Charitable Tax Rules

Qualified Charitable Organizations

Qualifying for the Income Tax Charitable Deduction

Not all gifts that are charitably motivated qualify for the federal income tax charitable deduction. For example, a gift directly to a needy family to help it through a difficult period may be charitable in intent, but it is not deductible. Nor is every gift to an organization that is exempt from federal income taxes deductible as a charitable contribution. To be deductible, the gift must be made to a qualified charitable organization. (All qualified charitable organizations are income tax exempt but not all tax-exempt organizations are qualified charities.)

What Is a Charitable Contribution?

Specifically, as defined in IRC Sec. 170(c), a charitable contribution is a contribution to or for the use of one of the following organizations:

$image\bullet.jpg$ A state, a possession of the United States, or any political subdivision of any of the foregoing, or the United States or the District of Columbia, but only if the contribution or gift is made for exclusively public purposes [IRC Sec. 170(c)(1)]

$image\bullet.jpg$ A corporation, trust, community chest, fund, or foundation--created or organized in the United States or in any possession thereof, or under the law of the United States, any state, the District of Columbia, or any possession of the United States

$image\bullet.jpg$ A corporation, trust, community chest, fund, or foundation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals

$image\bullet.jpg$ A corporation, trust, community chest, fund, or foundation where no part of the net earnings of which inures to the benefit of any private shareholder or individual; and which is not disqualified for tax exemption under section 501(c)(3) by reason of attempting to influence legislation, and which does not participate in, or intervene in (including the publishing or distribution of statements), any political campaign on behalf of (or in opposition to) any candidate for public office [IRC Sec. 170(c)(2)]

$image\bullet.jpg$ A post or organization of war veterans, or an auxiliary unit or society of, or trust or foundation for, any such post or organization $image\emdash.jpg$ organized in the United States or any of its possessions, where no part of the net earnings of which inures to the benefit of any private shareholder or individual [IRC Sec. 170(c)(3)]

$image\bullet.jpg$ In the case of a contribution or gift by an individual, a domestic fraternal society, order, or association, operating under the lodge system, but only if such contribution or gift is to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals [IRC Sec. 170(c)(4)]

$image\bullet.jpg$ A cemetery company owned and operated exclusively for the benefit of its members, or any corporation chartered solely for burial purposes as a cemetery corporation and not permitted by its charter to engage in any business not necessarily incidental to that purpose, if such company or corporation is not operated for profit and no part of the net earnings of such company or corporation inures to the benefit of any private shareholder or individual [IRC Sec. 170(c)(5)].

For purposes of the charitable deduction for individual (as opposed to corporate) taxpayers, however, not all qualified charities are created equal. As will be discussed in more detail later under percentage limitations, gifts to certain charities are deductible by the donor up to 50% of his or her contribution base. For the other qualified charities, the deduction limit is 30%.

Note that the Tax Cuts and Jobs Act of 2017 increased the 50% deduction rate to 60% for a donor's contributions made in "cash." For purposes of the remaining discussion, the higher 60% limitation for cash is not highlighted to avoid undue confusion.

50% Charities

All of the organizations described in IRC Sec. 170(c) qualify as charities for purposes of the federal income tax charitable deduction. However, only those Sec. 170(c) organizations described in Sec. 170(b)(1)(A), discussed below, are 50% charities, also commonly called public charities.

Churches

A church or a convention or association of churches is a 50% charity, as is a synagogue, or temple

Hospitals and Medical Research Organizations

A hospital is a 50% charity so long as its principal purpose or function is providing medical or hospital care or medical education or research. A medical research organization also qualifies as a public charity if it is directly engaged in the continuous active conduct of medical research in conjunction with a hospital. Further, the medical research organization must be committed to spending a contribution received in a calendar year by the start of the fifth calendar year beginning after the date the contribution is received.

Educational Organizations

Such an organization is a public charity if it normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where its educational activities are carried on. An elementary school, high school, college or university qualifies as a public charity if it meets the tests. There is no requirement that the school be a public school.

Organizations to Benefit Public Colleges and Universities

Public charities also include organizations that receive a substantial part of their support from governmental units and/or the general public and are organized and operated exclusively for the benefit of a state or municipal college or university. The organization must be organized and operated exclusively to receive, hold, invest, and administer property and to make expenditures to benefit a public college or university.

Governmental Units

A state, a possession of the United States, a political subdivision of a state or U.S. possession, the District of Columbia, and the United States are public charities for the purposes of contributions or gifts made for exclusively public purposes.

Publicly Supported Charities I

In addition to the types of charities described above, publicly supported charities also qualify as 50% charities. These are corporations, trusts, community chests, funds or foundations that normally receive a substantial part of their support from governmental units and/or direct or indirect contributions from the general public. This support does not include income received in the exercise or performance by the charity of its tax-exempt purpose.

The regulations provide two tests to determine if a charity normally receives a substantial part of its support from governmental units and/or contributions from the general public. Meeting either test qualifies the charity. Under the first test, charity is considered publicly supported, and a 50% charity, if it normally receives at least one-third of its total support from governmental units and/or the general public. A charity that fails this test can still qualify as publicly supported if it meets a second test. A charity meets this test if:

$image\bullet.jpg$ The support from governments and the general public is at least 10% of the organization's total support

$image\bullet.jpg$ The charity is organized and operated so as to attract new and additional support from government and the general public

$image\bullet.jpg$ The charity satisfies enough of the relevant factors concerning public support to show that it is publicly supported. These factors include the percent of public support, sources of support, the breadth of interests represented by the governing body, and the availability of public facilities and services

Publicly Supported Charities II

A second type of organization might also be considered publicly supported but under a different definition. A charity is also considered a 50% organization if it:

$image\bullet.jpg$ Normally receives more than one-third of its support annually from any combination of gifts, grants, contributions or membership fees and gross receipts from admissions, sales of merchandise, performance of services, or the furnishing of facilities in an activity which in not an unrelated trade or business, and

$image\bullet.jpg$ Normally receives not more than one-third of its support from gross investment income and net unrelated business taxable income.

Supporting Organizations

A charity whose purpose is to support another public charity also may qualify as a 50% charity. To qualify as a supporting organization, the charity must be organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of, one or more specific public charities. Further, the organization must be operated, supervised or controlled by the supported organization.

Also, the supporting organization cannot be controlled by one or more disqualified persons other than foundation managers and other than the supported charity. As defined in the relevant section in the private foundation rules, disqualified persons would include: a substantial contributor to the supporting organization; foundation managers; a 20% or more owner of an entity that is a substantial contributor; a family member of one of the above; a corporation, partnership, trust, or estate if a person in one of the categories above owns more than a 35% interest in it; a private foundation controlled by or receiving substantially all of its contributions from a person in one of the above categories; or a government official.

Click here to jump to a discussion of supporting organizations.

Certain Private Foundations

Generally, the term "private foundation," defined later in this chapter, is though of as synonymous with a 30% charity. However, IRC Sec. 170(b)(1)(A) provides that three types of private foundations are treated as public charities for purposes of the deduction limitation: private operating foundations, pass-through foundations and pooled-fund foundations.

Private Operating Foundation

This organization is one that spends substantially all of its income directly for the active conduct of the activities that constitute it exempt purpose. Further, an organization must meet one of three tests to qualify as a private operating foundation. It passes the asset test if most of its assets are devoted directly to its exempt purpose; it passes the endowment test if most of its investment return is used for its exempt purpose; and it passes the support test if most of its support comes from the general public.

Pass-Through Foundation

This organization is a private non-operating foundation that must distribute out of corpus an amount equal to 100% of the contributions it received in a tax year. The distributions must be made by the fifteenth day of the third month following the end of that tax year.

Pooled-Fund Foundation

A pooled or common fund private foundation is another type of non-operating private foundation. This type is one that pools contributions from all donors in a common fund and is organized and operated exclusively for the support of one or more public charities. The donor has the right to designate annually the public charity that will receive the income from his or her gift. Income must be distributed within 2½ months after the end of the tax year in which the income is earned. If the donor has the right to designate the recipient of the principal following his or her death, that principal must be distributed to the designated charity within one year following the donor's death.

30% Charities

Simply put, if a charity falls within the definitions of IRC Sec. 170(c) but does not qualify as a 50% charity under IRC Sec. 170(b)(1)(A), then the charity is a 30% organization. Gifts to such charities are deductible in a year to the extent that the total of these contributions does not exceed 30% of the donor's contribution base for the year.

30% charities are generally referred to as private foundations, although, as discussed above, not all private foundations are 30% charities. A "private foundation" is one of those terms that the tax code defines by exception. Section 509(a) defines a private foundation as any domestic or foreign organization defined in Section 501(c)(3), except for certain organizations. Not surprisingly, these excepted organizations include all of the 50% charities discussed earlier (other than the three types of private foundations) plus organizations organized and operated exclusively for testing for public safety.

To complete the circle, Section 501(c)(3) organizations basically are corporations and any community chest, fund or foundation that is organized and operated exclusively:

$image\bullet.jpg$ For religious, charitable, scientific, testing for public safety, literary or educational purposes

$image\bullet.jpg$ To foster national or international amateur sports competition

$image\bullet.jpg$ For the prevention of cruelty to children or animals

No part of their net earnings can inure to the benefit of any private shareholder or individual, and no substantial part of their activities can be devoted to the carrying on of propaganda or attempting to influence legislation. The organization cannot participate in political campaigns for or against any candidate for public office.

Private Foundation Rules

In addition to the lower percentage limitation when compared to public charities, private foundations are also subject to stringent and complicated tax rules governing operations. These private foundation rules will be discussed later in the program.

Identifying Qualified Organizations

A donor contemplating making a charitable contribution to an unfamiliar organization should have two very basic questions:

$image\bullet.jpg$ Is the organization a qualified charity?

$image\bullet.jpg$ Is it a 50% or 30% charity?

Generally, the charity will be able to give a donor the answer to these questions. If the charity is unable to provide the answers or if the donor wishes to verify the information, the basic resource is the "Exempt Organizations Select Check" portal at www.irs.gov.

Valuation

General Rule

Determining the amount of the income tax charitable deduction begins with valuing the assets donated. As a general rule, the amount of any income tax charitable deduction is determined by the fair market value of the contributed property. Fair market value is defined as the price at which the property would change hands between a willing buyer and willing seller, neither having to buy or sell and both having reasonable knowledge of all the relevant facts.

