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In This Deal, Everybody's a Winner (Except the IRS)

Tax and Financial News

July 2000

In This Deal, Everybody's a Winner (Except the IRS)

“Render unto the IRS that which is the IRS’s, but not a penny more than you have to!” is basically what any good CPA should help you do. The problem comes in deciding what belongs to the IRS and what doesn’t. If you take the view of any sensible person, the answer is “nothing”. Ask the government and the answer is “everything”.

While CPAs tend to take the “nothing” approach, we are also a realists with a healthy aversion to jail. So, we work within the confines of the law. Luckily, one of the things present law does for us is gives us a tax break on charitable contributions.

“Big deal,” you say, “you still have to give the money away.” Well…yes and no. There are a couple of ways to save taxes while still earning money on the assets you give away.

One of the highest marginal tax rates today is the estate (or death) tax that can reach as high as 55%. If your estate exceeds a certain level, your estate will pay some amount of federal death tax in addition to any death, inheritance or transfer taxes due to your state. That level is $675,000 in 2000 and 2001, but will gradually increase until it reaches $1,000,000 after 2005.

That’s the bad news. The good news is that anything you give to charity in your will is deductible before determining how large your estate is. That’s really good news because the charity will get 100% of what you intend for them to have. Unfortunately, this doesn’t save you any income taxes. Neither you nor your heirs will get an income tax benefit for the gift and you will miss out on the joy of giving.

The really great news is there are vehicles called Charitable Trusts that will help you keep some income tax benefits for yourself. There are three general types of charitable trusts:

  • Charitable Remainder Trust
  • Pooled Income Fund
  • Charitable Lead Trust

With either of these first two, you can give your money away, keep the income for your life and the lives of your designated beneficiaries plus get a tax deduction on top of all that! If you use the last type of trust, you basically keep your money, but give the income to the charity.

To understand the way you get a deduction from one of these vehicles, you have to understand the concept of “present values.” When we accountants use the term “present value” we are basically saying one dollar today is greater than the value one dollar 10 years from now because of inflation and other factors. That’s the principle on which these trusts work, so let’s look at them a bit closer.

Charitable Remainder Trusts are arrangements where you give cash or non-cash assets, or a combination of both, to a qualified trust. The terms of the trust allow you to receive the income off the assets in the trust (minimum of 5%) for a specified time. At some point, generally the donor's death or the death of the donor's designated beneficiary, the charity receives what is left in the trust at the end of the trust’s life. This is called the “remainder”.

Since you have legally given away the asset, you get to take a deduction for the present value of the asset. This is generally figured by multiplying the fair market value of the asset at the time the gift is made times a present value factor determined at the time the trust is formed. The determination of the present value factor takes into consideration the life expectancy of the donor and any designated beneficiaries.

While this is useful in any case, it is most useful if you have assets that have large gains in them and you don’t want to sell them because you don’t want to pay the tax.

Consider Sue who worked all her life, invested the money wisely and retired to Florida. Her investments give her taxable income of $400,000 per year. Her estate is $1,472,000, she has stocks that she bought for $175,000 that are now worth $797,000, but don’t pay dividends, and she loves animals, so she plans on giving all of her assets over the $675,000 limit to the ASPCA.

She can sell those assets and give the cash to the ASPCA, give the assets to the ASPCA outright or setup a trust with the ASPCA as a remainder beneficiary.

If she sells the assets and gives the cash to the ASPCA, she gets a $797,000 deduction for the donation, but she also pays tax on $602,000 of capital gains. Since her deduction is limited in several ways by the tax code, the donation not only costs her the $797,000 cash paid to the ASPCA, but also extra taxes.

If she gives the assets away, she will get a $797,000 deduction, but it will be limited to 30% of her income each year until the limit of the allowable deduction is reached. She also gets the good feeling of having helped out America's animals.

If, however, Sue puts the money into a charitable remainder trust, the trust can then sell the assets. Since the trust is not taxable, there is no tax to pay on the gain. Then, those gains can be put into non-taxable bonds and the interest paid to Sue. Even at the minimum required return of 5%, the non-taxable income to Sue will be $39,850. Even better, she will get a deduction for the present value of the $797,000 gift.

Now let's see. Turn non-earning assets into earning assets that pay almost $40,000 per year, pay no tax on the capital gain and get a deduction. Sounds like a pretty good deal to me. What do you think?

The example above is a Charitable Remainder Annuity Trust. There is also a Charitable Remainder Unitrust. This is the same as the Charitable Remainder Annuity Trust, but instead of a set return of, say 5%, the payment is determined every year based on the value of the assets at the beginning of the year.

Charitable Lead Trusts are basically the same as charitable remainder trusts, except the income earned is given to the charity as it is earned and the remainder goes to your heirs after seven years. You get a deduction for the value of the income the charity is expected to receive, but you also get the assets out of your estate. The only downside of this is that you may be subject to gift tax if the value of the gift to the heirs exceeds the $10,000 annual exclusion amount. Still, by reducing the value of the gift, you come out ahead. The less the gift is worth, the less you will pay tax on.

Since the asset returns to the beneficiaries in seven years, this is a very effective tool for transferring stock in a family business.

Pooled Income Fund "All this Charitable Trust stuff is great," you say, "but this lady has a ton of money. What about me? I don't have much and what I do have, I owe." Well, if you can invest a little money with your charity's pooled income fund, you can receive similar benefits as the big guys, but on a smaller scale.

A pooled income fund is similar to a Charitable Remainder Trust. The only difference is that it uses the funds of a number of people instead of one. Since trusts typically cost money to set up and administer, an investment of a few thousand dollars wouldn't yield much to a charity. However, if you can get 100 people to invest $1,000, then you can have a fund worth enough to establish a trust.

The main difference with the Pooled Income Fund is that the investments must be taxable investments and the investment income must be paid to the "investors" each year.


Ever since the tax code was drastically altered in 1986, in our quest to win against the IRS, most of the time, all we wind up with is a bad headache from pounding our heads against the wall. This time, however, we have a great chance to beat the IRS and help our fellow man, or animal as the case may be. What could be better?

Oh! Did we tell you the better news? If you take the tax savings from the gift you make, you may be able to buy “last to die” insurance to replace the value of the asset(s). If the ownership of the insurance is vested in your heirs, you have now found a way to give to your favorite charity without harming your kid's inheritance. That's called having your cake and eating it too. How often do you get that?

Come and see us and we'll discuss how we can give the IRS a good run for their money, or should I say, your money?

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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