3. ELEMENTS AND TIMING OF A CHARITABLE GIFT, Part 2 of 2

3. ELEMENTS AND TIMING OF A CHARITABLE GIFT, Part 2 of 2

Article posted in General on 19 August 2015| 2 comments
audience: National Publication, Russell N. James III, J.D., Ph.D., CFP | last updated: 31 August 2015
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Summary

We continue with Russell James guiding us through the elements of timing of gifts.

VISUAL PLANNED GIVING:
An Introduction to the Law and Taxation
of Charitable Gift Planning

By: Russell James III, J.D., Ph.D.

3. ELEMENTS AND TIMING OF A CHARITABLE GIFT, Part 2 of 2

Links to previous sections of book are found at the end of each section.

What about a credit card gift?  Suppose a donor makes a donation by credit card and the charity is credited with the funds.  However, it is not until much later that the donor actually makes the payment on the credit card to pay for this transfer.  At what point was the charitable gift completed?

The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity.  In this case, the donor delivered money to a charity on the date of the credit card transfer.  The fact that the donor borrowed this money is irrelevant.  The donor delivered money to a charity, meaning that the gift is a completed gift.  This is true even if the donor never pays the loan used to make the gift to charity.

Consequently, the gift in this scenario is a completed charitable gift for income tax purposes on December 31.  When, or if, the credit card bill is later paid is not relevant to the timing of the gift.
Let’s now consider a slightly different example.  In this case, the donor earns rebates from her credit card company.  The donor clicks online to donate those rebates to a charity.  Later, the credit card company mails a check to the charity.  At what point is the gift complete?
The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity.  This does not occur when the donor clicks online to donate the rebates, because neither the charity nor the charity’s agent has yet received any money or valuable property.  Instead, what has happened is that the donor has instructed her agent (the credit card company) to deliver money to a charity.  This instruction is not a completed gift until the donor’s agent actually delivers the money to the charity or the charity’s agent.
When the donor’s agent (the credit card company) delivers a check to the United States Postal Service (the charity’s agent), addressed to the charity, the gift is complete.  Thus, on day nine, the donor’s agent has delivered valuable property to the charity’s agent, making the gift complete for income tax purposes.
What about a legally enforceable contract?  In this case, the donor signs a legally enforceable contract (in the form of a pledge to donate).  As is required by accounting rules, the charity books this legally enforceable contract as an asset in the charity’s general ledger.  The charity, in this case, then sells the right to collect on this pledge to an accounts receivable purchasing agency.  As a result, the charity receives cash from the accounts receivable purchasing agency and then spends the cash.  Only later does the donor actually fulfill the pledge by making the agreed payment.  Given that the charity has already received and spent money resulting from the pledge, when does the charitable gift actually occur for income tax purposes?
The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity.  Prior to the donor fulfilling her pledge and actually transferring money to the charity, there is no gift.  Although it is true that the charity has received money, the charity has not received money from the donor.  The only thing the charity has received from the donor is a promise to pay money in the future.  And, a promise to pay money in the future to a charity is not a completed gift until the money is actually given.
Consequently, there is no charitable gift until the donor actually pays the pledge by transferring money to the charity.  Whatever the charity happens to do with the pledge in the meantime is irrelevant to the issue of when the charitable gift occurs.
Suppose a donor gives land worth $2 million to a charity, but keeps the right to repurchase the land for $500,000 during the first two years after the gift.  How much can the donor deduct immediately after making this transfer of land to the charity?  Can the donor deduct $2 million (the value of the land given to the charity), $500,000 (the minimum payment the charity will receive regardless of what happens), nothing, or some other amount?
In this case, the donor has delivered valuable property to a charity, but has kept a prohibited “retained interest.”  The donor has made a transfer of the property, but the donor can get that property back if the donor so chooses.  The deduction for this type of retained interest transfer is not calculated based upon the difference between the value received by the charity and the value retained by the donor.  Instead, there simply is no deduction so long as the prohibited retained interests remain.  Thus, for tax purposes, the donor has made no gift at the point of the initial transfer due to the donor’s retained interests in the property.

Because the donor has retained prohibited interests, there is no charitable deduction at the time of the initial transfer of the land to the charity.

