BENEFICIARIES

It has not been conventional to permit charitable gifts from a bypass trust, since the goal historically has been to maximize the assets outside the surviving spouse’s estate. Instead charitable bequests could be made by the surviving spouse or from the estate of the surviving spouse to garner an estate tax charitable deduction. However, the new tax paradigm might provide an incentive to rethink this traditional approach. If the family unit has charitable giving objectives, then selecting the optimal source from which to fund those charitable gifts could maximize the overall tax benefits of the contributions. The bypass trust might be in a higher income tax bracket than any family member so that distributions to charity may provide the biggest tax bang for the buck. Further, if the family unit will be making charitable donations in any event, using highly appreciated assets inside a bypass trust to fund charitable bequests may be a cost effective and simple means of avoiding future capital gains taxes without the risks associated with general powers or other approaches.

√ DEFINED VALUE MECHANISM

These have become common in estate planning for large estate planning transactions such as sales to grantor trusts, distributions in kind from GRATs, etc. When structuring such transactions the optimal spillover receptacle is a charity. If a charity is named it involves a third party that helps give support to the validity of the overall transaction. Public policy should also seem to favor protecting a potential gift to charity.

√ CHARITABLE LIMITATIONS

Contributions, reported on Form 1040 are deducted on Schedule A (below-theline deductions) and are subject to the 50%, 30%, or 20% of adjusted gross income (AGI) limitations. In contrast, however, on a Form 1041 for a complex (non-grantor) trust the charitable contribution deduction is reported abovethe- line and there are no percentage limitations. This is because the trust is governed by IRC 642(c) instead of IRC 170. So charitable trusts can provide a significant income tax advantage over individuals making a comparable donation. The deduction, on a complex trust, might shift net investment income (NII) for purposes of the 3.8% surtax from the trust to the tax-exempt charitable beneficiary. Practitioners should consider recommending that when clients are planning trusts, when appropriate, charitable beneficiaries or the right to make contributions, be included.

√ REMAINDER

Interest in Residence and Farms Generally, a charitable deduction is not permitted for charitable gifts of less than a donor’s entire interest in property. IRC Sec. 170(a)(3). Donations of a remainder interest in a farm or residence is subject to special and favorable rules. A client can donate a remainder interest in a residence, live there for the rest his or her life, yet gain a current income tax deduction. Home sale prices have recently fully recovered since the recession. The current low interest rates, combined with high home prices, make this a particularly valuable technique now.

√ CHARITABLE PLEDGES

It is not uncommon for clients to make commitments to charity. While this can be noble, if it is not preceded by rationale financial planning and forecasts, a client might find themselves in an awkward financial position where they may not feel comfortable carrying out the pledge. Children, or other heirs, when they become aware of the pledge might also try to convince the parent/donor to cancel the pledge in order to enhance their future inheritance. The enforceability of a charitable pledge will depend on state law and the facts involved. Some states will permit a charity to enforce a pledge even if there was no consideration given and even if the charity did not take steps to rely on that pledge (e.g., begin construction of a building based on a large pledge). Some courts will enforce a charitable pledge simply because of the social desirability of assuring that donors meet pledges. More Game Birds in America, Inc. v. Boettger, 125 NJL 97, 101 (1942).

√ IS IT DEDUCTABLE?

If a charity solicits donations to fund a particular projection, e.g., building a school, and if the condition of the solicitations is that the donations will be returned if the minimum funds are not received sufficient to fund the designated project, the client/donor cannot deduct the donated funds until it is assured that the condition will be met. Rev. Rul. 77-148, 1977-1 CB 63.

√ NAMING RIGHTS

Donors will often negotiate as a condition of their donation that a building be named after them. This presents a house of issues that practitioners are likely to become more involved with over time. First, there must be a donor agreement that clearly addresses all aspects of the naming in writing. While counsel is likely to be involved in the drafting, CPA practitioners should still play an active role. Be certain the client’s concerns as well as practical issues are addressed. How long does the charity agree to use the client/donor’s name for? What if the building is renovated? Demolished? Repurposed? How will the donor’s name be displayed? There is another issue that could raise potentially significant tax issues. If a wealthy retired donor negotiates to have a town theater named for her, there may be no income tax implications and the full amount of the donation may be deductible (subject to the usual charitable giving limitations). But what if the client/donor is currently involved in and owns a family business that operates real estate in the same locale that the theater that is being named will be located. Will the value of that naming right provide economic benefit to the local family business? Depending on the circumstances it might well provide a significant benefit. Does the value of that economic benefit have to be applied to reduce the potential charitable gift for income tax deduction purposes? The law is not clear and these situations could be very fact sensitive. The donor agreement counsel negotiates to confirm the naming right itself might be the primary document the IRS uses to challenge the deduction.

√ REFUND OF PLEDGE

If a charity makes a commitment to a client/donor to use the funds donated for a specific purpose but reneges on that application of the donated funds, the donor might be able to receive a refund of the donation. In one particular case the charity committed to build a modern animal welfare facility designed to serve a particular geographic region and to name seal rooms to be located in the new building for the donors. Instead, the charity unilaterally opted to build a smaller building without the separate rooms thereby negating the naming opportunity. The donors sued and received a refund of their donation. Adler v. SAVE, 432 N.J. Super. 101, 74 A.3d 41 App.Div. (2013).

√ QUALIFIED APPRAISAL

Practitioners should exercise care to assure that when a client submits an appraisal to support a contribution that the appraisal meets all the criteria for a qualified appraisal if required or the donation may be denied. No charitable contribution deduction is permitted for donations exceeding $5,000 (excluding cash or marketable securities) unless the donor obtains a “qualified appraisal” by the due date of the return. Treasury Regulations Sec. 1.170A-13(c)-13 list the details of these requirements. In one case the taxpayers donated residential property but the appraisal report submitted with the return neglected to include several required items necessary to a qualified appraisal: the expected date of the property being contributed to the city, the terms of the agreement between taxpayers and the city as to the use/demolition of the property, the appraiser’s qualifications, and the required statement that the appraisal was prepared for income tax reporting purposes. JAMES HENDRIX, ET AL., Plaintiffs, v. UNITED STATES OF AMERICA, Defendant Case No. 2:09-cv-132. The strict rules for what constitutes a qualified appraisal prohibit a party to the transaction from giving the appraisal. This can present a challenge when life insurance is donated because the insurance company who issued the policy, and likely would provide the Form 712 that is used to determine value, may not be able to be a qualified appraiser under these rules.


Martin M. Shenkman is the author of 42 books and more than 1,000 tax related articles. He has been quoted in The Wall Street Journal, Fortune, and The New York Times. He received his BS from the Wharton School of Pennsylvania, his MBA from the University of Michigan, and his law degree from Fordham University.