Charitable IRA Rollover Bill & Gift Annuity Tuition Plan

Charitable IRA Rollover Bill & Gift Annuity Tuition Plan

Article posted in Legislative on 16 July 1999| comments
audience: Partnership for Philanthropic Planning, National Publication | last updated: 18 May 2011


In this edition of Planned Giving Online, PGDC editors take a behind the scenes look at the lobbying activity surrounding the "Charitable IRA Rollover" legislation and explore the "Charitable Gift Annuity Tuition Plan."

by: Emanuel J. Kallina, II, Esquire & Jonathan D. Ackerman, Esquire

Charitable IRA Rollover Bill

In the last week of June, several representatives from the National Committee on Planned Giving (including Craig Wruck, Government Relations Chair, Tanya Howe Johnson, Executive Director, Jeff Comfort, President-Elect, and Government Relations Committee members, Sandra Kerr and Jonathan Ackerman) met with various tax writing staff for Congressional leaders to discuss NCPG and the Charitable IRA Rollover Bill.

NCPG had taken a position in support of S. 1086 and H.R. 1311. The staffers' reception was generally very warm and they appreciated NCPG's input in the process. NCPG was pleased to have the opportunity to introduce itself and discuss its mission with Congressional leaders. Both Democrats and Republicans alike shared a commitment to charity and a general agreement that the Bill is a good one. However, the only concern, which was also shared by all, was the fiscal propriety of the Bill. Each representative expressed concern that the Bill was not revenue neutral, and in fact, would be a revenue loser. The Joint Committee on Taxation, when it considered this Bill last year, anticipated an approximately $3 billion revenue loss over the next 10 years. New numbers have not yet been forthcoming. However, considering the projected $869 billion 10-year tax cut plan by Representative Archer, $3 billion did not appear insurmountable.

After this set of meetings, the prospect for success seemed promising. However, it soon became clear that the House was not fully committed to including the original version of the Bill in its tax plan. This week, Representative Archer, Chairman of the House Ways and Means Committee, released the Financial Freedom Act of 1999. This tax proposal contains a 10% reduction in income taxes, a reduction in the capital gains tax, a repeal of the estate and gift tax regime, the charitable split dollar prohibition provision, among other things. However, the Charitable IRA Rollover Bill was not included. Many speculate that the Financial Freedom Act was politically charged and released to raise issues in the upcoming budget negotiation in the Fall. According to Representative Charles Rangel, ranking Democrat on the House Ways and Means Committee, this Act is "more a set of talking points than a real tax plan." He also predicts those proposals have "no chance of becoming law." President Clinton has vowed to veto this Bill, and Senator Roth is expected to release his own tax plan today.

BREAKING NEWS -- Senate Finance Committee Chair William V. Roth's bill, the "Taxpayer Refund Act of 1999," contains the Charitable IRA Rollover provisions as in S. 1086, except the donor must be at least 70 ½ years old at the time of the transfer either to charity directly or to a life income plan.

Craig Wruck, NCPG Government Relations Chair, states, "We are very proud of the efforts of NCPG. Hundreds of letters have flooded the offices of Congressional leaders. NCPG has certainly been noticed and will continue to work diligently for the passage of this legislation."

PG Online will keep you abreast of the outcome of these efforts.


The History

In the early 1990s, two educational institutions requested private letter rulings. These schools wanted to establish a program whereby their donors could save money for college tuition on behalf of children and grandchildren, while at the same time making a gift to the institutions. They wanted, however, a flexible Tuition Plan which did not have the restrictions inherent in many of the other tuition savings plans around the nation.

The first institution to apply for the ruling (a college) settled on a deferred gift annuity which would commence payout when the prospective student expected to enter college. For example, in a typical scenario, a grandparent might contribute $25,000 cash on behalf of a 3 year old grandchild, purchasing a deferred gift annuity which guarantees the grandchild will receive $20,000 per year for 4 years, commencing when the grandchild is projected to be entering college.