Now consider that same scenario two years later.  Assuming that the donor has not exercised the option to purchase the land, that option to purchase the land expires.  Does this have any effect on the donor’s ability to take a charitable deduction?
The donor initially delivered property to the charity with a prohibited retained interest.  That transfer is not considered to be a charitable gift until all prohibited retained interests expire or are given to the charity.  Two years later, the donor’s prohibited retained interest expires.  Thus, at that point, the donor has no retained interests in the property and the gift is finally a completed charitable gift.
Because the donor no longer has any retained interests, the charity becomes the sole owner of the property.  The value of that transfer is the value of the property, in this case $2 million.  Thus, the donor may deduct a $2 million charitable gift, but not until all prohibited retained interests either expire or are transferred to the charity.
There are some types of restrictions on charitable gifts that do not interfere with the charitable deduction.  These are restrictions where the chance of interfering with the charity ownership is negligible, or where the donor restricts the use of the charitable funds for a specific charitable purpose.  The donor is allowed to restrict the use of funds for a specific charitable purpose and can even retain the right to receive the money back if the charity does not use the funds for that purpose.  Indeed, this is a common legal result of putting a restriction on a charitable gift.  The charity’s penalty for violating the restriction is that the donor then has the right to demand the return of his or her gift.
So, let’s take a look at a common scenario.  Suppose a donor gives money to a university and directs that the funds must be spent on athletic scholarships.  This use is considered to be a charitable use of the funds.  Under state law, if the university fails to use the funds for the designated charitable purpose, the donor has the right to demand the return of the funds.  What is the effect on the charitable deduction given that the donor retains this level of control over the gift?
This retained control by the donor is perfectly acceptable because it is restricting the gift to be used for a specific charitable purpose.  The retention of this right has no impact on the timing or amount of the charitable gift deduction.  The gift is deducted just as it would be if the gift were given with no restrictions.
Suppose instead of limiting the use of the funds to athletic scholarships, the donor gave money to the university, and directed that the funds must be spent on a scholarship for a specific student.
In this case, the transfer is not a charitable gift.  A person is not a charity.  A transfer to a specific person, even a financially needy person, is not a charitable gift.  Requiring the charity to transfer the funds to a specific person makes this a transfer to a specific person, and therefore not a charitable gift.

Note that the donor can restrict the beneficiaries to certain groups, but not to a specific individual.  Thus, it is permissible for a donor to restrict his gift to funding scholarships for athletes, or even for students from a particular county.  These are categories of people and not specific individuals.  (Of course, if the donor restricted recipients using such categories that only one specific person could qualify, this cannot be used as a sneaky way to avoid the tax consequences of restricting the gift to a specific individual.  This would still be, in reality, restricting the gift to be used for a specific person.)

Suppose that the donor intended to transfer the funds to benefit a specific individual, but did so in a more subtle manner than blatantly retaining a legally enforceable right.  Could this softer approach result in both a transfer to a specific individual and a charitable deduction?  This issue was addressed in a federal appeals court case where the donor to a university included the following note with his gift: “I am aware that a donation to a scholarship fund is only deductible if it is unspecified, however, if, in your opinion, and that of the authorities, it could be applied to the advantage of [specific named student], I think it would be constructive.”  The college received the gift and applied the money to the student’s account.  What was the tax result?
The donor’s deduction was disallowed.  Although not based upon mandatory legally enforceable rights, the court recognized this as a soft way to both take a charitable deduction and benefit a specific individual.  Such a combination was not consistent with the goals of the charitable tax law, and thus the gift was not deductible.
This chapter ends by examining a special exception to the previous timing rules.  The exception applies only to charitable gifts from C-corporations.  (A C-corporation is the normal, standard corporation form, as contrasted with smaller closely-held S-corporation.)

This special rule for C-corporations allows them to make a charitable gift within 2 ½ months after the end of the tax year and treat the charitable gift as if it was made in the prior tax year.  This exception is allowed only for C-corporations using accrual accounting and only where the board authorized the giving during the tax year.

The motivation for allowing this exception to the normal timing rules is that such corporations are limited to deducting a maximum of 10% of their net income for charitable gifts.  Calculating the corporation’s net income for the year (especially when on an accrual accounting basis) is a difficult process.  This difficulty would otherwise prevent corporations from making deductible charitable gifts up to the maximum, because of the uncertainty in knowing the corporation’s net income for the year prior to the end of the year.  By giving C-corporations on an accrual accounting basis this extra 2 ½ months, the tax code permits sufficient time to both calculate the net income for the previous year, and make charitable transfers up to the 10% of net income limit.  However, the board must have committed to making such gifts in the previous taxable year.  So, the charitable transfer idea cannot have been a new one that occurred after the end of the tax year, but must have already been authorized.
This ends the section on elements and timing of a charitable gift.  As in other areas of charitable planning, it starts with a simple rule.  In this case, the rule is that a deductible charitable gift occurs when the donor delivers money or valuable property to a charity or agent of the charity.  However, when that rule is applied to a variety of complex scenarios its interpretation can become challenging.  Nevertheless, understanding what is deductible and when it is deductible is a fundamentally necessary skill for anyone who will be advising donors about charitable transactions.  Thus, there is practical value in understanding the intricacies of the elements and timing of a deductible charitable gift.

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