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Charitable Giving Cases Hit The Courts

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Naples, Fla.

Tax courts have seen a number of cases over the past year dealing with charitable giving and the uses of life insurance.

Some of the issues discussed here at LIMRAs annual advanced sales conference include certain aspects of charitable split dollar and the structuring of life insurance gifts to charities.

Stephan Leimberg, CEO of Leimberg Information Services Inc., and co-author of The Tools and Techniques of Charitable Planning, published by The National Underwriter Company, detailed the results of several of this years cases.

In the first case he spoke about, Leimberg said a taxpayer had purchased a single premium whole life insurance policy on his life and named a public charity as an irrevocable beneficiary. As this was done, the insured transferred all the rights in the policy to the charity, with the exception of the legal title to the contract.

“The problem here is theres no deduction–and possible estate tax inclusion because hes retained the title,” said Leimberg.

In this instance, as Leimberg explained, the donor was only keeping the title to the contract due to the licensing requirements that would have been imposed on the agent. The agent in this case was not licensed in the state where the charity existed, so the intent was to avoid the licensing requirement and get the policy in force.

“The IRS says technically, if you dont assign everything you dont get a deduction,” he said.

But in this case, the IRS agreed that if the insured transferred every economic right, the IRS would allow the deduction–even though the title was retained. Leimberg emphasized that this was the result in this case and that agents should not take this approach when planning for clients.

Instead, he continued, agents should “play it safe.” He told the advanced marketing attorneys present here to “make sure your agents know their clients must not keep any rights [to the policy], or theres no deduction.”

Another component to this case involved the timing of the deduction. Leimberg explained that since most policies have a free-look period, where the policy might be canceled, the donor may not take the deduction until that period has passed. “The cancellation right delays the date of the deduction,” he said.

Thus, he said, agents should express the importance of not waiting until December to make a charitable gift of life insurance. “The best time to make a contribution to charity is right now, the month of November.”

And while charitable split dollar was also on the docket for the past years tax court cases, one case revealed that payments made by a charitable foundation for the purpose of a split-dollar agreement are considered as “qualifying distributions” from the charity.

According to Leimberg, a private foundation is required by law to distribute 5% of its assets every year for charitable purposes. “Failure to distribute that amount results in a very harsh excise tax,” he said. An outlay from the charity for any other purpose is considered a “taxable expenditure,” and Leimberg noted that this might also be subject to excise taxes.

But the ruling stated that if the expenditure is reasonable and in furtherance of the exempt purposes of the organization, it is not a taxable expenditure.

“So we need to ask ourselves before we sell any life insurance to an organization, is this a reasonable expense?” he explained. “We know if we can justify the reasonableness, we can sell life insurance to charities to help attract, recruit and retain key executives.”

But for some charitable split-dollar arrangements, the tax court ruled in favor of the IRS. Leimberg explained that for years he felt there were a number of reasons why some charitable split dollar arrangements would not work, but in the Addis v. Commissioner case, it was the donors failure to substantiate the gift that revoked the deduction.

The Addis case was a classic charitable split-dollar scheme, where the Addises made charitable gifts and expected those gifts to be used as premium payment for an insurance policy which was part of a split-dollar agreement with the Addis family trust.

The tax court found that the charity provided consideration for the Addises contribution and that it was not accurately substantiated in the receipts from the charity. This resulted in a disallowance of their entire deduction.

“These cases tell us that the IRS is going to find a way to shut down scams,” he said.

According to Leimberg, agents presenting charitable planning ideas to their clients need to ask the question, “Is what the client got back both incidental and insubstantial?”

He explained, “If someone donates $1 million and gets back a plaque that costs $25, thats incidental and insubstantial. But if he gets a car, or money gets shifted into his kids trust–thats not incidental and not insubstantial.”

The final case Leimberg discussed involved the use of life insurance as a charitable gift, where a generous donor “wanted to transfer a term life insurance policy from his own personal life insurance trust to a foundation.”

Leimberg explained that since this individual was the founder of the private foundation, a substantial contributor to the foundation, and a director of the foundation for life, he was considered a “disqualified person” with respect to the charity. In addition, the insured wanted to continue to make gifts in the amount of the premium to the charity.

“He specifically did not require the charity to pay the premium with his contribution, and he gave up the right to make any decisions as director of the foundation vis ? vis the life insurance on his life–he separated himself,” Leimberg said. The tax courts ruled that this would not be considered self-dealing or jeopardize the income tax status of the policy.

“If you dont attach any strings, you wont have any problems,” he said.

Reproduced from National Underwriter Life & Health/Financial Services Edition, November 25, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.