CGNA: Key Terms and Concepts

CGNA: Key Terms and Concepts

Article posted in Assets, General on 9 August 2017| comments
audience: National Publication, Bryan K. Clontz, CFP®, CLU, ChFC, CAP, AEP | last updated: 11 August 2017
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Summary

We continue through Charitable Gifts of Noncash Assets with the definitions of basic terminology which many of us take for granted. Clarity and understanding of language is vital to understand.

This article is an excerpt from Charitable Gifts of Noncash Assets, a comprehensive guide to illiquid giving by Bryan Clontz, ed. Ryan Raffin. Published by the American College of Financial Services for the Chartered Advisor in Philanthropy Program (CAP), with generous funding from Leon L. Levy. For a free digital copy, click here, and to order a bound copy from Amazon, click here.

By Ryan Raffin

Below are brief definitions for key terms and concepts used throughout this book. Where appropriate, we have included links and references to additional information. For more general charitable laws and regulations, see General Regulations and Information.

A split interest gift is a planned giving vehicle whereby the donor retains some interest (financial or otherwise) in the gifted property or proceeds from its sale. The nonprofit gets the other portion of the property, and the donor typically receives a tax deduction for that portion. A common type of split interest gift discussed in this book is the deferred gift, where the nonprofit does not receive its portion of the gift until after some period of time has passed, often the donor’s lifetime. Important split interest planned giving vehicles include:

  • The charitable remainder trust, where the donor retains a present income interest for a term of years or life, and the charity receives a remainder interest. It is the most common deferred gift discussed in this book. Payments can be a fixed dollar amount (a charitable remainder annuity trust) or a fixed percentage of trust assets (a charitable remainder unitrust). A CRAT makes regular payments to the donor in a set dollar amount (at least five percent of the initial fair market value of the assets). A CRUT makes regular payments to the donor in a set percentage of the principal as valued on a certain day each year (at least five percent of the trust, as valued on an annual basis). The donor receives an immediate tax deduction for the present value of the remainder—that is, the difference between the amount paid and the actuarially-determined present value of the annuity payments.

    “CRT Primer,” Planned Giving Design Center, http://www.pgdc.com/calculation-center/charitable-remainder-trusts/crt-advisor-information (last visited July 27, 2016).
     
  • The charitable gift annuity, which is technically an annuity contract that the donor purchases from the charity. The donor provides some amount of money in exchange for regularly scheduled payments to one or two named individuals for the balance of their lives. The donor receives an immediate tax deduction for the present value of the remainder—that is, the difference between the amount paid and the actuarially-determined  present value of the annuity payments.

    Fox, R.A. (August 14, 2014), “Charitable Gift Annuities,” Planned Giving Design Center, http://www.pgdc.com/pgdc/charitable-gift-annuites.
     
  • The charitable lead trust, which is the inverse of a charitable remainder trust. Here, the charity receives income from the property for a term of years (or lifetime of some living person the trust agreement names), and the donor or heirs receive it afterwards. Payments can be a fixed dollar amount (a charitable lead annuity trust) or a fixed percentage of trust assets (a charitable lead unitrust). The advantage of a properly designed charitable lead trust is that it can allow for favorable estate tax treatment. Availability and amount of income tax deduction depends on the structure of the trust.

    Peebles, J. (August 27, 2015), “A Practical Look at Charitable Lead Trusts, Part 1 of 3,” Planned Giving Design Center, http://www.pgdc.com/pgdc/practical-look-charitable-lead-trusts-part-1-3.
    IRC § 664 (charitable remainder trusts)
    Treas. Reg. § 1.170A-6 (charitable lead trusts)
    Treas. Reg. § 1.170A-1 (charitable gift annuities)

Assignment of income occurs when the taxpayer donates appreciated capital assets, and there is some right to receive income from those appreciated assets. In that case, the IRS will disregard the donation and require the taxpayer to recognize capital gain on the assets, as if the taxpayer had sold the assets personally and was simply donating the proceeds. Typically, this occurs when the owner of a closely held business agrees to sell the company, and donates a portion of his shares prior to completion of the sale. Since the taxpayer is nearly certain to receive income, the IRS states that he cannot avoid it by assigning it to another.

Similar to assignment of income, a pre-arranged sale involves a quid pro quo agreement (formal or otherwise). For example, a donation conditioned on the nonprofit’s use of the proceeds to complete another transaction with the donor. More common is a case where the charity signs some agreement to sell before receiving the assets. In these cases, the IRS will characterize the transaction instead as the donor’s realization of capital gain and subsequent donation. Even if there is a right of first refusal, so long as the charity is not compelled to sell the asset, there will not be a pre-arranged sale.

Kallina II, E.J. and Temple, P. (October 14, 1995), “How Far Is Too Far? The Prearranged Sale and The Palmer/Blake Conundrum,” Planned Giving Design Center, http://www.pgdc.com/pgdc/how-far-too-far.

