taxation of charitable gift annuities

Taxation of Charitable

Gift Annuities

Russell James, J.D., Ph.D., CFP®

Professor, Texas Tech University


Gift Annuities

1. Calculating the deduction

Charitable Deduction

Ordinary Income

Tax Free Return of

Investment

Capital Gain

Gift Taxes

$4,000

Annuity

Charitable deduction

is the value of

what you give less the value of what you get

back

$100,000 Cash─ Value of AnnuityCharitable Deduction

Donor gives

$100,000

Charity pays age 55 donor

$4,000 per year for life

$4,000

Annuity

$100,000Cash

What is the value of an annuity?

Find the §7520 rate https://www.irs.gov/businesses/small-businesses-self-

employed/section-7520-interest-rates

Multiply annual payment by annuity factor in IRS Pub. 1457

https://www.irs.gov/retirement-plans/actuarial-tables

Value of annuity

Section 7520 Interest Rates

Valuation Month

120% of Applicable Federal Midterm Rate

Section 7520 Interest Rate

Revenue Ruling

November 2016 1.61 1.6 Rev. Rul.

2016-26December

2016 1.76 1.8 Rev. Rul. 2016-27

January 2017 2.36 2.4 Rev. Rul.

2017-2



Choose current or one of last

two month’s rate

$4,000/year age 55 donor on 1/31/17

Nov 1.6%Dec 1.8%Jan 2.4%

Value of fixed

annuity

Section 7520 Interest Rates

Valuation Month

120% of Applicable Federal Midterm Rate

Section 7520 Interest Rate

Revenue Ruling

November 2016 1.61 1.6 Rev. Rul.

2016-26December

2016 1.76 1.8 Rev. Rul. 2016-27

January 2017 2.36 2.4 Rev. Rul.

2017-2

Find the §7520 rate

2.4%https://www.irs.gov/businesses/small-businesses-self-



For the lowest annuity

valuation [highest

charitable deduction]

select

Jan. 2.4%

Table S - Based on Life Table 2000CMInterest at 2.4 Percent

Age Annuity Life Estate Remainder Age Annuity Life Estate Remainder

0 34.2376 0.82170 0.17830 55 18.1993 0.43678 0.56322

1 34.3011 0.82323 0.17677 56 17.7570 0.42617 0.57383

2 34.1418 0.81940 0.18060 57 17.3129 0.41551 0.58449

3 33.9727 0.81534 0.18466 58 16.8678 0.40483 0.59517

4 33.7967 0.81112 0.18888 59 16.4213 0.39411 0.60589





$4,000 X 18.1993www.irs.gov/retirement-plans/actuarial-tables






$4,000 X 18.1993www.irs.gov/retirement-plans/actuarial-tables

Value of annuity

$72,797.20

If annuity pays more

than annually, add adjustment factor from

Table K


$100,000Cash

Donor gives

$100,000



$4,000

Annuity

$100,000 Cash─ $72,797 Annuity

$27,203 Deduction

2018 2019 2020 2021 2022 … Death

…

2017

IRS requires annuity

value <90% of transfer

If charitable deduction is not >10% of transfer, it

doesn’t qualify




www.irs.gov/retirement-plans/actuarial-tables

Value of annuity

For two lives use Table R

Annuity factor is(1-remainder)

§7520 rate

Charitable deduction

is the value of what you give less the value of

what you get back


Gift Annuities

1. Calculating the deduction


Gift Annuities

2. Taxes onpayments


Ordinary Income

Tax Free Return of

Investment

Capital Gain

Gift Taxes

$4,000

Annuity

Part of each annuity check just gives you back some of the money you paid

Initial Gift

Annual Payments

Charity $100,0001/31/2017

Donor $4,0001/31/2018

1/31/2019

1/31/2020

+ Return of InvestmentEarnings

Initial Gift

Annual Payments

Charity $100,0001/31/2017

Donor $4,0001/31/2018

1/31/2019

1/31/2020

+ Return of InvestmentEarnings

The rest is earnings (taxable)

Suppose you put some

money in the bank

Each year you withdraw all

of the interest and some of

what you originally put

in

Do you pay taxes when

you withdraw the money

you originally put in?




No.

That is like getting your own money back that you buried in the ground




No.

Do you pay taxes on the

interest earned?


interest earned?

Yes.


interest earned?

