Deductions

Charitable Gift Annuities

It’s worth the time and effort to get up to speed on CGAs

Key Takeaways:

  • A CGA enables individuals or married couples to make a gift to a charity in exchange for an income stream that will last for the lifetime of the last survivor.

  • A CGA is a tax-advantaged way to give to worthy causes and retain predictable income. Most CGAs are in the form of cash or marketable securities, but there are many other variations.

  • The deduction is available in the year of the gift and can be carried forward for five additional years if you can’t utilize it currently.

A Charitable Gift Annuity (CGA) is a split-interest gift in which the donor makes a gift, but retains a right to an income stream. Most CGAs are very straightforward; individuals or married couples make a gift to a charity in exchange for an income stream that will last for the lifetime of the last survivor. Most gifts are made in cash or marketable securities and provide immediate income to the donor.

CGA basics

First, every state has regulations regarding CGAs issued by in-state nonprofits and often in the state of nonresident donors. The CGA is a contract between the charity and the donor, and that contract, much like a commercial annuity issued by an insurance company, becomes a general obligation of the charity. This means that all the assets of the charity are available to pay the annuity income to the donor. This alone has kept many smaller charities from offering gift annuities to their donors. However, there are now organizations such as the Charitable Giving Resource Center (CGRC) that provide turnkey gift annuity programs for small organizations. Assistance includes calculation, administration, financial stability and money management resources for organizations that are too small to handle all those responsibilities themselves.

There is a nonprofit association of organizations called the American Council on Gift Annuities (ACGA) that provides guidance on gift annuities and gift annuity rates. While charities may establish their own gift annuity rates, those that don’t utilize the ACGA rates will be required by their state to hire an independent actuary to perform the necessary calculations. The ACGA rates are meant to provide a remainder balance of 50 percent of the original gift to the charity at the death of the last survivor. This means that the charities have immediate access to some amount of the donated property that they can use for their charitable purposes.

For the donor, perhaps the greatest benefit of a CGA is the ability to make a gift to a favored organization. This should always be the first part of any conversation you have with your advisors.

Tax benefits

There are a number of economic and financial benefits as well. First, there is an income tax charitable deduction for the calculated benefit to charity. The deduction is based on the net present value of the future gift. The deduction is available in the year of the gift and can be carried forward for five additional years if the donor is not able to utilize it currently. In addition to the income tax deduction, there is a possible deferral of capital gains tax. Donors who choose to give appreciated property in exchange for their annuity will not realize the immediate gain on disposition that would normally be due upon sale. The capital gains tax will be stretched out over the lives of the income beneficiaries and paid as they receive income. In fact, one of the attractive benefits of the CGA is the nature of the income. Effectively, there is the possibility of three different tiers of income with each annuity payment:

  1. Ordinary income, which is the presumed interest rate applied to the gift.

  2. Capital gains tax based on the appreciation of the property over its cost at the time of the gift.

  3. Return of capital that is free of tax.

These factors can create a very attractive “after tax” income for some donors.

Further benefits come in the area of estate planning. Assets given to charity are normally out of the estate for estate tax purposes. And though there is a retained income, since that income ceases at death it essentially removes the gifted asset from the taxable estate. While most estates won’t face federal estate tax because of the current exemption being so high, it is important to remember that many states impose their own estate tax and impose it on far smaller estates.

Other applications and considerations

While we’ve covered the very basics of CGAs, there are many other things to know from the perspective of income flexibility and asset transfer. Most CGAs provide income that begins immediately upon the completion of the transfer of the asset to charity. However, it is possible to establish an annuity or series of annuities that will be deferred for a period of time. It is also possible to structure annuities that increase the payment amount over time. There are many reasons why you might consider these options. Planning for retirement is the first thing that comes to mind, but providing income to pay for a grandchild’s college tuition is also a common reason. The possibilities seem endless.

Although we have discussed gifts only of cash and marketable securities because they are the most common assets used, almost any other asset can be utilized. With only 10 percent of American wealth held in liquid assets, freeing up illiquid resources might make the best approach. CGAs can be created with gifts of artwork, real estate, cash-value insurance policies, distributions from qualified plans such as IRAs, closely held stock and almost any other asset you can think of. The rules that govern each of these assets vary, and advisors must become familiar with them in order to provide the most appropriate recommendations to their clients.

Conclusion

While CGAs can be remarkably simple on the surface, they encompass many disciplines and have many variations. Contact me any time to see how this powerful planning tool-and its many nuances--can help you better serve your charitable desires, as well as your estate and income planning needs.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Am I eligible for a Qualified Business Income (QBI) Deduction?

Due to recent tax law changes effective 2018, many are left in a state of confusion about what tax credits or deductions their business may qualify for.  For business owners, the Qualified Business Income deduction is one of the most advantageous new deductions available to them.  It allows for qualified businesses to deduct up to 20% of their income, reducing their tax bill by a considerable margin.  What makes a business a “Qualified Business?”

