Charitable Gift Annuity

Charitable Gift Annuity

Technical Report posted in on 7 April 2008| 4 comments
audience: PhilanthroTec, National Publication | last updated: 18 May 2011
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Abstract

A charitable gift annuity is described generally as a transaction in which an individual transfers cash or property to a charitable organization in exchange for the charity's promise to make fixed annuity payments to one or two life annuitants. This comprehensive report discusses the origin of gift annuities, how they are designed and regulated, how charitable contribution deductions are determined, taxation of distributions to annuitants, taxation of gift annuities to issuing organizations, and creative planning opportunities for donors.

Introduction

As its name suggests, a charitable gift annuity consists of two elements: 1) an outright charitable gift, and 2) the purchase of a fixed income annuity contract. Payments can begin immediately or can be deferred for a period determined by the donor and set forth in annuity contract. The payment period can be measured by one annuitant's life (who is in most cases is the donor) or by the lives of two joint and survivor annuitants (who are usually husband and wife). Charitable gift annuities are not issued for a fixed term of years. As will be discussed, however, it is possible to terminate the annuity payments in advance of the life measuring term.

Unlike charitable remainder trusts or pooled income funds, whereby the obligation to make payments is limited solely to the contributed assets or segregated fund, a charitable gift annuity is considered a general obligation of the issuing charitable organization. Charitable gift annuities, therefore, take on much of same characteristics as commercial annuities with the issuing charity acting as the insurer. Many states require issuing organizations to be licensed and to maintain investment reserves.

Annuity Rates

In order to provide for a gift component, the rates offered by organizations in connection with charitable gift annuities are lower than those available from commercial insurance carriers.

Most organizations offer annuity rates as suggested by The American Council on Gift Annuities -- a qualified 501(c)(3) organization formed in 1927 as the Committee on Gift Annuities for the purpose of providing educational and other services to American charities regarding gift annuities and other forms of planned gifts.

The Council deals with all matters pertaining to charitable gift annuities and meets periodically to establish suggested annuity rates that will result in issuing charities realizing a 50% actuarial residuum from the annuity agreements they issue. The rates are based on current mortality studies, prevailing and projected investment returns on invested reserves, and projected administrative costs.

The annuity rate is based on the age and number of annuitants. The most recently published rates apply to gift annuities issued on or after July 1, 2008. Rates begin at 3.3% for single-life annuitants age 0 - 5 and increase to 10.5% for single-life annuitants age 90 and older. Rates for joint-and-survivor life annuities are less to reflect longer combined actuarial life expectancies. As will be discussed, charitable gift annuities are limited to one or two annuitants.

The purpose of using standardized rates is to discourage competitive rate setting among charities and thereby ensure that a significant portion of the transfer will be available for charitable purposes. In 1995, however, a lawsuit was filed by a donor who charged that charities that issued gift annuities had conspired to fix the rates they offered donors and that such practices violated both antitrust and securities laws. Congress, recognizing the primacy of charitable gift annuities as fundraising tools, enacted two laws designed to specifically exempt charitable gift annuities from antitrust laws.1

As an alternative to using the suggested ACGA rates, some organizations choose to develop their own rates based on their own investment experience, charitable residuum goals, and the investment/reserve requirements under state law.

Determining the Annuity Amount

The annuity rate is stated as a percentage that, when multiplied by the net fair market value of the amount transferred, determines the annual amount payable to the annuitant. The annual amount can then be paid annually, semi-annually, quarterly, monthly or as otherwise set forth in the annuity agreement.

Example 1: Mr. Jones, age 70, transfers $100,000 on January 1, 2008 to a charitable organization in exchange for a single life immediate charitable gift annuity. The suggested ACGA annuity rate corresponding to his age is 6.5%. Mr. Jones will receive $6,500.00 per year.

Example 2: Mr. and Mrs. Jones, both age 70, transfer $100,000 on January 1, 2008 to a charitable organization in exchange of a joint and survivor life immediate payment charitable gift annuity. The annuity rate corresponding their ages is 5.9%. Mr. and Mrs. Jones will receive $5,900.00 per year as long as at least one of them survives.

Deferred Payment Gift Annuity Rates

With a Deferred Payment Gift Annuity (DPGA), the annuitant(s) start receiving payments at a future time, the date chosen by the donor, which must be MORE than one year after the date of the contribution. As with Immediate Gift Annuities, payments can be made monthly, quarterly, semi-annually or annually.

The following procedures are used for calculating adjustment factors for deferred annuities issued on or after July 1, 2001:

1. Determine the annuity starting date, which is:
  • One year before the first payment, if payments are made annually.
  • Six months before the first payment, if payments are made semi-annually.
  • Three months before the first payment, if payments are made quarterly.
  • One month before the first payment, if payments are made monthly.
2. Determine the number of whole and fractional years from the date of the contribution to the annuity starting date (the deferral period). Express the fractional year as a decimal of four numbers.

3. For a deferral period of any length, use the following formula to determine the compound interest factor:

F = 1.0525d, where
F is the compound interest factor and
d is the deferral period

Example 3: If the period between the contribution date and the annuity starting date is 14.5760 years, the compound interest factor would be 1.052514.5760 = 2.1082.