Palmer v. Commissioner, 62 T.C. 684 (1974), aff'd on other grounds, 523 F.2d 1308 (8th Cir. 975); Blake v. Commissioner [83-1 USTC 9121], 697 F.2d 473 (2d Cir. 1982), aff'g 42 TCM 1336 (1981); Ferguson v. Commissioner, 108 T.C. #14 (1997) (assignment of income doctrine)

A corporation (either S or C status) which donates all or substantially all of its assets to charity will recognize gain or loss on the property. “Substantially all” is loosely defined, but 70 to 80 percent of assets is often enough to trigger gain recognition. Additionally, courts have also focused on the business’s ability to continue its operations after the donation.

Peebles, L.H., (May 17, 2005), “A Hidden Trap for Generous Corporations,” Planned Giving Design Center, http://www.pgdc.com/pgdc/hidden-trap-generous-corporations.

Treas. Reg. § 1.337(d)-4(a)(1) (gain recognition for transfer of “all or substantially all” corporate assets)

An easement is a permanent restriction on the use of real property. In the nonprofit realm, it is most often seen as a qualified conservation easement. The restriction reduces the value of the property, and the donor receives a corresponding tax deduction as a result. These easements are put in place to preserve environmental, historical, or recreational real property.

Fox, R. (February 3, 2016), “Easement Does It,” Planned Giving Design Center, http://www.pgdc.com/pgdc/ease-ment-does-it.

IRC §§ 170(f )(3), 170(h) (partial interests gifts and qualified conservation contributions)

A donation must be an undivided portion of the entire interest in most cases. This means that the donor generally cannot carve out only some rights in the property, but must give a portion of all of their interest. For example, an owner of mineral development rights could not donate only right to net profits. The gift must be a “full slice” of the interest.

Newman, D.W. (September 30, 2015), “Charitable Gifts of Real Property,” Planned Giving Design Center, http://www.pgdc.com/pgdc/charitable-gifts-real-property.

Treas. Reg. § 1.170A-7(b)(1)(i) (undivided portion of entire interest requirement)

A gift of a partial interest in property is where the donation is not an undivided portion of the entire interest. Here, the donor is giving some specific portion of her rights to the nonprofit donee, and retaining others. For example, the donor might give the charity a remainder interest in her farm, while retaining the right to live on and use the farm for her lifetime. Generally, these gifts are not deductible, but there are some important exceptions, such as the example here and others discussed in this book.

James III, R. (March 30, 2016), “Gifts of Partial Interests, Part 1 of 3,” Planned Giving Design Center, http://www.pgdc.com/pgdc/10-gifts-partial-interests.

Rev. Rul. 76-331, 1976-2 C.B. 52 (partial interest rule and retained mineral rights)

An important factor for donors is the tax character of donated property. First, the property is either an ordinary income asset or capital asset. If the property is the type that the donor sells in his normal business, it is an ordinary income asset. If the property is held and not for sale in the ordinary course of business, it is a capital asset. If the capital asset has been held a year or less, it is short-term capital gain property. If the capital asset has been held for more than a year, it is long-term capital gain property.

James III, R. (October 7, 2015), “Visual Planned Giving: An Introduction to the Law and Taxation of Charitable Gift Planning,” Chp. 5: Valuing Charitable Gifts of Property, parts 1 and 2, http://www.pgdc.com/pgdc/5-valuing-charitable-gifts-property-part-1-2; http://www.pgdc.com/pgdc/5-valuing-charitable-gifts-property-part-2-2

IRC §§ 1221 – 1223 (character of property)

A qualified appraisal is an assessment of property value by a certified professional with experience in valuing the type of property at hand. For certain types of asset with values over $5,000, the IRS requires the taxpayer to obtain a qualified appraisal. This information must be submitted with the donor’s itemized charitable deductions.

IRS Publication 561 (April 2007), Determining the Value of Donated Property, https://www.irs.gov/publications/p561/index.html.

Treas. Reg. § 1.170A-13(c) (appraisal requirements)

A bargain sale is where the donor gives the property to the donee nonprofit in exchange for some consideration worth less than the fair market value of the donated property. This consideration can be cash, but can also be other property. Essentially, the bargain sale is part-gift and part-sale, so the donor receives a tax deduction only for the gift portion and must recognize gain (but not loss) on the deemed sale portion.

Hoffman, M.D. (May 10, 2011), “Bargain Sales,” Planned Giving Design Center, http://www.pgdc.com/pgdc/bargain-sales.

Treas. Reg. § 1.1011-2 (bargain sale regulations)

Rev. Rul. 67-246, 1967-2 C.B. 104 (part-gift, part-sale treatment for bargain sales to charity)

Unrelated business taxable income (or “UBTI”) is the income which a tax-exempt organization derives from trade or business which is not substantially related to its exempt purposes. A corporate nonprofit will pay tax at ordinary corporate rates on any UBTI. Further, excessive UBTI may put the nonprofit at risk of losing its tax-exempt status entirely.

