Draft:Charitable Gift Financing

Charitable Gift Financing (CGF) is a financial strategy designed for high-income and high-net-worth individuals. It allows donors to make substantial charitable contributions by leveraging specialized third-party financing. Through this approach, individuals can significantly amplify the value of their charitable gifts without needing to provide the full cash amount upfront. In essence, CGF enables donors to take out loans to fund their charitable giving. The donations are immediately tax-deductible Internal Revenue Code (IRC) Section 170(a), often allowing the donor to maximize their tax benefits in the current year. The loans are repaid overtime, typically through life insurance proceeds. CGF is most commonly used in the United States and assists donors maximize the impact of their charitable giving while preserving liquidity for other investment opportunities or financial needs.

Overview

Mechanism

Charitable Gift Financing (CGF) works by enabling donors to borrow the majority of the donation amount from a specialized third-party lender. The donor typically contributes a smaller portion of the gift upfront and finances the remainder with a loan. The repayment of the loan is often structured through future earnings or proceeds from a life insurance policy death benefit. This strategy enables the donor to make larger charitable contributions than their available cash would typically allow, while also receiving immediate tax benefits. It also enhances legacy planning, as the structured repayment of the loan provides continued charitable impact even after the donor's death.

Legal Considerations

Charitable Gift Financing is governed by U.S. tax law, particularly Rev. Rul. 78-38, which allows deductions for charitable gifts made through financing. However, in order to comply with the law, CGF must meet the requirements of the Economic Substance Doctrine, which confirms that the transaction serves a purpose beyond just tax avoidance. The donation must have a genuine charitable intent, and the loan must represent a real financial obligation for the donor.

Economic Substance Doctrine

The Economic Substance Doctrine is a legal principle that prevents taxpayers from entering into transactions solely for the purpose of obtaining tax benefits. For Charitable Gift Financing to adhere to this doctrine, it must pass two tests: the Objective Test, which ensures the transaction changes the donor’s financial position beyond tax savings, and the Subjective Test, which requires the donor’s primary intent to be philanthropic rather than tax-driven. The donor must demonstrate that the gift has a meaningful impact on their economic position, and the loan must be a bona fide liability.

Benefits

Charitable Gift Financing (CGF) offers significant advantages, one of them is tax benefits. Since the contribution is a cash donation it is considered fully tax-deductible, up to 60% of the donor's Adjusted Gross Income (AGI), as outlined in IRC Section 170(a). This can substantially reduce taxable income of the donors, particularly for high-income individuals. By using Charitable Gift Financing donors can further amplify their giving by making larger contributions without depleting their immediate liquid assets, preserving cash flow for other financial needs. By structuring loan repayment through life insurance contract, CGF also aids in legacy planning, ensuring continued charitable impact after the donor's death. This combination of flexible financing and tax advantages makes CGF an attractive strategy for high-income individuals aiming to maximize their philanthropic efforts.

Compliance and Risks

To benefit from CGF, donors must adhere to Internal Revenue Service (IRS) regulations, particularly the Economic Substance Doctrine. Failure to meet certain requirements may lead to the disqualification of the tax benefits and could result in penalties imposed by the IRS. Proper documentation of both the charitable intent and the financial structure is crucial to proving the validity of the donation using financing. Detailed records and a clear demonstration of the philanthropic purpose validates the transaction in the eyes of the IRS. Additionally, donors should carefully evaluate the long-term financial impact of repaying the loan, which typically relies on proceeds from a life insurance policy. The insurability of the donor, therefore, becomes a critical factor in the overall planning and underwriting process. If the donor(s) do not qualify for sufficient life insurance coverage, this adversely affect the viability of using Charitable Gift Financing strategy.

Use in Legacy and Estate Planning

Charitable Gift Financing is commonly utilized as a legacy enhancement and estate planning tool. By structuring loan repayments through life insurance contracts, the heirs of the donor(s) can perpetuate a continued impact of charitable contributions long after donors passing. This approach allows individuals to meet their long-term philanthropic objectives, ensuring their charitable gifts remain active, often through an endowment, and, at the same time optimizing family’s estate planning needs. With proper structuring, charitable giving can also help reduce estate tax liabilities. By making charitable contributions, donors decrease the size of their overall taxable estate, thus lowering the potential estate tax burden. In case of Charitable Gift Financing strategy, where the loan is repaid using life insurance proceeds, donors can achieve a dual benefit by benefitting both charitable causes and their heirs in a tax-advantaged manner.

See also

• Donor-advised fund
• Planned giving
• Charitable remainder trust
• Economic substance

References

Category:Charity in the United States