Charitable planned giving is often described as "donor-centered.' In contrast with the annual campaigns conducted by most charitable organizations, which are by nature designed by meet the needs of the institutions, fund raising through planned giving concerns itself with the needs of individual donors. Needs may vary, from estate planning to sheltering income, but in all cases, the donor's situation is paramount.

Since the codification of charitable remainder trusts in 1969, professional advisors have viewed them as a relatively simple means of fulfilling a donor's philanthropic wishes while at the same time providing tax, estate and financial benefits. As time has passed, the use of these instruments has grown more sophisticated. Now, with charitable giving one of the few remaining methods of tax reduction, advisors are increasingly being asked for innovative solutions to their clients' tax and estate planning needs. This article will demonstrate how, by giving property away through a carefully designed philanthropic plan, it is possible for a donor to improve his or her financial situation.

In the current climate of economic uncertainty and low interest rates, charitable remainder trusts remain an excellent way to increase the return on low-yielding assets. With the proper investment strategy, it is possible to achieve a dramatic increase in the income from property with low returns.

Alice's Stock
Assume that Alice, age 70, acquired stock in XYZ Inc. in 1960 for $1000. Today, that stock is worth $10,000, but is yielding only $300 a year, or 3%. If Alice were to sell the stock in order to reinvest the proceeds at a higher rate of return, she would realize long-term capital gain of $9000. Taxed at a rate of 28%, Alice would be left with only $7480 of her $10,000 proceeds to invest. At, let us say, an 8% rate of return on her net proceeds of $7480, Alice would receive $598 a year. This represents a return of less than 6% on Alice's $10,000 worth of stock.

However, if she were to establish a charitable remainder annuity trust at a fixed rate of 8% funded with the XYZ Inc. stock, the trustee would he able to invest the entire $10,000 of proceeds from the sale of the stock, because neither Alice nor the trust, as a tax-exempt entity, is subject to tax on the capital gain. Alice would receive $800 annually for life.

By creating the trust she has almost tripled her income from the 3% return the stock had been yielding. Had she not created the trust, Alice would have had to invest the $7480 remainder after payment of income tax on the capital gain to return almost 11% in order to receive $800 annually.

In addition to her increased income, Alice has generated a current income tax charitable deduction based on the full fair market value of the stock. Considering her age and life expectancy and the annuity rate of 8% using IRS tables, Alice's tax deduction is calculated to be approximately $4250. This represents the present value of the gift of the remainder interest to the charity which will receive the principal upon Alice's death.

If Alice has combined income tax brackets of 40% in the year she establishes this trust, her cash savings would be $1700 (i.e., $4250 times 40%). Thus, the actual cost to Alice of making the gift to the trust is $8300, ($10,000 less $1700) and her effective rate of return is 9.6% ($800 divided by $8300).

Alice has also removed from her estate an asset that might have been taxed at a rate as high as 55% for federal estate tax purposes alone. Should she wish to pass an equivalent asset to the heirs who might otherwise have received it, Alice can use the cash generated by the tax savings resulting from the income tax charitable deduction to replace the asset, through the purchase of life insurance, zero coupon bonds or other current or deferred investment instruments. If this purchase is properly structured (through a life insurance trust or otherwise), the asset will pass to Alice's heirs free of estate taxes. in appropriate situations, a donor like Alice can actually pass on to their heirs an asset of greater value than that used to fund the trust, through the leveraging effect of life insurance.

What Alice has accomplished is the following: 1) obtained higher income for life on a low-yielding asset; 2) realized a significant income tax deduction; 3) paid no income tax on the capital gain; 4) removed the asset from her estate; and 5) replaced the asset for her heirs, free of any estate tax. Alice has also, through the gift of the charitable remainder interest in the trust, helped her favorite charity to plan for its future. It is clear that Alice has, through an irrevocable charitable gift, put herself in a better financial position than she would have been in had she sold the XYZ stock and reinvested the proceeds herself while making a significant charitable gift.

Appreciated Property
Alice has improved her economic situation through the relatively straightforward means of a simple charitable remainder trust. It is possible, however, to be more creative and, by using the same basic vehicle, tailor it to meet the differing needs of a variety of donors and donee organizations.

Imagine a situation similar to Alice's: A major donor owns low-yielding, highly appreciated property. Now add to that situation a charity that has embarked on a capital campaign to construct a new school building. A charitable remainder trust can be established with the appreciated property, as outlined above, for the ultimate benefit of the charity. The trustee, then sells the property at fair market value, but, instead of investing the proceeds, lends them to the charitable remainderman, who executes a mortgage in favor of the trust secured by the real property under construction. The interest on the loan is set at a rate equal to the annuity rate and the debt service flows through the trust as the annuity payment.

The charity has obtained immediate use of the proceeds for its capital campaign without waiting for the expiration of the intervening life interests; the trust asset is a nonamortizing mortgage with a clearly defined cash flow; and the donor has converted his or her low-yielding asset into an enhanced life-long income stream. The donor has generated an income tax charitable deduction; has not incurred any tax liability for realized capital gain on the transfer or subsequent sale; and, as Alice did, has removed the asset from their estate and may replace its value for their heirs.

