Wednesday, April 24, 2024
GiftLaw Pro
GiftLaw Note: The Service approved a proposed deferred college annuity program.

Under Sec. 514(c)(5) of the Code, qualified gift annuities must be issued with an annuity value less than 90% of the value of the property, the contract must not guarantee a minimum amount of payment and the annuity must be payable over one or two lives. In order to enable the charitable annuity to be used for a four-year payout that benefits a college student, it is necessary to fund the annuity while the child is young and later convert the one-life payment to a fixed number of years.

This private letter ruling notes that the deferred annuity is a qualified annuity and allows "an acceleration agreement" that enables the recipient to exchange the life annuity for "installment payments over a period of years." Therefore, a one-life annuity can be converted to a four-year term for the benefit of a student. The conversion would, of course, utilize the IRC Sec. 7520 tables to make certain that the value of the term of years is equal to the value of the life annuity interest.
This is in reply to the request for various rulings regarding the proposed deferred college annuity program described in your letter of May 12, 1993.

You been recognized as exempt under section 501(c)(3) of the Internal Revenue Code and are a supporting organization within the meaning of section 509(a)(3) of the Code. You were organized by A for the purpose of accepting gifts and bequests, engaging in fund-raising activities and managing and investing your assets to support and benefit B and C. You represent that A, B, and C are affiliated organizations which have been recognized as exempt under section 501(c)(3). A, B, and C have all been recognized as public charities under section 509(a)(3) or 509(a)(1).

Your current primary fund-raising activity is the sale of charitable gift annuities. You propose to establish a program for the sale of deferred college annuities. This program will enable a donor to make a contribution to you and to receive (or have paid to a designated recipient) annuity payments that may coincide with the college age of a relative or other individual. Under this plan the recipient may assign his or her right to payments under this annuity to you or a third party so long as the assignment is made prior to the date of the first annuity payment. Pursuant to an acceleration agreement the recipient and/or alternate recipient may exchange the annuity for installment payments over a period of years corresponding to the years during which the participant would normally attend college. In your letter of May 12, 1993, you indicate that the annuities sold under this program will satisfy the relevant provisions of the Code and regulations. The annuity is the sole consideration issued in exchange for the property transferred to you. Additionally the value of the annuity will be less than 90 percent of the value of the property contributed by the donor determined in accordance with the regulations. At the time of the purchase, the annuity is payable over the life of one or two designated individuals in being at the time the annuity is issued. Finally, the annuity does not guarantee a minimum or specify a maximum amount of payments, and the amount of payments are not adjusted for any reason.

A is your sole member and its trustees elect the members of your Board of Trustees. Your Code of Regulations requires that at all times at least a majority of your trustees shall be persons who are serving as trustees of the organizations you provide support to. The program was designed by an independent company. In your letter of July 7, 1993, you state that "[you] do not have a contractual arrangement with [the company that designed the program] nor do any of the individuals, companies, principals, officers or directors have any relationship with any of [your] officers or directors or with any of the principals, officers or directors of the organizations [you] support."

The financial information you have submitted establishes that you have made annual contributions to the affiliated supported organizations.

You have requested the following rulings regarding this proposed program:

(1) That the sale of deferred college annuities by you will not be considered commercial-type insurance under section 501(m)(2).

(2) That income derived by you as a result of the sale of deferred college annuities will not be considered income from an unrelated trade or business as defined in section 511 through 513 of the Code.

(3) That income derived by you from the sale proceeds for deferred college annuities will not be considered debt-financed income within the meaning of section 514 of the Code.

Section 501(c)(3) of the Code provides for the exemption from federal income tax of organizations organized and operated exclusively for charitable purposes.

Section 501(m)(1) of the Code provides that an organization described in section 501(c)(3) will be eligible for recognition of exemption under section 501(a) "only if no substantial part of its activities consists of providing commercial-type insurance."

Section 501(m)(3)(E) of the Code provides that the term "commercial-type insurance" does not include charitable gift annuities.

Section 501(m)(4) provides that for purposes of this subsection, the issuance of annuity contracts shall be treated as providing insurance.

Section 501(m)(5) of the Code provides that for purposes of section 501(m)(3)(E) the term "charitable gift annuity" means an annuity where a portion of the amount paid in connection with the issuance of the annuity is allowable as a deduction under section 170 or 2055, and the annuity is described in section 514(c)(5) (determined as if any amount paid in cash in connection with such issuance were property).

