By: Irwin Scherago ischerago@mlg.com

With lightning speed another year has ended and we are one month into 1995. While it is early in the year, it is never too early to properly plan your gift giving program to your family and to charitable organizations.

Size of Gifts To Family and Friends

A taxpayer may make as many $10,000 gifts to as many donees (family or friends) as he or she can afford and there will be no requirement of filing a gift tax return. This $10,000 amount is known as the annual exclusion.

If a husband and wife join together, they can make gifts of up to $20,000 to as many donees as the pocketbook will permit.

There is no limit to the number of annual exclusionary gifts which can be made by one donor. If a donor has four (4) children and fourteen (14) grandchildren, the donor can make gift of $180,000 and, if the donor's wife joins in, $360,000. The annual exclusion gift can be a very powerful estate reducer, followed systematically over a period of years and even a "one-time-shot" on the eve of death.

Once an individual donor makes a gift to a single donee in excess of $10,000, the donor will be using up his or her once-in-a-lifetime Federal Exemption Equivalent of $600,000. This amount, as we know, is derived from the Federal Unified Credit against estate and gift taxes of $192,800.

Annual Exclusion Gifts Must Be Gifts of Present Interests

For a gift to qualify for the gift tax annual exclusion, it must be a gift of a present interest. A gift of a present interest is one that the donee-recipient-beneficiary can enjoy immediately.

Gifts in Trust Do Not Qualify For Annual Exclusion

Often, a parent, aunt or uncle wishes to make a gift to a child, niece or nephew but does not wish the donee/beneficiary to immediately have possession of the property. This is quite usual when the gift is to a minor (under the age of 18) or even a young adult in the 20 to 30 year range who has not proved his or her money handling abilities. The elder generation donor will seek to use a trust as the vehicle of transfer and, unless the proper language is used in the trust, the trust will not qualify for the annual, $10,000, gift tax exclusion.

Little People, Little Gifts Making Gifts to Minors and Young Adults

The simplest way to make a gift to a minor that will qualify for the annual gift tax exclusion is by using the New York (Conn, N.J., etc.) Uniform Gifts to Minors Act ("UGMA").

The UGMA account is created by the Donor (parent, grandparent, aunt, uncle, etc.) setting up a bank account or stock brokerage account for the minor.

Title of the Account. "Joe Glutz, custodian for Jenny Glutz, under the NYUGMA"

What Assets My Be Held By an UGMA? Stocks, bonds, life insurance policies, annuity contracts, a limited partnership interest, money, real estate, and an interest in art or antiques [Sec 7-4.2 of the New York Estates, Powers and Trusts Law ("EPTL")] may all be held in a UGMA.

No matter the nature of the gift, the property must be delivered to (if it is tangible art), or registered in the name of, the custodians.

Who is Taxed on the Income of the UGMA?

(a) The minor beneficiary's name and social security number is given to the institution and the minor will be taxed on the income.

(b) The Parent-Custodian will be taxed on the income to the extent it is used to discharge a parental obligation of support.

(i) Buying a minor's clothing is a permitted use, but also a parental obligation and as such is taxable to the parent.

(ii) Buying a minor's "sunfish" is a permitted use, but not a parental obligation and as such is taxable to the minor.

(iii) Paying a beneficiary's college tuition is a permitted use and is taxable to the parent if it is the custom and standard of the class that the parents pay for college. Avoid any question of to whom the income will be taxed by cutting the check directly to the beneficiary and let the beneficiary pay the college tuition.

When Must Custodianship Terminate?

In New York State, the custodianship must terminate at either age 18 or 21 and the donor has the choice when creating the account [EPTL Section 7-4.4(d) and 7-4.11].

Death of Grantor/Custodian.

If the Grantor/Creator of the UGMA is also the custodian, the value of the UGMA account will be included in the Grantor/Custodian's Gross Estate under Section 2038 of the Internal Revenue Code.

