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Federal Income Taxation of Charitable Remainder Annuity Trusts and Charitable Remainder Unitrusts and Their BeneficiariesThesis

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Federal Income Taxation of Charitable Remainder Annuity Trusts and Charitable Remainder Unitrusts and Their Beneficiaries

Federal Income Taxation of Charitable Remainder Annuity Trusts

The internal revenue code defines charity and charitable organizations. Only the concerns that fulfill all the parameters are eligible for an exemption from tax. Consequently, if the donors make a contribution to a charity that is not exempted, the donation will not be exempted from the income. There are laws that govern the charities its definitions and the incidence and consequences of the transactions of these types of organizations that are well defined in the statutes. Thus we have to see the exact definition of what is 'charity' and 'charitable institution'.

Definition & Classification of Charity

There may be any number of definitions of charity and charitable organizations. Charity and the legal use of tax exceptions begins at the definition of charity as is defined in "section 501(c)(3) 501(c)(3) of the Internal Revenue Code" which stipulates that the earnings of the organization, that is no part of it must be paid or be invested in "any private shareholder or individual." (Internal Revenue Service, 2009b) The activists are not charitable, at least that is what can be discerned by the fact that action organizations, the ones that conduct campaigns for a cause or influence legislation, or campaign activity in a manner for political candidates. Such organizations, though may be charitable in nature are not included in the definitions of a charitable organization. The organizations that fully qualify within the scope of the requirements are 'charitable organizations'. Organizations thus that comply with the "sections 501(c) (3) are eligible to receive tax-deductible contributions." (Internal Revenue Service, 2009b)

Analysis of Taxation and its Incidence on Beneficiaries for Charities

The definition of a trust is said to be: A separate taxable entity "for federal income tax purposes." The trusts are legally of many types, but generally are created out of the will or arrangement by a donor or creator of the trust and an appointed trustee takes the charge and responsible of the trust and all assets and property of the trust which is a new legal entity. The beneficiary or beneficiaries are the person or persons who derive benefit from the trust or are entitled to receive income or benefits from the values held by the trust. Thus the beneficiaries could be a class of persons as described by the charter of the trust eg: Visually challenged persons. Or it could even be the members of the trust including the founder, in which case too the trust being a separate entity can hold the amounts in trust for them. Thus the beneficiaries could be any person. There are business and investment trusts that are created for the purpose of business or are based on profit making and this is usually done using the capital provided by the donors or creators of the trust. This type of trust closely resembles a partnership and can be taxed as a business entity in the same way as a company. Thus there is no tax exemption as in the case of charitable trusts. (CCH Incorporated, Commerce Clearing House, CCH Tax Law, 2007) A liquidating trust likewise is formed to liquidate assets and it is taxed as a trust.

The IRS has spelt out "the rules for income tax deductions for charitable contributions by individuals." (Internal Revenue Service, 2009a) The deductions have to be itemized. An individual can "deduct up to 50% of your adjusted gross income," if donated with some exceptions. "The 50% limitation applies to all public charities." (Internal Revenue Service, 2009a) The organizations that qualify for deductions "of a charitable contribution under the section 170(c) of the Internal Revenue Code: are primarily contributions made to any activity by a state of the United States and all political subdivision within the state and the District of Columbia," if the program to which the donation is made is for public purposes. (Internal Revenue Service, 2009a) This is the first clause that provides complete exemption. The next is a contribution to entities like if made to a trust, fund, or foundation, community chest, corporation that is incorporated "in the United States or its possessions, and the District of Columbia." (Internal Revenue Service, 2009a) The condition is that such an entity must be operating only for promoting and operates exclusively towards "charitable, religious, educational, scientific, or literary purposes, or for the prevention of cruelty to children or animals. Other entities are a church, synagogue, or other religious organization, a war veterans' organization, nonprofit volunteer fire company; civil defense organization created under federal, state, or local law; a domestic fraternal society operating under the lodge system, but only if the contribution is to be used exclusively for charitable purposes; a nonprofit cemetery company if the funds are irrevocably dedicated to the perpetual care of the cemetery as a whole and not a particular lot or mausoleum crypt." (Internal Revenue Service, 2009a)