Note: The F factor in this example applies to deferred annuities issued prior to July 1, 2008. The factor for deferred annuities issued on or after July 1, 2008 is 1.0475.

4. Multiply the compound interest factor (F) by the immediate gift annuity rate for the nearest age or ages of a person or persons at the annuity starting date.  

Example 4: If the sole annuitant will be nearest age 65 on the annuity starting date and the compound interest factor is 2.1082, the deferred gift annuity rate would be 2.1082 x 6.0% = 12.6% (rounded to the nearest tenth of a percent).

Comments:

The annuity starting date for purposes of calculating the deferred gift annuity rate will be the same as the annuity starting date for calculating the charitable deduction, if payments are at the end of the period (which is usually the case). This was not true with the pre-July 1, 2001 methodology.

An annuitant is credited with compound interest for the entire period from the date of contribution to the annuity starting date. Under the pre-July, 2001 methodology, compound interest was credited only for the number of whole years between the two dates.

Charities issuing deferred gift annuities in New York and New Jersey may need to use a slightly lower compounding rate depending on the deferral period. Information regarding this subject will be posted on the ACGA website (www.acga-web.org) and on the new gift annuity rate sheets.

Note for Organizations Issuing Deferred Gift Annuities in New York and New Jersey

Through August of 2008, the following compound interest factors during the deferral period noted will satisfy the requirements of New York and New Jersey:

For deferral periods of zero to no more than five years:

  • Single-life and two-life annuities, whatever the gender of the annuitants, a compound interest factor of 5.25%.

For deferral periods of more than five years to no more than 10 years:

  • Single-life and two-life annuities, whatever the gender of the annuitants, a compound interest factor of 5.25%.

For deferral periods of more than 10 years to no more than 20 years:

  • Single-life annuity (male annuitant), compound interest factor of 5.15%.
  • Single-life annuity (female annuitant), compound interest factor of 4.75%.
  • Two-life annuity (both males), compound interest factor of 5.0%.
  • Two-life annuity (both females), compound interest factor of 4.65%.
  • Two-life annuity (one male and one female), compound interest factor of 4.8%.

For deferral periods of more than 20 years:

  • Single-life annuity (male annuitant), compound interest factor of 4.25%.
  • Single-life annuity (female annuitant), compound interest factor of 4.0%.
  • Two-life annuity (both males), compound interest factor of 4.2%.
  • Two-life annuity (both females), compound interest factor of 4.0%.
    • Two-life annuity (one male and one female), compound interest factor of 4.05%.

Federal Income Tax Consequences

Charitable gift annuities give rise to three primary income tax issues:

  • Computation of the charitable contribution income tax deduction
  • Taxation of annuity payments to the annuitants
  • Recognition of gain to the donor on the transfer of appreciated property as consideration for the annuity agreement.

Charitable Contribution Income Tax Deduction

In general, an individual is entitled to a charitable contribution deduction for income tax purposes for the gift portion of the amount transferred. This amount is equal to the excess of the net fair market value of the property transferred over the present value of the annuity. It is referred to as the present value of remainder interest.

The amount of deduction the donor can actually claim may be equal to the present value of remainder interest, or may be reduced under the percentage limitation and reduction rules as described in IRC §170. If, for example, the property transferred consists of: 1) tangible personal property that has been held by the donor long-term and is unrelated to the organization's tax-exempt purpose; or 2) property that if sold by the donor on the date of transfer would have produced ordinary income, the deduction may be reduced.

Determining the Present Value of the Annuity

The following discussion is applicable for annuities issued after April 30, 1989:

For single life immediate gift annuities, the present value of the annuity is determined by multiplying the annual annuity amount payable under the agreement by the Pub. 1457, Table S factor which corresponds to the annuity rate and the age of the annuitant. If the annuity amount is payable annually at the end of the first annual period, no further adjustment is required. If, however, payments are to be made more frequently than once per year, or if any payments are to be made at the beginning of the period, further adjustments are required. If payments are made more frequently than annually, a payment frequency factor from Pub. 1457, Table K is multiplied by the Table S factor to provide an adjusted annuity factor. The resulting factor is multiplied by the annual annuity amount to determine the present value of the annuity.

Example 5: Computation of Present Value of Annuity for Single Life Immediate Annuity

Continuing from Example 1, Mr. Jones, age 70, transfers $100,000 to a charitable organization on January 1, 2008 in exchange for a single life charitable gift annuity. The suggested ACGA annuity rate corresponding to his age is 6.5%. Mr. Jones will receive $6,500.00 per year payable in equal installments at the end of each calendar quarter.

