An Interview with Michael Lynch
The Community Foundation recently sat down with Northwest Connecticut attorney Michael Lynch to discuss his work in planning for clients’ long-term goals and thoughtful giving through their estate planning.
An Interview with Michael Lynch
The Community Foundation recently sat down with Northwest Connecticut attorney Michael Lynch to discuss his work in planning for clients’ long-term goals and thoughtful giving through their estate planning.
NCCF: How do you work with your clients on their charitable goals?
ML: Every client is different. The charitable decisions they make are largely based on the experiences they have had in their lives. I always ask my clients,“what’s your overarching goal?”That really frames the whole conversation. They have very different answers. Some want to leave a gift to their children or grandchildren. Some are inclined to give to social service organizations. Some feel a strong connection to the local natural environment.
NCCF: How do you work with your clients to balance charitable goals with the wishes of their family members?
ML: Clients often want to leave some money to their children or their grandchildren, but they also have experienced the importance of work in their lives and see the importance of work in the lives of their children and grandchildren. I think most people understand that lives can be ruined by big inheritances. I can think of several people who received a large inheritance and really struggled. Ultimately, it was not a good influence on their lives. A large inheritance or an inheritance received at the wrong time, can have a negative impact. I might work with a client to set up a fund, so their grandchildren don’t receive any inheritance until they are 30 or even 50 years old, or a client may decide to calculate what a helpful amount of money might be to leave to their children or grandchildren and give the rest of their money to local charities or scholarship funds.
NCCF: What are some of the benefits your clients enjoy when they give charitably?
ML: Charitable giving is so important. It affects all of us throughout our lives— when we go to a hospital —when we are working toward our college education—the programs that are available to our children— so many of the things that add comfort and inspiration to our lives exist because of gifts people made through their estates. It’s what makes Northwest Connecticut a great place to live. People often think about charitable giving as a tax benefit, and it can be. But, giving is about so much more than a tax benefit. I encourage clients to give based on their charitable goals, not ignoring state and federal tax benefits, but not shaping their gifts solely based on them either. Creating an estate plan that meets their needs, achieves their goals for leaving gifts to their family, and makes possible the charitable giving that will become an important part of their legacy; that’s what’s really important.
NCCF: When do you recommend clients give through a Community Foundation?
ML: I don’t encourage my clients to give to any specific charity. It’s always their decision. However, I do caution clients from giving a large amount of money to one charity or naming specific charities if that client is likely to live for another 20 years. I often suggest clients consider establishing a fund with the Northwest Connecticut Community Foundation that supports their favorite charities or charitable interests. Clients can establish a named fundthrough their estate planning that supports specific charities or a named fund that supports charities working in a specific field, such as helping homeless animals, providing basic needs like food and shelter to those struggling, or supporting innovative arts projects and programs. Giving through a community foundation fund offers a level of oversight. If a specific charity becomes defunct or veers wildly from its mission, the community foundation will adjust accordingly, and ensure that your gift continues to meet your goals. I have served on the Boards of many charities. Charites can change dramatically over the decades. I tell clients, “you may have a good feeling toward one charity today, but that charity may be vastly different in 10 or 20 years. And, in fact, may not even be in existence.” By establishing a fund with the Northwest Connecticut Community Foundation, you can ensure that your gift will be used how and when it was intended. You can even specify if that gift can be used all at once or specify that it be invested as an endowment (well-invested and awarding a percentage of its value to charities, while preserving its growing balance), providing cash flow to your favorite causes, forever.
CASE STUDY: The Values-Based Charitable Remainder Trust
Stacy, age 40, has lived a very privileged life as an only daughter. When Stacy was born, it was a dream come true for her parents. They were very affluent and, during Stacy's childhood, they smothered her with love, affection, time and money. Stacy soon became very accustomed to the constant "spoiling" and financial support of her parents. As a result, Stacy possessed little drive and initiative. In fact, her idea of a productive day consisted of shopping trips and hours at the salon. Throughout her adult life, Stacy continued on this path. While she was a good person with a good heart, the her parents felt that Stacy did not mature into a financially responsible adult.
During a visit with their estate planning attorney, the they expressed their concerns about Stacy. They did not want to leave their entire estate to Stacy outright because they feared that she would simply spend it away. Instead, the they wanted an estate plan that provided retirement security, fostered financial responsibility and encouraged a love of philanthropy.
