Charitable Gift Annuity Taxation

1. A donor with a 10 year life expectancy purchases a gift annuity for $12,000. The immediate charitable tax deduction is $2,000. If the donor receives an annual annuity check for $1,250, how much of the 14th check is considered to be annual return of investment?

A donor with a 10 year life expectancy would have already received back his or her original investment by the time of the 14th annual check. Thus, no part of any check received after the donor’s life expectancy (i.e., after the 10th check) is return of investment.

Explanation

A donor with a 10 year life expectancy would have already received back his or her original investment by the time of the 14th annual check. Thus, no part of any check received after the donor’s life expectancy (i.e., after the 10th check) is return of investment.

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2. What is the total capital gain if I purchase stock for $20,000, it increases in value to $200,000 and I give it to a charity in exchange for a gift annuity worth $100,000 paid to my nephew?

The annuity portion is worth 50% of the amount I gave (200,000/100,000=.50), thus I can use 50% of the original cost basis of $20,000, which is $10,000. I received something (the annuity) worth $100,000, and I can subtract $10,000 of my cost basis from that, leaving me with a capital gain of $90,000 ($100,000-$10,000). The capital gain would be $90,000 regardless of whether it was paid to me or to my nephew, but because it was paid to my nephew the entire capital gain will be recognized (i.e., taxed) immediately, rather than being paid out as I receive each annuity check.

Explanation

The annuity portion is worth 50% of the amount I gave (200,000/100,000=.50), thus I can use 50% of the original cost basis of $20,000, which is $10,000. I received something (the annuity) worth $100,000, and I can subtract $10,000 of my cost basis from that, leaving me with a capital gain of $90,000 ($100,000-$10,000). The capital gain would be $90,000 regardless of whether it was paid to me or to my nephew, but because it was paid to my nephew the entire capital gain will be recognized (i.e., taxed) immediately, rather than being paid out as I receive each annuity check.

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3. I purchase stock for $20,000, it increases in value to $200,000 and I give it to a charity in exchange for a gift annuity worth $100,000 paid to me for my life. At the time of purchase my life expectancy was 9 years. How much of each annual annuity check during my life expectancy will count as capital gain to me?

The annuity portion is worth 50% of the amount I gave (200,000/100,000=.50), thus I can use 50% of the original cost basis of $20,000, which is $10,000. I received something (the annuity) worth $100,000, and I can subtract $10,000 of my cost basis from that, leaving me with a capital gain of $90,000 ($100,000-$10,000). The capital gain of $90,000 would recognized over the course of my 9 year life expectancy, thus $10,000 ($90,000/9 year life expectancy) per year will count as a capital gain to me.

Explanation

The annuity portion is worth 50% of the amount I gave (200,000/100,000=.50), thus I can use 50% of the original cost basis of $20,000, which is $10,000. I received something (the annuity) worth $100,000, and I can subtract $10,000 of my cost basis from that, leaving me with a capital gain of $90,000 ($100,000-$10,000). The capital gain of $90,000 would recognized over the course of my 9 year life expectancy, thus $10,000 ($90,000/9 year life expectancy) per year will count as a capital gain to me.

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4. I purchase stock for $100,000, it increases in value to $200,000 and I give it to a charity in exchange for a gift annuity worth $160,000 paid to me for my life. At the time of purchase my life expectancy was 40 years. How much of each annual annuity check during my life expectancy will count as tax free return of investment to me?

The annuity portion is worth 80% of the amount I gave (160,000/200,000=.80), thus I can use 80% of the original cost basis of $100,000, which is $80,000. The basis used for the annuity of $80,000 is returned over the course of my 40 year life expectancy, thus $2,000 ($80,000/40 year life expectancy) per year will count as a tax free return of basis to me.

Explanation

The annuity portion is worth 80% of the amount I gave (160,000/200,000=.80), thus I can use 80% of the original cost basis of $100,000, which is $80,000. The basis used for the annuity of $80,000 is returned over the course of my 40 year life expectancy, thus $2,000 ($80,000/40 year life expectancy) per year will count as a tax free return of basis to me.

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5. A donor with a 10 year life expectancy purchases a gift annuity for $12,000. The immediate charitable tax deduction is $2,000. If the donor receives an annual annuity check for $1,250, how much of the first check is considered to be annual return of investment?