This sounds simple in theory but may not be as simple in practice, especially with donations of non-cash assets. The fair market value of one dollar is one dollar, even if it doesn't buy what it used to. However, valuation can be more difficult for other assets. But before going into the rules for valuing property, it is important to factor in another complexity—the timing of the gift.

Timing

The fair market value of donated property is determined as of the date of the gift. Generally, the date of the gift for valuation purposes is the date the gift is considered complete. A gift is complete when delivery of the donated property is deemed made to the charity, and the gift is unconditional.

If the gift is subject to a condition that must be fulfilled before the gift is effective or subject to one that would defeat the charity's interest if the condition is met, the gift still may be considered complete if the condition is one unlikely to occur. The likelihood of occurrence must be so remote as to be negligible. Let's examine "date of gift considerations" for commonly donated assets.

Check

A gift by check is made when it is mailed or unconditionally delivered to the charity, if the check clears the donor's bank in due course and no restrictions are placed on the time and manner of the check's payment. A check, then, mailed at the end of one tax year but not received by the charity until the following tax year is deductible in the year mailed.

Bank-By-Phone

A donation made by a bank-by-phone transaction is a gift on the date payment is made by the bank.

Credit Card

The gift is made in the year the charge is made.

Internet

An online contribution is essentially the same transaction as a gift made by debit or credit card. Once the money leaves the bank account, or the donor incurs a credit card charge, the gift is made.

Cell Phone

Text-to-give is now an accepted way to make charitable contributions. In January 2010, Congress passed a law permitting the deduction of cash contributions made by text for the relief of Haitian earthquake victims for the previous tax year. Congress relaxed the usual requirement of a bank record or charity acknowledgment substantiating the gift in lieu of a cell phone bill. This suggests that the gift is made at the time the donor incurs the charge for the text gift from the cell phone provider.

Stock

The date of the gift depends on how ownership is transferred. If a properly endorsed certificate (or an unendorsed certificate with a signed stock power) is mailed or delivered to the charity or the charity's agent, the date of the gift is the date of mailing or delivery. For a certificate sent by mail, this rule assumes that the certificate is received by the charity or agent in the ordinary course of the mail.

If the donor delivers a stock certificate to the issuing corporation or to the donor's broker (and agent) to have the stock reissued in the name of the charity, then the gift is not complete until the stock is transferred to the charity's name on the corporation's books. This transfer process may take up to several weeks, putting the date of gift beyond the donor's control. For this reason, making a gift this way is not recommended.

For gifts of stock registered in street name, the gift is complete when the shares are transferred to the charity's name on the brokerage firm's books. One or more days may pass from the time the donor requests transfer until the stock shows up in the charity's account. It is the donor's responsibility to report the correct date and value of the gift, so he or she should be careful to find out the precise date the transfer was completed--especially when the gift is made near the end of the donor's tax year.

Mutual Fund Shares

A gift of mutual fund shares is complete when the shares are received in the charity's account. The charity may have to open an account with the investment company to accomplish the transfer, which can cause a time lag that affects the date of the gift. The fund may require the donor to provide a letter of instructions that identifies the charitable transferee and the number of shares to be transferred. The fund may also require the charity to identify a responsible officer who is authorized to redeem the shares.

Pledge

Even if a pledge is enforceable under state law, no deduction is allowed until the pledge is fulfilled.

Promissory Note

A promissory note given by a donor to a charity is not deductible until paid.

Real Estate

Generally, a gift of real estate is made when a properly executed deed to the property is delivered to charity.

Determining Fair Market Value

Fair market value is relatively easy to determine when there is a prescribed valuation methodology and an organized market for the particular type of property involved. But valuation can become more problematic when the methodology is subjective or there is no organized market in which FMV is being continuously determined through buy-and-sell transactions. The fair market value of donated property generally may be established in three ways:

1. A "qualified appraisal"

2. The donor's acquisition cost if the property was purchased in a bona fide arm's length transaction shortly before the donation or

3. The sale of the property if the charity disposes of it shortly after the donation in an arm's length transaction.

Qualified Appraisals and Other Documentation

Under IRC Sec. 170(f)(11)(A)(i), an income tax charitable deduction will not be allowed for an otherwise-qualified noncash gift exceeding $500 unless the taxpayer complies with the statutory appraisal and other documentation requirements. The exceptions: gifts of publicly traded securities [IRC Sec. 6050L(a)(2)(B)] and certain qualified vehicles later sold by the charity [IRC Sec. 170(f)(12)(ii)].

Publicly traded securities are those traded regularly in an established market for which market prices are readily available. This includes stocks and bonds traded on national, regional, and city exchanges and the over-the-counter market, as well as mutual funds.

Property Description

A donor who gives property (other than cash, publicly traded securities or qualified vehicles) to charity and claims a deduction of more than $500 must attach to the income tax return a description of the property and other information the IRS may require [IRC Sec. 170(f)(11)(B)].

Qualified Appraisals

A donor who gives property (other than cash, publicly traded securities or qualified vehicles) to charity, and who claims a deduction of more than $5,000, must obtain a written, qualified appraisal from a qualified, independent appraiser and attach to the income tax return claiming the deduction such information as the IRS may require [IRC Sec. 170(f)(11)(C)]. The qualified appraisal itself need not be attached to the return unless the IRS so requires for a particular gift.

"Qualified appraisal" retains the same meaning as in prior Treasury regulations [now codified as IRC Sec. 170(f)(11)(E)(i)]. We'll discuss the contents of a qualified appraisal shortly.

A donor who claims a deduction for a noncash gift of more than $500,000 must attach the entire qualified appraisal to the income tax return [IRC Sec. 170(f)(11)(D)]. For noncash gifts (other than publicly traded securities) of $500,000 or less, only an appraisal summary (Form 8283) has to be filed.

For gifts of closely held stock, or what the IRS calls "nonpublicly traded stock," the $5,000 threshold increases to $10,000 [Reg. Sec. 1.170A-13(c)(7)(ix)]. When such gifts fall within the corridor between $5,000 and $10,000, the donor must attach a "partially completed appraisal summary" on Form 8283 to the income tax return for the year of the gift [Reg. Sec. 1.170A-13(c)(7)(x)]. Also, for certain contributions of clothing or household property not considered in good condition, the $5,000 threshold is lowered to $500.

Aggregation of Similar Property

In applying the $500, $5,000 and $500,000 thresholds, the donor must combine all gifts of "similar items of property" for the year, even if made to different organizations. If the total of such similar gifts exceeds the pertinent threshold, the statutory requirements apply [IRC Sec. 170(f)(11)(F); see Reg. Sec. 1.170A-13(c)(3)(iv)(A)]. This raises the question, of course, of when gifts are similar. Suppose a donor has donated collectible postage stamps. Later he donates various items related to philately, as well as books on philately. Are these "similar" items that must be aggregated? Yes, said the IRS in a private letter ruling [PLR 8604025]. In other words, stamps and books were reckoned similar for purposes of applying the aggregation rule. Likewise, art books and display frames or cases donated in the same year as works of art might be subject to aggregation.

For similar items of property, only one qualified appraisal is required for the aggregated items.

Contents of a Qualified Appraisal

A qualified appraisal must be signed and dated by the appraiser and should include all of the following [Reg. Sec. 1.170A-13(c)(3) and (4)]:

$image\bullet.jpg$ A detailed description of the property

$image\bullet.jpg$ The date of the gift

$image\bullet.jpg$ The physical condition of the property

$image\bullet.jpg$ Any restrictions relating to the charity’s use or disposition of the property

$image\bullet.jpg$ The appraiser’s name, address, and taxpayer identification number

$image\bullet.jpg$ The appraiser’s qualifications, especially education, experience and certification

$image\bullet.jpg$ A declaration that the appraisal was performed for tax purposes

$image\bullet.jpg$ The date of the appraisal

$image\bullet.jpg$ The fair market value of the gift property on the date of the gift

$image\bullet.jpg$ The method of determining the fair market value

$image\bullet.jpg$ The standards used by the appraiser in determining value

$image\bullet.jpg$ The fees paid by the donor for the appraisal.

Qualified Independent Appraiser

To be "qualified," an appraisal must be made by a qualified, independent appraiser, meaning, a person who:

1. Has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements to be determined by the IRS in its regulations

2. Regularly performs appraisals for which he or she receives compensation

3. Can demonstrate verifiable education and experience in valuing the type of property for which the appraisal is being performed

4. Has not been prohibited from practicing before the IRS by the Secretary at any time during the three years preceding the conduct of the appraisal, and

5. Is not excluded from being a qualified appraiser under applicable Treasury regulations

An appraiser might be "qualified" to make the appraisal, but not "independent." The appraiser cannot be the donor, the charity, or certain related parties whose objectivity regarding the appraisal might be suspect. The appraiser may not be any of the following:

$image\bullet.jpg$ The donor

$image\bullet.jpg$ The recipient charity or an employee thereof

$image\bullet.jpg$ The person from whom the donor acquired the property (with certain exceptions)

$image\bullet.jpg$ Any person employed by or related to any of the above, or

$image\bullet.jpg$ An appraiser who is otherwise qualified, but who has some incentive to overstate the value.

The IRS may reject an appraisal if the appraising party or organization has an exclusive working relationship with the charity [see Kaplan v. Comm'r, 43 T.C. 663 (1965)].

The appraiser must sign and date the appraisal, and also must sign a declaration that he or she understands that a false appraisal may subject the appraiser (as well as the donor) to penalties.

The IRS does not publish a list of acceptable appraisers. The American Society of Appraisers does publish a directory of certified appraisers by state and by specialty (www.appraisers.org).

Timing of Qualified Appraisal

A qualified appraisal must be obtained no earlier than 60 days prior to the date of the charitable gift, and no later than the due date for filing the donor's income tax return (including extensions) on which the gift is first reported [Reg. Sec. 1.170A-13(c)(3)(i)].

Appraisal Fees

The appraiser's fee cannot be based on a percentage of the value of the appraised property, nor can the fee be based on the amount allowed as a charitable deduction [Reg. Sec. 1.170A-13(c)(6)].

Appraisal fees may not be lumped with the charitable contribution, but they are an expense paid in determining income tax liability [see IRC Sec. 212(3); Rev. Rul. 67-461, 1967-2 C.B. 125]. As such, they are deductible as a miscellaneous itemized deduction, subject to the 2%-of-AGI floor [IRC Sec. 67(a)].