There are a several requirements to qualify for the QBI deduction.  Could your business be qualified for these tax deductions?  Read on to find out:

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

17 Red Flags for IRS Auditors

Here is a nice article provided by Joy Taylor of Kiplinger:

 

By Joy Taylor, Assistant Editor | March 2017

 

Ever wonder why some tax returns are eyeballed by the Internal Revenue Service while most are ignored? Short on personnel and funding, the IRS audited only 0.70% of all individual tax returns in 2016. So the odds are pretty low that your return will be singled out for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.

 

That said, your chances of being audited or otherwise hearing from the IRS escalate depending on various factors, including your income level, the types of deductions or losses you claim, the business you're engaged in, and whether you own foreign assets. Math errors may draw IRS inquiry, but they'll rarely lead to a full-blown exam. Although there's no sure way to avoid an IRS audit, these 17 red flags could increase your chances of unwanted attention from the IRS.

 

1. Making a Lot of Money

Although the overall individual audit rate is only about one in 143 returns, the odds increase dramatically as your income goes up. IRS statistics for 2016 show that people with an income of $200,000 or higher had an audit rate of 1.70%, or one out of every 59 returns. Report $1 million or more of income? There's a one-in-17 chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Only 0.65% (one out of 154) of such returns were audited during 2016, and the vast majority of these exams were conducted by mail.

We're not saying you should try to make less money — everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.

2. Failing to Report All Taxable Income

The IRS gets copies of all of the 1099s and W-2s you receive, so be sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.

3. Taking Higher-than-Average Deductions

If the deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don't be afraid to claim it. There's no reason to ever pay the IRS more tax than you actually owe.

4. Running a Small Business

Schedule C is a treasure trove of tax deductions for self-employed people. But it's also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions and don’t report all of their income. The IRS looks at both higher-grossing sole proprietorships and smaller ones.

Special scrutiny is also given to cash-intensive businesses (taxis, car washes, bars, hair salons, restaurants and the like) as well as to small business owners who report a substantial net loss on Schedule C.

Other small businesses also face extra audit heat, as the IRS shifts its focus away from auditing regular corporations. The agency thinks it can get more bang for its audit buck by examining S corporations, partnerships and limited liability companies. So it’s spending more resources on training examiners about issues commonly encountered with pass-through firms.

5. Taking Large Charitable Deductions

We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.

That's because the IRS knows what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for noncash donations over $500, you become an even bigger audit target. And if you've donated a conservation or façade easement to a charity, chances are good that you'll hear from the IRS. Be sure to keep all of your supporting documents, including receipts for cash and property contributions made during the year.

6. Claiming Rental Losses

Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. This $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and over 750 hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation.

The IRS actively scrutinizes rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. It’s pulling returns of individuals who claim they are real estate professionals and whose W-2 forms or other non-real estate Schedule C businesses show lots of income. Agents are checking to see whether these filers worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business. The IRS started its real estate professional audit project several years ago, and this successful program continues to bear fruit.

7. Taking an Alimony Deduction

Alimony paid by cash or check is deductible by the payer and taxable to the recipient, provided certain requirements are met. For instance, the payments must be made under a divorce or separate maintenance decree or written separation agreement. The document can’t say the payment isn’t alimony. And the payer’s liability for the payments must end when the former spouse dies. You’d be surprised how many divorce decrees run afoul of this rule.

Alimony doesn’t include child support or noncash property settlements. The rules on deducting alimony are complicated, and the IRS knows that some filers who claim this write-off don’t satisfy the requirements. It also wants to make sure that both the payer and the recipient properly reported alimony on their respective returns. A mismatch in reporting by ex-spouses will almost certainly trigger an audit.

8. Writing Off a Loss for a Hobby

You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. To be eligible to deduct a loss, you must be running the activity in a business-like manner and have a reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you're in business to make a profit, unless the IRS establishes otherwise. Be sure to keep supporting documents for all expenses.

9. Deducting Business Meals, Travel and Entertainment

Big deductions for meals, travel and entertainment are always ripe for audit, whether taken on Schedule C by business owners or on Schedule A by employees.

A large write-off will set off alarm bells, especially if the amount seems too high for the business or profession. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, place, people attending, business purpose, and nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast

10. Failing to Report a Foreign Bank Account

The IRS is intensely interested in people with money stashed outside the U.S., especially in countries with the reputation of being tax havens, and U.S. authorities have had lots of success getting foreign banks to disclose account information. The IRS also uses voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean — in exchange for reduced penalties. The IRS has learned a lot from these amnesty programs and has been collecting a boatload of money (we’re talking billions of dollars). It’s scrutinizing information from amnesty seekers and is targeting the banks they used to get names of even more U.S. owners of foreign accounts.

Failure to report a foreign bank account can lead to severe penalties. Make sure that if you have any such accounts, you properly report them. This means electronically filing FinCEN Form 114 by April 15 to report foreign accounts that combined total more than $10,000 at any time during the previous year. And taxpayers with a lot more financial assets abroad may also have to attach IRS Form 8938 to their timely filed tax returns.

