Caraker Law Firm Blog

Estate Planning and Charitable Intentions

Posted by Chad Caraker on Tue, May 06, 2014 @ 11:30 PM

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For many reasons, people are making a greater effort to make sure that their estate plan has an effect on both their own family, and a variety of charities.  The New York Times recently ran a piece entitled In Estate Planning, Family Isn’t Always First by Caitlin Kelly that said as much.  While many still aren’t making an effort to put together estate plans for the efficient administration of asset transfer at death, many, many more are at a higher rate than in years past.

It is mere speculation to think that charities have done a better job educating the populace about the benefits of giving to their organization during and after the recession.  Or, perhaps the advent of tools like Donor Advised Funds such as those offered by Fidelity, T. Rowe Price and Vanguard, have changed the giving landscape.  Regardless, clients seem to be interested in either creating a legacy or benefiting many of the same organizations they worked with closely during life, through their estate plan.

Both the client and the estate planner should have an in depth discussion about who the client is ultimately trying to benefit.  It is critically important for the estate planner to make a proper determination about the ultimate beneficiary of the client’s estate plan.  This is true if the client has a long history of giving to a particular organization, or even if the client decides that an organization is worthy of receiving their assets at death, but has never directly given to that organization.

For the sake of explanation, take this example.  If a client indicates that he or she wishes to benefit the United Way, problems could arise if the estate plan merely transfers assets at death to “United Way.”  Did the client intend to benefit the global organization, or a local chapter of the United Way?  While the answer to this question might seem obvious if the client had a long history of involvement with her local chapter of the United Way organization, it may not be obvious if she deemed them to have a worthwhile purpose that she planned to benefit with a bequest from her estate, even though she did not benefit the organization during life.

A general goal of estate planning is to inject efficiencies into the process of asset distribution at death.  Lack of clarity regarding charitable intent can make estate administration grossly inefficient.  If the Executor of the estate, or Trustee of the client’s Trust is unsure of the exact beneficiary of the estate, he or she may have to seek guidance to properly abide by their fiduciary duty under the law to properly administer the estate.  That fiduciary duty could result in request for Court interpretation of the Last Will or Trust, an inefficient process, to say the least.  The Court process could be both time consuming, and costly to all involved.

It is certainly possible to reduce the likelihood of confusion during estate planning.  A good estate plan drafter should do some homework.  Information from the client should be gathered to find out more about the organization that is to be the recipient of the client’s estate distribution.  There are times when the organization may simply not be a viable recipient of the estate bequest.  While many charitable organizations do great things, some of them are tenuously in existence, at best.  Perhaps one individual effectively runs the charity and if something happened to that person, the entity would shut down.  If this is the case, the estate planner should draft accordingly to allow the Trustee some flexibility. Perhaps the Trustee distributes assets to an alternative organization in existence at death.  Or the bequest lapses if the organization no longer exists.  All of this information can be included in the plan.

To prevent the type of confusion illustrated above in the United Way example, the estate planner should clarify the client’s wishes and investigate the organizational structure of each charity.  It could be that there is one umbrella organization where all funds are directed, but noted as benefitting a particular geographical division of the organization.  Some entities are really an amalgam of multiple regional charities that are loosely held together and merely market together without having a structural entity controlling them. 

Upon investigation, the estate planner should be able to learn how to properly draft the charitable bequest.  That bequest should include the proper legal name of the entity and its Federal Tax Identification number.   It may be helpful to the Executor or Trustee to also include a current address and phone number in the beneficiary designation.  The planner should also include directions regarding what happens if the organization either no longer exists or if it has been acquired or absorbed into a successor organization.  All of these events are very possible, especially when the plan preparation is removed by many years from the date of death.

If you have questions about how you can properly plan for charitable distributions at death, or any other estate planning questions, please contact our office.

Tags: Financial Planning, Estate Planning, Fiduciary Responsibility, Retirement Planning, Charitable Gift Planning, Trust Administration, Estate Administration, Donor Advised Funds

Income Tax Consequences of Terminating a Whole Life Insurance Policy

Posted by Chad Caraker on Thu, Feb 20, 2014 @ 04:05 PM

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The United States Tax Court just handed down a decision in Black v. Commissioner of Internal Revenue, T.C. Memo 2014-27, that explains what the income tax consequences are when this situation occurs.  In the opinion, the taxpayer had been the owner of a whole life insurance policy for over twenty years.  The policy had both cash value and loan features.  The policy allowed the taxpayer to borrow up to the cash value of the policy.  Loans from the policy would accrue interest and if the policy holder did not pay the interest then it would be capitalized as part of the overall debt against the policy.

The taxpayer had the right to surrender the policy at any time and receive a distribution of the cash value less any outstanding debt, which could include capitalized interest.  If the loans against the policy exceeded the cash value, the policy would terminate.  In this case, the taxpayer invested $86,663 in the life insurance policy, his total premiums paid for the policy.  Prior to the termination the total the taxpayer had borrowed from the policy was $103,548, however with capitalized interest over time the total debt on the policy was $196,230. The policy proceeds retired the policy debt at termination.

The taxpayers in this case were issued a 1099-R showing a gross distribution of $196,230 and a taxable amount of $109,567.  The non-taxable difference of $86,663 was the taxpayers’ investment in the policy – premiums paid. None of the information was included on the taxpayers’ return.  The taxpayers eventually amended their return and included as income the amount of $16,885 which represented the difference between the loan principal amount borrowed of $103,548 and the amount of premiums paid of $86,663.  Ultimately, the IRS disagreed with the taxpayers’ representation of the tax consequences of the life insurance policy termination.

The primary issue in the case then centered around whether or not the capitalized interest from the outstanding policy loans should be included in income. The Court explained that the money borrowed from the policy was a true loan with the policy used as collateral.  There were no income tax consequences on distribution of loan proceeds from the insurance company to the taxpayers.  Further, the Court explained that this is true of any loan as the taxpayers’ were obligated to re-pay the insurance company the debt owed.

The Court explained that when a policy is terminated then the loan is treated as if the proceeds were paid out to the taxpayers and the taxpayers then retired the outstanding loan by paying it back to the insurance company. The Internal Revenue Code provides that proceeds paid from an insurance company, when not part of an annuity, are generally taxable income for payments in excess of the total investment.  The insurance policy at issue treated the capitalized interest as principal on the loan. Therefore, when the policy is terminated, the loan, including capitalized interest, is charged against the proceeds and the remainder is income. This outcome makes sense or else the return on investment inside of the policy would never be taxed.

The taxpayers ended up with a large tax bill and a tough pill to swallow.  Ultimately, the result is logical in the context of capturing deferred income tax consequences.  Clearly, it would have been beneficial for the taxpayers to have consulted with counsel prior to preparing their tax return in order to avoid an unwelcome tax bill, penalties and interest.

Should you have transactions that you are unsure of when it comes to their income tax consequences, feel free to contact our office.  If you find yourself in receipt of an adjustment to your tax return based on exam action that you disagree with, or an assessment has been made and you have simply decided you were incorrect in your analysis, call us, we can help.

Tags: Life Insurance Policy Surrender, Financial Planning, Estate Planning, Tax Delinquency, Retirement Planning, Life Insurance, Interest, IRS, Income Tax, Penalties, Capitalized Interest