Contributions by Entities

In addition to filing a Form 8283 (discussed below), C corporations must meet the IRC Sec. 170(f)(11) appraisal requirements.

In the case of contributions by pass-through entities, the statutory requirements are applied at the entity level but the deduction is awarded or denied at the partner, shareholder or member level [IRC Sec. 170(f)(11)(G)]. Thus, flow-through entities should provide copies of appraisals or other required documentation to owners who report their allocable share of an entity's charitable contribution on their personal income tax returns.

If inventory is donated, an appraisal is needed only if the deduction claimed exceeds the inventory's basis by more than $5,000 [Reg. §1.170A-13(c)(1)(ii)].

Special Rules for Gifts of Artworks

A donor who donates artworks with a value of $20,000 or more must include an 8x10 color photograph (or 4x5 color transparency) and a signed appraisal with the tax return on which the deduction is claimed. Artworks include such things as paintings, sculptures, ceramics, prints and drawings, watercolors, textiles, antiques, historical artifacts, carpets, decorative items, and rare books and manuscripts.

For a donation of artworks that have been appraised at $50,000 or more, the donor may request, for a fee of $2,500, a Statement of Value from the IRS prior to filing the tax return on which the deduction is claimed [IRS Pub. 561, p. 4]. A qualified appraisal must accompany the request, although the IRS is free to accept or reject the appraised value.

Form 8283 $image\emdash_red.jpg$ Noncash Charitable Contributions

The donor must file Form 8283 if the amount of the deduction claimed for all noncash gifts is more than $500 for the year, determined after any required reductions in fair market value for the particular gift, but without regard to the percentage-of-AGI limitations on the charitable deduction. For property gifts of more than $500 but not more than $5,000, a donor must complete Section A of Form 8283. If one item, or a group of similar items, exceeds $5,000 in value, a donor must also complete Section B (unless the property is publicly traded securities).

Form 8282 $image\emdash_red.jpg$ Donee Information Return

Charitable organizations must file Form 8282 (the so-called "tattletale" form) to report to the IRS any sale or other disposition of donated property (other than publicly traded securities) within three years after the contribution if the property was valued at $5,000 or more. When required, Form 8282 must be filed with the IRS within 125 days of the disposition, and there are penalties on charities who fail to comply (up to an annual maximum of $250,000). Charities also must provide a copy of Form 8282 to donors, and additional penalties apply to charities who fail to do so.

The information that must be reported by the charity includes:

$image\bullet.jpg$ Name, address, and TIN of the charity

$image\bullet.jpg$ Name, address, and TIN of the original donor

$image\bullet.jpg$ Amount received by charity upon disposition

$image\bullet.jpg$ Date of disposition

The IRS has ruled privately that a charity's failure to include the donor's taxpayer identification number (TIN) renders Form 8282 incomplete [PLR 200101031].

No reporting by the charity is required if the property is gratuitously transferred by the charity or consumed by the charity, provided these are done in pursuit of the charity's exempt purpose. Thus, the consumption of a donated vaccine would not have to be reported by a charitable organization as it administered inoculations.

Overvaluation Penalty

Overvalued charitable gifts that result in underpayments of tax are potentially subject to the accuracy-related (or negligence) penalty [IRC Sec. 6662] and the anti-fraud penalty [IRC Sec. 6663].

The accuracy-related penalty is 20% of the tax underpayment that results from, among other things, a "substantial valuation misstatement." Such a misstatement occurs if the value claimed on a tax return is 150% or more of the correct valuation. The penalty doubles to 40% if the claimed value exceeds the correct value by 200% or more. The penalty is not imposed unless the resulting underpayment exceeds $5,000, or $10,000 in the case of C corporations. The IRS can waive the penalty if it determines that the taxpayer acted in good faith and there was reasonable cause for the misstatement of value [IRC Sec. 6664(c)] (except in the case of "gross" valuation of 20% or more).

The anti-fraud penalty is 75% of any resulting underpayment of tax. The accuracy-related penalty does not apply to any portion of an underpayment to which the fraud penalty applies.

Substantiation Of Gifts

A charitable contribution in any amount made in cash requires the donor to retain either: a cancelled check; a receipt (or letter or other written communication) from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution; or, in the absence of a cancelled check or a receipt, other reliable written records showing the name of the donee, the date of the contribution and the amount of the contribution. Furthermore, charitable contribution of $250 or more must be substantiated by a "contemporaneous written acknowledgment" from the charity. A gift that is not so acknowledged is not deductible [IRC Sec. 170(f)(8)(A)]. This canceled check is not sufficient substantiation when the contribution is $250 or more.

The charity's written acknowledgment must be "contemporaneous"; that is, provided no later than the due date for filing the donor's income tax return on which the deduction is claimed (including extensions) [IRC Sec. 170(f)(8)(C)].

A contemporaneous written acknowledgment must include the following:

$image\bullet.jpg$ The amount of cash received, or a description (but not the value) of property received other than cash

$image\bullet.jpg$ A description and good-faith estimate of the value of any goods or services the charity provided in exchange for the gift, or a statement that none were provided [Reg. Sec. 1.170A-13(f)(1)]

A donor's failure to obtain the contemporaneous written acknowledgment, when the gift is $250 or more, results in a complete loss of any charitable deduction for the gift. But Sec. 170(f)(8) compliance alone may not be sufficient to assure a charitable deduction.

With respect to non-cash gifts, the law does not require the charity to put a value on the property received when substantiating receipt of the gift. Valuation of the property is the donor's responsibility. However, some charities take it upon themselves to provide a determination or estimate of the gift's value. This may serve as a double-check on the donor's own valuation and save an overvaluation penalty.

Summary Of Documentation Rules

$image\bullet.jpg$ A cash gift of any amount requires the donor to retain a cancelled check; a receipt; or reliable records that document the gift adequately.

$image\bullet.jpg$ If a gift is valued at $250 or more, the donor should obtain a contemporaneous written acknowledgment from the charity.

$image\bullet.jpg$ If a noncash gift is more than $500, attach a property description and Form 8283 to the donor's income tax return.

$image\bullet.jpg$ If a noncash gift is more than $5,000, obtain a qualified appraisal and attach to the donor's return Form 8283 and such additional information as the IRS may require.

$image\bullet.jpg$ If a noncash gift is more than $500,000, attach Form 8283 and a qualified appraisal to the donor's return.

Valuation of Particular Types of Property

Publicly Traded Securities

The fair market value equals the mean of the high and low selling prices quoted for the stock on the date of the gift. If there is no sale on the valuation date but there are sales within a reasonable period before and after the gift, an inverse weighted average of the means between the high and low sales on the nearest date before the gift and the nearest date after the gift. The average is weighted inversely by the respective number of trading days between the selling date and the date of the gift.

If stock is traded on more than one exchange, the high and low selling prices used are from the exchange where the stock is principally traded.

Listed Bonds

Generally, the FMV is the mean of the highest and lowest selling prices quoted for the bond on the date of the gift. If the highest and lowest selling prices for a bond are not available for the date of the gift in a generally available listing or publication but closing prices are available, FMV may be determined by the mean of the closing price on the date of valuation and the closing price on the nearest trading day before the valuation date.

If there were no sales on the preceding trading day but there were sales within a reasonable period before the gift, a weighted average is used. The average is of the price on the date of valuation and the price on the nearest day before the valuation date. The closing price on the date of the gift is weighted by the number of trading days between the previous selling date and the date of the gift.

If there were no sales on the date of the gift but there were within a reasonable time before and after, an inverse weighted average of quoted selling prices of the nearest date before the gift and the nearest day after the gift are used.

Bid and Asked Prices

If actual prices are not available on the date of the gift or within a reasonable period before or after, a mean of the bid and asked prices on the date of the gift may be used. If no bid and asked prices on the date of the gift are available but they are available on dates within a reasonable period before and after the gift date, an inverse weighted average may be used to establish FMV.

Closely Held Securities

The usual factors in valuing closely held stock are:

$image\bullet.jpg$ The nature of the company's business

$image\bullet.jpg$ The economic outlook for the economy generally and for the specific industry

$image\bullet.jpg$ The company's book value

$image\bullet.jpg$ The company's earning history and dividend paying ability

$image\bullet.jpg$ Intangible assets

$image\bullet.jpg$ Prior sales of the same stock

$image\bullet.jpg$ The value of comparable stocks

$image\bullet.jpg$ The size of the block of stock to be valued

Mutual Fund Shares

The FMV is its public redemption price on the valuation date. If this is not available, the FMV is the last public redemption price on the first day before the gift date for which the price is available.

Life Insurance Policies

If the policy is paid-up (i.e., no premium remains to be paid), the policy's fair market value is its replacement cost. This is the amount an insurance company would charge to issue an identical policy at the time the policy is transferred.

If premiums remain to be paid, the policy's FMV is equal to its "interpolated terminal reserve value" (approximately the policy's cash value) plus the part of the last premium payment that covers the policy period following the date of the gift.

Life insurance is ordinary income property. So, if the policy's FMV exceeds the donor's cost basis for the policy, the charitable deduction will be limited to the policy's cost basis. The reduction rules for ordinary income property are discussed in the next chapter.

Real Estate

The fair market value of real estate generally is its appraised FMV based on the property's highest and best use, regardless of how the property had been used or how the donee expects to use the property. The appraisal may include comparable sales, replacement cost, and/or capitalization of income. If the donated property is mortgaged, the gift value is the property's fair market value in excess of the mortgage.

Reduction Rules

At a Glance

As a general rule a non-cash charitable gift entitles the donor to an income tax charitable deduction for the property's fair market value (FMV). However, if the donor contributes ordinary income property or certain capital gain property, the amount of the contribution is reduced below the fair market value by certain "reduction rules."

Definitions

Before going into the details of the rules, however, it will be helpful to establish some basic definitions of relevant terms.

Appreciated property—This is property that has increased in value since being acquired by the owner. The property's fair market value exceeds the owner's cost basis.

Capital asset—Generally, this is property that, if sold for its FMV, would produce either long- or short-term capital gain, depending on the holding period. Capital assets include most non-business property, property held for investment, and business property not held for sale in the ordinary course of the business.

Capital gain property—This is a capital asset that, if it had been sold on the date of the gift for its fair market value, would have produced long-term capital gain. The property has appreciated and has a holding period of more than one year.