The present value of the annuity is calculated as follows:

A. Input Assumptions
Date of transfer January 01, 2008
Fair market value of property transferred $100,000.00
Date of first payment March 31, 2008
Annual annuity rate for immediate annuity 6.5%
Payment frequency Quarterly
IRC Sec. 7520(a) election to use 11/2007 discount rate of 5.20%
The mortality table is based on the census taken in 1990
Nearest age of Mr. Jones on the date of the gift is 70
B. Present Value of Remainder Interest - Immediate
1. Net fair market value paid for annuity $100,000.00
2. Annual annuity rate 6.5%
3. Annuity amount payable on an annual basis $6,500.00
4. Factor for present worth of a single life annuity (based on table R(2)) 9.0013
5. Adjustment factor based on payment frequency from Pub. 1457, Table K 1.0193
6. Adjusted value of $1.00 (Line 4 * Line 5) 9.175
7. Adjusted annuity value (Line 3 * Line 6) $59,637.50
8. Excess of actual 1st payment over pro rata 1st payment (0 for pro rata first payment) $0.00
9. Present value of annuity (Line 7 + Line 8) $59,637.50
10. Minimum value of annuity (lesser of line 1 and line 9) $59,637.50
11. Present value of remainder interest (Line 1 - Line 10) $40,362.50

Determining Present Value of Annuity for Joint and Survivor Immediate Annuity

For joint and survivor immediate payment annuities, the computation steps are different. The present worth of annuity factor is calculated by first obtaining the joint life factor from Pub. 1457, Table R(2). The factor is then subtracted from 1.00000 with the resulting amount then divided by the 120% of the Applicable Federal Midterm Rate in effect for the month of the contribution or, at the election of the taxpayer, during either of the two prior months.2 The remaining steps of the computation are identical to those for a single life annuitant.

Example 6: Computation of Present Value of Annuity for Joint and Survivor Immediate Annuity

The following computation is based on Mr. and Mrs. Jones transferring $100,000 to a charitable organization on January 1, 2008 in exchange for an immediate payment joint and survivor charitable gift annuity. The annuity rate corresponding to their ages is 5.9%. Mr. and Mrs. Jones will receive $5,900.00 per year payable in equal installments at the end of each calendar quarter. The present value of the annuity is calculated as follows:

A. Input Assumptions
Date of transfer January 01, 2008
Fair market value of property transferred $100,000.00
Date of first payment March 31, 2008
Annual annuity rate for immediate annuity 5.9%
Payment frequency Quarterly
IRC Sec. 7520(a) election to use 11/2007 discount rate of 5.20%
The mortality table is based on the census taken in 1990
Nearest age of Mr. Jones on the date of the gift is 70
Nearest age of Mrs. Jones on the date of the gift is 70
B. Present Value of Remainder Interest - Immediate
1. Net fair market value paid for annuity $100,000.00
2. Annual annuity rate 5.9%
3. Annuity amount payable on an annual basis $5,900.00
4. Factor for present worth of a two life annuity (based on table R(2)) 11.2202
5. Adjustment factor based on payment frequency from Pub. 1457, Table K 1.0193
6. Adjusted value of $1.00 (Line 4 * Line 5) 11.4367
7. Adjusted annuity value (Line 3 * Line 6) $67,476.53
8. Excess of actual 1st payment over pro rata 1st payment (0 for pro rata first payment) $0.00
9. Present value of annuity (Line 7 + Line 8) $67,476.53
10. Minimum value of annuity (lesser of line 1 and line 9) $67,476.53
11. Present value of remainder interest (Line 1 - Line 10) $32,523.47

To run your own computations, simply go to Gift Calculator section of this site. 

Determining Present Value of Annuity for Single Life Deferred Payment Annuity

The computation of the present value of annuity for deferred payment gift annuities differs significantly from their immediate payment counterparts. The following computation assumes that

Example 7: Computation of Present Value of Annuity for Single Life Deferred Annuity

Mr. Jones, age 70, transfers $100,000 to a charitable organization on January 1, 2008 in exchange for a single life charitable gift annuity. Payments will commence on January 1, 2013. The effective annuity rate corresponding to his age and deferral period is 9.0%. Mr. Jones will receive $9,000.00 per year payable in equal installments at the end of each calendar quarter. The present value of the annuity is calculated as follows:

A. Input Assumptions
Date of transfer January 01, 2008
Fair market value of property transferred $100,000.00
Date of first payment January 01, 2013
Annuity starting date (payment period before 1st payment) October 01, 2012
Annual annuity rate for immediate annuity 7.1%
Payment frequency Quarterly
Deferred annuity interest adjustment factor 1.2607
Annual annuity rate adjusted for deferral 9%
IRC Sec. 7520(a) election to use 11/2007 discount rate of 5.20%
The mortality table is based on the census taken in 1990
Nearest age of Mr. Jones on the date of the gift is 70
B. Present Value of Remainder Interest - One Life Deferred
1. Age nearest to annuity starting date 75
2. Age nearest to date of transfer 70
3. Value of Dx from IRS Pub. 1457, Table H based on  
  (a) Line 1 age 1349.611
  (b) Line 2 age 2052.744
4. Line 3(a) divided by Line 3(b) 0.657467
5. Unadjusted value of $1 of single life annuity from IRS Pub. 1457, Table S based on Line 1 age 7.6013
6. Adjustment factor based on payment frequency from Pub 1457, Table K 1.0193
7. Adjusted value of $1 of single life annuity (Line 5 * Line 6) 7.748
8. Value of $1 of deferred single life annuity (Line 4 * Line 7) 5.0941
9. Annual annuity rate for deferred annuity 7.1%
10. Deferred annuity interest adjustment factor 1.2607
11. Deferred annuity rate (Line 9 * Line 10) 9%
12. Net fair market value paid for annuity $100,000.00
13. Annuity amount payable on an annual basis (line 11 * Line 12) $9,000.00
14. Present value of annuity (Line 8 * Line 13) $45,846.90
15. Minimum value of annuity (lesser of Line 12 and Line 14) $45,846.90
16. Present value of remainder interest $54,153.10

To run your own computations, simply go to Gift Calculator section of this site.

