Thursday March 28, 2024

3.3.9 Income, Gift and Estate Taxes

Income, Gift and Estate Taxes

Income Taxation:   The major benefits of a gift annuity are an income tax charitable deduction and partly tax-free payments.

Gift Taxation:   If a gift annuity is acquired for another person, there is a taxable gift of the value of the annuity contract.

Estate Tax:   With a one-life gift annuity, when the annuitant passes away, there is no remaining value and therefore no estate tax.

Income Taxation

The major benefits of a charitable gift annuity are an income tax charitable deduction and partly tax-free payments. Reg. 1.1011-2(a). In addition, if the donor/annuitant passes away prior to his or her life expectancy, the unrecovered basis may be deducted on the final income tax return as a miscellaneous itemized deduction not subject to the 2% limit. Sec. 72(b)(3) and Sec.67(b)(10).

Gift Taxation

If a gift annuity is acquired for another person, there is a taxable gift of the value of the annuity contract. This is displayed on line "E" of the Crescendo gift annuity deduction worksheet. It is the difference between the amount transferred and the charitable deduction.

With a current annuity, it is permissible to use the annual exclusion. Reg. 25.2503-3(b). The annual exclusion qualifies because the current annuity interest is considered a "present" interest. If the annuity contract value exceeds the available exclusion (or two exclusions if the gift is from a husband and wife), it may be necessary to use a portion of the applicable gift exemption amount. Alternatively, the donor may retain a testamentary right of revocation. Doing so prevents a present interest until the date each payment is made. However, this option is generally available for annuities in which the donor is a concurrent or successive annuitant. For more information on concurrent or successive annuities, see GiftLaw Pro Ch. 3.3.2.

If a donor funds a deferred payment gift annuity for another person other than a spouse, it will be necessary to use the applicable gift exemption. A deferred payment gift annuity is a future interest. Since the annuitant may not assign the interest, there is no present right to income. Therefore, the present interest annual gift exclusion is not available, and a portion of the lifetime gift exemption must be used to cover the value of the annuity contract.

Estate Tax

With a one-life gift annuity, when the annuitant passes away, there is no remaining value and therefore no estate tax.

If a married couple creates a gift annuity, normally it is funded with community or jointly owned property. When the first spouse passes away, the life interest in that person's one-half of the annuity is transferred to the surviving spouse. If the first spouse had retained a testamentary power of revocation over that one-half interest, it will be included in his or her estate. However, this one-half interest in the annuity qualifies for the marital deduction. Sec. 2056(b)(7)(C)(i). Of course, if the power of revocation was not retained by the deceased spouse, there was a gift at time of funding the annuity, but there also was a qualified marital gift deduction. Sec. 2523(f)(6)(A).

If a two-life annuity is created for the donor and a child, nephew, niece or other person who is not a spouse, it is helpful to retain a power of revocation. This power of revocation is a "string" that precludes the donor from making a current gift.

If the second person predeceases the donor, then there is no remaining annuity value when the donor passes away and no estate tax consequence. However, if the child, nephew, niece or friend survives the donor, the annuity contract will be included in the donor's estate. Sec. 2039(a). It will be valued as of the date of the donor's death. The valuation must be completed using the date of death as the funding date, the Applicable Federal Rate for that date and the annuity payout and frequency. Since there is no charitable deduction in this valuation, it is not permissible to use the two-month "look back," and the AFR for the month of death must be used.

The calculation should use the full first payment option and the contract value will be reported on line "E." This contract value must be included on the estate tax Form 706 of the donor.

Example 3.3.9A

Mary Johnson funds a gift annuity for herself and her niece, Susan Smith. The gift annuity is funded with stock with a cost basis of $20,000 and current value of $100,000. The annuity pays income for two lives.

Mary passes away five years later. Mary retained a testamentary power of revocation and thus the annuity contract is included in her estate. At the date of Mary's death, the one-life annuity contract is recalculated using Susan's age, an assumed AFR, the next payout date and the option for full payment-short period. Based on Susan's age, the line "E" annuity contract value is $64,353.75. This amount will be included in the Form 706 estate tax return of Mary Johnson. Note that the original income taxation schedule is maintained. Because Mary Johnson passed away before the full capital gain amounts had been reported, Susan Smith will continue to report the capital gain recognition until the gain has been fully recovered. Only during the latter years of the payouts to Susan will she receive tax-free return. The income taxation schedule is similar to an installment note in tax treatment. Once the schedule is created, it must be followed, regardless of the length of the first life.


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