The college intended to take the money received from the sale of the gift annuity and to invest it at a rate of return high enough to fulfill its commitment to the donor, while at the same time hopefully leaving a significant residue for its own charitable purposes.

This arrangement, however, ran into some technical difficulties, because the income earned on the investment of the $25,000 would be subject to UBIT unless the gift annuity met the criteria of Code Section 514(c)(5). In fact, while the Tuition Plan was being developed and refined, Congress amended the Code in 1988 to add Code Section 501(m), which made the contributed amount (i.e., the $25,000) subject to taxation as if the college were an insurance company, unless the annuity once again fell within the scope of Code Section 514(c)(5).

The difficulty in complying with Code Section 514(c)(5) lay in the requirement that the annuity be payable over the life of one or two people in being at the time the annuity is issued. The college obviously desired to commute payments so that the annuity monies could be bunched together to pay tuition during the college years, rather than being spread out over the grandchild's lifetime.

In light of the significant tax risks, especially if the Tuition Plan were extremely successful, the college requested a private letter ruling from the Service and offered three alternative theories for not being subject to taxation under Code Sections 514(c)(5) and 501(m). See, discussion of Tax Considerations below.

The third theory was accepted by the Service, namely that a standard gift annuity, payable for the life of one or two individuals, could be issued, and the annuitant (the grandchild) could sell or exchange the annuity prior to the annuity starting date for one or more installment payouts. Apparently, the Service agreed with the college that the annuity was a property right and as such could be sold or assigned; and any prohibition upon alienation was void as against public policy.

The deferred gift annuity Tuition Plan was unique in the sense that, unlike other plans, it offered a tax deduction up front, grew on a tax-free basis and was partially non-taxable upon payout. These benefits were not lost to the IRS agent handling the matter, who apparently tried to find some reason to tax the annuities as unrelated business income, despite compliance with Code Section 514(c)(5). The agent's argument that the Tuition Plan created UBIT and was taxable under Code Section 501(m) might explain in part GCM 39826's heavy focus on this issue.

IRS Rulings

The Service has issued several Private Letter Rulings concerning a deferred gift annuity Tuition Plan: Private Letter Rulings, 9042043 issued July 24, 1990; 9108021 issued November 26, 1990 and 9527033 issued April 10, 1995. In each ruling, the Section 170(b)(1)(A)(ii) institutions intended to engage in the sale of deferred gift annuities. Under the plans, individuals would make a payment of cash or property in return for a deferred gift annuity. The purpose of the annuity was to provide funds for education and each donor would designate one recipient and one alternate recipient. The recipient was entitled to a lifetime payout but had an option to sell or assign his or her annuity to the institution or to a third party in return for a lump sum payment or installment payments over several years. It was contemplated that recipients would use the funds generated by the annuity to attend college at the particular institution. However, that was not required and the recipients could in fact use the funds for any purpose.

The Service favorably ruled that (i) income from the sale of deferred gift annuities was not subject to the tax on unrelated business income under Code Sections 511 through 513, and (ii) interest income derived from investment of annuity funds was excludable from the computation of unrelated trade of business tax under the provisions of Section 512(b)(1).

In addition, the Service has recognized the validity of a deferred college annuity plan operated by a Section 509(a)(3) supporting organization. See, Private Letter Ruling 9407008 issued November 12, 1993.

In this ruling the plan allowed donors to make a contribution to a Section 509(a)(3) organization and to receive (or have paid to a designated recipient) annuity payments that may coincide with the college age of a relative or other individual under the plan. Under the plan the recipient could assign his or her right to payments under the annuity to the Section 509(a)(3) organization or to a third party so long as the assignment was made prior to the date of the first annuity payment. Pursuant to an acceleration agreement, the recipient and/or alternate recipient could exchange the annuity for installment payments over a period of years corresponding to the years during which the participant would normally attend college.

