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PUBLISHED ARTICLES REVISED SEPTEMBER 25, 1997 Wendell R. Bird* Bird & Associates, P.C. Atlanta, Georgia TABLE OF CONTENTS
A. Definition A charitable gift annuity is a gift to charity, not in trust, in exchange for a lifetime annuity, where the value of the gift is worth considerably more than the present value of the annuity so that there is a significant charitable component. The charitable component is 50% under the recommended rates of the American Council on Gift Annuities. A charitable gift annuity essentially is a bargain sale with an installment payment in the form of an annuity. This differs from a charitable remainder trust, because the annuity there is paid out of a specific trust corpus, whereas the charitable gift annuity is an unsecured claim against the charity's assets. B. Uses. 1. American Council Survey. The American Council conducted an extensive survey of charitable gift annuities in 1994. Issuers of gift annuities divided as follows:
The minimum gift annuity written was typically $5,000. The minimum age permitted was on average about 55 for immediate-payment annuities, and about 45 for deferred-payment annuities. However, the average ages were 77 for immediate-payment annuities, and 57.4 for deferred-payment annuities. The entire contribution was kept in reserve until the donor's death by 87.4% of charities in explicitly regulated states, while only the required reserve was kept and the rest was used by 8.7% of the charities. The survey's conclusion was interesting: Gift annuities are cost effective for charities. Consider the present value of an annuity:However, this conclusion does not consider any development office cost beyond an assumed 0.75% per year. 2. Valuation. The present value of a commercial gift annuity is determined "by reference to the cost of a comparable contract purchased from an insurance company." The value of the annuity is computed using an interest rate equal to 120% of the midterm applicable federal rate for the current month or one of the two prior months. However, IRS actuarial tables (IRS Pub. 1457) do not apply if the donor has a terminal illness. Special rules apply if the contributed property is appreciated or encumbered (see below). The value of the charitable contribution, which is deductible, is the difference between the contributed property and the annuity. C. Examples The following examples assume a $100,000 contribution, a 7.60% adjusted federal rate, a lifetime quarterly payout beginning in 3 months, and an annuity rate as recommended by the American Council on Gift Annuities : Example 1: Two Lives Ages 65 and 60. An annuity rate of 6.7% ($6,700 per year) yields an annuity present value of $71,825, and a gift value of $28,175. Example 2: One Life Age 65. An annuity rate of 7.2% ($7,200 per year) yields an annuity present value of $57,651, and a gift value of $42,349. Example 3: Two Lives Ages 75 and 70. An annuity rate of 7.2% ($7,200 per year) yields an annuity present value of $63,930, and a gift value of $36,070. Example 4: One Life Age 75. An annuity rate of 8.4% ($8,400 per year) yields an annuity present value of $54,994, and a gift value of $45,006. II. BENEFITS OF CHARITABLE GIFT ANNUITIES A. Advantages 1. To the Charity The benefits to the charity are: The contribution, which is equal to the difference between the value of the property contributed and the present value of the annuity, which is normally about half the property contributed. Immediate withdrawal and use, if applicable reserve requirements are met, of that difference. In fact, the charity may not promise the annuity out of the contribution, or it will be treated as a trust, which will deprive the donor of an income tax and gift tax deduction, because it is not a Section 664 trust. Simpler administration, as compared with charitable remainder trusts.2. To the Donor The benefits to the donor are the following: Life income, even if the contributed property is illiquid, to the donor or to a named beneficiary. Part of the life income is a nontaxable return of principal, and part is taxable income . A charitable deduction for the difference between the contribution and the annuity value. The charitable deduction can be taken currently by a high-income donor, even though the annuity start date may be deferred until the income is needed. Removal of the contributed property from the donor's gross estate, except to the extent the donor saves the annuity payments or gives a survivor annuity to someone other than a spouse. Note: The usual substantiation rules apply for charitable contributions. B. Disadvantages 1. To the Charity The disadvantages to the charity are the following: It must administer, or pay for administration, of the annuity.2. To the Donor The disadvantages to the donor are the following: An unsecured promise of annuity income, except to the extent reserve requirements exist and are met and are not subject to the charity's creditors.C. Options Because charitable gift annuities are privately negotiated, the following options are selected: Annuity payout percentageIII.DEVELOPMENTS INVOLVING CHARITABLE GIFT ANNUITIES A. Texas Case A lawsuit was brought against the Lutheran Foundation, the American Council on Gift Annuities, and about 1900 charities using its suggested rates, alleging that the defendants violated federal and state antitrust laws by price fixing, violated federal and state securities laws by selling unregistered securities, violated state insurance law by selling commercial annuities without insurance company registration, and violated state banking law by acting as a trustee without bank trust department powers. The American Council and other defendants pointed out that the annuities were not commercial annuities because their payouts were much lower, because of the