WSJ article: GETTING PERSONAL: IRA Charitable Rollover Comes With Risks

For those who don't have subscriptions to the WSJ, here is the article mentioned in my previous post:

* DECEMBER 29, 2009, 2:44 P.M. ET

GETTING PERSONAL: IRA Charitable Rollover Comes With Risks

By Shelly Banjo
A DOW JONES NEWSWIRES COLUMN


NEW YORK (Dow Jones)--Donors who have tapped their individual retirement accounts for charitable donations under a popular temporary tax break may be in for a surprise come tax season.

In some states, distributions from a charitable IRA rollover may not be tax-free, as many charities have indicated in their promotional materials.

While these distributions escape federal taxes, they may be subject to income tax by states that don't allow charitable deductions and count IRA distributions as taxable income. Other states are facing delays in incorporating federal tax rules into state law.

In New Jersey, where taxpayers with an income between $500,000 and $1 million face a 10.25% rate, donors may pay more than $10,000 in state taxes for a $100,000 charitable IRA rollover. Donors who don't factor in extra income from an IRA distribution may mistakenly be bumped into a higher tax bracket.

Pushing for Congress to extend the IRA-giving provision, financial advisers and charities laud the extra tax break for generating an extra $140 million for charity since it was enacted in 2006.

Taxpayers ages 70 1/2 and older are typically required to make annual distributions from their retirement accounts (though distributions for 2009 were suspended). The distributions are included in their federal adjusted gross income and are taxed as such. The charitable IRA rollover lets taxpayers make donations directly to charitable organizations from their IRAs without counting them as income and paying federal taxes on them.

State taxes are a different story, says Eric Abramson, an estate and charitable planning adviser in Paramus, N.J.

"There can be a cost on the state income-tax level, and for a large gift it could mean a substantial income-tax hit. It's important to bring this to the client's attention and make sure the cost is quantified and handled appropriately," he says.

Overlooking state taxes could have wider implications for national charities such as the American Red Cross or United Way, where donations are already suffering from the strained economy.

"The last thing nonprofits need is to face the wrath of an angry donor who wasn't informed," says Jonathan Gudema, a planned giving consultant with Changing Our World Inc., a fund-raising and philanthropy consulting firm.

Many organizations, including The College of New Jersey and Overlook Hospital Foundation in Summit, N.J., state clearly in marketing materials that benefits apply only at the federal level.

"We find many of our donors are willing to pay the small price that this might increase their income taxes to reduce the assets held in a retirement plan," says Kenneth Cole, senior director at Overlook. "In some cases, IRA assets are the only funds they have to make a charitable gift."

Other charities have steered clear of handing out financial advice altogether.

"Legally and ethically we can't put ourselves in the position to dispense financial advice," says Ted Mills, associate director of gift planning at Princeton University. "We tell our donors twice or even three times to review any important decisions with financial advisers."

(Shelly Banjo is a Practice Management and Getting Personal columnist who writes about wealth management and philanthropy; she covers topics including the business of financial advisers, investment strategies and charitable giving. She can be reached at 212-416-2242 or by email at shelly.banjo@dowjones.com.)

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Planned Giving in the news - WSJ reports on NJ Taxing of IRA Charitable Rollover Gifts

I am feeling a bit like the grinch.

I totally missed this issue of New Jersey taxing IRA charitable rollover gifts for 4 years. Then I hear a top attorney mention it in passing, put it on my blog, a conversation with a nice WSJ reporter (thanks for the quote!).... My guess is that there will be people paying taxes that might have just been overlooked - now that the Wall Street Journal reported on it.

Here is the WSJ story:

http://online.wsj.com/article/BT-CO-20091229-706347.html?mg=com-wsj

Just to understand this issue, a NJ accountant confirmed for me that NJ does not defined adjusted gross income (AGI) in the same way the IRS does (Most states do follow the IRS in this regard). And, yes, NJ requires you to add any IRA withdrawals (qualified IRA charitable rollovers or not) to your NJ AGI. NJ state income taxes range from the 5% to 6% for medium to semi-high income earners. 8% to over 10% to higher earners ($150,000 to $500,000 and up).

So we are talking about real dollars out of donor's pockets. The one NJ charity I asked about this (who did promote it but carefully stated that it only avoided federal income tax) said they informed everyone and they had not problems.

I hope that's true - now that the cat is out of the bag. What I mean is that this quirk in New Jersey's tax law, which for all I know could be unique among the states, was relatively unknown. Maybe your accountant would have been aware of it but why would you need to tell him (all accountants are men, right?)? And, if there is not an automatic reporting mechanism from IRA custodians to NJ tax authorities (like there is to the IRS), how would anyone in the NJ taxing authority know to go after the tax if not voluntarily reported.