Reason. The Custodian has the right to determine when a beneficiary will enjoy the property. The custodian need not make any distributions until the termination date or the donor can distribute the UGMA assets for the benefit of the beneficiary at any time prior to the termination date. The power of acceleration or deferment is a power to determine not only when the account may be enjoyed, but, if a minor beneficiary dies before termination, who will enjoy the asset. [See Rev Rul, 57-366 and Rev Rul 59-357, including the UGMA in Donor's Gross Estate]. In the Estate of J.F. Chrysler (CA2) 66-1 USTC 12, 405, UGMAs were excluded from the Donor's Gross Estate since the donor, Jack Chrysler, was not the Custodian.

Who Should Be Trustee of UGMAs?

Death of Beneficiary. The UGMA account is included in the beneficiary's Gross Estate at the beneficiary's death [EPTL Sec 7-4.4(G)].

2503(C) TRUST

Trust. This is a true trust and it provides that income may be accumulated until a beneficiary attains age 21 [2503(c) of the Internal Revenue Code] and still qualifies for the annual exclusion.

Assets. Similar to the UGMA, a 2503(c) Trust may hold any asset susceptible of ownership (no cache of cocaine permitted).

Income. The income will be taxed to the trust because it generally is not distributed until the beneficiary reaches the age of 21. If the Trust retains the income, the Trust would be taxed at the Trust income tax rate.

Trust Income Tax Rate

The Alternative to a UGMA Account And A 2503(c) Trust Is A Regular Trust With Crummey Powers

Problem with a UGMA and a 2503(c) Trust.

This writer has found that if a UGMA or a 2503(c) Trust is started early in a minor's life, the assets can build up to a powerful sum. A $270,000 UGMA or 2503(c) trust is not unheard of.

The problem is that the creator of the trust does not wish the minor, now young adult, to receive all that money at 18, 21 or even 25 or 30. Certainly, not until the beneficiary has shown a proclivity to earning as opposed to spending.

Answer. Create a regular trust with normal principal payout ages of 25/30/35. However, this gift to a trust is not a gift of a present interest, except if it is to a 2503(c) trust. If you include the "Crummey provision" in a trust which permits the minor or minor's custodian to withdraw the annual additions, up to $10,000, it thereby qualifies the gift for the annual $10,000 exclusion.

"Qualified Transfers"

Gifts Not Subject to $10,000 Annual Exclusion And Which Do Not Use Federal Exemption

Education. Remember, that payments made by a donor directly to an educational institution for the tuition of a donee are "qualified transfers" and are in addition to the annual $10,000 exclusionary gifts and do not encroach upon the $600,000 once-in-a-lifetime exemption.

Medical. In addition, a "qualified transfer" applies to amounts paid directly to a medical service provider for diagnosis, mitigation, cure, treatment and prevention of disease and/or injury. The donor must write the check directly to a hospital or other medical service provider.

Qualified Transfer May Be to an Unrelated Person.

The donor and the donee for whom the payment is to be made do not need to be related by blood or marriage (unmarried live togethers and dear friends qualify).

Kiddie Tax. In all our computations and permutations, let us no forget that when minors receive gifts, while the gifts may be tax free, the income earned on the gifts is not tax free, if the gift is not invested in municipal bonds.

A minor under the age of fourteen is taxed at his/her parents's tax rate on all unearned income in excess of $1,200.

A minor over the age of fourteen is taxed at his own tax rate.

Single Tax Rate

Married Filing Jointly

If a married couple had taxable income of $100,000, they would be in the marginal bracket of 31%. If their child had $5,000 of unearned income:

the child's tax would be $1,269

If the child was over 14, the tax would be $ 664

If the trust pays the tax $1,247

Investment Strategy Dictated By Taxation.

For minors under the age of 14, if the assets are $30,000, or more, in size, and earnings will be above 4% ($1,200), tax-free municipals mixed with low yield, high growth company stocks, is dictated for a UGMA.

UGMA accounts and 2503(c) and Crummey trusts, for minors, if fed regularly with $10,000 annual contributions, can have significant growth and earnings ($10,000 annually, 4% net income plus 10% growth, will grow to $193,373 in 10 years).

Once a minor is over the age of 14, a 2503(c) or Crummey Trust should pay the income it receives to the minor's UGMA. The minor will be taxed at 15% on income up to $22,750, if the Trust retained the income, it would be taxed at a rate between 28% (over $1,500 income) and 39.6% (over $7,500 income).