Determining Present Value of Annuity for Joint and Survivor Deferred Payment Annuity

The calculation of the present value of annuity for joint and survivor deferred annuities the most complex of all because deferral factors must be calculated for each annuitant separately.

Example 8: Computation of Present Value of Annuity for Joint and Survivor Deferred Annuity

Mr. and Mrs. Jones, both age 70, transfer $100,000 to a charitable organization on January 1, 2008 in exchange for a joint and survivor life charitable gift annuity. Payments will commence on January 1, 2013. The effective annuity rate corresponding to their ages and deferral period is 7.9%. Mr. Jones will receive $7,900.00 per year payable in equal installments at the end of each calendar quarter. The present value of the annuity is calculated as follows:

A. Input Assumptions
Date of transfer January 01, 2008
Fair market value of property transferred $100,000.00
Date of first payment January 01, 2013
Annuity starting date (payment period before 1st payment) October 01, 2012
Annual annuity rate for immediate annuity 6.3%
Payment frequency Quarterly
Deferred annuity interest adjustment factor 1.2607
Annual annuity rate adjusted for deferral 7.9%
IRC Sec. 7520(a) election to use 11/2007 discount rate of 5.20%
The mortality table is based on the census taken in 1990
Nearest age of Mr. Jones on the date of the gift is 70
Nearest age of Mrs. Jones on the date of the gift is 70
B. Present Value of Remainder Interest - Two Life Deferred
    1st
Annuitant
2nd
Annuitant
1. Age nearest to annuity starting date 75 75
2. Age nearest to date of transfer 70 70
3. Value of Dx from IRS Pub. 1457, Table H based on    
  (a) Line 1 age 1349.611 1349.611
  (b) Line 2 age 2052.744 2052.744
4. Line 3(a) divided by Line 3(b) 0.657467 0.657467
5. Value of Lx from IRS mortality table based on    
  (a) Line 1 age 60449.0 60449.0
  (b) Line 2 age 71357.0 71357.0
6. Line 5(a) divided by Line 5(b) 0.847135 0.847135
7. Unadjusted joint life deferred discount factor (Line 4 above * Line 6 in other column) 0.556963 0.556963
8. Unadjusted value of $1 of single life annuity from Pub. 1457, Table S based on Line 1 age 7.6013 7.6013
9. Adjustment factor based on payment frequency from Pub. 1457, Table K 1.0193 1.0193
10. Adjusted value of $1 of single life annuity (Line 8 * Line 9) 7.7480 7.7480
11. Value of $1 of deferred single life annuity (Line 4 * Line 10) 5.0941 5.0941
12. Factor from Table R(2) (for remainder interest) 0.49426
13. 1.00000 minus Line 12 (factor for life estate) 0.50574
14. Unadjusted value for $1 of joint and survivor annuity (Line 13 divided by AFR = factor for annuity) 9.72580
15. Adjusted value of $1 of joint and survivor annuity (Line 9 * Line 14) 9.91350
16. Adjusted value of $1 of joint life annuity (Line 10 (1st) + line 10 (2nd) - Line 15) 5.58250
17. Sum of Line 7 for first and second annuitant 1.113926
18. Deferred discount factor (1/2 of Line 17) 0.556963
19. Value of $1 of deferred joint life annuity (Line 16 * Line 18) 3.1092
20. Value of $1 of deferred annuity (Line 11 (1st) + Line 11 (2nd) - Line 19) 7.0790
21. Annual annuity rate for immediate annuity 6.3%
22. Deferred annuity interest adjustment factor 1.2607
23. Deferred annuity rate (Line 21 * Line 22) 7.9%
24. Net fair market value paid for annuity $100,000.00
25. Annuity amount payable on an annual basis $7,900.00
26. Present value of annuity (Line 20 * Line 25) $55,924.10
27. Minimum value of annuity (lesser of Line 24 and Line 26) $55,924.10
28. Present value of remainder interest (Line 24 - Line 27) $44,075.90

Taxation of Payments to Annuitants

One of the great advantages of charitable gift annuities is the way in which payments are taxable to the annuitant(s). These rules are found in IRC §72.

Under this section, a portion of the annuitant's payment is taxable as ordinary income with the remaining portion considered a tax-free return of the donor's principal.

If appreciated property was transferred by the donor in exchange for a gift annuity, any gain arising from the purchase of the annuity payments (i.e., the present value of the annuity) may qualify to be reported by the annuitant on the installment basis over his or her lifetime.

The computation of these amounts is based on three factors:

  • the investment in the contract
  • the expected return, and
  • the exclusion ratio

Investment in the Contract

The "investment in the contract" is a term that is synonymous with the present value of the annuity. If, however, the charity reinsures its payment obligation by purchasing an annuity contract from a commercial insurance carrier, the investment in the contract is the aggregate amount of premiums transferred to the insurance company. Otherwise, it is calculated as illustrated in the previous examples.3

Expected Return

The "expected return" is the aggregate amount of annuity payments the annuitant will receive over his or her actuarial life expectancy. For single life annuities purchased after June 30, 1986, the expected return multiple is found in Reg. §1.72-9, Table V. For joint and survivor annuities, the expected return multiple is found in Reg. §1.72-9, Table VI.