Question: What planned gift would give Stacy philanthropic involvement? How could this planned gift be structured to provide Stacy with retirement and financial security?
Solution: After consulting with their attorney, Stacy's parents decided that a customized one-life, 5% Charitable Remainder Unitrust (CRUT) might achieve their objectives. Specifically, the they would create the "Stacy Flexible Foundation." This "foundation" would actually be a FLIP CRUT. A FLIP CRUT pays the lesser of the actual net income produced by the assets in the trust or the trust's chosen payout rate until a "trigger event." Upon the occurrence of the trust's trigger event (which could be a set date in the future or the sale of an asset in the trust), the trust "flips" to a standard CRUT. Starting the next calendar year after the flip, the trust begins paying income at the trust's payout rate, regardless of the trust's net income.
The charitable beneficiary of the FLIP CRUT would be a Donor Advised Fund (DAF) created in Stacy's name. In an effort to involve Stacy in philanthropy, in addition to being the charitable remainderman, the DAF would also be named as a 1% income beneficiary. The FLIP CRUT would pay out 5%, with 4% going to Stacy and 1% going to the DAF, if the trust earned less than 5%, the ratio of the payments would remain the same. As a result, the DAF would receive distributions every year from the FLIP CRUT. (Note that there would not be additional charitable income tax deductions for the 1% income distributions to the DAF each year.)
The DAF would then make distributions each year to local charitable organizations based upon Stacy's recommendation. Note that the actual DAF distribution decisions are made solely by the charity where the DAF is funded. However, in most cases, the charity will follow the recommendations of the donor and donor's family. Stacy's parents hope this yearly, active involvement with the DAF and local charities will cultivate new personal relationships and new values for Stacy.
Stacy could also make gifts from the trust principal to the DAF during her life, by disclaiming part of her interest in the trust. By doing so, Stacy could provide greater funding to the DAF and also enjoy a charitable tax deduction for the value of the gifted income interest. See PLR 9550026. Lastly, upon Stacy's death, the FLIP CRUT would distribute its principal to the DAF. At that point, Stacy's children could be involved with the future DAF distributions.
The FLIP CRUT would also allow the Stacy's parents to meet their financial and retirement goals for Stacy. The FLIP CRUT would be invested for growth until Stacy turns 55 (the trigger event). After that point, the FLIP CRUT would turn into a standard CRUT and provide a steady stream of income for the rest of Stacy's life. With a lifetime 4% payout (plus 1% to the DAF each year for a total payout of 5%) on a very large trust, there would be significant income available for Stacy's retirement years.
While not certain of its success, the Stacy's parents feel comfort knowing that they are providing Stacy with an opportunity to grow and mature as an adult. Consequently, they are very pleased with this values-based charitable remainder trust plan.
How Charities May Collect IRA Beneficiary Designations
Traditional IRAs are funded with pretax dollars and grow tax free. Many traditional IRAs are created through rollovers of other types of qualified plans at retirement. The payouts from traditional IRAs are ordinary income because these IRAs are funded with pretax dollars. IRAs and other qualified retirement plans now equal approximately one-fourth of household net worth. In September of 2018, the Federal Reserve estimated that net household worth in America was $107 trillion. The Investment Company Institute (ICI) estimated in November 2018 that total retirement assets were $28.3 trillion. Of the total $28.3 trillion, the two largest components are IRAs and 401(k) accounts. The ICI estimate of IRA balances is $9.26 trillion. The 401(k) asset value in November 2018 was estimated to be $5.35 trillion dollars.
IRA and 401(k) Bequests to Charity
With substantial retirement plan values, there are obvious benefits for charitable individuals who transfer IRAs or 401(k) plan to charity through beneficiary designations. Because the 2019 estate exemption of $11.4 million eliminates estate or gift tax for 99.8% of estates, the typical tax on bequests to children and other beneficiaries is income tax on traditional IRAs and other qualified plans.
The taxwise inheritance plan for a parent who wants to benefit both family and charity is to make charitable transfers through an IRA, 401(k), 403(b) or other qualified retirement plan. Because charities are exempt from tax, they may receive an IRA or other qualified plan tax-free. If given their choice, children or other heirs would prefer to receive the home, stocks, land or other assets. These assets receive a step-up in basis under Sec. 1014. Children and other heirs generally will avoid payment of income, capital gains or estate tax on their inheritance.