The annual return of investment during the donor’s life expectancy is the money used to buy the annuity divided by the donor’s life expectancy at the time of purchase. Because the charitable tax deduction was $2,000, this means that $10,000 of the gift annuity purchase price was used to purchase the annuity. (The remaining $2,000 was used to make a gift to the charity, not to purchase the annuity.) Thus, $10,000 divided by the donor’s 10 year life expectancy is $1,000. $1,000 of each check during the donor’s life expectancy will be return of the donor’s original investment.

Explanation

The annual return of investment during the donor’s life expectancy is the money used to buy the annuity divided by the donor’s life expectancy at the time of purchase. Because the charitable tax deduction was $2,000, this means that $10,000 of the gift annuity purchase price was used to purchase the annuity. (The remaining $2,000 was used to make a gift to the charity, not to purchase the annuity.) Thus, $10,000 divided by the donor’s 10 year life expectancy is $1,000. $1,000 of each check during the donor’s life expectancy will be return of the donor’s original investment.

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6. What is the total capital gain if I purchase stock for $100,000, it increases in value to $200,000 and I give it to a charity in exchange for a gift annuity worth $160,000 paid to my nephew?

The annuity portion is worth 80% of the amount I gave (160,000/200,000=.80), thus I can use 80% of the original cost basis of $100,000, which is $80,000. I received something (the annuity) worth $160,000, and I can subtract $80,000 of my cost basis from that, leaving me with a capital gain of $80,000 ($160,000-$80,000). The capital gain would be $80,000 regardless of whether it was paid to me or to my nephew, but because it was paid to my nephew the entire capital gain will be recognized (i.e., taxed) immediately, rather than being paid out as I receive each annuity check.

Explanation

The annuity portion is worth 80% of the amount I gave (160,000/200,000=.80), thus I can use 80% of the original cost basis of $100,000, which is $80,000. I received something (the annuity) worth $160,000, and I can subtract $80,000 of my cost basis from that, leaving me with a capital gain of $80,000 ($160,000-$80,000). The capital gain would be $80,000 regardless of whether it was paid to me or to my nephew, but because it was paid to my nephew the entire capital gain will be recognized (i.e., taxed) immediately, rather than being paid out as I receive each annuity check.

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7. What is the total capital gain if I purchase stock for $10,000, it increases in value to $100,000 and I give it to a charity in exchange for a gift annuity worth $80,000 paid to my nephew?

The annuity portion is worth 80% of the amount I gave (80,000/100,000=.80), thus I can use 80% of the original cost basis of $10,000, which is $8,000. I received something (the annuity) worth $80,000, and I can subtract $8,000 of my cost basis from that, leaving me with a capital gain of $72,000 ($80,000-$8,000). The capital gain would be $72,000 regardless of whether it was paid to me or to my nephew, but because it was paid to my nephew the entire capital gain will be recognized (i.e., taxed) immediately, rather than being paid out as I receive each annuity check.

Explanation

The annuity portion is worth 80% of the amount I gave (80,000/100,000=.80), thus I can use 80% of the original cost basis of $10,000, which is $8,000. I received something (the annuity) worth $80,000, and I can subtract $8,000 of my cost basis from that, leaving me with a capital gain of $72,000 ($80,000-$8,000). The capital gain would be $72,000 regardless of whether it was paid to me or to my nephew, but because it was paid to my nephew the entire capital gain will be recognized (i.e., taxed) immediately, rather than being paid out as I receive each annuity check.

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8. I purchase stock for $100,000, it increases in value to $200,000 and I give it to a charity in exchange for a gift annuity worth $160,000 paid to me for my life. At the time of purchase my life expectancy was 40 years. How much of each annual annuity check during my life expectancy will count as capital gain to me?

The annuity portion is worth 80% of the amount I gave (160,000/200,000=.80), thus I can use 80% of the original cost basis of $100,000, which is $80,000. I received something (the annuity) worth $160,000, and I can subtract $80,000 of my cost basis from that, leaving me with a capital gain of $80,000 ($160,000-$80,000). The capital gain of $80,000 is recognized over the course of my 40 year life expectancy, thus $2,000 ($80,000/40 year life expectancy) per year will count as a capital gain to me.