What I am getting at is that this quirk was ripe for everyone to ignore and not pay any state income tax on IRA charitable rollovers. If was an unknowing donor of such a gift, knowing that I get no new charitable deduction, I wouldn't bother telling my accountant.

But now, me, the grinch, stirs up the pot, the WSJ picks up the story, and now accountants in NJ will be on the look out for these "gifts" to add them to your NJ AGI.

Or maybe not.

Happy holidays!

New York Times - Great Editorial on Estate Tax Shenanigans

When I read an article or opt ed piece and I agree with every word, it deserves a post:

http://www.nytimes.com/2009/12/28/opinion/28mon1.html

This one is right on point about the impending estate tax repeal in 2010 and the political process. Nothing further needs to be said.

Planned Giving Articles - Et tu, New York Times?

I better start reading the New York Times because I am almost missed this one by about two months.

The link is below but here is my introduction:

It's about the National Heritage Foundation (NHF) bankruptcy situation. The article starts out bemoaning the fact that NHF had to take $25 million of its Donor Advised Fund (DAF) money to settle with its 107 gift annuitants. Then the article moves into a loose discussion about gift annuities. Check it out if it interests you but please see my after-article comments below

http://www.nytimes.com/2009/11/12/giving/12FUND.html?_r=1&scp=1&sq=national%20heritage%20foundation%20gift%20annuities&st=cse

I was asked by a friend today about a line in this article that made a board member nervous.

I am going to try and keep my comments ask kind as possible. The article's beginning leaves out one crucial legal fact: DAF money is considered from a legal point of view to be TOTALLY and COMPLETELY UNRESTRICTED. That's the deal - sorry DAF donors. If the charity runs into financial trouble (like NHF did), DAF money is TOTALLY AND COMPLETELY AVAILABLE. Period. If the DAF donor doesn't like it, then start a private foundation.

That is why the legal cases of most of NHF's DAF donors were thrown out of court. It doesn't excuse any fraud committed by NHF in obtaining those donations.

Secondly, my problem with this article is that it seems to be pitting DAFs as the good guy and CGAs (gift annuities) as the bad guy. Or maybe not. I actually know the author, and I think she is a great writer, but something tells me that the editors messed this one up. I really couldn't respond to the question I received this morning because I had no idea where the article was going.

Third point - this is a quote from the article:

Faced with shrunken endowments, charities are seeking to bolster giving by heavily marketing gift annuities, emphasizing the income stream they offer.

The article offers no proof of this statement and if you asked me, I would say the opposite. I think charities have slowed their CGA marketing out of fear of the liabilities they are dealing with. Getting new annuities is actually a good idea for a basically healthy program but it has nothing to do with NHF or the initial part of the story.

There was an interesting story there - it just never came out. It is interesting to note that DAF money was used to pay off CGA donors of a charity going into bankruptcy. What was also interesting was the fact the CGA donor mentioned actually received back $131,239 from his initial CGA gifts of $235,000.

Considering what Madoff investors, as well as other ponzi scheme investors, will receive, I think the NHF CGA donors did pretty well. I am guessing that this donor got to keep his initial charitable deductions. He was barely out of pocket if you think about it. The story should have been how CGA donors had a right to receive something in the bankruptcy - and obviously were in a decent place in the line.

Something about the whole article bothers me - is it only me? Isn't there lack of focus? No wonder a board member is pulling a quote from the piece to cause some trouble. It took me a few minutes to figure out what it was talking about.

Holiday Greetings - December 31, 2009

With all of the focus on health care, Congress will apparently let the estate tax lapse.

They also let the standard end of year tax extender fall off the radar, too. There goes the IRA charitable rollover, for now.

Oh well.

RE: the estate tax. Some victory against the death tax. What the idiots crying about the so-called death tax never say is this:

#1 - in 2010, estates will start paying capital gains tax on capital gains over $1.3 million (we had an unlimited step-up in basis at death until now). Who knows, maybe this will generate more money for the government than the dreaded death tax (at least it will tax less wealthier decedents). The government tried taxing capital gains at death in 1976, apparently it was a disaster from record a keeping point of view and was quickly repealed. The big problem is determine the basis (ie..the starting point for starting the cap gains tax on so-called profits). The rule is that if you can't determine the basis, you are supposed to assume a zero basis (ie...apply the tax to 100% of the value of the asset).

#2 - Impact on charitable bequests: Most charities receive their bequests these days from non-estate tax paying estates (ie..estates under the $3.5 million exemption). Sounds like the repeal of the estate tax won't affect charitable bequests. The only problem I see is that when you break down the estate tax filing numbers reported by the IRS, you find a very high percentage of annual bequest dollars coming from the larger, higher estate taxed estates. My theory: the $5 million+ estates do use attorneys in efforts to avoid estate tax; a lot of lawyers might advise their clients to not bother with their charitable bequests without the incentive to avoid estate taxes (at least for 2010). It will be interesting to see if there is an impact or not on the overall numbers for U.S. bequests.