The expected return multiple is also subject to adjustment for the payment frequency of the annuity. These adjustment factors are found is Reg. §1.72-5(a)(2).

Exclusion Ratio

The "exclusion ratio" represents the percentage of each annuity payment that is considered a recovery of principal and, therefore, excluded from the annuitant's gross income. It is calculated by dividing the investment in the contract (i.e., the present value of annuity) by the adjusted expected return. The remainder of each annuity payment is considered ordinary income.4 It is important to note that once the annuitant's principal has been repaid completely, the entire amount of future annuity payments are treated as ordinary income.

Recognition of Gain on Transfer of Appreciated Property

A charitable gift annuity is by definition part gift and part purchase of an annuity contract. In other words, it is a sale of property by the donor to the issuing organization for less than fair market value. Accordingly, if appreciated property is transferred as consideration for a gift annuity, the transaction is subject to the bargain sale rules as described in IRC §1011(b).

In the case of a charitable gift annuity, the investment in the contract is considered an amount realized by the donor for purposes of the bargain sale rules. Therefore, the adjusted cost basis in the property must be apportioned between the investment in the contract and the contributed portion to determine the amount of gain recognized by the donor.

Gain that is recognized from the bargain sale of appreciated property may be reported ratably over the life expectancy of the annuitant provided the following conditions are met:

  • the transfer qualifies for a charitable contribution income tax deduction under IRC §170;
  • the donor is at least one of the annuitants; and
  • the annuity is non-assignable except to the issuing organization.5

Example 9: Calculating Recognized Gain from the Bargain Sale of Appreciated Property

Mr. Jones, age 70, transfers $100,000 of stock to a charitable organization on January 1, 2008 in exchange for an immediate payment single life charitable gift annuity. Mr. Jones' cost basis in the stock is $25,000. Following is the computation of recognized gain arising from the bargain sale of the stock.

1. Gross Fair market value of asset transferred $100,000.00
2. Adjusted cost basis 25,000.00
3. Debt secured by asset $0.00
4. Minimum value of annuity (from section B) $58,669.51
5. Total amount realized (Line 3 + Line 4) $58,669.51
6. Non-contributed portion factor (Line 5 / Line 1) 0.5866951
7. Basis allocated to non-contributed portion (Line 2 * Line 6) 14,667.38
8. Depreciation subject to recapture as ordinary income $0.00
9. Amount of realized capital gain (Line 5 - Line 7) $44,002.13
10. Amount of realized ordinary income (Line 8 * Line 6) $0.00
11. Amount of realized long term capital gain (Line 9 * Line 10) $44,002.13
12. Portion of gain allocated to debt (Line 3 / Line 5) 0
13. Ordinary income due to debt reportable in year of transfer (Line 10 * Line 12) $0.00
14. Long-term capital gain due to debt reportable in year of transfer  
  (Line 11 * Line 12) $0.00
15. Ordinary income which may be reported ratably over life expectancy  
  of annuitant(s) (Line 10 - Line 13) $0.00
16. Long-term capital gain which may be reported ratably over life expectancy  
  of annuitant(s) (Line 11 - Line 14) $44,002.13

For joint and survivor annuities, if one annuitant's separate property is used to fund the agreement, the gain can only be reported over the donor annuitant's life expectancy.6 If the donor dies prior to the entire gain being reported, the surviving annuitant may continue to report the gain ratably until it has been recognized completely just as if the decedent had lived until life expectancy.7 Conversely, if the property is owned jointly by the annuitants, the gain can be reported ratably over their joint life expectancies.

If the sole annuitant of a single life annuity or both annuitants of a joint and survivor annuity die prior to the gain being reported completely, the remaining gain need not be reported as income in respect of a decedent.8

Recognition of Gain on Transfer of Debt Encumbered Property

When debt encumbered property is transferred in exchange for a gift annuity, the amount of debt plus the investment in the contract is considered an amount realized by the donor for purposes of application of the bargain sale rules.

It is important to note that gain attributable to the debt-encumbered portion of the property does not appear under the regulations to qualify for ratable reporting. The investment in the contract is determined based on the net fair market value of the property transferred. Because net fair market value is obtained by subtracting all indebtedness, the gain attributable to the debt does not appear to qualify under Reg. §1011-2(a)(3). The donor recognizes gain attributable to the indebtedness presumably in the year of transfer.

When the transferred property is both appreciated and debt encumbered, the portion of the gain that qualifies for ratable reporting is determined by first dividing the investment in the contract by the total amount realized, then multiplying the product by the total realized gain. The difference is reportable in the year of transfer.

Example 10: Computation of Recognized Gain Arising from Bargain Sale of Appreciated Debt-Encumbered Property

Mr. Jones, age 70, transfers $100,000 of real property to a charitable organization on January 1, 2008 in exchange for an immediate payment single life charitable gift annuity. Mr. Jones' cost basis in the property is $25,000. There is a $25,000 mortgage secured by the property. Mr. Jones has owned the property and the mortgage has been in place for more than five years. The following report illustrates that Mr. Jones would have to report a long-term capital gain of $18,750 attributable to the indebtedness in the year of transfer.