Cost basis—Also known as adjusted basis or tax basis, this is the amount the owner paid for the property. If the property was received as a gift, the donor's cost basis carries over to the donee, increased by any gift tax paid on the appreciation portion of the property. If acquired from a decedent, the basis is stepped up to the fair market value of the property for estate tax purposes.

Fair market value—The tax law defines this as the price at which the property would exchange hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.

Holding period—This is the length of time the person has owned a capital asset. For the property to qualify as a long-term capital asset, the property's holding period must be more than one year. Generally, a person's holding period starts the day after purchase. However, if the property is acquired as a gift or from a decedent, the prior taxpayer's holding period is added on.

Long-term capital gain—This is gain from the sale of an appreciated capital asset held for more than one year. Under the current tax rates, long-term capital gain is taxed at 0%, 15% or 20% depending on the applicable capital gains tax bracket compared to a maximum rate of 37% for ordinary income. Plus, the 3.8% net investment income tax may apply to capital gains.

Ordinary income property—This is property that, if the donor had sold it at its FMV on the date of the gift, would produce any gain other than long-term capital gain.

Short-term capital gain—This is gain from the sale of an appreciated capital asset held for one year or less. Short-term capital gain is taxed as ordinary income.

Ordinary Income Property

If property donated to charity would have produced ordinary income had it been sold on the date of the gift for its fair market value, then the amount of the contribution must be reduced by the amount of ordinary income that would have been realized.

Short-term capital gain property - If a capital asset with a holding period of one year or less is donated to charity, the allowable deduction is the property's fair market value reduced by the ordinary income element.

Inventory—Assets held by a taxpayer for sale to customers in the ordinary course of business produce ordinary income when sold. A gift of inventory to charity, then, provides the donor with a deduction equal to the inventory's fair market value minus the amount of ordinary income that would have been realized if the inventory had been sold at its FMV.

IRC Sec. 162 allows a taxpayer to deduct certain costs as business expenses. However, a taxpayer is not permitted to deduct items both as a cost of goods sold and as a charitable gift. To prevent such a double deduction, the tax rules govern which cost items are part of the basis of the donated inventory and which are deductible as business expenses.

There are a few exceptions to the general rule that a deduction for inventory is limited to cost basis. One applies to gifts of inventory for the care of the ill, needy, or infants (minors). If a corporation, other than an S corporation, makes a gift for such a purpose, the amount of the deduction is reduced by only one-half of the gain that would have been ordinary income. However, the deduction cannot exceed twice the inventory's cost basis.

Another exception applies to corporate gifts of newly manufactured (by the corporation) scientific equipment to colleges, universities, or scientific research organizations. The deduction equals the property's cost basis plus one-half of appreciation. As in the case of the first exception, the deduction cannot exceed twice the property's cost basis. This second exception is not available for S corporations, service corporations, or personal holding companies.

Recapture rules—The tax code (Section 1245 for personal property and Section 1250 for real property interests) allows a taxpayer to depreciate the cost of certain assets over a period of time. These depreciation deductions decrease the taxpayer's cost basis in the property. Absent a provision to the contrary, if this property is later sold the reduced cost basis could result in a significantly increased amount of long-term capital gain, which is taxed at a lower rate than ordinary income. To prevent this outcome, the code provides that (at least part of) any gain equal to past depreciation deductions be recaptured as ordinary income. So, if recapture property is contributed to charity, for deduction purposes the fair market value of the property must be reduced by the amount the gain that would have been recaptured as ordinary income.

Other examples of ordinary income property include:

$image\bullet.jpg$ Property owned by the person who created it or by a person who was given the property by the artist.

$image\bullet.jpg$ Section 306 stock--preferred stock distributed in a tax-free corporate reorganization or as a nontaxable stock dividend is ordinary income property to the extent of earnings and profits allocated to the stock when distributed.

$image\bullet.jpg$ Original issue discount bond.

$image\bullet.jpg$ Accounts and notes receivable acquired in the ordinary course of the donor's business.

$image\bullet.jpg$ Life insurance policy, to the extent the cash value or replacement cost exceeds net premiums paid.

$image\bullet.jpg$ U.S. obligation issued on a discount basis and payable without interest at a fixed maturity date of one year or less on the date of issue, to the extent the sales price exceeds the purchase price.

$image\bullet.jpg$ Partnership interest, to the extent the value is attributable to the partnership's unrealized receivables or inventory items that have appreciated substantially in value.

Certain Long-Term Capital Gain Exceptions

As stated earlier, the general rule for gifts of property to qualified charities is that the amount of the charitable deduction equals the property's fair market value. The tax code carves out a major exception to this general rule for gifts of ordinary income property. Under this exception, the fair market value must be reduced by the ordinary income that would have been realized if the property had been sold at its FMV on the date of the gift.

This seems to leave a modified general rule that gifts of long-term capital gain (LTCG) property are valued at the property's fair market value for charitable deduction purposes. But there are exceptions even to this modified rule.

Tangible Personal Property Put to Unrelated Use - The first exception involves gifts of tangible personal property to qualified charities. Tangible personal property includes items such as furniture, art, collectibles, and automobiles, to name just a few types. If the use of the property by the charity is unrelated to the charity's exempt purposes, then the allowable deduction must be reduced by the amount of LTCG that would have been realized if the property had been sold for its FMV on the date of the gift.

The burden is on the donor to determine whether the donated property will be used for a related purpose. A donor meets this responsibility and can treat the use as related if he or she establishes that (1) the property was not in fact put to an unrelated use, or (2) it was reasonable, at the time of the gift, to assume that the property would not be put to an unrelated use.

Tangible personal property received by a charity and then sold is put to an unrelated use. This is so even if the proceeds are used to further the tax-exempt purposes of the charity. The test is the use of the property. A donor will have to reduce his or her gift by the amount of the LTCG that would have been received had the property been sold on the date of the gift for its FMV. A way out for the donor of the property is to show that it was reasonable to assume that the gift would not be put to an unrelated use. Showing this is unlikely for gifts to charitable auctions or rummage sales, when the purpose of the activity is to sell items to raise money for the charity. But what about a gift of books to a library when the books were later sold? The outcome probably would depend on what was known and when it was known.

In the case of gifts of art to museums, the regulations provide a safe harbor. If the gift is of a type normally retained by museums for museum purposes, the donor can reasonably assume that the gift will not be put to an unrelated use, even if the museum later sells the property. The safe harbor does not apply if the donor had actual knowledge of a pending sale.

It is not always easy to anticipate what a related use will be. For example, art given to a retirement home and displayed in the home was found to be a gift for a related purpose because it enhanced the environment of the residents. Similarly, a stamp collection given to a university and displayed in an art gallery and used in art classes was ruled to be put to a related use.

LTCG Property to 30% Charities—If a donor contributes long-term capital gain property to a private foundation (unless it qualifies as a 50% charity), his or her deduction for the property generally is limited to its cost basis. The deduction equals the property's fair market value minus the amount of long-term capital gain property that would have been realized if the property had been sold for its fair market value on the date of the gift.

There is an exception to the cost-basis-only rule for gifts of LTCG property to a private foundation. If stock donated to a private foundation meets the definition of "qualified appreciated stock," then the stock is deductible at its fair market value. Qualified appreciated stock is any stock of a corporation: (1) for which market quotations are readily available on an established securities market as of the date the stock is contributed, and (2) that is long-term capital gain property.

Stock in a corporation is considered qualified appreciated stock only to the extent that the cumulative amount of such stock contributed to private foundations does not exceed 10% of the value of all of the corporation's outstanding stock. Gifts of the stock by the donor's spouse, siblings, ancestors and lineal descendants are attributed to the donor for purposes of the 10% test.

Step-Down Election—The preceding two reductions in the allowable charitable deduction by the amount of LTCG are mandatory when the reduction rule is applicable. However, one reduction is elective.

Gifts of cash and ordinary income property to 50% charities are deductible up to 60% of the donor's contribution base in the year of the gift. Gifts of long-term capital gain property to such charities are deductible at 30% of the donor's contribution base. However, the tax code permits a donor to elect to have LTCG property deducted at the 50% level. The trade-off is that the amount of the contribution is its cost basis rather than its fair market value.

Application of the Reduction Rules

The above material discussed two types of reduction rules--those for ordinary income property and those for certain LTCG property. It is important to keep in mind that these two types of rules are not mutually exclusive--both may apply to the same gift.

Percentage Limitations

At a Glance

After determining the amount of the charitable contribution for gifts using the valuation and reduction rules, an individual taxpayer's next step is to determine how much of the contribution may be deducted on the tax return for that year. This amount is determined by applying the 50% and 30% limitations briefly mentioned in the discussion of qualified charities. Bear in mind (as previously noted under "What is a Charitable Contribution"), the Tax Cuts and Jobs Act of 2017 increased the 50% deduction rate to 60% for charitable contributions made in "cash."

Applying the Limitations

These limitations are applied against the taxpayer's contribution base for the year. Contribution base is defined as the taxpayer's adjusted gross income (AGI) for the year, computed without regard to any net operating loss carryback.

For spouses filing jointly, the contribution base is determined using the couple's AGI. A taxpayer's AGI equals his/her gross income reduced by the "above the line" deductions. The deductions include payments to an IRA and one-half of self-employment tax. Itemized deductions are not "above the line" deductions.

These percentage limitations are commonly discussed as applying against the taxpayer's AGI rather than against the contribution base. However, keep in mind that a taxpayer's contribution base and adjusted gross income are not necessarily the same amount.

50% Charities

50% charities or public charities are those organizations described under IRC Sec. 170(b)(1)(A). As you will recall from the discussion of the types of charities, these charities include churches, schools, hospitals, governmental units, and charities receiving substantial support from the general public. Also included are private operating foundations, pass-through foundations, and pooled-fund foundations.

Gifts "to" 50% Charities

The general rule for contributions "to" 50% charities is that a taxpayer's deduction in a year for charitable gifts cannot exceed 50% (60% for cash) of the donor's contribution base for the year. (The reason for the quotation marks will become clear during the later discussion of gifts "for the use of" charities.)

For example, if a taxpayer has a contribution base of $75,000, the taxpayer's deduction for gifts to 50% charities will be limited to $37,500 or one-half of the $75,000 contribution base. If the taxpayer's charitable contributions exceed $37,500, the excess deductions perhaps may be carried over and deducted in later years. The carryover rules will be discussed later. The general rule applies to gifts to 50% charities of cash and many types of property. However, a stricter limit applies to gifts of long-term capital gain property valued at fair market value for deduction purposes.

