Friday March 29, 2024

4.2.6 Gift Annuity Bailout

Gift Annuity Bailout

Gift Annuity Description:  A current or immediate gift annuity is a contract between the charity and the donor.

Business Background for Annuity Bailout:  The gift annuity bailout functions very well when the owners have both a "C" Corporation and real property.

Goals of Business Founders:  The business founders typically have four goals in this situation.

The Gift Annuity Bailout Achieves All Four Objectives:  First, the C corporation is transferred to a family limited partnership (FLP).

Double Depreciation:  The business founders built the plant and were able to depreciate it.

Gift Annuity Bailout Steps:  First, the C corporation, which is valued at $3 million, is transferred to a family limited partnership.

Gift Annuity Description


A current or immediate gift annuity is a contract between the charity and the donor. The donor transfers property to the charity and the charity promises to pay the annuity for one life or two lives. Sec. 514(c)(5).

As a contractual obligation, the annuity payments are secured by the assets of the charity. Most charities maintain an annuity reserve fund, which is required by some state insurance commissioners. However, the endowment and even all of the real property and other assets of the charity stand behind the promise to pay a gift annuity.

From the perspective of the donor, a gift annuity is a relatively simple agreement. He or she transfers cash, securities or other assets to the charity and receives a payment for one or two lives. The payment may be made monthly, quarterly, semiannually or annually. In addition, there is an income tax deduction and partially tax-free payout from the annuity contract.

When the gift annuity is created, part of the value represents a charitable gift and part is the amount exchanged for the annuity contract. There are several specific Treasury requirements for qualification as a gift annuity. A qualified gift annuity must be for one or two lives, there must be a minimum 10% charitable deduction, there can be no guaranteed minimum or maximum payments, and the annuity may not be adjusted based on the income earned on the transferred property. Sec. 514(c)(5).

Business Background for Annuity Bailout


The gift annuity bailout functions very well when the owners have both a C corporation and real property. Many businesses use a C corporation for the operating entity. However, in order to pass through depreciation to the owners, the real estate is owned personally.

Goals of Business Founders


The business founders typically have four goals in this situation. If they are now at retirement age, they would like to do the following:

1. Obtain secure income.
2. Pass business to children with no tax.
3. Facilitate an incentive plan for the good of the children.
4. Obtain a double depreciation benefit.

The secure income can be obtained through a charitable gift annuity. The business can be transferred through various leveraged means to children. A depreciation benefit will be available also for children.

But the key goal is the incentive plan. Since the parents started a business and over the years built it up, they understand very clearly how challenging it is to operate a successful business. If their children receive the business without the lessons the parents learned along their life path, they fear the business will not be successful. In addition, it is essential for the children to have a sense of ownership. They will be far more successful in the future if they perceive correctly that they have participated significantly in the growth of the business.

In order to create an incentive for the children to acquire business skills, the parents are opposed to an outright gift of the business to children. This is true even if that can be done with zero gift or estate tax. Rather, they would like a plan that provides them secure income, transfers part of the business to children and allows the children the benefit of acquiring for themselves the balance of the business.

The Gift Annuity Bailout Achieves All Four Objectives


First, the C corporation is transferred to a family limited partnership (FLP). The FLP or other leveraged-giving device is then given to children. While the cost basis in the C corporate stock will be quite low, it is contemplated that the children will operate the business for many years. If the business is successful, there would be significant additional appreciation and the initial low cost basis is not a significant issue.

Second, the real property - such as a plant - is transferred to charity for a gift annuity. Since the charity is receiving a less desirable asset than cash or public stock, a discount will usually be applied. Part of the property, perhaps 15% or 20%, is transferred outright to charity and the balance is transferred in exchange for the charitable gift annuity.

Third, the charity is able to sell the property to the children. Normally, the children will not have the cash to purchase the plant outright. However, the plant may be purchased on an installment note. Over a period of years, the children use profits from the business to acquire the plant. The acquisition of the plant requires the children to operate the business successfully in order to generate these profits. There thus is an incentive for the children to learn and apply good business management principles.

Double Depreciation


The business founders built the plant and were able to depreciate it. Since the children are purchasing the plant from the charity at fair market value, they acquire a new stepped up basis in the building. Therefore, they are able to depreciate the building a second time.

Example 4.2.6A Wallace Gift Annuity Bailout

Larry and Pam Wallace started a small manufacturing business when they were in their late 30s. Larry and Pam have operated the business for over 35 years and now would like to retire and receive secure income.

Their two children, Sam and Alice, are both involved in the business. Sam and Alice would like to acquire ownership in the business and operate it as a second-generation family business. Larry and Pam set up a C corporation to minimize liability from the manufacturing business, but have always owned the land and building individually. Larry was very pleased that they have been able to depreciate the building over the last 20 years of operation.

After discussing the gift annuity bailout with their tax advisor, Larry and Pam decide that it will meet all of their objectives.

Gift Annuity Bailout Steps


First, the C corporation, which is valued at $3 million, is transferred to a family limited partnership (FLP). With the FLP discounts, annual gift exclusions and their exemption equivalents, they are able to gift this family limited partnership to Sam and Alice over a period of two years.

Second, the real property (including the manufacturing building) is transferred to a major charity in exchange for a charitable gift annuity. The real property is appraised at $2.5 million. Larry and Pam transfer 20% outright, for an immediate gift of $500,000 in value, and 80% in exchange for a $2 million gift annuity. Since the charity owns 100% of the asset, there should be no fractional interest discount. Based upon their ages, the gift annuity will pay $140,000 per year. They especially enjoy their tax benefits. The charitable deduction of over $600,000 is an appreciated, or 30% type, deduction. They will be able to write off approximately $100,000 per year over the current year and five more years. In addition, the $140,000 in income will be about $58,000 of ordinary income, $78,000 of capital gain and $4,000 tax-free each year. The combination of the charitable deduction and the capital gain and tax-free income will enable them to have significantly increased after-tax income.

Third, there is excellent incentive in the plan. The major charity then sells the property to the family corporation for cash and a note totaling $2.5 million. Over a period of 15 years, Sam and Alice will use company profits to pay off the note and acquire the building. This natural incentive will enable them to learn good business skills and to feel that through their own efforts they acquired a major portion of the business. This sense of ownership will be very helpful in facilitating their long-term success.

Fourth, there is the double depreciation benefit. Larry and Pam depreciated the building over a period of 20 years. With the acquisition of the building by the corporation, Sam and Alice have a new basis and will be able to depreciate it a second time.

The plan achieves all of the objectives of Larry and Pam. It provides a secure retirement income, transfers the business to their children Sam and Alice, encourages the development of good business skills and leaves Sam smiling over the double depreciation benefit.

Case Studies on Gift Annuity Bailout

Greenco Gift Annuity Bailout:   Bill and Clara Green consider themselves very fortunate. Bill was born in Estonia. While he was an infant his parents immigrated to America. He attended high school and State College on the East Coast. After he received an engineering degree, Bill worked for two different companies on the East Coast. He met Clara, married and they have two children, Susan and Harry.


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