1. Gross Fair market value of asset transferred $100,000.00
2. Adjusted cost basis 25,000.00
3. Debt secured by asset $25,000.00
4. Minimum value of annuity (from section B) $44,002.13
5. Total amount realized (Line 3 + Line 4) $69,002.13
6. Non-contributed portion factor (Line 5 / Line 1) 0.6900213
7. Basis allocated to non-contributed portion (Line 2 * Line 6) 17,250.53
8. Depreciation subject to recapture as ordinary income $0.00
9. Amount of realized capital gain (Line 5 - Line 7) $51,751.60
10. Amount of realized ordinary income (Line 8 * Line 6) $0.00
11. Amount of realized long term capital gain (Line 9 * Line 10) $51,751.60
12. Portion of gain allocated to debt (Line 3 / Line 5) 0.362307656
13. Ordinary income due to debt reportable in year of transfer (Line 10 * Line 12) $0.00
14. Long-term capital gain due to debt reportable in year of transfer  
  (Line 11 * Line 12) $18,750.00
15. Ordinary income which may be reported ratably over life expectancy  
  of annuitant(s) (Line 10 - Line 13) $0.00
16. Long-term capital gain which may be reported ratably over life expectancy  
  of annuitant(s) (Line 11 - Line 14) $33,001.60

Example 11. Taxation of Annuity Payments to Annuitant

Continuing with Example 8, the following report shows the computation of how annual annuity payments are taxed to Mr. Jones' throughout his actuarial life expectancy.

1.  Expected return multiple from Table V (Reg. 1.72-9) 15.3
2.  Expected return multiple adjustment factor based on payment frequency
    (Reg. 1.72-5(a)(2)) -0.1
3.  Adjusted expected return multiple (Line 1 + Line 2) 15.2
4.  Annual annuity payment (from section B) $4,950.00
5.  Expected return (Line 3 * Line 4) $75,240.00
6.  Return of annuitant's investment in contract
    (Minimum value of annuity from section B) $44,002.13
7.  Exclusion ratio (Line 6 / Line 5) 0.584824
8.  Annual amount excluded from taxable income (Line 4* Line 7) $2,894.88
9.  Annual amount reportable as ordinary income (Line 4 - Line 8) $2,055.12
 
Ratable Reporting of Realized Gain:
10.  Expected return multiple from Table V (Reg. 1.72-9) 15.3
11.  Adjusted expected return multiple (Line 10 + Line 2) 15.2
12.  Amount of ordinary income that can be reported ratably over life  
  expectancy of annuitant(s) (from section E) $0.00
13.  Amount of gain that can be reported ratably over life expectancy  
  of annuitant(s) (from section E) $33,001.60
14.  Number of annuity payments each year 4
15.  Total number of annuity payments over which to spread capital gain
  (Line 11 * Line 14) 60.8
16.  Number of annuity payments in year of first payment 4
17.  Number of remaining payments to spread capital gain (Line 15 - Line 16) 56.8
18.  Potential exempt income per payment (Line 8 / Line 14) $723.72
19.  Ordinary income reportable with each annuity payment  
  (Line 12 / Line 15) but (Line 19 + Line 20 < Line 18) $0.00
20.  Capital gain reportable with each annuity payment  
  (Line 13 / Line 15) but (Line 19 + Line 20 < Line 18) $542.79
  Total   Ordinary   Exempt   LTCG
Year   Payments Income   Income   Income   Income
 
2008   4   4,950.00   2,055.12   723.72 2,171.16
2009-2022   4   4,950.00   2,055.12   723.72 2,171.16
2023   4   4,950.00   4,371.07   144.73 434.20
2024+   4   4,950.00   4,950.00   0.00 0.00

Tax Reporting to Annuitant

The taxation of distributions from charitable gift annuities to annuitants is reported on Form 1099-R. The total amount distributed during the year is reported in box 1. The amount taxable as ordinary income is reported in box 2a. Any amount taxable as a capital gain is reported in box 3 and any nontaxable amount is reported in box 5. Code F is entered in box 7. See Reg. §1.1011-2(c) Example 8.

Gift and Estate Tax Considerations

Gifts to Charity

A charitable gift annuity consists of part outright charitable gift of a present interest and part purchase of an annuity contract. Section 6019 of the regulations provides a list of gifts that are exempt from the requirement of filing a gift tax return. These exceptions include a gift of a present interest of the gift tax annual exclusion amount ($12,000 in 2008 and $13,000 for 2009, indexed for inflation) or less to any person during the calendar year.9 The term "person" includes charitable organizations.10 Accordingly, even though the donor might be the only annuitant, if the amount transferred less the present value of the annuity exceeds the annual gift tax exclusion amount, a gift tax return is required for the amount transferred to charity.

Gifts of Annuity Payments to Non-Donors

If annuity payments are made to any person other than the donor, the donor has made a gift to the non-donor in an amount equal to the present value of the annuity payable to them. If the annuity payments commence immediately, the gift is of a present interest and qualifies for the annual gift tax exclusion.11 Conversely, if the transfer is made to a deferred gift annuity or the non-donor is a participant of a joint-and-survivor annuity, the gift is of a future interest and does not qualify for the annual gift tax exclusion.