However, if a parent transfers the home, stocks or land as a bequest to charity and leaves the IRA to children or other family members, they will pay a large (and unnecessary) income tax. If they were given the choice, the children or other heirs would always take the tax-free assets and prefer that the charitable transfer be funded through a traditional IRA or other qualified plan.
The ICI $9.26 trillion value suggests there is a significant potential for both IRA rollovers and for IRA beneficiary designations. Approximately 32% of IRA assets are held by individuals age 70½ and above, according to DQYDJ.com, an Exclusive Member of Mediavine Finance. With 32% of IRA balances held by persons who are age 70½ and therefore can roll over up to $100,000 per year, there is approximately $3 trillion in IRAs and $1.7 trillion in 401(k) assets that potentially may be used for qualified charitable distributions (QCDs). The 401(k) assets would need to be rolled over into an IRA, and then could be used for QCDs.
If the target market group is age 60 and above, the potential is even larger for IRA or 401(k) beneficiary designations to charity. The DQYDJ.com analysis suggests that 58% of total IRA and 401(k) assets are held by persons age 60 and above. These IRA and 401(k) owners could designate charity as the beneficiary of a portion of their $5.37 trillion in IRA assets and $3.1 trillion in 401(k) assets.
IRA and 401(k) Potential Value for Charity
The key to receiving these IRA rollover gifts is a multichannel marketing program with both electronic and print components. If charities have effective multichannel marketing programs and donors over age 60 designate 2% of their IRAs and 401(k)s to charity, then the amount of gifts may equal $166 billion. Because IRAs and 401(k)s continue to grow in value, this $166 billion amount could be substantially greater by the time the individuals age 60 and over pass away.
IRA is a Trust for an Individual
IRAs are governed by Sec. 408 and Reg. 1.408 of the Internal Revenue Code and Regulations. The IRA is a trust created for the "exclusive benefit of an individual or his beneficiaries." See Sec. 408(a). It must be a "trust created or organized in the United States (as defined in Sec. 7701(a)(9)) for the exclusive benefit of an individual or his beneficiaries." Reg. 1.408-2(b).
The IRA may be designated to charity. If the IRA owner designates a portion of the fund to children and a portion to charity, in order to permit children to use the "IRA stretch" plan, the IRA amount should be distributed to charity by September 30 of the year after the IRA owner passes away. Reg. 1.401(a)(9)-4. IRA distributions and reporting are described in IRS Pub. 590-B. When the IRA is distributed to an individual or a charity, the custodian will file IRS Form 1099-R.
With the rapid growth in the number of IRA designations to charities, many nonprofits have encountered problems with the transfer from custodians to charities upon demise of the IRA owner. Some IRA custodians may require the charity to setup an IRA account, claim that the charity is subject to provisions of the Patriot Act or decide to withhold 10% of the IRA to pay income tax. Charities and their counsel must understand the correct responses to these claims in order to expedite the receipt of IRA proceeds.
IRA Collection and 401(k) Bequests to Charity
Problem: The IRA custodian claims that the charity must set up a new account.
Response: The charity is not an individual and therefore not qualified to set up an IRA account. Under Reg. 1.408-2(b), an IRA account must be for "the exclusive benefit of an individual or his beneficiaries." A charity is a corporation and defined as a "person" under the IRC, but a nonprofit corporation is clearly not an individual. Therefore, the charity is not qualified to set up an account. The appropriate response for the custodian is to transfer the designated amount directly to the charity.
Problem: The custodian attempts to apply the Patriot Act or FINRA Rule 2090 (Know Your Customer) to the charity. Some IRA custodians ask for detailed personal and financial information of nonprofit board members.
Response: The USA Patriot Act was passed in 2001 for the purpose of protecting America and reducing the risk that funds would be transferred overseas. Sec. 326 of the Patriot Act provides that "financial institutions" shall be required to exercise efforts to reduce the risk of funds being used by suspected terrorists or terrorist organizations. Patriot Act Sec. 326 applies if an individual or corporation attempts to open a bank account. The bank must maintain records to verify the person's identity, name, address and other identifying information and ascertain whether or not the person is on the list of known or suspected terrorists.