Yes.That is new money you didn’t have

before

The idea of taking all of the interest and some of the principal each year is similar to an

annuity

Each annuity check has some earnings and some return of original investment

earnings

return of original

investment

How much of each annuity check is return of the money you put in originally?

earnings

return of original

investment

$ used to buy annuityOriginal life expectancy

earnings

return of original

investment

Annual return of investment=

NOT the deductible gift part of the transaction

$100,000Cash

$4,000

Annuity

Donor gives

$100,000





$100,000Cash

$4,000

Annuity

Donor gives

$100,000

$ used for annuity partOriginal life expectancy



$100,000Cash

$4,000

Annuity

Donor gives

$100,000

*Original life expectancy is a euphemism for “Expected Return Multiple”. The table is found in Code of Federal Regulations 26§1.72-9. Adjustment for payment timing is in CFR 26§1.72-5(a)(2)(i)

$72,797 annuity portion cost

21.7 years*

$ used for annuity partOriginal life expectancy



$100,000Cash

$4,000

Annuity

Donor gives

$100,000

$72,797.2021.7

$72,797 annuity portion cost

21.7 years

= $3,354.71

2018 2019 2020 2021 2022 Life Expectancy

2017

Tax free return of investment is divided among each expected payment

Original Investment

…

2018 2019 2020 2021 2022 Life Expectancy

2017

Annuity payments after life

expectancy are 100% taxable

because all original investment has been returned

…

2018 2019 2020 … 2029 Life Expectancy Death

2017

…

$4,000Ordinary income


$3,355Tax freereturn

of invest-ment$645

Ordinary income


of invest-ment$645

Ordinary income


of invest-ment$645

Ordinary income


of invest-ment$645

Ordinary income

2018 2019 2020 … Death… 2029 Life Expectancy

2017


of invest-ment$645

Ordinary income

If early death, donor’s last tax return deducts original investment not yet given back


of invest-ment$645

Ordinary income


of invest-ment$645

Ordinary income

Compare a cash charitable gift annuity vs. splitting the gift amount between a

commercial annuity and an immediate gift

vs.$4,000

$4,000

Charity

Donor

Insurance Company

Donor

Charity

vs.$4,000

$4,000

Charity

Donor

Insurance Company

Donor

Charity

Original Amount – Annuity Price

Deductible Gift

Original Amount – Annuity IRS Value

Deductible Gift

vs.$4,000

$4,000

Charity

Donor

Insurance Company

Donor

Charity

Where the charity does not or cannot issue gift annuities in the donor’s state, consider this option for cash purchases


Gift Annuities

2. Taxes onpayments


Gift Annuities

3. Taxes onpaymentswith capital gains


Ordinary Income

Tax Free Return of

Investment

Capital Gain

Gift Taxes

$4,000

Annuity

I paid for it

I sell it forfair market value of

I have a capital gain of

Normal Capital Gain Rules

I paid for it

I give it to charity foran annuity worth

It has a fairmarket value of

I have a capital gain of

% of the property value

used for annuity

% of cost basis allocated to

annuity=

Step 1: Divide property value

Original cost$500,000Value $1,000,000Gave to charity for $800,000 annuity

$800,000Annuity Part

80%

$800,000 of value to donor


$800,000Annuity Part

80%

Step 2: Divide cost basis


$400,000Annuity Part of Cost Basis

80%

20%gift part of cost basis

$100,000

Annuity part of cost basis


$400,000Annuity Part of Cost Basis

80%

Annuity part

$800,000 value to donor─$400,000 annuity part of

basis

Gain: Annuity value less annuity part of basis



Gain: Annuity value less annuity part of basis

Annuity part

$800,000 value to donor─$400,000 annuity part of

basis$400,000 Gain

If donor purchases annuity for another

person with appreciated

property, tax on capital gain is paid

immediately

If donor is annuitant (or if

jointly purchased annuity for donor

and spouse), tax on capital gain is paid

overlife expectancy

Part of each year’s payment is capital gain

Four Thousand and no/100 $4,000Donor

Charity

2018 2019 2020 2021 2022 Life Expectancy

2017

Total capital gain is divided among each expected payment

Capital Gain

…

2016 2017 2018 2019 2020 Life Expectancy

2015

5 year life expectancy and $10,000 gain $2,000 of each check for 5 years is capital gain

$10,000 Capital Gain

$2,000

$2,000 $2,000

$2,000

$2,000

…

$4,000

Annuity

Donor gives $100,000 stock (cost $60,000)

Charity pays age 55 donor $4,000

per year for life

$4,000

Annuity



per year for life

Total capital gainOriginal life expectancy

$4,000

Annuity



per year for life


21.7 years (previous slides)

How much is this?

