Trends in Philanthropy

Fast ACTs, TRU Gifts, and a CRT Cafeteria; Will We CARE?

he world is changing. Technology, demographics, and the economy end each day in a new place. Value shifts from stocks to bonds to real estate and back to stocks. And in response to these changes, people change the way they invest and transfer wealth-shifting emphasis from federal estate tax to income tax and capital gains.

In light of all these changes, which charitable-giving techniques will continue to be effective in the future? Trends involving private foundations and total return trusts will undoubtedly continue. Innovative variations of charitable remainder trusts also have ongoing appeal as well. Let's review the varied suggestions made by analysts in recent months as well as the Charity, Aid, Recovery and Empowerment (CARE) legislation that is anticipated by the end of the year.

Future Trends

The stakes for philanthropic endeavors could not be higher. These dynamic times will soon witness the greatest transfer of wealth in the history of mankind. Over the next 40 or 50 years, between $40 trillion and $136 trillion could be transferred between generations.¹

Philanthropy vs. Taxes: Will charitable giving decline without an estate tax? That was the result initially feared by many members of the philanthropic community. Press reports, anticipating the worst, projected a decline of $6 billion in annual charitable contributions. Donors confronted with high transfer taxes are motivated to give to charity rather than have the same money go to pay taxes. In theory, without taxes to worry about, donors will leave everything to their families. However, this reasoning has not been borne out by the actual trends that are emerging.

A large portion of charitable giving comes from corporate foundations or the vast majority of middle-income individuals who make annual gifts based on generosity rather than tax motives.

Similar fears about a decline in charitable giving resulted when the top income tax rates were reduced as part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Yet, donations increased after that tax cut. In 2001, Americans gave $212 billion to charity, more than $1 billion more than in 2000. Charitable giving has continued to increase since the repeal of the estate tax.

Studies have shown that larger estates give a greater percentage of the estate's assets to charity. This was demonstrated as estates grew during the economic expansion of the 1990s. From 1992 through 1997, the value of charitable bequests rose 110% while bequests to heirs rose 57%. For estates above $20 million, charitable bequests went up 246% while bequests to heirs rose 75%.²

Supply-side theory supporting the lowering of taxes to increase discretionary spending and generate economic growth can also be applied to charitable giving. As one author put it, "It can be argued that charitable bequests may actually increase as a result of the reduction or repeal of estate taxes."³

Giving While Living

Doing worthwhile acts right now and being able to witness the beneficial impact of a lifetime gift to a charitable cause have influenced more donors to make lifetime charitable gifts. Lifetime gifts also provide current income tax benefits and income tax has more significance in light of the future elimination of the estate tax. Dollars spent resolving current problems may avoid the need for far greater expenditures in the future.

This is the philosophy of Charles Feeney, who may have coined the phrase "giving while living." Feeney was a co-founder of Duty Free Shoppers Group, Ltd., who sold his share of the business for $3.5 billion and then gave away all but $5 million of his fortune. In July, his foundation, Atlantic Philanthropies, announced that it would quadruple its current distribution of grants from $100 million annually to $400 million annually with the plan of exhausting its entire endowment in 12 to 15 years.⁴

For the highest profile philanthropists, magnificent gifts help define donors. Thus, when Ted Turner pledged $1 billion to the United Nations in 1997 and challenged the world's wealthiest to accelerate gifts, he was following in the tradition of Andrew Carnegie and John D. Rockefeller, who each made lifetime donations worth billions in current dollar value. Bill Gates of Microsoft not only followed suit, but eclipsed all others with grants to charities exceeding $2 billion in 1999 alone.⁵

Private Foundations: In an age of individual expression where Americans have their own websites and control their own retirement plans, personalized philanthropy can't be far behind. Combine that with the trend of giving while living and private foundations may be a major vehicle for future philanthropy.

Private foundations have already been on the rise as a result of tax changes. The prosperity of the 1950s led to a boon in private foundations. But abusive uses of these arrangements during the 1960s led to restrictions in the Tax Reform Act of 1969, including a 4% excise tax on investment income. Congress recognized that these restrictions were too severe and relaxed rules somewhat in 1976 and 1984. In recent years, the popularity in this vehicle has soared. Over the past fifteen years, the number of American foundations may have doubled.⁶

TRU Philanthropy: Lifetime charity typically involves split-interest trusts. The modern trend of total return investing has transformed this area. Lifetime income beneficiaries now have higher expectations of sharing in the growth of trust principal.

The CRT Cafeteria

Judging from the creative variations of charitable remainder trust (CRT) that have been suggested in recent articles, the CRT is the current planning vehicle of choice. The reason is simple. Without an estate tax, there is no estate tax benefit for making a charitable bequest at death. By comparison, a remainder trust provides the donor with annual income as well as a current income tax deduction.

Funding Options: CRTs are versatile and can be funded with many types of assets. Predictably, these include life insurance, a staple asset of planning efforts because it brings its own benefits to any arrangement in which it is included. With many estates being dominated by retirement plans, CRTs are also viewed as a suitable IRA beneficiary.

