Example 1. Janice, 50, wants to donate $100,000 to her favorite nonprofit. After meeting with her advisor, she learns that she could use her $100,000 to fund a single premium whole life insurance policy and name the nonprofit as the beneficiary. When she dies, the nonprofit will receive a check for approximately $260,000 from the insurance company. Because Janice can change her beneficiary designation at any time, it does not constitute an immediate gift and, therefore, Janice will not receive a charitable deduction when she funds the policy. At death, her estate will receive a tax deduction for the value of the death benefits paid to the nonprofit. The nonprofit is pleased with this arrangement because they will receive the proceeds in a timely fashion following the death of the donor. Janice is also satisfied that her estate will qualify for an estate tax deduction upon her passing.
Example 2. Spencer, 75, is a retired university professor with two independent adult children. With Spencer's consent, the university took a life insurance policy out earlier this year on Spencer. The policy will pay $500,000 upon Spencer's death. The policy's premiums each year are $15,000. Spencer wants the nonprofit to hold the policy and, upon his death, use the $500,000 to fund an endowment for scholarships at the university. While completely within its discretion, the university decides to keep the policy. However, it does not want to be responsible for the annual premiums. Thus, Spencer agrees that each year he will contribute an unrestricted gift of $15,000 to the university. As a result, the university feels comfortable holding the policy. In addition, Spencer will receive a $15,000 charitable deduction each year that he makes the contribution. If the gift is made in cash, it will be subject to the 60% AGI limitation.
Example 3. Oscar and Maria purchased a second-to-die whole life policy that has a cash value of $400,000. Oscar and Maria have paid annual premiums of $10,000 for 25 years. Their basis in the policy is $250,000 (25 x $10,000 annual premium). Oscar and Maria contribute the policy outright to their favorite nonprofit. Accordingly, they are entitled to a charitable deduction of $250,000 since their basis is less than $400,000. The reduction rules prohibit a charitable deduction for the ordinary income component.Substantiation Rules
The $250,000 deduction will be subject to the 50% AGI limitation (not the 30% limitation), because no capital gain element is involved in the charitable deduction. Once the nonprofit owns the policy, it can surrender the policy to the insurance company. Assuming no surrender or administrative charges, the nonprofit will receive $400,000. As a tax-exempt entity, the nonprofit has no income tax liability imposed at the time of surrender.
Example 4. Ali took out a life insurance policy many years ago which has a cost basis of $50,000. The policy is now worth $100,000. Ali took a loan out against the policy for $80,000. Ali no longer needs the policy since her children are grown and she would like to donate it to her favorite nonprofit. If Ali donates the policy, her basis will be prorated between the charitable gift and the sale (i.e. the loan forgiveness). Thus, her basis will be $10,000 ($20,000/$100,000 x $50,000). Because she is limited to the lesser of her basis or value, Ali's deduction will be $10,000. In addition, Ali will be taxed on ordinary income of $40,000 ($80,000 "loan forgiveness" less $40,000 allocated basis).Life Settlements
Example 5. Robin owns a $250,000 life insurance policy with a current value of $100,000. Robin pays annual premiums of $11,000 and the total amount of premiums paid so far is $33,000. Robin wants to transfer the policy to a nonprofit in exchange for a gift annuity. Since the current value of the policy is $100,000 (not $250,000), the nonprofit agrees to a one-life $100,000 gift annuity for Robin who is 59.
Pursuant to Sec. 170(e), the charitable deduction is based upon the lesser of cost basis or policy value. Robin's cost basis is her premiums paid thus far, which amounts to $33,000. Because this amount is less than the policy value of $100,000, the $33,000 cost basis is used to determine Robin's charitable deduction. Based upon this lower figure, Robin's charitable deduction is approximately $11,000. In addition, each annuity payment will include a tax-free return of principal, which is based upon the $33,000 cost basis.
To accomplish this calculation in Crescendo's software, there are a couple of adjustments. First, the property value and cost basis will be $100,000 and $33,000, respectively. Second, on the "options" screen, one must enter 100% for "ordinary gain" and 0% for "long-term capital gain." As a result, Crescendo's software will produce the appropriate calculations.
Example 6. Pat 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 the policy to a charitable remainder trust but does not need income until retirement in 10 years. Pat's advisor explains that donating to a FLIP unitrust could provide a deduction and delay income payments. 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 FLIP CRT with a trigger date in 10 years and transfers the policy to the CRT. The trustee elects to surrender the policy and conservatively reinvest the funds.Gifts and Irrevocable Life Insurance Trusts
Pursuant to Sec. 170(e), the charitable deduction is based upon the lesser of cost basis, $250,000, or the policy value, $400,000. Here, the $250,000 cost basis is lower and, based upon this figure, Pat's charitable deduction is approximately $87,000.
To accomplish this calculation in Crescendo's software, 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's software will produce the appropriate calculations.
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