The limitation on deductions varies with the type of organization. In the case of private foundations, cemetery organizations, veteran's organizations and fraternal societies, the deduction are allowed at 30% adjusted gross income. The 30% limitation applies to "organizations described in section 170(c) that do not qualify for the 50% limitation." (Internal Revenue Service, 2009a) There are organizations that either have registration abroad or are thus foreign entities or are incorporated in the U.S. But operate abroad. There is a distinction between the two. The U.S. "formed organizations though carrying on activities in foreign countries, are also charitable organizations" and contributions to them shall also be given the benefit of deduction. (Internal Revenue Service, 2009a) Some organizations in Canada though foreign organizations, contributions are deductible because of the tax treaty. Other wise the contribution to alien entities is not considered as charitable contribution and no deduction is allowed. If property other than cash is donated "to a firm which is qualified, the fair market value of the property" could be deducted. (Internal Revenue Service, 2009a)


Some recent legislation has removed the special status of charitable organizations and has brought them under the scrutiny. "The Pension Protection Act of 2006 was passed on August 17, 2006." (Internal Revenue Service, 2009c) The statute amends "the tax law provisions affecting tax-exempt organizations." (Internal Revenue Service, 2009c) Thus from 2008, the tax "exempt organizations with gross receipts of $25,000 or less must file an annual notice, using a filing system specially created. The controlling organizations must report all loans to controlled organizations and all income derived from them." (Internal Revenue Service, 2009c) The transfers between controlled and controlling organizations are also to be reported. The organizations have to file and this applies to "Section 501(c) (3) organizations that file unrelated business income tax returns." (Internal Revenue Service, 2009c) Added to that, the "private foundation and excess benefit penalty excise taxes are doubled." (Internal Revenue Service, 2009c) The law also brings new qualifying requirements for funds like "donor advised funds, supporting organizations and credit counseling organizations are subject to new requirements." (Internal Revenue Service, 2009c) Current "exempt organizations are also required to report if they acquire life insurance contracts that provide benefits to the exempt organization and private investors, and if both have an interest in the contract." (Internal Revenue Service, 2009c)

Benefits and Deductions:

The donor gets benefits of tax deductions as per law. Deductions are made available to the donors "by the Internal Revenue Code and Internal Revenue Service regulations," and these donations could be cash or property. (Braunstein; Burger, 2007) In the U.S. about "$43.4 billion in deductions are being claimed for non-cash charitable contributions" and these claims were raised by "25.3 million individual returns." (Braunstein; Burger, 2007) With the passing of the Pension Protection Act of 2006, there have been regulations with regard to donations and "all cash donations claimed as deductions by" the assessed should show collateral "bank records or certificates from the charity." (Braunstein; Burger, 2007) The pension fund thus provides the user of the fund "control over the donation, and allows a claim when the gift is made," and the donor can recommend his or her own charities. The rule is that after 2007 any donor-advised fund must also have an immediate acknowledgement document that "the fund sponsor that it retains exclusive legal control over the assets contributed." (Braunstein; Burger, 2007) However, the organization sponsoring the fund will lose the tax exempt status "tax-exempt status under IRC § 501(c) (3)." (Braunstein; Burger, 2007)

The stringent policies of the IRS was necessitated and resulted in the taxing of the beneficiary due to the misuse of the exemption provisions. The enquiry conducted by the 'Government Accountability Office -- GAO' found that the majority of the tax exempt organizations paid federal taxes; there were tens of thousands of who also abused the federal tax system. Of the unpaid taxes, 71% related to the payroll taxes and its penalties or interest from 1981. The audit also found that 'individuals who were top officials of the tax exempt entities' had… [END OF PREVIEW]

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