Assets Deductible Under the General Limit

Contributions of the following types of assets qualify under the maximum 50% limit:

$image\bullet.jpg$ Cash

$image\bullet.jpg$ Ordinary income property

$image\bullet.jpg$ Capital gain property held short term

$image\bullet.jpg$ Tangible personal property held long term but contributed to an unrelated use

Remember from the discussion of the reduction rules that the three types of property listed above are deductible at their cost basis, not their fair market value.

Overall 50% Limit

The 50% (60% for cash) limit does not apply individually to each gift or to gifts of each category of assets. It is an aggregate limit on the donor’s annual charitable deduction for all gifts to 50% charities during that year (or carried over from previous years).

Actually the 50% limit is much broader than simply the limit that applies to gifts to 50% charities of the assets discussed above. A taxpayer's charitable deduction for a year is limited to no more than 50% (60% for cash) of the taxpayer's AGI for all gifts (and carryovers) to all qualified charities. The other percentage limits are subject to this overall limit. In reaching this overall limit, gifts are considered in a particular order, beginning with current gifts of 50% charity assets to 50% charities. The application of these rules will be discussed in more detail later.

Limitation for Long-Term Capital Gain Property

As mentioned earlier, gifts of long-term capital gain property that are deductible based on the property's fair market value are subject to a stricter deduction limitation. The limitation for this type of property is 30% of the taxpayer's contribution base in the year of the gift. Again, excess contributions may qualify for deduction in a later year. The 30% limitation applies, then, to capital gain property (such as stocks, bonds, real estate, and tangible personal property put to a related use) owned for more that one year.

Step-Down Election

The ability to deduct long-term capital-gain property at its full fair market value is certainly an advantage despite the lower deduction limit unless the taxpayer cannot take advantage of the full deduction in the allotted time span—the year of the gift plus the carryover period. Because the amount of the deduction in a year is based on a limit applied to AGI, a taxpayer, for example, may have an AGI low enough so that the potential deduction for a significant gift to charity cannot be fully used.

However, a taxpayer contributing long-term capital-gain property is not required to use the 30% limit rather than the 50% limit. In fact, the tax code permits a taxpayer to elect the high deduction limit. However, the price paid for this election is that the property is deductible not at its fair market value but at its cost basis. That is, the amount of the deduction for the property is reduced by the long-term capital gain that would have been realized if the property had been sold. The deductible amount is stepped down to its cost basis in exchange for a step up to the higher limit.

A taxpayer makes the election by attaching a statement to that effect to the tax return. Once made, it cannot be revoked. When a taxpayer makes this election, it applies to all gifts of long-term capital-gain property made to 50% organizations during the tax year. A taxpayer may not pick and choose among the items of property donated, electing the increased limit for some but not for others.

When might this election be beneficial to a taxpayer? The bottom line is that the answer depends on a taxpayer's particular circumstances. However, there are situations that may point one way or the other. If the property is only slightly appreciated, taking advantage of the 50% limit while foregoing tax benefit of deducting the small appreciation may make sense. Already mentioned is the taxpayer's AGI. If it is low enough so that the taxpayer will not be able to use the full deduction even at the 30% limit, the election may be advantageous. As it may be where the taxpayer's AGI is expected to drop over the next few years. The higher limit also may be beneficial when the taxpayer's survival, because of advanced age or ill health, for the full carryover period is doubtful. But the amount of appreciation, the taxpayer's current and expected AGI, and age or health are only three factors that may be relevant. Again, all of the relevant circumstances should be considered by the taxpayer.

Contributions to 30% Charities

As discussed earlier, 30% charities are qualified charities other than 50% organizations. Contributions to 30% charities also are subject to an overall deduction limitation of: (1) 30% of the taxpayer's AGI for the year or (2) the excess of 50% of the taxpayer's AGI over the amount allowable for gifts to 50% organizations, whichever is less.

30% and 20% Limits

As in the case of gifts to 50% charities, two limits apply to gifts to 30% charities. In place of the 50% and 30% limits for public charities, 30% and 20% limits apply to 30% charities. The 30% limit applies to gifts to 30% charities of all types of assets, except long-term capital-gain property. In other words, gifts of cash, ordinary income property, and short-term capital-gain property are subject to the 30% limit.

Gifts of all types of long-term capital-gain property are subject to the reduced 20% limit, even property subject to the reduction rules. To review the applicable rules, generally gifts of LTCG property to 30% organizations are deductible only to the extent of the taxpayer's cost basis in the property. However, gifts of qualified appreciated stock are deductible based on fair market values. Qualified appreciated stock is stock of a corporation for which market quotations are readily available on an established securities market as of the date of contribution and which is capital-gain property.

Gifts "for the Use of" Charities

The discussion to this point has been about gifts "to" either 50% or 30% charities. When gifts are made "for the use of" one of these charities, the applicable percentage limitations are the same as those for 30% charities. So, a gift for the use of a public charity is subject to the 30%/20% limits rather than the normal 50%/30% limits.

The definition of a "for the use of" gift is not entirely clear. Some courts that have examined the question have generally held "for the use of" to be equivalent to "in trust for." IRS regulations on the subject provide that a gift to charity of an income interest in property, whether or not in trust, is a gift "for the use of."

Applying the Limits

If a taxpayer's charitable gifts in a year are subject to only one of the limits discussed in this chapter, computing his/her deduction amount should be relatively simple. Complications arise when more than one limit applies. In what order are the limits to be applied in arriving at the deductible amount?

IRS Publication 526 Charitable Contributions provides the following guide:

$image\bullet.jpg$ Contributions subject only to the 50% limit, up to 50% of AGI.

$image\bullet.jpg$ Contributions subject to the 30% limit, up to the lesser of (a) 30% of AGI, or (b) 50% of AGI minus contributions to 50% charities, including contributions of capital-gain property subject to the 30% limit.

$image\bullet.jpg$ Contributions of capital gain property subject to the 30% limit, up to the lesser of: (a) 30% of AGI, or (b) 50% of AGI minus other contributions to 50% charities.

$image\bullet.jpg$ Contributions subject to the 20% limit, up to the lesser of: (a) 20% of AGI, (b) 30% of AGI minus contributions subject to the 30% limit, (c) 30% of AGI minus contributions of capital-gain property subject to the 30% limit, or (d) 50% of AGI minus the total of contributions to 50% charities and contributions subject to the 30% limit.

$image\bullet.jpg$ Again, the total amount deductible cannot exceed the overall limit of 50% of the taxpayer's AGI.

Carryover of Excess Deductions

If a gift to a qualified charity exceeds the applicable 50% (60% for cash) or 30% limit, the donor may carry the excess deduction forward for up to five years. So, for example, if qualified gifts to a 50% charity exceed the amount deductible under the 50% limit, the excess may be deductible in the year after the gift, and so on. A taxpayer, then, has six years (the year of the gift plus the five following years) to use up the charitable deduction.

Generally, carryovers retain in later years the same character they had in the year of the original gift. A gift of cash to a public charity, then, will be treated the same in a carryover year as it was in the year of the gift. One exception involves the effect of the stepped-down election in a year on carryovers of contributions of 30% long-term capital gain property. If the election is made, these carryovers must be recalculated as if the taxpayer had made the election in the years when the carried over gifts were made. This recalculation, however, does not affect the amount of the deduction taken for those gifts on earlier returns.

Carryovers add another layer of complexity to determining the amount of the charitable deduction for the current year. Generally, carryovers are deducted after current-year gifts and in the same order as current year gifts. Carryovers from earlier years are deducted before those for later years.

Partial Interests

Overview

At a Glance

Donors are motivated to make gifts to charitable organizations for several reasons, principally to further philanthropic ambitions while receiving a charitable tax deduction. Although the donor desires to make the contribution, he or she may want to retain an interest in the gifted item. In this case, the donor makes a partial interest gift or a contribution of less than a donor's entire interest in an asset to a charitable organization.

Examples of partial interest gifts include transactions in which a donor:

$image\bullet.jpg$ Holds a life estate interest in a farm, with a remainder interest going to a charitable organization.

$image\bullet.jpg$ Owns a valuable painting and agrees to hold the painting for six months, and then give the painting to a museum to use for the remaining six months of each year.

$image\bullet.jpg$ Gives land to a conservation society while maintaining a mineral interest in the land for himself.

General Rule

A charitable deduction is generally not allowed for donors making partial interest gifts, unless transferred by means of a:

$image\bullet.jpg$ Charitable remainder annuity trust,

$image\bullet.jpg$ Charitable remainder unitrust, or

$image\bullet.jpg$ Pooled income fund.

Exceptions

Donors making partial interest gifts which fail to qualify for the charitable deduction under the general partial interest rule may still be eligible for the deduction if the gift falls into one of several exceptions. The exceptions include donations of:

$image\bullet.jpg$ A remainder interest in a personal residence or a farm

$image\bullet.jpg$ An undivided portion of the donor's entire interest in property

$image\bullet.jpg$ A qualified conservation contribution

$image\bullet.jpg$ A work of art detached from its copyright

Remainder Interest in a Personal Residence or a Farm

At a Glance

A donor who contributes outright (not by trust) an irrevocable remainder interest in a personal residence or a farm to a qualified charitable organization, can claim a charitable deduction for the present value of the remainder interest. In other words, the donor can receive a charitable deduction even though he holds a life estate or an estate for a term of years over the gifted property.

Definition

Tax regulations define a personal residence or farm as follows:

$image\bullet.jpg$ Personal residence - Personal residence is property used by the donor as his personal residence, even if it is not used as his principal residence. The IRS has classified such things as a vacation home, a yacht (used as a residence) and stock owned in a cooperative housing corporation as personal residences.

$image\bullet.jpg$ Farm - A farm is land used by the donor (or his tenant) for the production of crops, fruits, or other agricultural products or for the sustenance of livestock.

Common Questions

If a charity becomes the recipient of a remainder interest in a farm or personal residence, the following situations may arise:

Gifts of less than the entire residence - Donors may contribute a remainder interest of less than the entire residence property and still claim the charitable deduction.

Furnishings and fixtures - In determining a donor's charitable deduction, a personal residence includes the value of fixtures (permanent attachments), but not furnishings. The IRS has even decided in a private ruling that a donor who installed fixtures (heating and air conditioning system) after donating a remainder interest in the residence to a charitable organization could claim a deduction for the fixtures.