The Patriot Act and FINRA Rule 2090 (Know Your Customer) do not apply to U.S. nonprofits if they are not creating a bank or IRA account. See Patriot Act Sec. 326. In addition, our U.S. nonprofit is not on the known or suspected terrorist list. Therefore, there is no application of the Patriot Act or FINRA Rule 2090 to the distribution of an IRA balance to a U.S. nonprofit that is not setting up a bank or IRA account.
Problem: The IRA custodian may withhold 10% of the distribution and send it to the IRS.
Response: U.S. nonprofits are tax exempt. While there is generally a requirement to withhold tax on IRA distributions to individuals, it is possible to elect no tax withholding on IRS Form W-4P. In any case, a qualified exempt charity is not subject to income tax and there is no requirement for withholding.
Letter to General Counsel to Facilitate IRA Collection
Some IRA custodians will promptly distribute the funds to a nonprofit, but others may delay or create roadblocks to that distribution. In order for a nonprofit to collect its share of an IRA, it may be necessary to send a letter to the general counsel of the bank or other financial custodian. Below is a specimen letter that nonprofits may modify and send to the general counsel of the IRA custodian. This letter may be modified to conform with the nonprofit's name, address and specific goals. The donor's name and account number also must be updated.
Specimen Letter to General Counsel of IRA Custodian
January 1, 2019
Mr. or Ms. General Counsel
1234 Michigan Avenue
Chicago, IL 00000
Dear General Counsel:
We have been informed that Favorite Charity is a beneficiary of the IRA of Jane Doe. The IRA account number is 123-45-678. We request that you liquidate the IRA funds held for our benefit and send a check to us within 30 days at our address: Favorite Charity, Bequest Administrator, 123 Oak Street, Chicago, IL 00000.
Favorite Charity is not required to open an IRA account with a custodian to receive an IRA distribution. Under Reg. 1.408-2(b), an IRA account must be created "for the exclusive benefit of an individual or his beneficiaries." A charity is a nonprofit corporation defined as a "Person" under the IRC, but a charity clearly is not an individual and therefore not permitted to set up a Sec. 408 IRA account. In addition, as custodian you are trustee of an IRA trust under Reg. 1.408-2(b). You are required by federal and state law to comply with the fiduciary responsibilities of a trustee. If you fail to make the distribution as required in your contract with the IRA owner, you are potentially in breach of your duty of fiduciary responsibility.
Favorite Charity is not subject to the USA Patriot Act (Pub. L. 107-56) or FINRA Rule 2090. Sec. 326 of the USA Patriot Act requires banks and other custodians to determine that a person opening an account is not on the suspected terrorist list. First, IRC Sec. 408 does not permit a nonprofit to open an IRA account. Because the charity cannot open an IRA account, both the Patriot Act and FINRA Rule 2090 do not apply to an IRA distribution to charity. In addition, we are a U.S. recognized exempt charity and not on a suspected terrorist list.
Finally, IRA custodians may withhold 10% of a distribution to individuals and remit that amount to the Internal Revenue Service. We are tax exempt and elect under IRS Form W-4P to not have tax withheld. Because we are tax exempt, there is no requirement for withholding on your part. Enclosed is a copy of our IRS tax exemption letter. Our IRS identification number usable on Form 1099-R is 00-1234567. There is no IRS requirement to have an IRA account for you to issue Form 1099-R
Because we are not permitted to open an IRA account, the USA Patriot Act and FINRA Rule 2090 do not apply to a U.S. charity not opening an IRA account and withholding is not required, we request that you remit within 30 days the full distribution to the above address. If you are unable to distribute our vested IRA funds within 30 days, then, in a manner similar to Sec. 6662(a), we should receive the IRA funds and a 20% penalty amount. Because after the 30-day period you are in breach of contract and breach of trustee fiduciary responsibility due to noncompliance with terms of the IRA agreement, we will be willing to settle for the IRA funds plus a 20% penalty.
If you feel you are unable to make this prompt distribution as requested, please have your Legal or Compliance Department provide a written explanation of your legal basis for not distributing these IRA funds to us. Reminder -- this is a trust. You are subject to a breach of fiduciary responsibility claim for failure to follow trust terms.
Vice President, Favorite Charity
Expected Response to General Counsel Letter
This letter has two keys that encourage IRA distributions. The 30-day limit and the 20% penalty will cause the letter to be sent to the IRA custodian general counsel. Legal counsel will recognize that he or she does not wish to create a claim for breach of fiduciary responsibility. The general counsel can negotiate with the nonprofit to drop its claim for breach of trustee fiduciary responsibility and the 20% penalty in exchange for the IRA distribution. This letter should move the IRA custodian forward and encourage a prompt distribution.
