Wednesday April 24, 2024

4.4.5 Insurance to CRT or CGA

Insurance to CRT or CGA

Transfer to CRT:  In some cases, a donor may not want to give a life insurance policy outright to charity, but instead may want lifetime income.

Exchange for CGA:  In some cases, a donor may not want to give a life insurance policy outright, but instead may want lifetime income.

Ordinary Income Spread Over Lifetime:  If Pat Policy surrenders her life insurance policy she will have $150,000 of ordinary income ($400,000 - $250,000).

Transfer to CRT
In some cases, a donor may not want to give a life insurance policy outright to charity, but instead may want lifetime income. It is generally permissible for a donor to transfer a life insurance policy to a charitable remainder trust (CRT) or charitable gift annuity (CGA). The issue will depend heavily upon applicable state law. Thus, if state law allows a charity to own a life insurance policy, then state law will likely also allow a transfer of a policy to a CRT or for a CGA. For a full discussion on the transfer of life insurance, see GiftLaw Pro 4.4.1.

Once the insurance has been transferred to the CRT, the income stream to the donor will be taxed according to four-tier accounting principles. One question that arises, however, is regarding the tax-free portion of the payout. Payouts from a CRT holding life insurance may be treated as a return of principal to the extent they are the return of premiums paid by the policy, provided that all ordinary income, capital gain and tax-free income have previously been distributed.

CRT Example 4.4.5A

Pat Policy owns a $1 million life insurance policy with a current value of $400,000. Pat pays annual premiums of $10,000 and the total amount of premiums paid so far is $250,000. Pat wants to transfer her policy to a charitable remainder trust.

Since the current value of the policy is $400,000 (not $1 million), the initial trust value will be $400,000. Therefore, Pat creates a one-life, 5% payout CRUT and transfers her policy to the CRT trustee. The trustee then may hold or surrender the policy. In this instance, for liquidity and diversification purposes, the trustee elects to surrender the policy and reinvest the funds.

Pursuant to Sec. 170(e), the charitable deduction is based upon the lesser of cost basis or policy value. $250,000 is less than $400,000, so, although $400,000 is the initial trust value, the $250,000 cost basis is used when determining Pat's charitable deduction. Based upon this lower figure, Pat's charitable deduction is approximately $99,000.

To accomplish this calculation on Crescendo, there are a couple of adjustments. First, the trust value and cost basis will be $400,000 and $250,000, respectively. Second, on the "options" screen, one must click on "reduce deduction to basis." As a result, Crescendo will produce the appropriate calculations.

Exchange for CGA
In some cases, a donor may not want to give a life insurance policy outright, but instead may want lifetime income. It is generally permissible for a donor to transfer a life insurance policy to a CRT or CGA. The issue will depend heavily upon applicable state law. Thus, if state law allows a charity to own a life insurance policy, then state law will likely also allow a transfer of a policy to a CRT or for a CGA. For a full discussion on the transfer of life insurance, see GiftLaw Pro 4.4.1.

CGA Example 4.4.5B

Pat Policy owns a $1 million life insurance policy with a current value of $400,000. Pat pays annual premiums of $10,000 and the total amount of premiums paid so far is $250,000. Pat wants to transfer her policy to charity in exchange for a gift annuity.

Since the current value of the policy is $400,000 (not $1 million), charity agrees to a one-life $400,000 gift annuity for Pat who is 59. Once charity is the owner of the policy, it may hold or surrender the policy. In order to meet its gift annuity obligations, charity elects to surrender the policy and reinvest the funds.

Pursuant to Sec. 170(e), the charitable deduction is based upon the lesser of cost basis or policy value. $250,000 is less than $400,000, so, although $400,000 is the gift annuity value, the $250,000 cost basis is used when determining Pat's charitable deduction. Based upon this lower figure, Pat's charitable deduction is approximately $57,044. In addition, each annuity payment will include a tax-free return of principal, which is based upon the $250,000 cost basis.

To accomplish this calculation on Crescendo, there are a couple of adjustments. First, the property value and cost basis will be $400,000 and $250,000, respectively. Second, on the "options" screen, one must enter 100% for "ordinary gain" and 0% for "long-term capital gain." As a result, Crescendo will produce the appropriate calculations.

Ordinary Income Spread Over Lifetime
If Pat Policy surrenders her life insurance policy she will have $150,000 of ordinary income ($400,000 - $250,000). However, if she transfers the policy in exchange for a gift annuity, the question is "does the amount of ordinary income attributable to the annuity get spread out over the donor's lifetime or is it triggered immediately upon transfer?" While there is no precedent, it appears that the ordinary gain will be spread over the donor's life expectancy.

The rationale for this assumption is threefold. First, the tax regulations state that any gain realized upon funding a gift annuity is spread out over the lifetime of the donor if the donor is the only annuitant or the donor and a successor annuitant are the only annuitants. See Reg. 1.1011-2(b)(1). In this case, Pat Policy is the only annuitant. Therefore, she should be able to spread the gain out over her life expectancy.

Second, gifts of other types of ordinary income property enjoy this "deferral" of gain benefit. For example, inventory and other ordinary income property commonly are transferred in exchange for a gift annuity. In those situations, the ordinary gain is regularly spread out over the donor's lifetime.

Finally, in 1986, Congress enacted an amendment to Sec. 72 of the Tax Code, which deals with annuities in general. In the amendment, it provided that certain transfers would trigger ordinary income. For instance, a transfer of a commercial annuity requires the taxpayer to recognize the gain, if any, as ordinary income. However, there were no similar ordinary income trigger rules with respect to life insurance. As such, it is arguable that life insurance in exchange for a gift annuity does not require the donor to immediately report the ordinary income.

Case Studies on Insurance to CRT or CGA

Planning Gifts of Life Insurance: Current, Deferred, Contingent & Split Interest, Part 5 of 6:   Many years ago when Dr. Mimms was just a budding young surgeon and father, he decided to purchase a life insurance policy on his life "just in case."

Planning Gifts of Life Insurance: Current, Deferred, Contingent & Split Interest, Part 6 of 6:   Many years ago when Dr. Mimms was just a budding young surgeon and father, he decided to purchase a life insurance policy on his life "just in case."

Related Topics on Insurance to CRT or CGA

4.4.4  Form 8283 and Form 712:    If a person or an estate makes a noncash charitable contribution greater than $500, IRS Form 8283 must be included with his, her or its tax return. If the property is not publicly traded stock that may be valued on an exchange and exceeds $5,000 in value ($10,000 for closely held stock), a qualified appraisal is required. The appraisal must be made not earlier than 60 days prior to the gift and not later than the date the return is due (with extensions).

      Quiz-Basic



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