Shared remainder interest - The Internal Revenue Service allows a donor to give a remainder interest in a residence to an individual and a charity as tenants in common.

Imposing Conditions or Contingencies on Remainder Interest

A donation of a remainder interest in a personal residence or farm must be irrevocable. Imposing a condition or establishing a gift with the charitable organization subject to a contingency will prohibit the donor from claiming the charitable deduction, unless the conditions or contingency is so remote as to be negligible.

Valuation of Deduction

The amount of the contribution for a gift of a remainder interest in a personal residence or farm is the present value of the remainder interest. Determining this value can be complicated, because the appropriate remainder interest factor from IRS Publication 1457 and depreciation adjustment factors from IRS Publication 1459 must be applied. However, the amount of depreciation (as determined by looking at an adjustment factor) is only required for income tax calculations (not estate or gift tax purposes).

Undivided Interests

At a Glance

A donor may claim a charitable deduction for a contribution of an undivided portion of the donor's entire interest in property. The interest must extend over:

$image\bullet.jpg$ A fraction or percentage of each and every substantial interest or right owned by the donor, and

$image\bullet.jpg$ The entire term of the donor's interest in the property.

A donor may be still denied a charitable deduction if the donor divided the gifted property (creating a partial interest) with the intention of avoiding the partial interest rule.

Examples

Examples of valid gifts of an undivided interest include:

$image\bullet.jpg$ Donor gives an undivided 20% remainder interest in his personal residence to a charitable organization.

$image\bullet.jpg$ Donor gives one-half of his life estate interest in an office building to a charitable organization (he holds no other interest in the building).

$image\bullet.jpg$ Donor contributes a one-third interest of a painting to an art museum, meaning the art museum will display the painting for four months out of the year, with the donor maintaining the painting for the remaining eight months.

Valuation

The amount of the charitable deduction for a donation of an undivided interest is the fair market value of the contributed interest.

For example, Mark, an avid art collector, donates a one-half interest in one of his valuable paintings to the city art museum. Under the agreement, he will display the painting in his private collection during six months of the year, with the museum displaying the painting in the remaining six months. The painting is valued at $1,000,000 on the contribution date. He purchased the painting ten years ago for $500,000.

Mark may claim up to a $500,000 charitable contribution for the donation (assuming the property is put to a related use). The deduction is still subject to the 30%-of-AGI limitation on donations of appreciated long-term capital-gain property.

Partial Interest Gifts of Tangible Personal Property

The Pension Protection Act of 2006 significantly changed the rules governing charitable gifts of a fractional interest in tangible personal property. Once a donor makes a gift of a partial interest in tangible personal property, the donor (or the donor’s estate) must make a subsequent gift (or gifts) of his or her total interest in that property before either ten years elapse or the donor’s death. Failure to do so results in the retraction of all tax benefit generated by the contribution of partial interest gift(s).

Qualified Conservation Contributions

A donor may claim a charitable deduction for a qualified conservation contribution.

Definition

A "qualified conservation contribution" is a contribution of a "qualified real property interest" to a qualified organization, with such land to be used exclusively for conservation purposes.

A "qualified real property interest" is [as defined in IRC Sec. 170(h)(2)]:

$image\bullet.jpg$ A donor's entire interest in real property (other than a "qualified mineral interest")

$image\bullet.jpg$ A remainder interest in real property

$image\bullet.jpg$ A restriction (granted in perpetuity) on the use which may be made of the real property

A "qualified mineral interest" is subsurface oil, gas or other minerals, including the right of access to those minerals.

Conservation purposes is defined in IRC 170(h)(4) as:

$image\bullet.jpg$ The preservation of land areas for outdoor recreation by, or the education of, the general public.

$image\bullet.jpg$ The protection of a relatively natural habitat of fish, wildlife, plants, or similar ecosystems.

$image\bullet.jpg$ The preservation of open space (including farmland and forest land) where such preservation is for: 1) the scenic enjoyment of the general public; or 2) pursuant to clearly delineated federal, state, or local governmental conservation policy and would yield a significant public benefit.

$image\bullet.jpg$ The preservation of a historically important land area or a certified historic structure.

A contribution's purpose must be protected in perpetuity to be considered "exclusively for conservation purposes." Thus, a qualified conservation contribution could not revert to the donor upon the occurrence of some future contingency.

Easements

The most well known qualified conservation contributions are donations of easements. A donation of an easement is classified as a qualified conservation contribution by meeting the IRS requirement for a qualified real property interest. An easement is a property term used to describe the right to use the property of another.

The easement contribution is most commonly made in the form of either a conservation easement or facade easement.

Transfers Subject to Mineral Retention

A charitable deduction is not allowed if the donor retains a mineral interest and is allowed at any time to make extractions or removals by a surface mining method. A deduction is allowed for certain mining methods that have limited, localized impact on the property.

Complexity of Law

The qualified conservation contribution is a complex area of tax law. Due to the complexity, a donor of a qualified conservation contribution should verify (preferably through legal counsel) that the transaction complies with the applicable law, regulations and private rulings.

Valuation

The value of the charitable deduction for a donation of a qualified conservation contribution depends upon the property interest donated to charity. For example:

$image\bullet.jpg$ Entire interest in property - A donor who contributes an entire interest in property (other than mineral interest) will take the fair market value of the property's surface rights (without regard to the value of the mineral rights).

$image\bullet.jpg$ Remainder interest - A contribution of a remainder interest will be determined by taking depreciation and depletion amounts into account. (Note that depreciation is not taken into account for purposes of estate tax calculations.) Furthermore, the property's current fair market value is determined by taking into account any preexisting or contemporaneously recorded rights, which limit the conservation purposes for which the property may be put.

$image\bullet.jpg$ Perpetual conservation restriction - The contribution value of a perpetual conservation restriction is the fair market value of the restriction on the date of transfer. The fair market value should be determined by examining a substantial record of a marketplace sale. If such records are not available, the "before and after valuation" should be used, meaning the difference between the land's FMV before the restriction is granted and the FMV after the restriction is granted.

Note: A donor will not be able to claim a deduction if the grant of a conservation restriction will have no material effect, or will enhance the property's value.

Deduction of Qualified Conservation Property

Click here for a discussion of the increased incentive for donating qualified conservation property.

Insubstantial Rights

A donor who retains certain rights in a gifted property is not automatically denied a charitable deduction on the contribution. However, such rights must be "insubstantial" for the donor to avoid the partial interest rule. "Insubstantial" rights mean rights that cannot effectively reduce the donee's entire interest in the property.

Here are some examples of how the IRS has ruled on whether a donor holds insubstantial rights.

Insubstantial rights vs. Substantial rights

Insubstantial rights

(deductible)

Substantial rights

(non-deductible)

$image\bullet.jpg$ Donor retains right to hunt on gifted property

$image\bullet.jpg$ Donor retains the right (during his life) to veto any
structural or decorative changes donee university may make on gifted property

$image\bullet.jpg$ Donor retains right to store property year-round in a donated vacation home

$image\bullet.jpg$ Donor retains right to vote shares of donated stock

$image\bullet.jpg$ Donor retains mineral rights in underlying contributed land

$image\bullet.jpg$ Donor retains right for life to receive payments due under a 60-year timber lease

Recordkeeping & Substantiation

At a Glance

In a court of law, a judge would be unlikely to rule in favor of an attorney who presented a client's case without the use of any physical evidence (i.e. memorandums, letters, financial records, police reports, etc.). Likewise, the IRS might deny an income tax charitable deduction to a donor who does not submit the necessary proof, or keep the necessary records, of a completed donation. How does a donor present the necessary proof? The basic IRS requirements are two-fold, the donor must:

$image\bullet.jpg$ Maintain detailed contribution records compliant with IRS regulations, and

$image\bullet.jpg$ Tender to the IRS a written acknowledgment, or substantiation, from the charitable organization verifying the donation (if the donation is above a certain amount).

Recordkeeping Rules

A donor is required to maintain records for all contributions for which an income tax charitable deduction is claimed. Additional requirements may apply depending on whether the contribution is from cash or property and the amount of the contribution.

If a contribution of cash is completed, a donor must maintain one of the following documents as evidence of the donation:

$image\bullet.jpg$ Canceled checks

$image\bullet.jpg$ Receipts (or letters or other communications) from the charitable organization that lists: name of the donee charitable organization, date of the contribution, and amount of the contribution.

A donor making a non-cash contribution to a charitable organization must keep written records covering the transaction. The records must include the following information:

$image\bullet.jpg$ Name and address of the donee charitable organization

$image\bullet.jpg$ Date and site of the contribution

$image\bullet.jpg$ Fair market value of the property (and the method of determining that value, including an appraisal report if used) on the date of the contribution

$image\bullet.jpg$ Description of the property (if the property is a security, the document must include: the name of issuer, type of security, whether the security is regularly traded on the stock exchange or on an over-the-counter market)

$image\bullet.jpg$ Any agreement the donor may have entered into for the use, sale or disposition of the contribution

$image\bullet.jpg$ Cost or other basis in the property if subject to reduction rules, including the amount of (and manner of determining) the required reduction

$image\bullet.jpg$ For a contribution of less than the donor's entire interest in the property: the amount of the deduction for the current year and each prior year, name and address of the donee charitable organization, place where property is located (if tangible), and name of any person who has possession of the property.

Substantiation Rules

For a donor to receive a charitable deduction, he or she must substantiate any donation over $250 by sending written verification to the IRS of the contribution. Donors should be mindful that the IRS strictly upholds its substantiation requirements. In numerous rulings the IRS has declared, "no substantiation, no deduction."

The IRS requires the donee charitable organization to provide the donor with a written dated receipt documenting each separate contribution. However, the charitable organization may send the donor annual or quarterly statements listing each itemized contribution.

Canceled checks are not considered adequate documentation.

The written documentation from the charitable organization must include the following information:

$image\bullet.jpg$ The nature and amount of the payment, and

$image\bullet.jpg$ The value of any goods or services (quid pro quo) received by the donor in return for making the contribution.*

The law specifies that the written substantiation must be "contemporaneous." That means the substantiation must be secured from the charity no later than the due date of the return on which the deduction is claimed (including extensions).

* The substantiation requirements do not apply if the donee charitable organization files a substantiation return with the IRS. Although this exception was enacted to assist charities with administrative hassles and costs of making receipts, it is likely that donors will still require documentation from the charitable organization verifying the filing.