The Service ruled favorably that (i) the sale of deferred college annuities was not considered commercial-type insurance under Code Section 501(m)(2), (ii) the income derived by the 509(a)(3) organization as a result of the sale of the deferred college annuities was not considered income from an unrelated trade or business as defined in Code Sections 511 through 513, and (iii) the income derived by the Section 509(a)(3) organization from the sale proceeds of the deferred college annuities was not considered debt-financed income within the meaning of Code Section 514.


Without attempting to analyze the various tax aspects of a generic gift annuity, it might nonetheless prove helpful to focus on some issues that are unique to the Deferred Gift Annuity Tuition Plan.

Income Tax Issues on the Purchase of the Lifetime Gift Annuity

If the grandparent in our example transfers appreciated long term capital gain property to the college in return for the deferred gift annuity, income tax issues may arise, depending upon who is the annuitant. If the grandchild, as opposed to the donor, is the annuitant, all unrecognized capital gain in the appreciated property is immediately taxable. If the donor is the annuitant on the other hand, immediate recognition of long term capital gain can be avoided and the gain will be reported over the term of the expected payout.

In addition, any unrecognized long term capital gain on a sale or exchange of an asset for a gift annuity would also be accelerated if the annuitant could later sell or swap the gift annuity to any person or entity other than the charity issuing the annuity. In GCM 39826 and Private Letter Rulings 9042043 and 9108021, the annuitant was given the right to sell the annuity to either the college or any other person or entity, in order to have the greatest amount of flexibility. This flexibility should be eliminated as an option if appreciated property is being transferred.

Income Tax Issues on the Sale or Swap of the Gift Annuity

An obvious first question concerns the tax implications of selling the lifetime annuity for a 4 year term certain annuity (in the above hypothetical). Under Code Section 72, as long as this sale or swap takes place prior to the annuity starting date, there will be no acceleration of income taxes. See, Code Section 72(e)(2)(B) and Regulation Section 1.72-11(e). Instead, the new annuity contract will have the same exclusion ratio as the old, pro-rated over the 4 year term certain.

When the lifetime annuity is sold in the future for the term certain annuity, another major issue concerns the computation of the exact amount of the annual 4-year payout. It would appear impossible for a charity to lock in today an amount that it is willing to pay in the distant future when a sale or a swap actually might take place, except by a formula which is based upon mortality and interest assumptions in existence at the time of such future sale. In fact, 15 years from today there may be other factors which the Code or the Service would require be taken into account other than mortality and interest assumptions.

Any commitment today to a 4-year payout amount which is in excess of fair market value at the time of such sale or swap could give the Service room to raise the pervasive "private inurement" argument. Further, any such commitment might even impair the current income tax deduction which is available today based upon the amount the contribution exceeds the present value of the deferred lifetime payout.

Income Tax Issues on the Payout

Upon the annuity payout of $20,000 per year during the 4 college years, the grandchild will be taxed under Code Section 72, but will be entitled to exclude from income the "investment in the contract," which will be pro-rated over the 4-year period.

However, the grandchild may be subject to the additional 10% tax of Code Section 72(q).

Gift Tax Issues

In order to determine the amount of the charitable gift (for income, gift and estate tax purposes), the Service first determines the present value of the income flow to the annuitant, based upon mortality factors, current interest rates under Code Section 7520 and the length of the deferral period until the payout. From this number, the Service subtracts the amount of the contribution to arrive at the charitable deduction amount.

If the annuitant is not the donor, then not only will a gift to charity take place, but there will be a gift to the annuitant equal to the present value of the income flow. The donor can prevent the gift from being completed by reserving in the annuity agreement the right to revoke by his or her will the income interest of the annuitant. In this event, however, upon the death of the donor the then present value of the annuity will be taxable in the estate of the donor.

It appears that, depending upon the terms of the gift annuity agreement, the income interest payable to the annuitant will qualify as a present interest. See, Regulation Section 25.2503-3(a). If this exclusion were available, then the grandparent and his or her spouse would each be entitled to a $10,000 per donee exclusion under Code Section 2503, and many gifts under the Tuition Plan would not adversely impact the donor(s)' unified credit.