11. Claiming 100% Business Use of a Vehicle

When you depreciate a car, you have to list on Form 4562 the percentage of its use during the year was for business. Claiming 100% business use of an automobile is red meat for IRS agents. They know that it's rare for someone to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.

The IRS also targets heavy SUVs and large trucks used for business, especially those bought late in the year. That’s because these vehicles are eligible for favorable depreciation and expensing write-offs. Be sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for a revenue agent to disallow your deduction.

As a reminder, if you use the IRS's standard mileage rate, you can't also claim actual expenses for maintenance, insurance and the like. The IRS has seen such shenanigans and is on the lookout for more.

12. Taking an Early Payout from an IRA or 401(k) Account

The IRS wants to be sure that owners of traditional IRAs and participants in 401(k)s and other workplace retirement plans are properly reporting and paying tax on distributions. Special attention is being given to payouts before age 59½, which, unless an exception applies, are subject to a 10% penalty on top of the regular income tax. An IRS sampling found that nearly 40% of individuals scrutinized made errors on their income tax returns with respect to retirement payouts, with most of the mistakes coming from taxpayers who didn’t qualify for an exception to the 10% additional tax on early distributions. So the IRS will be looking at this issue closely.

The IRS has a chart listing withdrawals taken before the age of 59½ that escape the 10% penalty, such as payouts made to cover very large medical costs, total and permanent disability of the account owner, or a series of substantially equal payments that run for five years or until age 59½, whichever is later.

13. Claiming Day-Trading Losses on Schedule C

People who trade in securities have significant tax advantages compared with investors. The expenses of traders are fully deductible and are reported on Schedule C (investors report their expenses as a miscellaneous itemized deduction on Schedule A, subject to an offset of 2% of adjusted gross income), and traders’ profits are exempt from self-employment tax. Losses of traders who make a special section 475(f) election are fully deductible and are treated as ordinary losses that aren’t subject to the $3,000 cap on capital losses. And there are other tax benefits.

But to qualify as a trader, you must buy and sell securities frequently and look to make money on short-term swings in prices. And the trading activities must be continuous. This is different from an investor, who profits mainly on long-term appreciation and dividends. Investors hold their securities for longer periods and sell much less often than traders.

The IRS knows that many filers who report trading losses or expenses on Schedule C are actually investors. So it’s pulling returns and checking to see that the taxpayer meets all of the rules to qualify as a bona fide trader.

14. Failing to Report Gambling Winnings or Claiming Big Gambling Losses

Whether you’re playing the slots or betting on the horses, one sure thing you can count on is that Uncle Sam wants his cut. Recreational gamblers must report winnings as other income on the front page of the 1040 form. Professional gamblers show their winnings on Schedule C. Failure to report gambling winnings can draw IRS attention, especially if the casino or other venue reported the amounts on Form W-2G.

Claiming large gambling losses can also be risky. You can deduct these only to the extent that you report gambling winnings (and recreational gamblers must also itemize). But the costs of lodging, meals and other gambling-related expenses can only be written off by professional gamblers. The IRS is looking at returns of filers who report large miscellaneous deductions on Schedule A Line 28 from recreational gambling, but aren’t including the winnings in income. Also, taxpayers who report large losses from their gambling-related activity on Schedule C get extra scrutiny from IRS examiners, who want to make sure these folks really are gaming for a living.

15. Claiming the Home Office Deduction

The IRS is drawn to returns that claim home office write-offs because it has historically found success knocking down the deduction. Your audit risk increases if the deduction is taken on a return that reports a Schedule C loss and/or shows income from wages. If you qualify for these savings, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That's a great deal.

Alternatively, you have a simplified option for claiming this deduction: The write-off can be based on a standard rate of $5 per square foot of space used for business, with a maximum deduction of $1,500.

To take advantage of this tax benefit, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children's playroom as a home office, even if you also use the space to do your work. "Exclusive use" means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night.

16. Engaging in Currency Transactions

The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as a person depositing $9,500 in cash one day and an additional $9,500 in cash two days later).

17. Claiming the Foreign Earned Income Exclusion

U.S. citizens who work overseas can exclude on 2016 returns up to $101,300 of their income earned abroad if they were bona fide residents of another country for the entire year or they were outside of the U.S. for at least 330 complete days in a 12-month span. Additionally, the taxpayer must have a tax home in the foreign country. The tax break doesn’t apply to amounts paid by the U.S. or one of its agencies to its employees who work abroad.

IRS agents actively sniff out people who are erroneously taking this break, and the issue keeps coming up in disputes before the Tax Court. Among the areas of IRS focus: filers with minimal ties to the foreign country they work in and who keep an abode in the U.S.; flight attendants and pilots; and employees of U.S. government agencies who mistakenly claim the exclusion when they are working overseas.

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail  info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc. The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles. Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.