charitable component, and were instead bargain sales. The American Council's suggested rates were based on a 50% annuity present value and a 50% residual to charity, and were contained in three tables (single-life, joint-and-survivor, and deferred annuities). The U.S. District Court granted partial summary judgment against the charitable gift annuity issuers under Texas insurance law, holding that the issuers violated Texas insurance law by selling annuities without insurance law compliance and also violated Texas trust law: The Court, therefore, declares as a matter of law that (1) the Foundation's sale of annuities and charging of annuity management fees to Ms. Peter constitutes the unauthorized business of insurance under the Texas Insurance Code; and (2) that the Foundation illegally accepted and exercised the office of trustee of Plaintiffs' Texas trusts in violation of Texas law.Ozee v. American Council on Gift Annuities, 888 F. Supp. 1318, 1328 (N.D. Tex. 1995). That decision prompted many states to enact exemption or permit statutes that reduced general insurance requirements for charitable gift annuities. The District Court then refused a motion to dismiss that was based on the Charitable Gift Annuity Antitrust Relief Act of 1995. 943 F. Supp. 685 (N.D. Tex. 1996). The U.S. Court of Appeals for the Fifth Circuit refused, on petition for mandamus, to reverse that decision. Ozee v. American Council on Gift Annuities, ___F.3d___ , 1997 WL 169400 (5th Cir. 1997). In fact, the Court of Appeals sanctioned the charities' counsel $15,000, saying that they should have brought a certified appeal (before final judgment) or a direct appeal (after final judgment), rather than a petition for mandamus. The appellate decision prompted Congress to pass, unanimously in both houses, The Charitable Donation Antitrust Immunity Act of 1997. After that decision, the American Council is again asking the U.S. District Court to dismiss the case. The case is now styled Richie v. American Council on Gift Annuities. The District Court earlier did deny class action status to the suit. The court also denied the American Council's motion to dismiss, which was based on the exemptions created by two federal laws passed in late 1995, on September 30, 1996. B. Philanthropy Protection Act This Act creates an exemption from many federal securities laws except antifraud provisions for charities writing gift annuities, pooled income funds, charitable remainder trusts, and charitable lead trusts, and consolidating the funds for investment purposes. The exemption extends to the Securities Act of 1933 and the Securities Exchange Act of 1934 (regulating disclosure and registration of securities), and the Investment Company Act of 1940 (regulating funds). The exemption from broker-dealer registration applies only to employees or volunteers soliciting charitable gift annuities, who do not receive any special compensation based on the volume or value of annuities. The Act also creates an exemption from most state securities laws except antifraud provisions, so long as the respective states do not affirmatively pass laws to the contrary within the next three years (through December 8, 1998). The Act provides that compliance with its provisions may be used as a defense in all administrative and judicial actions pending on or commenced after the date of enactment (December 8, 1995). 109 Stat. 685 (1995). The Act also requires charities to provide to each donor to a fund, at the time of the donation, written information describing "the material terms of the operation of such fund." That requirement is undefined. A 90 day grace period (to March 7, 1996) applied to allow disclosure for a time after the donation. There is some dispute whether disclosures must be made for annuities issued before December 8, 1995. C. Charitable Gift Annuity Antitrust Relief Act of 1995 This Act provides that it is not a federal antitrust violation for charities to use a uniform annuity rate when issuing charitable gift annuities qualifying under Code § 501(m)(5). It also provides that it is not a state antitrust violation under similar laws, unless the respective state affirmatively acts within three years to make it an antitrust violation. The Act was also retroactive to pending lawsuits. 15 U.S.C. § 37, 109 Stat. 687 (1995). The suggested annuity rates of the American Council on Gift Annuities are indeed designed to reduce annuity rates and avoid charity competition. The Council was formed to end annuity rate competition among charities, and to foster charitable giving with prudent annuity rates. These two federal laws do not address the treatment of charitable gift annuities as insurance under state law. About three-quarters of the states actively or potentially treat charitable gift annuities as insurance, which may not be offered in the state without registration as an insurance company and as insurance agents. The remaining quarter of the states offer exemptions that require application, or in some cases, that are automatic. D. Charitable Donation Antitrust Immunity Act of 1997 This recent law amends the 1995, to add to the antitrust exemption for Section 501(c)(3) organizations using common or recommended annuity rates, to say that charitable gift annuities and charitable remainder trusts are exempt from antitrust laws. The 1997 law also makes issuers of charitable gift annuities and charitable remainder trusts immune from suit under antitrust laws. The new law was passed unanimously. 15 U.S.C. § 37, 111 Stat. 241 (1995). *Senior attorney at Bird & Associates, P.C., graduate of Yale Law School, co-chair of American Bar Association Subcommittee on Charitable Contributions and Trusts. Copyright 1997 W.R.Bird. All Rights Reserved. Back to index of published articles. |
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