Right of Revocation

A donor can avoid generating a taxable gift when the annuity is created by reserving the right to revoke a non-donor's annuity interest. Taxable gifts will occur as payments are actually received by the annuitant and, as gifts of a present interest, will quality for the annual gift tax exclusion.

Marital Gift Tax Deduction

If a donor creates a charitable gift annuity for the sole benefit of a spouse, the gift will qualify for the unlimited gift tax marital deduction.12 The rules become more complicated, however, when the husband and wife are co-annuitants. The unlimited gift tax marital deduction is available to a husband and wife only if both spouses are the sole annuitants and each have the right to receive payments prior to the death of the first spouse. In other words, the annuity must be payable jointly and then to the survivor.13

As an alternative, if a donor creates an annuity with his or her separate property whereby the entire annuity payment is paid for the life of the donor with the donor's spouse receiving survivor payments, the gift will not qualify for the gift tax marital deduction. In such case, the donor should reserve the right to revoke the spouse's interest thereby making the gift incomplete. As discussed in the next section, in the event the donor spouse dies first, the present value of the annuity included in the donor spouse's estate will qualify for the unlimited estate tax marital deduction.

If a married couple creates a joint-and-survivor annuity with their community (or joint tenancy) property whereby they will receive equal payments, a taxable gift will exist if the present value of the survivor annuity of each spouse differ. The gift is equal of one-half the differential. The resulting amount will qualify for the unlimited gift tax marital deduction.14

Estate Tax Consequences

If the donor is the sole annuitant of a charitable gift annuity, the only amount that may be includible in his or her estate is the amount of any annuity payment that is due, but has not yet been received, on the date of death. Many charitable gift annuity agreements provide that the obligation to make payments ends with the last regular payment prior to the death of the annuitant. If not, any final prorated payment will be included in the estate of the annuitant.

If a donor creates an annuity for the benefit of a non-donor annuitant, the present value of the annuity (less the gift tax annual exclusion, if applicable) is included in the donor's adjusted taxable gifts.15 No amount is includible in the donor's estate. If, however, the donor retains the right to revoke the annuitant's interest and then predeceases the annuitant, the present value of the annuity as of the date of the donor's death is includible in the donor's gross estate.16 Continuing with this example, if the annuitant is the donor's spouse, the amount includible in the donor's estate will qualify for the unlimited estate tax marital deduction.17

If a donor creates a joint-and-survivor annuity with separate property payable to himself and his spouse, in the event the donor predeceases the spouse, the present value of the spouse's annuity on the donor's date of death will be included in the donor's gross estate.18 The amount so included will qualify for the unlimited estate tax marital deduction.19

If a married couple creates a joint-and-survivor annuity with their community (or joint tenancy) property whereby they will receive equal payments, and each retains the right to revoke the other's interest as to their one-half interest, upon the death of the first spouse, one-half of the present value of the surviving spouse's annuity interest will be includible in the estate of the decedent spouse. The amount included will qualify for the unlimited estate tax marital deduction.20

Tax Considerations to Issuing Organization

When a charitable organization issues a gift annuity, it creates a liability equal to the expected return to the annuitant. Under IRC §514(c)(5), such acquisition indebtedness will cause the issuing organization to have unrelated business income to the extent of such liability unless the following conditions are met:

  • The obligation to pay the annuity must be the sole consideration for the property transferred.
  • The present value of the annuity must be less than 90% of the net fair market value of the property on the date of transfer.
  • The annuity must be payable over one or two lives in being at the time the annuity is issued.
  • The annuity contract does not guarantee a minimum or maximum number of payments and does not provide variable payments.

Also, if the property transferred for the gift annuity is debt encumbered, the issuing organization will not have acquisition indebtedness for ten years after the date of issue if:

  • the donor has held the property for at least five years prior to the date of transfer;
  • the debt has been in place for at least five years prior to the date of transfer; and
  • the organization accepts the property "subject to" rather than "assume" the indebtedness.

Planning Opportunities

Low Cost of Implementation and Participation

Charitable gift annuity agreements are provided by the issuing charitable organization and are not generally subject to modification. This fact eliminates the need for drafting a customized gift agreement for each individual donor (although donors may desire the agreement to be reviewed by professional advisors). When compared to a charitable remainder trust, which requires an individually prepared trust instrument with its attendant cost, charitable gift annuities are very economical and convenient to implement. Furthermore, the minimum investment for a charitable gift annuity is usually significantly less than for a charitable remainder trust. The minimum investment for a pooled income fund may be comparable to a charitable gift annuity.

Attractive After-Tax Returns

Given the favorable income tax benefits associated with charitable gift annuities--both in terms of the charitable income tax deduction and favorable taxation of annuity payments-- those evaluating them should consider the net cost of the contribution and the effective after-tax yield of the annuity payments.

Transferring Debt Encumbered Property

Whereas the transfer of debt-encumbered property to a charitable remainder trust is either prohibited or presents significant tax risks, the transfer of such property in exchange for a charitable gift annuity may offer an ideal solution. Because a charitable gift annuity does not utilize a trust, the transfer of debt-encumbered property does not run afoul of the grantor trust rules. And as discussed earlier, such transfers do not give rise to acquisition indebtedness for a period of ten years if certain conditions are met, thereby providing the charitable organization ample time to dispose of the property or the indebtedness.