Further, debt-financed income can give rise to UBTI. Debt-financed property which generates income qualifies. This means that unpaid debt the nonprofit incurs in order to acquire or make improvements to property held for investment or not used in its exempt purpose will lead to tax on income that same property generates.

Rice, D. (May 10, 2016), “Bashing UBIT to Bits,” Planned giving Design Center, http://www.pgdc.com/pgdc/bashing-ubit-bits.

IRS Publication 598 (January 2015), Tax on Unrelated Business Income of Exempt Organizations, https://www.irs.gov/publications/p598/.

IRC § 512 (unrelated business taxable income) IRC § 514 (debt-financed income)

A capital call is a common provision in partnership and LLC operating agreements. Investors are required to pay in capital over a number of years. Nonprofits holding these interests may or may not be exempt.

Mayer Brown, “Addressing UBTI Concerns in Capital Call Subscription Credit Facilities,” November 2012, https://www.mayerbrown.com/files/Publication/8d5b0f8f-a76f-44b4-9141-6016dd2dddf7/Presentation/PublicationAttachment/3f2293fb-e97a-41d0-beea-6221271df252/Addressing_UBTI_Concerns_in_Capital_Call_Subscription_Credit_Facilities_Moulton_Fi.pdf.

An excess benefit is an economic benefit a nonprofit provides to an insider. The IRS levies an excise tax for any excess benefit the nonprofit gives to certain disqualified persons. That benefit is the amount above the fair market value of goods or services those disqualified persons provided. A disqualified person is one in position to significantly influence the affairs of the organization, including the family members of such persons.

Walsh, D. (May 23, 2013), “Reasonable Compensation: A Section 4958 Primer,” Planned Giving Design Center, http://www.pgdc.com/pgdc/reasonable-compensation-section-4958-primer.

IRC § 4958 (taxes on excess benefit transactions)

Inurement occurs when a tax-exempt organization’s income goes to the benefit of a private individual or organization. Any unjust enrichment for a private party may be sufficient. If the IRS finds inurement, it may revoke the organization’s tax-exempt status.

IRS Overview of Inurement/Private Benefit Issues in IRC 501(c)(3) (1990), https://www.irs.gov/pub/irs-tege/eotopicc90.pdf

Treas. Reg. § 1.501(c)(3)-1(c)(2)

Self-dealing occurs when there is a direct or indirect transaction between a private foundation and a disqualified person. As above, disqualified persons are persons, entities, or family members with significant influence on the private foundation. The IRS imposes an excise tax depending on the amount involved in the transaction.

Disqualified person: IRC § 4946

Self-dealing: IRC § 4941

Newman, D.W. (July 14, 1999), “Dealing with the Self-Dealing Rules,” Planned Giving Design Center, http://www.pgdc.com/pgdc/dealing-self-dealing-rules.

The adjusted basis of property is the net cost of the property after making certain tax adjustments. Most commonly, this is the cost paid for the property. However, it may also be increased by capital improvements, or decreased for any depreciation deductions previously taken.

Conversely, fair market value is the price that the property would sell for on the open market. The sale must be an arm’s length transaction between two reasonably informed parties, voluntarily engaging in the sale.

Adjusted basis: IRC §§ 1012, 1016

Fair market value: U.S. v. Cartwright, 411 U.S. 546, 551 (1973)

James III, R. (October 7, 2015), “Visual Planned Giving: An Introduction to the Law and Taxation of Charitable Gift Planning,” Chp. 5: Valuing Charitable Gifts of Property, parts 1 and 2, http://www.pgdc.com/pgdc/5-valuing-charitable-gifts-property-part-1-2; http://www.pgdc.com/pgdc/5-valuing-charitable-gifts-property-part-2-2

Passive income is excluded from unrelated business taxable income. This income includes dividends, interest, royalties, and rent. Essentially, revenue the tax-exempt organization derives from investment holdings will generally not be taxable.

IRC § 512(b)

Rev. Rul. 76-331, 1976-2 C.B. 52 (partial interest rule and retained mineral rights)

In some cases, the tax-exempt organization must put donated property to a related use for the donor to receive a tax deduction. If the donee organization’s use of the property is unrelated to its exempt purposes, no deduction is available. This rule applies only to donations of tangible personal property.

IRS Publication 526 (2015), “Charitable Contributions,” https://www.irs.gov/publications/p526/ar02.html.

Treas. Reg. § 1.170A-4(b)(3) (related use definitions)

Tax-exempt organizations can be classified as a public charity or a private foundation. Public charities receive at least a third of their support from the general public. Private foundations, meanwhile, do not rely on funding from the public, and are often supported by small groups of wealthy donors, typically families.

IRS Exempt Organization Operational Requirements: Private Foundations and Public Charities (April 22, 2016), https://www.irs.gov/charities-non-profits/eo-operational-requirements-private-foundations-and-public-charities. IRC §§ 501 (public charities), 509 (private foundations)

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