Special Substantiation Requirements

The following are transfers which are subject to special substantiation requirements:

Unreimbursed Expenses When Performing Services - If a donor accrues unreimbursed expenses while performing services for a charitable organization, the donor will hold a written acknowledgment if: the donor maintains sufficient records to substantiate the amount of the expense; and the donor obtains a statement from the donee charitable organization, outlining:

$image\bullet.jpg$ The services performed

$image\bullet.jpg$ A statement of whether the organization provided whole or part consideration to the donor for his or her services (and if consideration was received, a good faith valuation of the benefits should also be included), and

$image\bullet.jpg$ A statement of any "intangible religious benefits" which might have been provided to the donee.

Payroll deductions - Donors making contributions via a payroll deduction can substantiate their contributions with a combination of two documents: (1) W-2 form or a paystub (or any documents from a donor's employer documenting the amount of the contribution), and (2) a pledge card from the donee charitable organization indicating that no goods or services were provided as a quid pro quo for any contributions.

The IRS treats the amount of each payroll deduction as a separate contribution.

Non-Cash Contributions - Donors who make contributions of property, other than money, must present a receipt to the IRS as a written acknowledgment of the donation. The receipt must include: (1) the name of the donee, (2) a description of the property, and (3) the location and date of the contribution.

In lieu of a receipt, the donor may also use a letter or other written communication to substantiate the donation, which:

$image\bullet.jpg$ Acknowledges the donation

$image\bullet.jpg$ Shows the date of the contribution, and

$image\bullet.jpg$ Contains a description of the donated property.

Exception: If the receipt requirement is impractical, a donor's written records may be used to verify the information.

The IRS requires additional substantiation by donors who make a donation exceeding $500. Such donors must include in their return the additional information regarding the manner of acquisition and the basis of the gifted property, specifically:

$image\bullet.jpg$ How the donation was made (i.e. purchase, gift, etc.)

$image\bullet.jpg$ Date property was acquired, created or manufactured by or for donor

$image\bullet.jpg$ When property was substantially completed by the taxpayer (if produced or manufactured)

$image\bullet.jpg$ Basis of property transferred, other than publicly traded securities, held for over 12 months preceding the date of the contribution (if information is available)

$image\bullet.jpg$ Basis of property transferred, other than publicly traded securities, held by the taxpayer for 12 months or less preceding the date of the contribution

Note: If the claimed value of all of the donor's contributions in a year exceed $500, then he or she is required to complete portions of Form 8283 "Noncash Charitable Contributions."

CRTs and Pooled Income Funds - The IRS substantiation rules do not apply to property transfers made to charitable remainder annuity trusts and charitable remainder unitrusts. However, the substantiation requirements do apply to pooled income funds. In such a case, the donor meets the substantiation requirements by indicating whether any consideration (in whole or part) was provided to the donee in exchange for the transfer.

Quid Pro Quo Contributions - A written substantiation from a charitable organization must indicate whether the charity provided any quid pro quo (giving one valuable thing in exchange for another), goods or services, in partial exchange for the donor's contribution (e.g. event tickets). When the value of the donor's quid pro quo contribution exceeds $75, the charity has a duty to make a written disclosure of such value to the donor. The donor must also be alerted that only the excess of his or her contribution above the value of the quid pro quo is deductible.

Click here for the token benefit rules.

"Hygiene" Rules

At a Glance

The Internal Revenue Code includes a hodgepodge of tax rules applicable to the charitable giving field, sometimes known as "hygiene rules" because they seek to assure that transactions are not tainted by non-charitable motives.

Private Foundation Prohibitions

Private foundations are organizations with a restricted basis of support. Consequently, the IRS imposes various prohibitions on the organization to prevent private individuals from personally benefiting rather than the public-at-large. The prohibitions, subject to excise tax penalties if disregarded, disallow the following activities:

Self-Dealing Between Foundations and Their Contributors - A private foundation and a disqualified person (creators, substantial contributors, trustees, directors, members of their families, controlled corporation and trusts) cannot engage in self-dealing, which is:

$image\bullet.jpg$ Sales, exchanges or leases of property

$image\bullet.jpg$ Loans

$image\bullet.jpg$ Furnishing of goods, services or facilities

$image\bullet.jpg$ Paying compensation

$image\bullet.jpg$ Transferring income or assets from the foundation to the donor, or

$image\bullet.jpg$ Payment to government officials

Failure to Distribute at Least a Minimum Amount of the Foundation's Income for Exempt Purposes - The law requires a foundation to distribute annually the greater of:

$image\bullet.jpg$ The foundation's adjusted net income for the tax year, or

$image\bullet.jpg$ A minimum percentage of its investment assets (as valued for each tax year).

Holding Business Enterprises in Excess of Specified Maximum Ceilings - Disqualified individuals are prohibited from:

$image\bullet.jpg$ Owning more than 20% of the voting stock of any corporation, or

$image\bullet.jpg$ Owning more than 35% of the voting stock of any corporation, if an unrelated party has effective control.

If disqualified persons do not own more than 20% of the voting stock, the private foundation may own the corporation's non-voting stock. In contrast, if a disqualified person owns more than 20% of the voting stock, the private foundation may not own non-voting stock. Certain exceptions exist.

Investments That Jeopardize Tax-Exempt Status - A private foundation is prohibited from investing either principal or income in a way that would jeopardize its exempt purposes. Although no list of categories exist naming investments that violate the rules per se, the Internal Revenue Service will pay close scrutiny to the following activities:

$image\bullet.jpg$ Trading securities on margin

$image\bullet.jpg$ Trading in commodity futures

$image\bullet.jpg$ Investment in working interests in oil and gas wells

$image\bullet.jpg$ Buying warrants, and

$image\bullet.jpg$ Selling short.

Expenditures for Lobbying - A private foundation must not engage in the following "taxable expenditures," including:

$image\bullet.jpg$ Influencing legislation

$image\bullet.jpg$ Influencing the outcome of a public election

$image\bullet.jpg$ Making grants for non-charitable purposes

$image\bullet.jpg$ Making grants to non-public charitable organizations (unless the foundation exercises "expenditure responsibility")

$image\bullet.jpg$ Making grants to any individual for study or travel (unless the Internal Revenue Service approves in advance the grant-making procedures)

Certain exceptions exist under each prohibition.

Application to CRTs

Charitable remainder trusts are, in some ways, similar to private foundations. Both are susceptible to private benefit, so both must impose safeguards to prevent such abuses. Further, a charitable remainder trust will be treated as a private foundation for tax purposes if the trust assets continue to remain in the trust after the expiration of the noncharitable interest.

Two of the private foundation prohibitions apply to CRTs: self-dealing and taxable expenditures. Although technically only two prohibitions apply, the IRS issued a ruling on CRT qualifying language which listed all of the private foundation excise tax prohibitions as suggested language to be included in a CRT governing instruments. Therefore, regardless of the black letter law, some tax experts encourage placing all of the private foundation prohibitions in a CRT's governing instrument.

Unrelated Business Taxable Income

Charitable organizations must be cautious when determining what sort of income-producing activity in which to engage. If income is derived from activities unrelated to the organization's exempt purposes (unrelated business taxable income), then the charitable organization will be taxed on the income received at the applicable federal income tax rates.

The unrelated business income tax was first levied in the 1950s when members of the for-profit sector complained about unfair competition from non-profit organizations. The price structure of non-profit organizations did not have to reflect the tax burdens imposed upon the for-profit sector.

The unrelated business income tax applies to all non-profit organizations, and to charitable remainder trusts, with the exception of governmental instrumentality (governmental instrumentalities do not include universities or colleges).

Let's look at an example.

State University sells clothing items, posters and programs at home football and basketball games. Last year, the university received $1,000,000 in income from the sales. This income would be classified as unrelated business taxable income and taxed at corporate income tax rates.

A three-part test must be used to determine if an organization is responsible for paying unrelated business income tax.

1. Does the income arise from the conduct of a trade or business?
A trade or business means activities in which the production of income arises from the sale of goods and performances of services (whether the organization makes a profit is irrelevant).

2. Is the trade or business regularly carried on?
An activity is considered to be "regularly carried on" if it is maintained with a continuity and frequency comparable to a commercial endeavor.

3. Is the trade or business substantially related to the organization's exempt purpose?
An activity that generates income must be substantially related to the accomplishment of the organization's exempt purposes.

Debt-Financed Income

Donated property encumbered by a mortgage, debt, or similar lien, or acquired with borrowed funds, is classified as debt-financed. Income received by the charity from debt-financed property will be treated as unrelated business income if the property is put to a use unrelated to the charitable organization's exempt purposes.

Generally, the above rule applies regardless of whether the donee charitable organization assumes and agrees to the indebtedness.

Two exceptions exist to this general debt-financed income rule:

$image\bullet.jpg$ Bequeathed property with a mortgage - If the charitable organization receives mortgaged property through a bequest, a 10-year grace period shields the transfer from the unrelated business income tax.

$image\bullet.jpg$ Gifted property - If mortgaged property is given during the donor's lifetime to a donee charitable organization, and the mortgage was placed on the property at least five years prior to the gift with the property being held by the donor for over five years, then a 10-year grace period shields the transfer from the unrelated business income tax.

Note: The grace periods do not apply if the charitable organization assumes the debt, or makes equity payments.

Applicable Federal Rate (AFR)

The Applicable Federal Rate (AFR), the government's monthly interest rate that is used to calculate the charitable deduction for split-interest gifts, has dipped to unprecedented lows in recent years.

Click here to jump to a list of recent monthly AFRs.

Origin and Purpose of the AFR

The IRS prescribes time-value-of-money tables to value partial interests in property: life estates, term-of-years interests, remainders and reversions. This is important in planned giving because it enables us to determine the income, gift and estate tax charitable deductions.

Until 1984, the IRS tables used a fixed interest rate of 6%. As interest rates rose dramatically during the early 1980s, the 6% fixed rate departed increasingly from economic reality. The IRS reacted by promulgating new tables with a 10% fixed interest rate. The IRS also followed the private sector trend toward unisex mortality assumptions.

Eventually, Congress abandoned the fixed interest-rate system entirely. IRC Sec. 7520 adopted the current system of valuation tables that use floating monthly interest rates. Thus, the same property transfer may have a different value next month versus this month because the federal interest rate may change. IRC Sec. 7520 was effective for transfers on and after May 1, 1989.

