ESTATE PLANNING THROUGH CHARITABLE GIVING

Marcia Geltman, CPA, Partner Glenn Schwier, CPA, JD

December 9, 2015

www.nisivoccia.com

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Why do people give to

charity?

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Why do people give to charity?

• Income tax deduction

• Minimize estate tax

• Legacy

• Be charitable

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Better to give to charity while

alive or at death?

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Better to give while alive or at death?

• While alive: – Enjoy the rewards

– Reduce current tax liability

– May have to listen to children objecting

• At death: – Get to use money while alive

– Get to change your mind while alive

– Don’t have to listen to children objecting

– May require accounting to state attorney general

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Foundations – a good compromise

• Allow you to enjoy the rewards while alive

• Get current tax benefit

• Allows you to change your mind as to what charity you would like to support

• Can appease children by paying them to be trustees or manage the investments

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What are Foundations?

• A type of exempt charity.

• Typically privately funded and serve as a vehicle for charitable giving.

• Allows the donors to control the assets as long as they act in a proper fiduciary capacity.

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History of Private Foundations

• First entered in legislation in 1950 with expanded legislation through 1969.

• In 1997 there were approximately 44,000 private foundations with assets of over $2 billion.

• In 2013 there were approximately 87,000 private foundations, 2/3s of which are considered small (holding less than $50 million in assets.)

• In total they held about $800 billion in assets.

• About 34% are located in NY and CA. NJ has about 3%.

(data.foundationcenter.org) (Thomas A Troyer – 1969 Private Foundation Law: Historical Perspective on Its Origins and Underpinnings) (Stanford Social Innovation Review)

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Private Foundations v Public Charities

All exempt entities are considered private foundations unless they qualify as a public charity. Private foundations generally receive their funding from one source and therefore are not publicly funded (one of the requirements of a public charity).

There are 27 organization types which can qualify for other than a private foundation. They fall within 4 categories:

• Exempt by statute – federal, state & local government agencies

• Publicly supported – example - American Red Cross

• Supporting organizations – example - Friends of the Library

• Organizations testing for public safety

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Applicable IRS Code Sections

• IRC Section 170 – provides for charitable deduction to qualified organizations

• IRC Section 501-505 – exempts qualified corporations from paying tax

• IRC Section 507-509 – private foundations

• IRC Section 4940-4948 – excise tax penalties applicable to private foundations

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IRC Section 509

Defines a private foundation as an organization OTHER THAN:

• IRC 509(a)(1)Those described in IRC Section 170(b)(1) – religious, educational, hospitals or medical research, state supported colleges, governmental units or receives substantial support from the general public or government.

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IRC 509 (cont’d)

OR

• 509(a)(2) Receives >1/3 support from gifts, grants and membership fees and <1/3 from investment income

• 509(a)(3) Supporting organization

• 509(a)(4)Formed for testing public safety.

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Types of Private Foundations

• Family Foundations

• Corporate Foundations

• Pooled Common Fund Foundations (publicly supported – community trust funds)

• Operating Foundations

• Donor Advised Funds - must distribute income within 2½ months after year end.

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Income Tax Deductions

• 50% of AGI to public charities

• 30% of AGI to private foundations (also limited to 10% of stock in any one company)

Donations of appreciated property reduced limitations of 30% to public / 20% to private foundations

5 year carryover of unused amounts

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Do Private Foundations pay tax?

• There are several types of excise tax which apply to private foundations.

• The first is an excise tax of 1% or 2% of your annual net income.(The percentage depends upon the amount of qualifying distributions.)

• There is also an excise tax for failure to distribute at least 5% of the value of the assets each year. The excise tax is 30% of the undistributed income. This excise tax is increased to 100% if the amount is not distributed within 2 years.

• Other excise taxes for not following rules such as no self-dealing.

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Other requirements of Private Foundations

• Strict prohibition against self dealing with donors. No loans, leases, purchases, sales, etc. Management fees are acceptable as long as they are reasonable.

• Restrictions on receiving funds from other private foundations. Private foundations generally can not make donations to other private foundations unless certain requirements are met.

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Operating Foundations

Provides more liberal tax treatment for donations. However, substantially all of the income must to directly to the activity conducted. (example family operated museum)

In addition, must meet one of the three following tests:

1. Asset test: > 50% of the assets must be devoted to the activity

2. Endowment test: Distributions must equal at least 2/3s of minimum distribution OR

3. Support test: 85% of its support must come from general public and from at least 5 tax exempt organizations. Not more than 25% from one organization and not more than ½ from investment income.

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Bargain Sales

Sell land valued at $80,000 to charity for $20,000. Initially paid $10,000 for the land.

A portion of the transfer is a donation and a portion of the transfer is a sale.

