At a recent Trusts & Estates webinar sponsored by St. Jude Children’s Research Hospital, philanthropy expert Jonathan Tidd discussed the pitfalls and safe havens involved in common gift planning situations. It’s important for practitioners to be aware of these issues or their clients may suffer the consequences. Here are a few of the questions from the audience and Tidd’s responses:
Self Dealing
Trusts & Estates: Why is the payment considered self dealing if a donor makes an enforceable pledge and subsequently, the donor’s private foundation pays the pledge?
Jonathan Tidd: The answer lies in the Treasury Regulations. Treas. Regs. Section 53.4941(d)-2(f)(1) provides in part:
In addition, if a private foundation makes a grant or other payment which satisfies the legal obligation of a disqualified person, such grant or payment shall ordinarily constitute an act of self-dealing to which this subparagraph applies. However, if a private foundation makes a grant or payment which satisfies a pledge, enforceable under local law, to an organization described in section 501(c)(3), which pledge is made on or before April 16, 1973, such grant or payment shall not constitute an act of self-dealing to which this subparagraph applies so long as the disqualified person obtains no substantial benefit, other than the satisfaction of his obligation, from such grant or payment. In addition, a donor is a disqualified person with respect to their PF pursuant to Treas. Regs. Section 53.4946-1(1)(i).
Pledge Payment
TE: Can a pledge be written so it will be paid by either the individual or the PF?
JT: Yes, if the pledge is unenforceable under local law. But doing this is dangerous if the pledge is enforceable, and the donor who made the pledge is a disqualified person with respect to the PF. It’s dangerous because, as noted above, the payment by the PF would be self-dealing.
Mortgage Debt
TE: How does mortgage debt cause problems in charitable gift planning?
JT: Here are three problems.
- If the property subject to the debt is appreciated, and the property is given to a charity, the gift will be a bargain sale for federal tax purposes pursuant to Treas. Regs. Section 1.1011-2(a)(3), and the donor will realize gain.
- If the donor is personally liable on the debt, and the property is transferred to a charitable remainder trust as defined in Internal Revenue Code Section 664, the trust’s payment of the debt will be self-dealing under IRC Section 4941 and must be avoided. See Treas. Regs. Section 53.4941(d)-2(f)(1). Charitable remainder trusts are subject to the same self-dealing prohibition as PFs.
- If the debt-encumbered property is transferred to a charity for a gift annuity, the debt must be more than five years old, pursuant to Treas. Regs. Section1.514(c)-1(b)(3), and certain other requirements of that section must be met, or the annuity will be commercial insurance under IRC Section 501(m).
Bequests
TE: What are the biggest challenges with bequests to a charity?
JT: The biggest challenge, generally speaking, is dealing with onerous donor-imposed restrictions on the bequest. For example, if a donor makes a sizable bequest to establish a scholarship fund for members of a specific racial group, such a restriction would contravene federal law. There are ways to achieve such an objective, but finesse is required.