For the donee organization conducting a capital campaign, this transaction is a real boon. It obtains current use of funds from a major donor while guaranteeing to the donor an increased yield on their assets for the rest of their life. If this transaction were to occur in an annual campaign setting, the loan that has become the trust asset would be unsecured and might be considered an imprudent investment by the trustee. It is particularly appropriate for a capital campaign, however, because the loan is secured by a mortgage on the real property under construction. In this form of plan, one should take careful note of state law and he certain that the trust instrument is drafted to permit the trustee to make this form of loan.

Vacation Homes
Many donors today have a second residence that they use for only several months each year. The alert planner will recognize that this situation presents a golden opportunity for a charitable gift.

Assume that John and Mary have a condominium in Arizona in which they typically spend three months in the winter. For the rest of the year the apartment is vacant. John and Mary can make an irrevocable gift of an undivided three-fourth interest in the residence (representing the nine months of the year that they do not use their condominium) to their favorite charity. This gift of a partial interest in their residence will generate a current income tax charitable deduction for John and Mary equal to three-fourths of the fair market value of the apartment. If the condominium has a fair market value of $400,000, the deduction for the contribution of a three-fourth fractional interest is $300,000. If John and Mary at some point decide to spend their winters in Hawaii instead of Arizona, they can make a gift of the remaining one-quarter interest in the residence and receive a deduction equal to one- fourth of the value of the apartment, which may have appreciated since the date of their initial gift.

John and Mary may also have a valuable primary residence in which they intend to continue living. It is possible to structure a plan that will enable them to stay in their home and at the same time provide financial benefits to them and, ultimately, to a qualified charity. John and Mary can make an irrevocable gift of their home by deed to charity X while reserving a life estate which will run for both their lives.

While the charity would then own the house, John and Mary would be able to live in the house, as they intended, for the rest of their joint lives. The property is removed from John and Mary's estate and is, therefore, not subject to estate taxes. There is, in addition, no liability for income tax on any capital gain realized on the transfer to the charity.

If John and Mary are ages 80 and 77, respectively, and their home has a fair market value of $500,000, they would receive a current income tax charitable deduction of approximately $161,000 (derived from a calculation which depends upon an allocation of values to land, building and other depreciation factors), representing the present value of the remainder interest to charity X.

Assuming John and Mary are in a combined income tax bracket of 40% in the year the property is transferred to the charity, this deduction will generate more than $64,000 in actual tax savings for them.

Merging Interests
John and Mary's agreement with charity X may also reserve to them the right to relinquish their life estate at any time, either voluntarily or involuntarily. They may decide to move to a retirement residence, or they may be forced by circumstances to enter a nursing home. Should they elect voluntarily to leave their home at some point, their life estate would merge with the charity's remainder interest and the charity would have full title to the property. John and Mary's agreement with charity X would further obligate the charity to sell the property at no less than its then appraised fair market value within a period of time specified in the agreement and to pay to them a joint lifetime annuity of, say 8% of the net proceeds realized from the sale.

In this example, if the value of the house has appreciated to $600,000 by the time John and Mary vacate it, charity X might realize $550,000 on the sale, net of commissions and expenses. John and Mary's annuity, payable annually until the survivor of them dies, would be $44,000, or 8% of the sale proceeds. This increased income could be used by John and Mary for their retirement needs or to pay for the costs of nursing home or medical care.

In all of the transactions discussed above, regardless of their level of complexity, donors should be urged to consult with their legal or financial advisors. This leads to the question of the extent to which charitable organizations should go in providing these professional services to donors or referring donors to lawyers or other professionals. Charities ought not to represent donors in charitable planned-giving transactions. Furthermore, in order to avoid even the appearance of a conflict of interest, charities must be careful when referring prospective donors to particular professionals with ties to the organization.

Details of the advisor-client relationship should be worked out between them, independent of the charity. Questions of fees, scope of representation or other factors should not be addressed by the charity.

[These days) donors increasingly want not only a voice in how their contributions are used, but also tangible value from their gifts. Whether that value is an increased life income stream, one's name on a building or the right to remain in one's residence with a concurrent annuity for life, charities should be alert to the various cues given by their prospects and be prepared to tailor a plan that suits each donor's circumstances. This article has shown how it is possible for donors to improve their economic situations by several methods of charitable giving. It is up to the planned-giving professionals and donor advisors to see to it that donors get the word.

excerpted from "The Future of Fund Raising"
by Neil Myerberg and Charles Goldman
© 1993 Fund Raising Management magazine

Formerly an attorney for the Internal Revenue Service, specializing in estate and gift taxation, Neal Myerberg is currently CEO of the department of planning giving and endowments at UJA-Federation.

Noted author and lecturer on the subject of charitable planned giving, Chuck Goldman is associate executive director of the departnent of planning giving and endowments of UJA-Federation.