A personal note to our advisor colleagues
The community foundation is honored to work with you and your clients to structure charitable giving plans and establish funds that achieve both your clients’ charitable objectives as well as address our region’s greatest needs.
The professionals at the community foundation intimately understand the issues facing our community and how grants from funds can be impactful. We do this through deep knowledge of our area’s nonprofits, due diligence to ensure that each charitable dollar helps as many people as possible, and an unwavering commitment to investing in our community for the long term.
As we enter into an era of potential tax reform, we pledge to keep you informed of legislative developments that will require you and other advisors to navigate the important distinctions between community foundation donor-advised funds and commercial donor-advised funds, as well as the differences between donor-advised funds and private foundations.
No matter what legislation is passed and when, the community foundation team is here to educate you and your clients. We’ll also keep you posted on charitable giving options that are tax reform-neutral and suggest ways to leverage pre-legislation windows of opportunity. Please reach out with any questions you’d like to be sure we address in our advisor communications.
In the meantime, we’ve focused this newsletter on three legal doctrines: a fidiciary’s personal liability, ”incidents of ownership” in gifts of life insurance, and the nuances of giving S Corporation stock to charities--all of which represent important, decades-old bodies of law that can easily be overlooked in the rush of an advisor’s day-to-day work with clients.
Advisors' fiduciary obligations can get personal
With charitable bequests on the rise, and the possibility that more clients will be subject to Federal estate taxes in the future, many attorneys, accountants, and financial advisors are refreshing their recollections on the requirements of advising and administering taxable estates where one or more charitable organizations is a beneficiary.
Advisors’ fiduciary responsibilities to charitable beneficiaries are similar to fiduciary responsibilities to a decedent’s family members and other individual beneficiaries. Where a charity is a residuary beneficiary, for example, a fiduciary must pay careful attention to expenses and liabilities that impact the amount the charity ultimately receives. These liabilities and expenses include taxes, debts, fees, and costs incurred by the executor or trustee. A fiduciary should expect charity remainder beneficiaries to pay as much attention to the bottom line as family members.
Not only must a fiduciary watch expenses to maximize the remainder beneficiaries’ interests, but a fiduciary must also be careful to avoid making distributions too early and therefore potentially becoming personally liable if estate obligations surface later. This was the unfortunate situation in Estate of Lee, T.C. Memo. 2021-92, where the fiduciary ultimately was found by the Tax Court to be personally liable for amounts due under a Federal tax lien.
As you assist your clients with estate planning that involves charitable giving, consider encouraging your client to talk with the charitable organization about the intended bequest so that expectations are well-documented, even if the bequest likely will not materialize until well into the future. Remember, too, that some charitable clients can benefit from establishing a fund at the community foundation to receive and administer their bequests to charitable causes. In that case the professionals at the community foundation can assist as you structure a bequest in the client’s estate plan.
Finally, and critically, ensure that the legal documents or beneficiary designation forms reflect the correct name of the charity. There are more than 1.5 million charitable organizations in the United States, and many have similar names. If you have any questions about which charity your client intends to benefit, ask both the client and the charity to confirm the exact name and location of the organization.
Five pointers for gifts of life insurance to charities
“Incidents of ownership” are three powerful words in estate planning where life insurance is concerned. The phrase is a key component of Internal Revenue Code Section 2042, which provides for the inclusion in a taxpayer’s gross estate, for estate tax purposes, of the proceeds of insurance policies on the taxpayer’s life under two circumstances. First, if the proceeds are actually received by the estate, they are included. Second, proceeds are included in an estate when the money is received by named beneficiaries other than the estate if the taxpayer died possessing “incidents of ownership” in the policy.
Section 2042 is the reason an estate planning advisor typically strives to ensure that a client does not own life insurance policies on the client’s own life. This is frequently accomplished by creating an irrevocable life insurance trust. As an alternative, many clients give life insurance policies to charitable organizations, not only for the estate tax benefits, but also for potential income tax benefits during the client’s lifetime.
Before you assist your client with a gift of life insurance to a charity, here are five pointers:
Check state law first. Most--but not all--states allow transfers of life insurance policies to a charity.
Request change of ownership and change of beneficiary forms from the insurance company, and make sure you have the right forms. The paperwork is not always user-friendly. There are instances where a taxpayer completed the wrong set of forms and thus failed to accomplish the intended transfer. The charity will need to be the policy owner and, unless the charity intends to surrender the policy, also be the named beneficiary.
Carefully calculate the charitable income tax deduction for the gift of the life insurance policy to the charity. The taxpayer is eligible for a deduction equal to the lesser of the policy's value or the taxpayer’s basis (usually the total amount of premiums paid). The “value” of the policy is computed using the replacement cost or the “interpolated terminal reserve” plus unearned premiums.
Be sure to check for loans against the policy to avoid an income tax event for the taxpayer.
Finally, do not run afoul of the “insurable interest” rules, which can come into play where the charitable entity pays the premium on a life insurance policy transferred to or secured by the charity on your client’s life.
These three factors are a big deal in gifts of S Corp stock to charity
S Corporation, or limited liability company? That’s a question many family businesses grapple with in their formative stages. For years, S Corporations were frequently preferred for small businesses that wanted the protection of a corporate structure versus a traditional partnership. In the 1990s, limited liability companies, or LLCs, rose in popularity because they offered both favorable tax treatment and corporation-like protections. In recent years, lower tax rates have contributed to the resurgence of traditional C Corporations as a viable structure for a business.
Since the adoption of laws and regulations decades ago making them advantageous, many S Corporations and LLCs have grown into thriving, highly-valuable businesses that are owned by your clients and are therefore now the subject of your estate planning work. So, too, have grown many clients’ desires to unlock these assets to fulfill charitable goals.
Many advisors find themselves discussing the benefits of donating S Corp stock to a charity prior to the sale of a business, but rarely do advisors feel prepared for that discussion with a client. That’s why it is important to be generally aware of the rules before the topic arises in a client meeting. A discussion with your client is especially important as business succession plans are crafted because many business owners want to minimize tax liability and also give back to the communities where their businesses have flourished. As an advisor, you have a responsibility to understand what might be possible.
Donating S Corp stock to a charitable organization is an important option that your clients will want to consider, and understanding the complexities is critical. Three factors are particularly important:
This idea must be addressed early in the process of business succession planning, especially prior to any formal discussions about a sale. Indeed, the IRS is known for its keen eye in spotting transactions that could be construed as resulting in “anticipatory assignment of income,” especially where a charitable deduction is involved. At the same time, many charitable organizations prefer not to hold hard-to-value assets like S Corp stock for more than a few years. Balancing these factors requires thoughtful planning and timing.
Private foundations and certain donor-advised funds at trust-form institutions (which then trigger the trust tax rates) are permissible shareholders of S Corp stock. Moreover, public charities have been eligible S Corp shareholders since 1998. Before you explore an S Corp gift to a charity, be sure to review the rules related to permissible S Corp shareholders.
Charities holding S Corp stock may be subject to Unrelated Business Taxable Income rules. Be sure to show your client various alternative calculations to determine the most cost-effective structure for each transaction alternative.