CHARITABLE GIVING

Giving to the charity of your choice before year end 1995 can result in a reduction of your income taxes.

In the halcyon days of the 1950s and 1960s, when the top Federal income tax rate was 70%, a gift to a charity resulted in a substantial income tax saving. The Donor had an out-of-pocket cost of 25 cents on the dollar when State income tax was factored in. In 1995, we have a top Federal tax bracket of 39.6 and a gift to a charity costs the Donor 5 cents on the dollar after State tax is figured in.

Percentage Limitations:

A taxpayer may deduct cash gifts to charitable organizations up to fifty (50%) percent of his or her adjusted gross income (AGI) if the gift is to public charities (your college, church, the American Red Cross, etc.).

Deductions Include:

(a) out-of-pocket expenses incurred while serving a charitable organization

(i) travel

(ii) food and lodging, away from home overnight

(iii) automobile expenses-standard mileage 12 cents a mile or actual expense incurred method

(b) Travel expenses, meals and lodging (away from home overnight) are not allowed unless there is no significant element of personal pleasure or recreation (170K)

The deduction from adjusted gross income (AGI) is for contributions listed on Schedule A of the Form 1040

(a) Cash contribution (receipts/checks) can be totaled

(b) No receipts-you must list name and address

(c) Non-cash contributions:

(i) If over $500 total must list on Form 8283 (Donor, Date give, property description, value how you arrived at value, cost)

(ii) Appraisals: If over $5,000, you must attach an appraisal for all assets other than securities quoted on a National Exchange.

When Deductible.

(a) A gift is deductible in the year made.

(b) Checks, unconditionally delivered, are deductible in the year delivered ("mailed") to the charity

(c) Charge Card, in the year the charge is made (Rev Rule 78-38)

(d) Stock Certificate (properly endorsed with signature guaranteed)

(i) Date of mailing to a charity

(ii) If delivered to a Broker or to the issuing corporation, the Date the new certificate is issued

(e) Deed to a House or Realty

(i) The date recorded

(ii) Delivery to a Title Company is not good because you can get it back before delivery to County Clerk

(iii) Delivery to the County Clerk, probably alright, but deeds have been retrieved from a County Clerk's desk before recording.

Five Year Carryover. If a taxpayer's gifts in a calendar year exceed 50% of Adjusted Gross Income ("AGI"), the excess, non-deductible portion, may be carried over for five years.

For example, if AGI is $80,000, the gift limit is $40,000; a Gift of $100,000 is made. $40,000 is deductible in 1995; and $40,000 may be carried over to 1996 through the year 2000 until used up.

Remainder Interests in Real Property

A gift of a remainder interest in your personal residence and/or farm is permitted (1.170A-10).

This deductible gift of a remainder interest in a residence applies to:

(i) a principal residence

(ii) a vacation home

(iii) A cooperative apartment under Section 216(1)

This gift can also include a farm, its crops, its livestock and buildings.

The value of the gift is measured under Tables provided in the Internal Revenue Code.

GIFTS OF LIFE INSURANCE

(A) Affordable Method for Medium Sized Taxpayers and Estates to Make Gifts To Their Favorite Colleges/Churches. Life insurance that is purchased by the payment of a premium, which is a fraction of the cost of the ultimate proceeds payable to the beneficiaries of the policy, is one of the most affordable ways for an individual of modest circumstances to make gifts to his or her favorite charity.

(B) Assignment of Life Insurance Policies to Charitable Organizations. This is a traditional and affordable gift. The Donor/Insured acquires a policy on his life and then donates or transfers (assigns) the policy to the charitable organization who becomes the owner/beneficiary.

(1) Income tax deductions. Premiums paid on a life insurance policy are allowable as a charitable contributions deduction if the named beneficiary (the charity) cannot be changed.

The cash value of a life insurance policy is a deductible transfer to a charity, again, if the beneficiary and owner cannot be changed.