#3 - At the rate Congress moves on this issue, January 1, 2011 will be here quicker than you think. Probably without an adjustment to the estate tax laws, and the law will revert back to 2001 law: $1 million exemption and highest bracket of 55%. In other words, with inaction, Congress will bring us back to the good old days where my dad might start worrying about estate taxes again. Not so bad for charities if you ask me - might fuel another growth period in planned giving.

I guess we are headed for bedlam in estate tax issues for a year or more.

To think I was able to write this while my 4 kids are all over me is a mystery! Please forgive the typos and enjoy the holiday break.

Jonathan

Planned Giving Legal Tidbits - Bequest Pledges

This post is one that I've been itching to write since last week. Please read it carefully and think it over (even if you are not a New York fundraiser - these discussions are always relevant and they at least give you something to ask counsel in your own state)

I mentioned in the previous Legal Tidbits post that pledge agreements in New York that involve naming recognition are legally enforceable, binding commitments. Technically binding out of one's estate, too. And, naming recognition would include a named scholarship in addition to an actual name on a plaque somewhere.

The follow-up question I had as a direct result of hearing this info is what about bequest pledges where the naming only takes place upon the receipt of the pledged funds at death?

Surprisingly, top notch counsel said that case law in New York supported what he termed a contract to make a will as also being a binding obligation upon the parties (namely the estate to pay the pledge).

In legal terms, we are looking for consideration (more simply understood as value exchanged) in a contract context. New York courts not only agree that receiving a named honor in exchange for a pledged gift is consideration to create a binding contract, but the courts agree that a pledge to include a charity in your will that creates an agreed upon naming honor when the bequest matures (gotta love planned giving talk) is also a binding agreement (albeit contingent on both sides fulfilling their promises).

What I am getting at is that in New York, a pledge agreement whereby the donor agrees in writing to include a charity in his or her estate plan in some form or another to receive a naming honor at the time funds reach the charity is ENFORCEABLE as a binding pledge (whether you are included in the estate documents or not).

Long sentences, I know, but you have to say wow.

Sign on the dotted line and it's a gift? One of my clients - closing this fall alone over $5 million of these - said they didn't plan to actually list these commitments on their books. Funny thing - from both the accounting and legal points of view, they should be on the books.

OK, I would advocate some substantiation - like are we really in the will or does this donor really have these assets or is there an estate fight brewing. I would keep these for older donors generally. But, they are not only good planned gifts, but they are bookable (at least at present value).

Stay tuned for part 2 about bequest pledges entitled Don't try these at home. Just a word of caution before you go out and have hundreds of folks sign up.

Planned Giving Legal Tidbits - Pledges and State Tax Implications for IRA Rollover Gifts

I just returned from the annual planned giving quiz given by one of my favorite planned giving lawyer/guru in the field (He doesn't use the internet so I'll leave his name out but it should be pretty easy to figure out).

I learned two ideas - really important ones.

1. New Jersey will tax your New Jersey donors for making IRA charitable rollover gifts! Income tax, that is, on the IRA withdrawal.

That's what I heard. It's really too late to do anything about it if you have been encouraging donors from this state. It has to do with the fact that New Jersey doesn't offer a charitable income tax deduction... New York and Connecticut are fine.

I am wondering if there is a mechanism for New Jersey tax authorities to be notified when someone makes an IRA rollover gift?

My suggestion: cross your fingers regarding the past; confirm for the future (if it gets extended again) and put a caveat on all of your marketing materials that mention this option (especially if you are a NJ charity or have a lot of NJ prospects).

2. My favorite planned gift this year is the irrevocable bequest pledge. Why? Well, let's say that with life income gift business down, I can still look to many millions of closed gifts with these arrangement this past year.

Yes, the person sitting to my right today was from an Ivy League school which has a policy to do no binding pledges - fine if you are in the Ivy League. And, yes, they are tricky - and quite often very problematic when they mature.

Here is what I learned: in New York, all "naming pledges" are legally binding, including named scholarships. That might seem like an obvious point but hearing it from a top attorney puts it on another level for me. You don't need particularly special language - just something in writing where the charity says that it will name something in exchange for this gift.

Of course, the repercussions of this point can be negative. The problem that occurs is when a donor agrees to give the money for some naming opportunity, most often no one has the chutzpah to ask about the source of those funds. Technically, once the pledge is made, the donor (in theory) can't have his or her private foundation pay off that pledge.