Section 1.501(c)(3)-1(c)(1) of the Income Tax Regulations provides that an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3) of the Code. An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not organized and operated exclusively for one or more exempt section 501(c)(3) purposes unless it serves a public rather than a private interest. Thus to meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.

Rev. Rul. 78-41, 1978-1 C.B. 148, describes a trust whose sole purpose was to accumulate and hold funds for use in satisfying malpractice claims against a hospital. The trust was determined to be exempt because it was an integral part of the hospital, it was controlled by the hospital, and it was performing a function that the hospital could do directly.

Section 511(a) of the Code imposes a tax on the "unrelated business taxable income" of organizations described in section 501(c).

Section 512(a)(1) of the Code defines the term "unrelated business taxable income" as the gross income derived by any organization from any unrelated trade or business regularly carried on by it, less certain allowable deductions, and computed with the modifications listed in section 512(b).

Section 512(b)(1) of the Code excludes interest income from the computation of the tax on unrelated trade or business income.

Section 512(b)(4) of the Code provides that notwithstanding certain income exclusions, such as 512(b)(1), in the case of debt-financed property (as defined in section 514) there shall be included, as an item of gross income derived from an unrelated trade or business, the amount ascertained under section 514(a)(1), and there shall be allowed, as a deduction, the amount ascertained under section 514(a)(2).

Section 513(a) of the Code defines the term "unrelated trade or business" as any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of such profits derived) to the exercise or performance by such organization of the functions constituting the basis for its exemption.

Section 514(a)(1) of the Code states that in computing the unrelated business income tax under section 512, income derived from debt-financed property should be included.

Section 514(c)(5) of the Code provides that the rules concerning debt-financed property should not apply to the sale of annuities where (1) the annuity is the sole consideration issued in exchange for the property if, at the time of the exchange, the value of the property is less than 90 percent of the value of the property received in the exchange, (2) the annuity is payable over the life of one individual in being at the time the annuity is issued or over the life of two individuals in being at such time, and (3) the annuity is payable under a contract which does not guarantee a minimum amount of payments and does not provide for any adjustment of the amount of the annuity payment by reference to the income received from the transferred property or any other property.

The legislative history accompanying The Technical and Miscellaneous Revenue Act or 1988, Pub. L. 100-647 (1988) H.R. Rep. No. 795, 100th Cong., 2d Sess. 116 (1988) in adding the provisions of section 501(n)(3)(E), charitable gift annuities, provided that "[t]he present-law exception to the debt-financed property rules had historically exempted from tax any income resulting from the issuance of charitable gift annuities."

The information submitted establishes that you are controlled by the organizations that are to be the charitable beneficiaries of your program. In addition, the proposed annuity program will satisfy the various requirements in the Code and regulations governing charity gift annuities. You have also represented that the company that designed this program for you has no continuing contractual arrangement with you or any of your principals, officers or directors or those of your affiliated organizations.

The term "commercial-type insurance" for the purposes of section 501(m) of the Code does not include charitable gift annuities. Therefore, the provisions of section 501(m) are not applicable in this situation.

A program that involves the issuance of charitable gift annuities has traditionally been treated as a borrowing of money by the issuing organization rather than a trade or business. Therefore, the provisions of section 511 through 513 are not applicable because there is no trade or business present.

Inasmuch as there is an underlying financial obligation the property could be considered debt-financed within the meaning of section 514 of the Code. However, section 514(c)(5) provides that the rules concerning debt-financed property do not apply to the sale of annuities that satisfy the requirements set forth in that section of the Code. As stated above, you intend to structure your program in such a way so as to meet these requirements. Therefore, income derived from this program is not unrelated business taxable income.

Based upon the information submitted and presuming that the program will operate in the manner presented we have concluded that:

1. The sale of deferred college annuities by you will not be considered commercial-type insurance under section 501(m)(2) of the Code.

2. The income derived by you as a result of the sale of deferred college annuities viii not be considered income from an unrelated trade or business as defined in section 511 through 513 of the Code.

3. The income derived by you from the sale proceeds for deferred college annuities will not be considered debt-financed income within the meaning of section 514 of the Code.

Our holdings are contingent upon the program meeting all the requirements under section 501(m) and 514(c)(5) of the Code, including the requirement that a deduction be allowed under section 170 or 2055.

Because this letter could help resolve any questions about tax status, a copy should be kept in your permanent records. We are sending a copy of this letter to the appropriate key District Director.

This ruling is directed only to the organization that requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

Sincerely yours,
____
Marcus S. Owens
Director, Exempt Organizations Technical Division



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