Generation-Skipping Transfer Tax Issues

Depending once again on who is the annuitant, there may be generation-skipping transfer tax issues which need to be addressed. Assuming that the grandchild is the annuitant, a direct skip will occur upon the creation of the gift annuity, if the grandchild's parent is still alive. On the other hand, if a child is the primary annuitant and the grandchild is an alternate beneficiary, at the death of the child there will be a taxable termination. In either event, it is imperative that the charity is not required to pay any generation-skipping transfer tax, or no charitable tax deduction will be allowable.

Protecting the deduction can be achieved in a number of ways. First, if the grandchild is the primary annuitant and the transfer qualifies under Code Section 2642(c), the present value of the income payments may be equal to or less than the $10,000 per donee exclusion of Code Section 2503, or $20,000 for split gifts by husband and wife under Code Sections 2503 and 2513.

Second, the donor can always provide by will that his or her estate will be responsible for the payment of any such generation-skipping transfer taxes. Third, the surviving annuitant can be required under the annuity agreement to consent to the payment of such taxes prior to being entitled to any benefits under the gift annuity.

Fourth and finally, the donor can allocate his or her $1,000,000 generation-skipping transfer exemption under Code Section 2631 to the non-charitable portion of the annuity.


There are a number of benefits provided by the Tuition Plan, especially when compared to other plans. From the donor's perspective:

(1) The economic benefits are substantial. The before and after tax rate of return is good, despite having made a substantial contribution to his or her alma mater! In some other programs, such as the program offered by one bank, the benefits through a CD are pegged at 1.25% below the rate of inflation for tuition. If tuition costs rise 7.25% per year, the after tax return is really only 4%.

(2) The deferred gift annuity Tuition Plan pays a fixed benefit to the donor's grandchild -- it will not vary depending upon how well the college invests. The idea of certainty is very appealing to some donors.

(3) The donor can fund the annuity in whatever amount he or she likes, depending upon finances and the donor's own estimates as to the costs of attending college in the future. In other programs, such as the Series E savings program under Code Section 135, the taxpayer is limited to just tuition and fees.

(4) The grandchild does not have to attend a particular college, nor does he or she even have to attend an institution of higher learning. To receive the benefits of the Tuition Plan, the grandchild only need be alive. Other programs, especially those sponsored by states, require that the grandchild attend a state school, at a particular point in time or else the principal payment (in our case, $25,000) is returned, less administrative costs. Because of uncertainty in the law regarding the taxation of current income on the invested funds, Congress enacted Section 529 of the Code in 1996. This section provides the guidelines and requirements a qualified state-sponsored tuition plan ("QSTP") must adhere to in order to institute a QSTP and expands the eligible institutions the beneficiary can select. For a brief history of the QSTP with references, along with a discussion of a new type of QSTP involving programs offered in conjunction with investment companies, see The New QSTPs: Not Your Grandparents= State Tuition Plan, by A.L. Spitzer and Christopher E. Houston, The Exempt Organization Tax Review, March 1999, Vol. 23, No.3. In addition, if the Financial Freedom Act of 1999 (H.R. 2488) is passed, Code Section 529 will be amended, in part, to allow eligible educational institutions to directly create QSTPs on their own behalf, as opposed to through a state-sponsored plan.

(5) There are no administrative costs directly or indirectly assessed against the grandfather or the grandchild.

(6) The program is simple.

Some benefits of the Tuition Plan from the college's perspective include:

(1) The college has not guaranteed admission to any prospective student. Thus, it has not had to compromise any of its admissions standards, as required by some other tuition savings plans.

(2) The college benefits itself economically: (a) there is a substantial remainder which it can add to its endowment or use in other ways; and (b) if any of the annuitants actually attend the college, it has provided a source for payment of that individual's educational costs.

(3) As with any unique planned giving program, the Tuition Plan offers the development office an opportunity to improve relations with its alumni and friends, thereby opening the door for additional planned and outright gifts.

(4) The college is addressing a pressing social need in an innovative fashion to insure that children are more able financially to pay the costs of higher education and to insure at the same time its own economic survival.

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