$20,000/$80,000 = 25%. Therefore, 25% of the basis ($2,500 is allocated to the sale)

Charitable donation = $60,000

Gain on sale = $17,500 ($20,000 - $2,500)

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Tax Exempt Process

• EIN

• Articles of Incorporation

• Bylaws

• Conflict of Interest Policy

• 1023 Application

• Retroactive 27 months

• NJ CRI registration

• NJ REG-1E – Retroactive to Formation

– Filed within 6 months of formation

– ST-5

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Articles of Organization

• Exempt purposes clause

– Organized and

– operated

– exclusively for one or more of the following purposes: • Religious

• Charitable

• Educational

• Scientific

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Articles of Organization

• Dissolution • Remaining assets distributed to

– Charity

– State

– Federal

• Public Purpose

• Private Foundations

– Additional provisions required

• New Jersey

– Online formation

– Amending Certificate of Incorporation 21

Exemption Requirements

• Organized and operated exclusively for exempt purpose set forth in 501(c)(3)

– Not for benefit of private interests

• Earnings may not inure to private shareholder or individual

• Not an action organization

– influencing political campaigns or legislation

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Exempt Purpose

• Distribution of earnings.

– An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals. For the definition of the words “private shareholder or individual”, see paragraph (c) of § 1.501(a)-1

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Private Inurement

• Private inurement for tax-exempt organizations

– Revocation of tax exempt status

– Excess benefits tax

• not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals.

• An excess benefit transaction is a transaction in which an economic benefit is provided by an applicable tax –exempt organization directly or indirectly, to or for the use of a disqualified person, and the value of the economic benefit provided by the organization exceeds the value of the consideration received by the organization.

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Exempt Organization – trade or business

• An organization may meet the requirements of section 501(c)(3) although it operates a trade or business as a substantial part of its activities,

– if the operation of such trade or business is in furtherance of the organization's exempt purpose or purposes and if the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business, as defined in section 513.

– Business primary purpose determined by facts and circumstances must be considered, including the size and extent of the trade or business and the size and extent of the activities which are in furtherance of one or more exempt purposes.

– An organization which is organized and operated for the primary purpose of carrying on an unrelated trade or business is not exempt under section 501(c)(3) even though it has certain religious purposes, its property is held in common, and its profits do not inure to the benefit of individual members of the organization.

• Taxation of unrelated business income.

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Tax Exempt Status

• 1023 Application

– 1023-EZ

• Online

• $400 Filing fee

– 1023

• Paper filed

• $850 Filing fee

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1023 Application

• Paper application

– 26 pages

– 11 parts and 8 schedules

– User fee $850

• average gross receipts over $10,000 in 4 year period

– One year for IRS response

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1023 Application

• Balance sheet

• Revenue and Expenses

– Newly formed

– Projected 3 years

• Attachments

– Articles of Organization

– Bylaws

– Conflict of Interest Policy

• Determination Letter

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Tea Party Scandal

• Exempt Organization application reviewed

• Two years for IRS to review the application

• Conservative organizations perceived as targeted

• IRS cut backs

• Creation of 1023-EZ application

• Cost savings for Exempt Organizations

• Impact in future

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1023-EZ

• 3 pages

• Eligibility to file 1023-EZ – Gross receipts do not exceed $50,000

• Prior 3 years

• Next 3 years

– Projected

– FMV of assets do not exceed $250,000

– Not Foreign formed or mailing address

– Successor to or controlled by suspended entity under 501(p) (terrorist organization)

– Not successor to For-Profit entity

• Increased chance of Audit?

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1023-EZ

• Determination Letter

– may not be relied upon if it was based on inaccurate material information

– Does not require Exempt entity to produce documents

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Revocation

• Automatic Revocation

– Failure to file return or 990-N postcard for 3 consecutive year

• Nonprofessionals

– Example – School PTA

• Changes to board every year as students leave

• Don’t realize they have to file tax returns

• Refile 1023 application – $3,000 to $5,000

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Streamlined Retroactive Reinstatement

• Previously revoked – Streamlined retroactive reinstatement

• Eligible to file 990-EZ or 990-N if revoked for failure to file 3 consecutive years tax returns if

• Not previous automatic revoked

• Submit not later than 15 months after Revocation Letter

• User fee

• “Revenue Procedure 2014-11, Streamlined Retroactive Reinstatement”

• Form 990-EZ & 990-N

– Avoid Penalty for failure to file

» File 990-EZ (Retroactive Reinstatement)

» Eligible to file 990-N

• do not have to file

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Retroactive Reinstatement

• For 990 & 990-PF filers

– Within 15 months

– File 1023 or 1024

• “Revenue Procedure 2014-11, Retroactive Reinstatement”

– Reasonable cause statement at least one year

– Statement filed returns required for 3 years

– File 3 year returns that resulted in revocation

• “Retroactive Reinstatement”

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Retroactive Reinstatement

• After 15 months

– Same as within 15 months

• Plus

– Reasonable cause statement for all 3 years

– Reasonable Cause

• Exercised ordinary business care and prudence

• Facts and circumstances

• Steps to avoid or mitigate failure in future

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Bylaws

• Indemnification

– Statement that limits the personal liability of board members

• Minimum and maximum number of board members

• Procedure for electing Board

• Quorum

– minimum number of board members who must be present for official decisions to be made

– conference calls and electronic meetings

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Bylaws

• Term and term limits

• Titles of officers

• Removing Board Member

• Minimum number of board meetings per year

• How a special or emergency board meeting may be called

• Committee

– created or dissolved

• How the bylaws can be changed

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Bylaws

• Bylaws typically contain specific provisions detailing:

– The purposes or mission of the organization

– How board meetings are conducted

– How many officers the corporation will have.