Gift Must Be Absolute. If the donor retains the right to change the beneficiary, then there is no income tax charitable deduction for the cash value on the transfer of the policy or on the future premiums paid. (Rev Rul 76-143)

(2) Gift Tax Deduction. The transfer of a life insurance policy to a charitable organization qualifies for a gift tax deduction if the Donor does not retain the right to name the beneficiary of the proceeds at death.

(3) Estate Tax Deduction.

(a) Proceeds of life insurance owned by a decedent at time of his/her death are included in the decedent's Gross Estate (Section 2042); and

(b) Proceeds of life insurance assigned within 3 years of Insured's death are included in the decedent's Gross Estate.

(c) If policy of insurance is made payable directly to a charitable organization, then the proceeds will qualify for the estate tax charitable deduction, under Section 2055(a)(2)(3).

(d) There is no problem of obtaining an estate tax charitable deduction if the named beneficiary is a charity and the decedent is the owner at the date of death.

CHARITABLE REMAINDER TRUSTS ("CRTs")

Many individuals have a charitable feeling but would like an income tax deduction now and would also like to retain the income generated by the asset given to a charity for a term of years (not to exceed 20) or for their life.

What is it/How does it Work?

(1) An individual donor transfers assets to an irrevocable trust.

(2) The trust invests the assets transferred and pays the donor (now the income beneficiary) an annuity of not less than five percent of the trust asset value for:

(a) life; or

(b) a term of years not to exceed twenty

(3) At the end of the term, the named charity, or charities, receive the principal balance of the trust.

Income Tax Deduction. The charitable deduction is the fair market value of the asset transferred minus the present value of the annuity retained. The present value of the annuity is determined pursuant to the Internal Revenue Code.

Limitation On Deduction

(1) 50% of Adjusted Gross Income (AGI) for gifts to public charities;

(2) 30% of AGI for gifts to private foundations; and

(3) 30% of AGI for gifts of appreciated real estate, common stock, or other appreciated assets.

Example 1:

Martin Monroe transfers appreciated common stock to a CRT and receives back an annuity of 5% per annum for 20 years.

Value of the Charitable Gift

Example 2

If Martin Monroe transferred cash or non-appreciated corporate or treasury bonds, then the annual charitable deduction would be 50% of AGI:

INTERPLAY OF CHARITABLE DONATIONS
AND LIFE INSURANCE

1. Donees of large gifts wish to replace assets leaving their estates on termination of the CRT.

2. Assume a policy of life insurance for $500,000 for a male, age 55, is $10,000.

3. The increased cash flow using a CRT, in which the income is fully taxable to the donor, is $12,700 for five years and, if non-appreciated securities are used and tax free municipal bond interest is received, the cash flow increase is $24,000 a year for 4 years.

4. The additional tax free cash flow can be the basis of creating an estate tax free fund of $500,000.

Example: Martin Monroe has a gross estate of $1,500,000,
no spouse.

5. At no out-of-pocket cost to the taxpayer:

(a) The children's inheritance is increased by $223,000, or 20%;

(b) A net benefit to charity of $156,000 was created; and

(c) A total net estate increase of $379,000 is split 59% to children and 41% to charity.

ADMINISTRATION

1. Trustee. The Grantor (donor)/Income beneficiary can be the trustee, but not with closely held stock or real estate.

2. Principal Invasions. Not allowed, other than to meet the required annual annuity.

3. Additions to Trust. May be made to a Unitrust

(a) This increases annuity

(b) This creates additional charitable deductions

(c) Addition to annuity trust.

4. Income Tax of Donor Beneficiary. Income paid to the donor beneficiary retains the character it had in the trust, either tax free, ordinary, or capital gain.

The income received form a CRAT or a CRUT is taxed as follows:

(a) Ordinary income to the extent of current income and accumulated income not previously paid out.

(b) Capital gains income

(c) Tax exempt income

(d) Tax free return of capital

(e) The trust is exempt from tax

(f) Unitrust ("CRUT") provides for an annuity equal to a fixed percentage of trust principal at beginning of trust year. The CRUT could keep pace with inflation. You can add principal to a Unitrust.

(g) Annuity trust ("CRAT") provides for an annuity equal to a fixed percentage of the original principal or a fixed dollar amount out of original principal. You cannot add principal to this Trust.