But donating appreciated assets is where the real tax incentive lies. Not surprisingly, charitable giving has shifted its attention to real estate, which now represents a great deal of appreciated value. Thus, in California, a community foundation reported recent contributions that included "a mansion in Maui, a ranch in Montana, a Burger King franchise in Oregon, and an oil well in Los Angeles, as well as office buildings, industrial sites, and a 36-acre field of gladiolas."⁷

Note: Falling interest rates and declining stock values represent additional challenges for CRATs and CRUTs, respectively.⁸

The Fast ACT: The accelerated charitable remainder trust (ACT), is one of the more ingenious tax concepts ever devised, but it remains somewhat experimental. By compressing the time frame of a CRT, highly appreciated assets are donated to the CRT with a very short term and a very high payout. This results in most of the assets being returned to the donor in the form of an income interest. In the process, the donor has made a charitable donation and ends up with the same amount as if the assets had been sold and taxed. The donor essentially uses the CRT to "launder" the potential capital gains. Thus, $1 million is contributed to a two-year 80% CRUT and the donor ends up with more than $900,000, minimal income tax liability, and gets to make a charitable gift at little or no expense.

It has been suggested that ACTs could be used to process appreciated assets which could then be contributed to a private foundation, thus circumventing the limits on charitable deductions for contributions of appreciated property to a private foundation.

Caveat: Accelerated CRTs are the type of extreme arrangement that the IRS won't tolerate. In 1997, ACTs were targeted by proposed regulations from the IRS and adjustments to the tax code in the Taxpayer Relief Act of 1997. Thus far, restrictions on ACTs have only given rise to new versions of ACTs, but caution is clearly needed in this highly scrutinized area.⁹

Crux of the NIMCRUTs: The total return approach was put into action in the Net Income with right of Make up Charitable Remainder Unitrust (NIMCRUT). The NIMCRUT may be especially useful where non-liquid real estate assets are used to fund a charitable gift. The net income with makeup unitrust provisions enables the trustee to postpone income payments until the trust assets have been sold. Using a Flip Unitrust is also useful where real estate assets are involved. Once the real estate assets have been sold, beneficiaries of the income interest may prefer to "flip" the net income trust and have a straight unitrust with dependable income instead.

CRUTs vs. Stretch IRAs: Since retirement assets often include taxable income, they may be deemed a suitable source of revenues to fulfill charitable commitments. A rollover charity IRA can be established for one or more not-for-profit organizations (who can divide benefits on a percentage basis). Meanwhile, other retirement plans can be tapped to satisfy the owner's mandatory minimum distributions.

Both charities and family members can come out ahead when families with large retirement plans utilize a CRUT (or variations such as the NIMCRUT or Flip CRUT) instead of a "stretch" IRA. Financial planning emphasizes stretching the required minimum distribution of IRA assets. Despite the relaxation of rules in 2001, distributions to a sequence of beneficiaries must still be based on the life expectancy of the oldest beneficiary. By contrast, a CRUT can be named as the beneficiary of the IRA. The CRUT can then reinvest the assets and can benefit multiple beneficiaries for life. This approach defers distributions from an IRA for a longer period of time. However, potential shortcomings must be reviewed in this complex area.¹⁰

The CARE Package

Last February, the Senate adopted the Charity, Aid, Recovery and Empowerment (CARE) Bill of 2003 (S 476) by a vote of 95 to 5. In September, the House of Representatives passed its version of the bill [the Charitable Giving Bill of 2003 (HR 7)] by a vote of 408 to 13. A compromise of the two versions of the bill is expected to pass with broad bipartisan support by the end of the year. Here are some of the key elements of the proposals:

DEDUCTIONS FOR NON-ITEMIZERS: Donors who do not itemize their deductions would be permitted to deduct charitable contributions for a limited time, i.e., during 2004 and 2005. The deduction applies to contributions in excess of $250 for individuals and $500 for married couples filing jointly.

UNRELATED BUSINESS INCOME: CRATs and CRUTs that receive unrelated business income currently lose their charitable tax-exempt status. The House and Senate proposals would simply impose an excise tax equal to the amount of the unrelated business income instead.

IRA DISTRIBUTIONS: The proposed legislation would allow a donor over age 70.5 to make a direct transfer from an IRA to a charity and exclude the transferred amount from gross income. The Senate version of the law would lower the minimum donor age to 59.5 in allowing transfers to various charitable arrangements to qualify for the exclusion. Currently, the transferred amount would be included in income but would qualify for an itemized deduction. This deduction is subject to 20% and 50% of adjusted gross income ceilings.

PRIVATE FOUNDATIONS: The House version of this legislation would not include administrative expenses in calculating payments that meet the 5% payout required of private foundations. This would mean that compensation to disqualified persons in excess of $100,000 as well as first-class airfare would not be counted toward meeting the 5% required payout. In addition, a flat 1% tax rate would apply to net investment income instead of the current two-tier system of 1% and 2%. The House version of the legislation follows the President's 2004 budget but the Senate version does not address private foundations.

Note: The House version of the bill would also increase the 10% ceiling on corporate charitable deductions to 20% by 2012 and would raise the excise tax penalties for self-dealing from 5% to 25%.

The Future Is Now

Private foundations, total return trusts, creative charitable remainder trusts, and charitable uses of real estate may be trends for the future…but they are also part of the modern estate plan for today.

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