Explanation

The annuity portion is worth 80% of the amount I gave (160,000/200,000=.80), thus I can use 80% of the original cost basis of $100,000, which is $80,000. I received something (the annuity) worth $160,000, and I can subtract $80,000 of my cost basis from that, leaving me with a capital gain of $80,000 ($160,000-$80,000). The capital gain of $80,000 is recognized over the course of my 40 year life expectancy, thus $2,000 ($80,000/40 year life expectancy) per year will count as a capital gain to me.

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9. I purchase stock for $20,000, it increases in value to $200,000 and I give it to a charity in exchange for a gift annuity worth $100,000 paid to me for my life. At the time of purchase my life expectancy was 10 years. How much of each annual annuity check during my life expectancy will count as tax free return of investment to me?

The annuity portion is worth 50% of the amount I gave (100,000/200,000=.50), thus I can use 50% of the original cost basis of $20,000, which is $10,000. The basis used for the annuity of $10,000 is returned over the course of my 10 year life expectancy, thus $1,000 ($10,000/10 year life expectancy) per year will count as a tax free return of basis to me.

Explanation

The annuity portion is worth 50% of the amount I gave (100,000/200,000=.50), thus I can use 50% of the original cost basis of $20,000, which is $10,000. The basis used for the annuity of $10,000 is returned over the course of my 10 year life expectancy, thus $1,000 ($10,000/10 year life expectancy) per year will count as a tax free return of basis to me.

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10. IRS Table S (Based on Life Table 2000CM) for interest at 2.8 Percent lists the following factors for a person age 80: Annuity = 7.0895, Life Estate = 0.19851, Remainder = 0.80149.

James, age 80, has $100,000 cash that he wants to use to establish a charitable gift annuity in October of 2010. Using the ACGA suggested payout rate of 7.2% and the IRS §7520 rate of 2.8%, James income tax deduction for this donation would be:

To calculate John’s income tax deduction, start by calculating his annual payment, which is $100,000 X 7.2% = $7,200. Next, calculate the value of his annuity, which is $7,200 X 7.0895 = $51,044. His income tax deduction is the part of his $100,000 that is not used for the annuity. Therefore, his income tax deduction is $100,000 - $51,044 = $48,956.

Explanation

To calculate John’s income tax deduction, start by calculating his annual payment, which is $100,000 X 7.2% = $7,200. Next, calculate the value of his annuity, which is $7,200 X 7.0895 = $51,044. His income tax deduction is the part of his $100,000 that is not used for the annuity. Therefore, his income tax deduction is $100,000 - $51,044 = $48,956.

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11. Which interest rate must be used to calculate the value of the annuity part of a charitable gift annuity?

The §7520 rate for the month of the charitable gift annuity creation

The taxpayer may select the §7520 rate for the month of the charitable gift annuity creation or either of the two previous months. The §7520 rate is 120% of the applicable federal midterm rate.

Explanation

The taxpayer may select the §7520 rate for the month of the charitable gift annuity creation or either of the two previous months. The §7520 rate is 120% of the applicable federal midterm rate.

12. What is the appropriate tax rate for the portion of an annuity check that is calculated to be return of investment?

The applicable capital gains tax rate

The applicable personal income tax rate

The applicable ordinary income tax rate for passive investments

The applicable personal gift tax rate

Nothing (0%)

There is no tax on receiving back your own money. Thus, the portion of an annuity check calculated to be return OF investment is not taxable.

Explanation

There is no tax on receiving back your own money. Thus, the portion of an annuity check calculated to be return OF investment is not taxable.

13. In a cash transaction, how are the tax consequences different for a donor who purchases a charitable gift annuity for $100,000 paying $5,000/year for life as compared with a donor who uses part of $100,000 to purchase a commercial annuity paying $5,000/year for life and gives the rest of the $100,000 directly to the charity?

The tax consequences are identical

There is no charitable deduction for the second transaction

The charitable deduction for the commercial annuity transaction will be greater than for the gift annuity transaction

The tax consequences for the two transactions are similar. However, the charitable gift in a charitable gift annuity is (using bargain sale rules) the difference between the price paid and the value of the annuity based upon IRS value principles. In the second transaction, the gift is the amount left over after paying the price of the commercial annuity. If the price of the commercial annuity were identical to the value of the annuity portion of the gift annuity based upon IRS value principles, then the tax consequences would be identical. (This would not be true for a transaction using appreciated property, but this is a cash transaction.)