(h) The Donor's minimum annual annuity from a CRAT or a CRUT must be five percent minimum.

IN LIFE, AND CHARITABLE GIVING, TIMING IS EVERYTHING

You will be reading this article in late January or early February, 1995 and, while it may seem early in the year to plan gift giving, there is nothing sacrosanct in waiting until the eleventh hour to make gifts.

In fact, the last minute donor who hands out checks at the close of 1995 could very well face the following:

(1) If the gift is to a charity, the possible loss of a deduction; and (2) If the gift is to a child or friend, the loss of the 1995 annual exclusion of $10,000.

The recent (9/1/94) Fourth Circuit Court of Appeals cash Metzger v. Commissioner (94-2 USTC 60,179) held that a Donor's check that was drawn and presented for payment to the Donee/Beneficiary's bank on December 14, 1985 but was not accepted until January 2, 1986, constituted a completed gift and thus qualified for the annual exclusion in 1985. The Internal Revenue Service tried to contend that since the $10,000 gifts did not clear the Donor's bank until 1986, the Donor's 1985 gift, when bunched with another pair of 1986 gifts of $10,000, exceeded the annual exclusion amount allowable in 1986 and thus should be added back to the Gross Estate of the decedent who died in 1987.

The Court's opinion and analysis is most instructive as to the issue of whether or not gifts made late in a calendar year, or on the eve of death, will be honored for gift tax purposes and for estate tax purposes.

The Metzger Court held that when the checks cleared ALBERT METZGER's account on January 2, 1986, they "related back" to the gift in 1985. The Court reasoned:

(1) The Donor intended to make a gift. (The donor did not make the gifts directly but they were made by the son exercising a power of attorney, but the Court did not discuss this.)

(2) The checks were unconditionally delivered (on December 14, 1985) and

(3) Presentment of the check was made within the year for which favorable tax treatment was sought and within a reasonable time of issuance.

DO NOT HANG YOUR DEDUCTION HAT ON METZGER: BE TIMELY IN GIFT GIVING

There are numerous cases which are opposed to the Metzger doctrine of "relation back." The "relation back" theory holds that if the check is delivered but cashed at a much later date, the cashing of the check relates back to the date of the delivery for gift tax and estate tax purposes.

The Courts appear to be willing to allow deductions for late cashed checks in charitable situations (Estate of Spiegel v. Commissioner 12 Tax Court 524 (1949) and Belcher v. Commissioner 83TC227(1984)) where checks were delivered in one year but not deposited until a later year or delivered before death but not cashed until after death.

However, the Courts (Metzger notwithstanding) are not so sanguine when gifts are made to non-charitable donees in one year, or on the eve of death, and the checks are not cashed until a later year or after death (McCARTHY v. UNITED STATES (86-2 USTC 13,700, 1986: Checks delivered May 15 - 22, 1980 and not cashed at decedent's death May 24, 1990; and ESTATE of DILLINGHAM, 90-USTC 60,021, 10th Cir 1990 where checks delivered December 24, 1980 and not presented for payment until January 28, 1981 - Donor died June, 1981). The Courts in the above-cited cases held the gifts were in the decedents' gross estates. The Courts, in the non-charitable donee cases, find that the door is opened too wide for fraud and manipulation in intra-family transactions if the late cashing of gift checks is permitted to qualify as a completed gift when the checks were delivered. The Courts seem to view it as a "wait and see" game. If the donor gets better, the checks will not be cashed, but if the donor sinks or dies, the checks will be cashed. The Courts do not have that same problem with charitable gift checks because non-families are involved.

CONCLUSION

It is better to give than to receive, so goes the old saw. Charitable giving is especially rewarding because you are helping others at the same time you are procuring a tax benefit. Gifts to the family make the Donor and Donee feel good and, too, it also helps reduce the estate. Whether the gifts are to family or charities, for heavens sake, be timely and do not be a Tax Court Case.

Now, as we close, I would invite you all to join my late cousin's, (Sam Miller's) FLY Club. "Forget Last Year; Feel Lots Younger" and fly happily throughout 1995.