The other long standing issue with all pledges, particularly one's that are likely to be fulfilled from someone's estate, is their enforceability. It's a nightmare if you are not actually named in the estate.

A topic for future posts.

Underwater Endowments Training in New York

I have to admit that I am a bit of a cynic when it comes to educational programs. Usually, the speakers are going over things I know already and frankly, I am part of the ADD generation with about a 3 second attention span.

So, when I got ready to attend the NYC bar's 3hr presentation on Underwater Endowments (held last week), I packed plenty of snacks and extra reading material.

I've written on the topic, organized several presentations on it. What else can I learn except: when is New York going to pass UPMIFA!?!

I was wrong. I am going to use this opportunity to list some very important facts that I picked up (please go to previous posts on UPMIFA for background). All of these points are specific to New York (especially since New York still maintains the old UMIFA) but I still recommend that non-New Yorkers look over these tidbits because they are definitely food for thought.

1. When does an organization have an affirmative duty to literally restore an underwater endowment to its historic gift value (ie..put real money into the endowment account)?

I used to think this was an accounting canard. Wrong I was - at least partially. In New York, the AG says that if a permanent endowment goes below its historic gift value due to application of the org's spending-rate policy, then it does have an affirmative duty to replenish the endowment! On the flip side, if you can attribute the drop to market depreciation, you don't have an affirmative duty.

Wait a second. This doesn't make sense. You apply your spending rate, there is nothing wrong with that when you are not underwater. Then the market tanks and the fund goes negative. When is it the fault of the spending rate and not the market? A question I should have asked. It seems that the AG takes the position that if the market appreciation generally lagged behind the spending rate, the board should have adjusted the spending rate down to prevent the fund from going underwater. In other words, it's pretty murky in New York when to blame the spending rate vs. the market decline.

Advice for all boards (in UMIFA or UPMIFA states): watch the funds, know the original funding amounts of each fund, be aware of long term goals of each fund, spend less to extend life of fund of each fund when need be.

2. Have you ever had auditors or accountants claiming that you have bring back the permanent endowments to their historical gift value on your financials (aside from the NY AG's approach mentioned about but from an accounting point of view)? To me, this was part of the accountant's canard mentioned above. It turns out that there is some truth to this (and this may or may not apply to apply to UPMIFA states, too).

The accounting principals require that on your books, any underwater permanent endowments must make up the deficit from other assets on your books (ie..unrestricted assets).

Practically, this does not mean transferring funds from unrestricted accounts to the permanent endowment accounts. It means that the books have to allocate unrestricted assets towards the negative balances, all on paper though.

So if its only on paper, what's the big deal? The big deal is that underwater endowments drag down your bottom line net assets which might violate debt covenants (agreements with lenders to ensure that the organization maintains a certain level of assets).

Two solutions to this problem are: 1. try to make sure debt covenants are drafted to exclude the negative impact of underwater endowments; and 2. your financials should show negative underwater balances as separate and explained items.

3. I know New York is peculiar but the current proposed form of UPMIFA is a real doozy. There was some excitement that NY might include a presumption that greater than 7% spending rates are presumed to be imprudent. Not such a big deal to me but charities should rather do without it (still, my advice is to take the new law regardless of this provision).

The doozy though (for the proposed NY version) is a 90 day check the box provision. What's this??? UPMIFA, if passed as currently proposed in NY, would require all charities with living permanent endowment donors to send a letter to those donors giving the donors 90 days to decide whether the donor wants his or her fund to follow UPMIFA or to stay with the old UMIFA law. Actually, the wording is really screwy and assuming the law requires charities to use the law's language in the letter, it will give donors the impression that their choice is between the charity spending their entire fund (new law) vs. maintaining their fund (old law). Yikes for New York charities.

4. Incorporating in Delaware (or wherever) may actually help avoid NY's insane laws regarding endowments. When I heard this, I made them repeat it. According to the big shot attorneys on the panel at the bar conference, for these purposes only, the state of incorporation would control. This is a good question for your general counsel but some New York charities may already be off the hook in this area if they were incorporated in other states.

5. NY's proposed law, and included in other state versions, has an escape clause for older, smaller endowments. The uniform version of UPMIFA included a provision for less than $25,000 and older than 20 years permanent funds. It permits charities upon notice to their AG (90 days to protest) to release or modify restrictions if the purposes are unlawful, impracticable, impossible or wasteful. NY's version increased this old endowment escape clause to $250,000! I know NJ included a $250,000 version of this clause, too! NY's proposed version requires notice to living donors - not sure if this applies to other state versions.

I would say that if this law gets passed in NY, and certainly the 42 other state that have passed a form of UPMIFA, it would be time to clean up all of those old, out dated endowments.

For non-New Yorkers, check your UPMIFA (if you have it).