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Sunday, April 28, 2024
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Case Studies |
An Income Tax Deduction when a Gift Annuitant Dies Early
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Case:
Barbara Holmes had been a longtime volunteer and financial supporter of a national charity. She believed that whenever you can assist someone less fortunate with a "helping hand" it is your responsibility to do so. Because of her belief, she gave her time, love, and money whenever possible. In fact, she established a gift annuity with the charity many years ago. At the time, she was 75, with a life expectancy of 12 years. She gifted $10,000 of cash for an 7.1% gift annuity with annual payments. It also produced a nice charitable deduction. Each year Barbara received her annuity check, a portion of this check was tax-free to Barbara because it represented her investment in the annuity contract. See Sec. 72(b) of the Code.
Barbara was very happy with her gift to the charity and her annual payment stream. Unfortunately, Barbara unexpectedly passed away. Her family and CPA have now begun to wind up Barbara's financial affairs. They contacted the planned giving officer at the charity to inquire about the gift annuity Barbara purchased.
Question:
What issues need to be addressed with respect to Barbara's gift annuity? If there is a tax deduction allowable for Barbara's final tax return, how is that deduction reported?
Solution:
Barbara's payments from the gift annuity, as previously mentioned, were partially tax-free. This tax-free component would last until the end of her life expectancy. Because Barbara passed away before the end of her life expectancy, she did not receive all of her tax-free payments, which the IRS refers to as unrecovered investment. The amount of unrecovered investment may be claimed as an itemized deduction on Barbara's final income tax return.
With a $10,000 annuity and charitable gift of $4,736, Barbara's total investment in the annuity contract was $5,264. A portion of each payment was a tax-free return of this principal. Upon review, the records indicated Barbara had $3,070 of unrecovered investment in the annuity contract under Sec. 72(b)(4).
This amount is not deducted as a "charitable contribution deduction," but rather as an "other miscellaneous deduction" (not subject to the 2% floor). This deduction can be claimed on Line 27 of Schedule A of Form 1040. The $3,070 represents the tax-free payments Barbara should have received but never did. Accordingly, Barbara's personal representative reported this deduction for the year Barbara passed away.
Editor's note: See IRS Publications 529 and 575 for examples and support for this tax treatment.
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