– The duties and responsibilities of each officer.

– Reports due to directors.

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Bylaws- bad ideas

• Failure to follow Bylaws

• Ambiguous provisions

• Staff job descriptions, guidelines for fundraisers

– too detailed

• Obsolete purpose clause

• Not in compliance with the law

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Bylaws- bad ideas

• Too complicated

• Designed to comply with the laws of another state or jurisdiction.

• Do not include important provisions that may apply to your organization by default under applicable law.

• Not been customized to meet your needs.

• Changes too easily adopted without careful thought or too difficult to modify

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Conflict of Interest Policy

• 1023 Application – Appendix A

• Define conflict of interest – Financial

• Contract or transaction

– Nonfinancial

– Interested Person

• Board member

• officer

• Employees

• Family members

• Business partners

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Conflict of Interest Policy

– Disclosure

– Voting

– Procedures for managing conflicts

• Leaves room for discussion

• No participation in decision

• Example Buying Cameras

– Board member owns camera store

– Offers to sell to Exempt Organization at cost

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Trusts

CRATS

CRUTS

CLATS

CLUTS,

and of course NIMCRUTS

Charitable Remainder Trusts and Charitable Lead Trusts

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Charitable Remainder Trusts

A trust defined in IRC 664, the income of which must be distributed at least annually to a non charity either for the life of the individual or for a period of years, not to exceed 20 years. The remainder goes to the charity.

A charitable donation is allowed for the calculated remainder interest (using IRS tables per IRC Section 7520).

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CRATS and CRUTS

CRAT – Charitable Remainder Annuity Trust – pays a sum certain annually to one or more beneficiaries of which at least one is a non charity. The annual payment must be at least 5% but not more than 50% of the net fair market value of the assets as of the day they were transferred into the trust.

CRUT – Charitable Remainder Unit Trust – pays a fixed percentage of the fair market value at least annually to one or more beneficiaries of which at least one is a non charity. The annual payment must be at least 5% but not more than 50% of the net fair market value of the assets valued annually.

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NIMCRUTS

NIMCRUTs – Net Income with Make-Up Charitable Remainder Unitrust.

Provides for distribution of the lesser of annual income or fixed percentage. Any shortfalls can be made up in future years.

If the trust assets do not produce income, then no distribution is required. This works well if the trust asset consists of an annuity. This would allow for postponed income until retirement or other financial needs such as college tuition.

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IRC Section 664 requirements

In order for a Charitable Remainder Trust to qualify under IRC Section 664, it must meet the following requirements:

• Must be irrevocable

• Must operate in a manner consistent with the trust agreement

• The trust must be valid under local law

• The trust instrument must be substantially similar to the sample document provided in Revenue Procedures 89-20 and 89-21.

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Donations to CRATs and CRUTs

Cash

Appreciated Property

IRD (Income with respect to the decedent)

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CLTS - Charitable Lead Trusts

Charitable Lead Trusts are Charitable Remainder Trusts, but in reverse. The annual income goes to the charity with the remainder going to a non charitable beneficiary. One difference, these are not tax exempt entities, but rather are treated as trusts.

Two types – Grantor Charitable Lead Trusts and Non-Grantor Charitable Lead Trusts

Whether they are grantor or non-grantor charitable lead trusts, income distributions can still be determined based on annuity trust rules or unitrust rules.

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Grantor CLTs

Grantor CLTs – Individual puts money into a trust with the income stream going to a charity. The remainder interest after the term of the trust, goes to a non charitable beneficiary. The grantor gets an up front charitable deduction for the value of the income stream. However, as with grantor trusts, the grantor is then required to include the annual income on his tax return, even though it is being paid to a charity. For income tax purposes, this is more of a timing benefit. At the end of the trust term, the assets will either revert back to the grantor or to another remainder beneficiary. This would result in a gift tax, or estate tax issue.

If interest rates are low, lead interest will be calculated high resulting in a larger charitable deduction, even though the actual charitable contribution may be less as interest rates rise.

Contributions to Grantor CLTs are limited to 30%/20%cap gains. No 5 year carryover allowed.

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Non-Grantor CLTs

Non Grantor CLTs – Individual puts money into a trust with an income stream going to a charity. The remainder interest after the term of the trust, goes to a non charitable beneficiary, other than the donor. There is no income tax deduction to the grantor. The trust reports the income annually and gets a charitable deduction for the amount distributed to the charity. The remainder interest is considered to be a gift, subject to gift tax rules. If interest rates rise, the beneficiaries will receive more than the amount reported as a gift.

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Thank You

Thank you for participating in our seminar.

Please do not hesitate to contact us should you have any questions or need assistance.

Glenn Schwier, CPA, JD

Marcia Geltman, CPA

Nisivoccia LLP

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The End(s)

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