IRC Sec. 7520 prescribes an "applicable federal rate" (AFR) for various situations in which the time-value of money is a factor in valuing a property interest. One such situation is charitable gifts of partial interests in property, such as charitable remainder trusts, charitable gift annuities, charitable lead trusts, and certain other types of split-interest charitable gifts. Since the beneficiaries of these gifts include both private individuals and charities, the AFR is used to allocate a portion of the total value of the transfer to the separate parties.

Toward the end of each month, the IRS issues a revenue ruling that sets forth the federal interest rates for the following month. Different rates are provided for various tax purposes. Here, we'll focus only on the rate pertinent in calculating the charitable deduction, which is:

120% of the applicable federal midterm rate, rounded to
the nearest two-tenths of one percent.

Commercial tax services often make the 120% and rounding computations from the government's raw data, and report the final AFR rather than the IRS's unadjusted figure.

This single figure is divided into four sub-rates, depending on whether the payment period is annual, semiannual, quarterly or monthly. For example, if a charitable remainder annuity trust pays income monthly, quarterly or semiannually to the income beneficiary, the AFR is slightly lower than if the trust payout is made annually.

The floating rate prevented taxpayers from taking advantage of differences between the government's interest rate assumption and real-world interest rates. The difference could be quite dramatic under the fixed-rate system, and this allowed taxpayers to time their transfers to derive greater tax benefits than the underlying economic realities might support. This was true of charitable contributions as well as other types of transfers.

Of course, even the floating AFR is "locked in" at the time of the gift. Subsequent AFR movements have no effect on the charitable deduction determined at the time of the gift--no matter how much later AFRs may depart from the "assumed reality" at the time of the gift. The only time subsequent AFRs become important is when the original gift is modified in some permissible way--such as by relinquishing a life income interest in a charitable remainder trust in favor of the charitable remainderman. In this situation, the AFR at the time of relinquishment is used to value the second gift.

Selecting The Optimal AFR

Taxpayers may choose among AFRs in calculating the charitable deduction for a particular split-interest gift [IRC Sec. 7520(a)]:

$image\bullet.jpg$ The AFR for the month in which the contribution occurred

$image\bullet.jpg$ The AFR for the month prior to the month of the contribution, and

$image\bullet.jpg$ The AFR for the second month prior to the month of the contribution.

Moreover, since the AFR for next month is usually released by the 20th or so of the current month, there is really an "unofficial" fourth option: a donor can wait until next month to make the gift if the forthcoming AFR is more favorable than those available under the three standing options.

How do you know which AFR will produce optimal results for a particular gift? Here are the general recommendations:

Select the highest available AFR for:

$image\bullet.jpg$ A charitable remainder trust (annuity trust or any type of unitrust)

$image\bullet.jpg$ A charitable gift annuity (for highest charitable deduction-but see below)

$image\bullet.jpg$ The relinquishment of a life estate in a personal residence or farm (the remainder interest having previously been given to charity).

Select the lowest available AFR for:

$image\bullet.jpg$ A charitable lead trust (annuity trust or unitrust)

$image\bullet.jpg$ The gift of a remainder interest in a personal residence and farm

$image\bullet.jpg$ A charitable gift annuity (for highest income-tax-free payments, especially if the donor does not itemize and cannot use the charitable deduction)

$image\bullet.jpg$ The relinquishment of an income interest in a charitable remainder trust.

Because of the technical manner in which the AFR affects the calculation of the charitable deduction, the AFR will have less effect on charitable remainder unitrusts and charitable lead unitrusts than on charitable remainder annuity trusts and charitable lead annuity trusts, all other factors being equal.

Effect of AFR on Specific Giving Techniques

Below we illustrate the difference the AFR can make in the amount of the charitable deduction for various types of planned gifts. We assume in these examples that the highest AFR available to the donor is 7.0%, and that the lowest available AFR is 4.0%. This is an exaggeration of the spread that can be expected in the real world, but it will dramatize the beneficial effects of both careful timing of the gift and careful selection of the AFR.

Charitable Remainder Annuity Trust. With a charitable remainder annuity trust (CRAT), select the highest available AFR to maximize the donor's charitable deduction.

AFR selection can be very significant in the case of a CRAT, because the payout amount is fixed at the trust's inception rather than sliding with the value of the principal as in a charitable remainder unitrust (CRUT). When the AFR selected is higher than the CRAT's fixed payout rate, the government essentially allows a larger deduction in recognition of the likelihood that the charitable remainderman ultimately will reap the benefits of the appreciation in trust principal.

Charitable Remainder Annuity Trust

Principal: $500,000

Payout Percentage: 5%

Payout Frequency: Annual

	4% AFR	7% AFR
Present Value of Income Interest	$251,472	$202,132
Present Value of Remainder Interest	$248,528	$297,868
Charitable Deduction	$248,528	$297,868

The higher AFR increases the charitable deduction for the gift to the CRAT by $49,340.

Charitable Remainder Unitrust. Selecting the highest available AFR for a unitrust will result in an incrementally higher income tax deduction for the remainder interest in a charitable remainder unitrust (CRUT).

This is not as significant in the case of a CRUT as in the case of a CRAT because of the way the charitable deduction is computed. In a CRUT the payout amount slides up and down with fluctuations in the annual value of the trust corpus. The CRUT deduction reflects the fact that any appreciation in the principal will benefit the income beneficiary to some extent rather than inuring entirely to the ultimate benefit of the charitable remainderman.

Charitable Remainder Unitrust

Principal: $500,000

Payout Percentage: 5%

Payout Frequency: Annual

	4% AFR	7% AFR
Present Value of Income Interest	$234,425	$230,040
Present Value of Remainder Interest	$265,575	$269,960
Charitable Deduction	$265,575	$269,960

Note that even a huge 3.0% spread in the AFRs only increases Clara's deduction by $4,385.

If the donor (or other beneficiary) decides to forfeit his or her remaining income interest in a previously established charitable remainder trust, the lowest AFR should be selected to secure the greatest deduction.

Charitable Gift Annuity. The situation is a little more complicated for a charitable gift annuity. If the donor's priority is to maximize the income tax charitable deduction, then the same conclusion applies as for the charitable remainder annuity trust: select the highest available AFR.

However, if the donor's priority is to maximize the nontaxable portion of the annuity payments--at the conscious sacrifice of some portion of the charitable deduction--then the lowest AFR should be selected.

An example will demonstrate the tax trade-off that occurs with a charitable gift annuity, and the importance of identifying the donor's tax priority.

Charitable Gift Annuity

Principal: $100,000

Annuity: $6,800

Payout Frequency: Annual

	4% AFR	7% AFR
Charitable Deduction	$54,962	$61,492
Exclusion Ratio	73.6%	62.9%
Nontaxable Portion	$5,005	$4,277

If Samuel is primarily "deduction-motivated," the 7% AFR would give him a $6,530 larger deduction. In a 37% marginal income tax bracket, this would save $2,416 in income taxes. On the other hand, if he's mainly interested in tax-free payments, the 4% AFR would give him an additional $728 of tax-free income each year for his remaining life expectancy (fully taxable as ordinary income thereafter).

Gift of Remainder Interest in Personal Residence or Farm. As a general rule, gifts of a partial interest in property to charity have to be made in trust. One of the important exceptions is the outright gift of a remainder interest in a personal residence or farm. In valuing the remainder interest for charitable deduction purposes, the donor should select the lowest available AFR to maximize the charitable deduction.

Gift of Remainder Interest in Personal Residence

Fair market value: $600,000

Useful Life:
30 years

Value subject to depreciation:
$500,000

Salvage value:
$100,000

	4% AFR	7% AFR
Charitable Deduction	$309,422	$239,364

We see that the 3.0% difference in AFRs makes a difference of over $70,000 in the charitable deduction.

If the time should come when the donor (or other income beneficiary) wishes to relinquish to charity his or her remaining life estate in a personal residence or farm, after having earlier contributed the remainder to charity, the highest available AFR at the time of the relinquishment should be selected to maximize the deduction.

Charitable Lead Annuity Trust. An income tax charitable deduction is allowed for the charity's income interest in a charitable lead annuity trust (CLAT) only when the grantor is treated as the owner of the trust income under the grantor trust rules [IRC §170(f)(2)(B)]. In such a case, the donor should select the lowest available AFR in order to maximize the charitable deduction.

Charitable Lead Annuity Trust

Principal: $2,000,000

Term: 12 years

Payout %: 5

Payout Frequency: Annual

	4% AFR	7% AFR
Value of Remainder Interest	$1,061,490	$1,205,730
Value of Income Interest	$ 938,510	$ 794,270
Charitable Deduction	$ 938,510	$ 794,270

The lower AFR results in an additional charitable deduction of $144,240.

Charitable Lead Unitrust. As with a CLAT, an income tax charitable deduction is allowed for the charity's income interest in a charitable lead unitrust (CLUT) only when the grantor is treated as the owner of the trust income under the grantor trust rules [IRC §170(f)(2)(B)]. By selecting the lowest available AFR, the donor can maximize the charitable deduction. However, the increase will be much less impressive than with a CLAT because of the technical manner in which the deduction is calculated.

Charitable Lead Unitrust

Principal: $2,000,000

Term: 10 years

Payout %: 6

Payout Frequency: Annual

	4% AFR	7% AFR
Value of Remainder Interest	$1,104,026	$1,123,132
Value of Income Interest	$ 895,974	$ 876,868
Charitable Deduction	$ 895,974	$ 876,868

The lower AFR results in a slight increase in the charitable deduction of ($19,106).

Pooled Income Funds. The AFR usually has no bearing on the deduction for a contribution to a pooled income fund (PIF). Instead the fund's own recent earnings history is utilized to determine the applicable rate. Specifically, the highest annual rate of return that the fund earned during the three tax years immediately preceding the year of the gift must be used.

However, if the pooled income fund is newly established and does not yet have a three-year history, there is a deemed rate of return that must be used. The deemed rate for gifts made to new PIFs in 2025 is 4.0%.

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While the publisher has been diligent in attempting to provide accurate information, the accuracy of the information cannot be guaranteed. Laws and regulations change frequently, and are subject to differing legal interpretations. Accordingly, neither the publisher nor any distributor of this service shall be liable for any loss or damage caused or alleged to have been caused by the use or reliance upon this service.