Explanation

The tax consequences for the two transactions are similar. However, the charitable gift in a charitable gift annuity is (using bargain sale rules) the difference between the price paid and the value of the annuity based upon IRS value principles. In the second transaction, the gift is the amount left over after paying the price of the commercial annuity. If the price of the commercial annuity were identical to the value of the annuity portion of the gift annuity based upon IRS value principles, then the tax consequences would be identical. (This would not be true for a transaction using appreciated property, but this is a cash transaction.)

14. Which of the following tax consequences can NOT be generated by a charitable gift annuity?

Additions to taxable income

Deductions from taxable income

Postponement of capital gains tax

Gift taxes

All of the above can be generated by a charitable gift annuity

The charitable gift annuity creates additions to taxable income based upon the portion of the annuity payment that is ordinary income. It creates a charitable deduction from taxable income based upon the initial gift portion of the transaction. If the donor is also the person receiving the income (i.e., the annuitant), capital gains taxes are postponed and are paid out gradually over the life expectancy of the donor as he or she receives each annuity check. If someone other than the donor or the donor’s spouse is the annuitant, creating a charitable gift annuity can increase gift taxes (although an immediate annuity is reduced by the annual gift exclusion for present interest gifts). Therefore all of these consequences can result from the charitable gift annuity.

Explanation

The charitable gift annuity creates additions to taxable income based upon the portion of the annuity payment that is ordinary income. It creates a charitable deduction from taxable income based upon the initial gift portion of the transaction. If the donor is also the person receiving the income (i.e., the annuitant), capital gains taxes are postponed and are paid out gradually over the life expectancy of the donor as he or she receives each annuity check. If someone other than the donor or the donor’s spouse is the annuitant, creating a charitable gift annuity can increase gift taxes (although an immediate annuity is reduced by the annual gift exclusion for present interest gifts). Therefore all of these consequences can result from the charitable gift annuity.

15. A donor purchased an annuity that pays her $10,000 per year. During the first year of the annuity, $4,000 of the annuity check was capital gain, $4,000 was return of investment, and $2,000 was earnings. What is the proper taxation of the $10,000 annuity check received in the second year following the end of the donorÃ¢ï¿½ï¿½s life expectancy?

All $10,000 is taxed at the relevant personal income tax rate as ordinary income

All $10,000 is tax free

Only $2,000 is taxed at the relevant personal income tax rate as ordinary income, the rest is tax free

After a donor outlives his or her life expectancy, all annuity checks are 100% taxable as ordinary income. By that point the donor will have recognized all of his or her capital gain and will also have received back all of his or her original investment, thus leaving only ordinary income/earnings characterization for the entire amount of each subsequent annuity check.

Explanation

After a donor outlives his or her life expectancy, all annuity checks are 100% taxable as ordinary income. By that point the donor will have recognized all of his or her capital gain and will also have received back all of his or her original investment, thus leaving only ordinary income/earnings characterization for the entire amount of each subsequent annuity check.

16. A donor purchases a charitable gift annuity in August when the ÃÂ§7520 rate is 3.0%. If the rates were 2.8% for July and 3.2% for June, what rate should the donor use to calculate his best tax deduction?

The June rate, because a higher interest rate means that the value of the annuity is less.

The June rate, because a higher interest rate means that the value of the annuity is more.

The July rate, because a higher interest rate means that the value of the annuity is less.

The July rate, because a higher interest rate means that the value of the annuity is more.

The August rate, because that is the month in which the gift annuity was purchased.

The higher interest rate causes the annuity to be valued at a lower amount. Because the charitable gift is the difference between the amount paid and the value of the annuity, a lower value for the annuity means that the charitable gift amount, and thus the deduction, is larger. The donor may choose from the §7520 rates during the month of the transaction or the two previous months.

Explanation

The higher interest rate causes the annuity to be valued at a lower amount. Because the charitable gift is the difference between the amount paid and the value of the annuity, a lower value for the annuity means that the charitable gift amount, and thus the deduction, is larger. The donor may choose from the §7520 rates during the month of the transaction or the two previous months.