The bold words on the letter should be replaced by the nonprofit name, address and other information. The letter may be modified in the case of a Sec. 401(k), 403(b) or other type of qualified retirement account. Even with this collection letter, it may take a period of time for the custodian to respond.
IRA Transformative Gifts
With potential IRA and 401(k) bequests over $166 billion, all nonprofits should encourage lifetime and testamentary IRA gifts with a full-featured marketing program. Your Boomer and Quiet Generation donors can transform your organization through these IRA gifts. With the assistance of the IRA collection letter above, your nonprofit will quickly benefit from these excellent gifts.
Nonprofit Council Seeks Disaster Relief Tax Provisions
As parts of North and South Carolina recover from the winds, floods and tornadoes of Hurricane Dorian, the National Council of Nonprofits published a request for tax provisions to assist disaster victims.
Senate Finance Committee Chair Chuck Grassley (R-IA) appointed Sen. Richard Burr (R-NC) to lead the Senate Finance Committee Disaster Tax Relief Task Force. The task force is studying ways tax law can be used to assist victims of natural disasters.
David L. Thompson is President of the National Council of Nonprofits. He and 42 state nonprofit associations sent a letter to the task force Senators requesting four types of tax relief provisions.
- Flexible IRS Filing Deadlines - While the IRS has granted tax filing extensions after a disaster, there should be a standard extension accompanying the federal disaster zone declaration with an automatic time for that extension.
- Employer Tax Credits - After a federal disaster, many workers are temporarily unemployed due to destruction of buildings and warehouses. Congress has passed legislation with targeted tax relief for companies in disaster zones. These provisions are designed to encourage companies to resume normal employment levels. Because nonprofits do not pay income taxes but are significant employers, disaster relief tax bills should grant similar benefits to nonprofits by waiving their payroll taxes.
- Disaster Recovery - After a flood, fire, tornado or other natural disaster, nonprofits may provide food, clothing and shelter for weeks and even months. With an extended recovery period, the disaster relief tax incentives should have a longer duration to match the period of recovery.
- Targeted Universal Deduction - Disaster relief tax provisions often remove the 60% of AGI cash deduction limit for gifts to disaster recovery programs. With the number of itemizers reduced from 30% of taxpayers in 2017 to about 10% by the Tax Cuts and Jobs Act, there is a need for greater deductions for more taxpayers. A targeted "nonitemizer deduction" for gifts to disaster relief nonprofits would enable "all taxpayers to support their fellow Americans throughout the country in an immediate and responsible way." The targeted nonitemizer deduction could be limited to six months after the disaster declaration.
Senators Thune and Casey Support CHARITY Act
On May 15, Senators John Thune (R-SD) and Bob Casey (D-PA) introduced the Charities Helping Americans Regularly Throughout the Year (CHARITY) Act. The bill expands giving options for IRA charitable rollovers and addresses other charitable provisions.
The CHARITY Act includes four major provisions. If it is passed by the House and Senate and signed by the President, it would generally permit donors over age 70½ to transfer up to $100,000 per year directly from an IRA to a donor advised fund. Second, the act would simplify the excise tax paid by private foundations on investment income.
Volunteers who drive their vehicles on qualified charitable trips can currently deduct $0.14 per mile. That charitable mileage amount would be increased to the same rate as is currently permitted for medical and moving expenses. The medical and moving expense rate for 2019 is $0.20 per mile.
Finally, the CHARITY Act requires nonprofits to file their annual tax returns electronically. While nonprofits are exempt and ordinarily do not pay tax, they must file an information return each year.
Editor's Note: While the CHARITY Act has not yet passed, it is encouraging to see Congressional support for philanthropy and, especially, the existing IRA rollover. Americans over age 70½ should consider making an IRA rollover gift in 2019. The IRA charitable rollover is a great planning option for eligible IRA owners who are among the 90% of Americans who do not itemize. Because the IRA rollover qualifies for part or all of an IRA owner's required minimum distribution (RMD), IRA owners can make gifts from their IRAs, reduce their tax bill from their RMDs and still take the full standard deduction. For all donors, the IRA rollover is a convenient way to make gifts in 2019.