$4,000

Annuity



per year for life

Value of annuity- Basis used for sale partTotal capital gain

$4,000

Annuity



per year for life

Value of annuity- Basis used for sale partTotal capital gain

$72,797.20 (previous slides)

$60,000 basis X($72,797.20/$100,000)

$4,000

Annuity



per year for life

$72,797.20 (Annuity)- $43,678.32 (Basis used)$29,118.88 Capital Gain

$4,000

Annuity



per year for life



$29,118.88 Capital Gain

$4,000

Annuity



per year for life

$29,118.8821.7


$29,118.88 Capital Gain

= $1,341.88

Four Thousand and no/100

$1,341.88 is capital

gain

How much is tax free return of investment?

$4,000Donor

Charity

$4,000

Annuity



per year for life

Basis used for annuity Original life expectancy

$4,000

Annuity



per year for life

Basis used for annuityOriginal life expectancy

$60,000 basis X($72,797.20/$100,000)


$4,000

Annuity



per year for life


$43,678.3221.7 = $2,012.83

$60,000 basis X($72,797.20/$100,000)

$4,000

Annuity



per year for life

$2,012.83Return of

Basis

$645.29 Ordinary Income$

4,0

00

Ch

eck

$1,341.88Capital Gain

2018 2019 2020 … 2029 Life Expectancy Death

2017

…



$645 Ordinary income$1,342Cap Gain$2,013Return of Basis




2018 2019 2020 … Death… 2029 Life Expectancy

2017

If early death, donor’s last tax return deducts allocated basis not yet given back





Gift Annuities

3. Taxes onpaymentswith capital gains


Gift Annuities

4. Gift taxesandspecial assets


Ordinary Income

Tax Free Return of

Investment

Capital Gain

Gift Taxes

$4,000

Annuity

If donor names a different annuitant, the donor has made a gift to that person

1/31/2020

1/31/2019

1/31/2018

1/31/2017

1/31/20163rd Person 4,000

Five Thousand and no/100

Charity

Donor 3rd Person

Charity

1/31/2020

1/31/2019

1/31/2018

1/31/2017

1/31/20163rd Person 4,000

Five Thousand and no/100

Charity

Donor 3rd Person

Charity

The gift tax value of an immediate annuity can be reduced by the annual present

interest exclusion for gifts


Ordinary Income

Tax Free Return of

Investment

Capital Gain

Gift Taxes

$4,000

Annuity

Some tricky examples…

Long term capital gains for collectibles (art,

antiques, stamps, coins, jewelry) are taxed at a

higher rate (31.8%) than other capital

gains

//upload.wikimedia.org/wikipedia/commons/6/6a/Mona_Lisa.jpg

//upload.wikimedia.org/wikipedia/commons/6/6a/Mona_Lisa.jpg

$100,000 ($60,000 basis)

Donor gives

$100,000



$4,000

Annuity$2,012.83Return of Basis

$4

,00

0 C

he

ck

$1,341.88Collectibles Capital Gain(31.8% rate)

$645.29 Ordinary Income

The nature of the capital gain income doesn’t change, it is simply deferred. We don’t know in advance what tax rate will apply at that time.

0% rate if ordinary income tax rate is 15%?

15% rate if ordinary income tax rate is

25%?

3.8% Medicare tax if purchased after

1/1/13?

20% rate if ordinary income tax rate is

39.6%?

28% rate on collectibles capital

gain?

Donor gives $100,000 of unrelated use tangible personal property with $60,000 basis.

What is the deduction?

$100,000Art

Donor gives

$100,000



$4,000

Annuity

What is the deduction?

Remember: A charitable gift of unrelated use personal property is deducted at lower of basis or FMV

$100,000Art

Donor gives

$100,000



$4,000

Annuity

% of the property value

used for annuity

% of cost basis allocated to

annuity=

Step 1: Divide property value

Original cost$60,000Value $100,000Gave to charity for $72,797.20 annuity

$72,797.20Annuity Part

72.8%

Step 2: Divide cost basis

Original cost$60,000Value $100,000Gave to charity for $72,797.20 annuity

$43,678.32 Annuity Part of

Cost Basis

72.8%

Because I can deduct only cost basis for unrelated use tangible personal property mydeduction is $16,321.68 $43,678.32

Annuity Part of Cost Basis

72.8%Original cost$60,000Value $100,000Gave to charity for $72,797.20 annuity


Gift Annuities

4. Gift taxesandspecial assets

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Available from Amazon.com


Gift Annuities

Russell James, J.D., Ph.D., CFP®

Professor, Texas Tech University

taxation of charitable gift annuities

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