Deferred Gift Annuities with a Variable Starting Date

Traditional deferred charitable gift annuities have been established bearing a fixed annuity commencement date. This is fine if the annuitant knows exactly when they would like payments to begin; however, circumstances and financial needs often change. Can an annuitant, subsequent to the creation of the gift annuity, be given the right to elect when payments will commence?

In two separate private letter rulings, the Service has permitted annuitants the ability to start receiving payments either prior to or after the scheduled commencement date.21 The first request for ruling involved a joint and survivor annuity agreement that provided that in the event the first annuitant died prior to the commencement date, the surviving annuitant could elect to receive payments prior to the scheduled commencement date. Such a change was ruled to have no effect on the charitable deduction.

In the second ruling, the Service permitted an arrangement whereby the annuity contract allowed the annuitant to elect the commencement date of payments at any time after the annuitant, who is currently age 50, reached age 55. The election was to be made by the annuitant with the annual annuity payment determined based on the age of the annuitant in accordance with pre-existing tables.

The key to modifying the commencement date is to maintain the relationship of the amount claimed as a charitable deduction to the amount of economic benefit being conveyed to the annuitant. Because the deduction is produced when the contract is created, the only modification available is an adjustment of the annuity payment. If payments begin prior to the scheduled commencement date, the annuity amount is reduced. Conversely, if payments begin at some time beyond the scheduled commencement date, the annuity amount is increased. Neither ruling, however, provided for the annuity payments to be suspended once they had begun.

Deferred Gift Annuity Tuition Plan

Some colleges have utilized deferred charitable gift annuities to help parents and grandparents save for a child's or grandchild's educational expenses. Under this plan, a donor makes a contribution of cash or property to the college in return for a deferred gift annuity based on the life of the donor's child or grandchild. The donor will designate a primary recipient, and may designate one alternate. The recipient is entitled to a lifetime payout, but also has the option to sell or assign his or her annuity to the college or to a third party in return for a lump sum payment or installment payments. Ideally, the annuity payments will be for used college expenses, but nothing in the agreement prohibits them from being used for any purpose.22

Bargain Sale of Remainder Interest in Personal Residence or Farm in Exchange for Gift Annuity

An individual can contribute the remainder interest in their personal residence or farm to charity and retain the right to occupy and otherwise enjoy all of the benefits of ownership in the property for a term of years or their lifetime. This technique is commonly referred to as a Life Estate Agreement; it is described in detail in the Gift Vehicle Review section of the Reading Room.

In a life estate agreement, the economic interests in the property are divided into retained life estate and the remainder interest components. It is the latter that is contributed to charity. In exchange for the contribution, the donor also receives a charitable contribution income tax deduction for the present value of the charitable remainder interest.

One very creative planning technique involves combining a life estate agreement with a charitable gift annuity. This combination enables a donor to contribute the remainder interest in their personal residence or farm to charity, retain the lifetime use of the property, receive an income payable for life, and receive a current income tax charitable deduction.

The technique begins by calculating the present value of remainder interest in the personal residence; however, instead of contributing the entire remainder interest to charity, the donor transfers it as consideration in exchange for an immediate or deferred payment charitable gift annuity. The annuity payments are based on the contributed remainder interest with a portion of the remainder interest qualifying as a charitable contribution income tax deduction.

As with transfers of entire interests in appreciated real property, the transfer of the remainder interest in appreciated real property in exchange for a gift annuity is considered a bargain sale. The donor realizes gain attributable to the portion of the remainder interest used to purchase the annuity. This gain realized may qualify to be reported ratably as discussed previously in this section.

Because the purchasing charitable organization must make annuity payments from sources exclusive from the contributed remainder interest, acceptable candidates for this technique are generally older and have property that is debt-free or significantly debt-free.


  1. The Philanthropy Protection Act of 1995 (H.R. 2519, P.L. 104-62); The Charitable Gift Annuity Antitrust Relief Act of 1995 (H.R. 2525, P.L. 104-63); and The Charitable Donation Antitrust Immunity Act of 1997 (H.R. 1902, P.L. 105-26)back

  2. IRC §7520(a)(2). The rate used is 120% of the federal midterm rate in effect under IRC §1274(d)(1).back

  3. Reg. §1.72-6back

  4. Reg. §1.72-4back

  5. Reg. §1.1011-2(a)(4)(ii)back

  6. Reg. §1.1011-2(a)(4)(ii)back

  7. Reg. §1.1011-2(a)(4)(iii)back

  8. Reg. §1.1011-2(a)(4)(iii)(a)back

  9. IRC §2503(b); Rev. Rul. 80-281, 1980-2 C.B. 282back

  10. IRC §7701(a)(1)back

  11. Reg. §25.2503-3(b)back

  12. Reg. §25.2523(b)-1(b)(6)(iii)back

  13. IRC §2523(f)(6)back

  14. Ibidback

  15. IRC §2001(b)back

  16. IRC §2038back

  17. Reg. §2056(b)-1(g), Example (3)back

  18. IRC §2039(a)back

  19. IRC §2056(b)(7)(C)back

  20. Ibidback

  21. Ltr. Ruls. 9017071 and 9743054back

  22. Ltr. Rul. 9527033back

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