The gift of the policy or other property must be made to a qualified charity such as a nonprofit school or hospital, a church or synagogue, or a local or civic organization such as the Boy Scouts or Girl Scouts of America. Qualified means that the charity meets three conditions:
- the organization is operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competitions, or to prevent cruelty to children or animals;
- no part of the earnings of the organization can be used to benefit any private shareholder or similar individual; and
- the organization cannot be one disqualified for tax exemption because it attempts to influence legislation or participates in, publishes, or distributes statements for, or intervenes in, any political campaign on behalf of any candidate seeking public office.
The gift of the policy or other property must be made before the end of the taxable year, even if the client is an accrual basis taxpayer. (Corporations reporting income on the accrual basis are subject to a less stringent standard.)
The gift must be of the donor’s entire interest; generally, no deduction will be allowed for a gift of a partial interest (unless strict and narrow rules are met). So in most cases where a policy will be co-owned, or the death proceeds, cash values, or dividends will be split between noncharitable and charitable beneficiaries, no deduction will be allowed.
Records must be kept, preferably in the form of canceled checks payable to the charity and/or a receipt from the charity showing the date, amount, and identity of the donor and donee.
The gift must exceed any benefit the client receives from the charity. If the client receives a benefit from the charity in conjunction with his gift, the deduction will be limited to the excess of the amount donated over the value of the benefit received from the charity.
Insurable Interest
Assume your client purchases a policy on her life and donates it to a charity in a state in which the charity has no insurable interest in the client’s life. The IRS could argue that under state law the decedent’s estate (and therefore her heirs) could claim the policy proceeds in spite of the charity’s ownership because the charity has no insurable interest. The IRS could then argue that the client’s ostensible transfer of all her rights really gave the charity less than her entire interest in the policy. The IRS would state that even though the donor clearly thought she gave all the interest she actually had, because her estate could claim an interest in the proceeds, she was actually in control of the proceeds. The IRS would then seek to disallow income, gift, and estate tax deductions and include the proceeds in the insured’s estate, which would be the worst of all possible tax consequences.
Practitioners must carefully read the precise wording of applicable state law. Under New York law, for example, a charity has an insurable interest only if the insured is the policy purchaser and transferor. The statute does not appear to apply to a transfer where one spouse purchases a contract on the other spouse’s life and then assigns it to the charity, nor where the charity itself is the purchaser. Other states (Georgia, for example) provide that any institution that meets the Internal Revenue Code definition of a qualified charity has an insurable interest in the life of any donor.
Life insurance carriers generally look not only at whether an insurable interest exists, but also examine the extent of the insurable interest as part of their financial underwriting. For example, they may examine the donor’s history of giving to the charity and limit the amount of death benefit to what it would take to replace that amount.
Substantiation Rules
Substantiation rules set out the requirements that a donor must meet in order to document the value of the charitable gift. Failure to meet these requirements will result in the deduction for the charitable contribution being disallowed by the IRS. A gift of a life insurance policy is considered a noncash gift, and the substantiation requirements vary based on the value of the gift.
Less than $250
The donor should obtain a receipt from the charitable organization showing:
- the name of the charitable organization;
- the date and location of the charitable contribution; and
- a reasonably detailed description of the property.
Additional records must also be kept as detailed in IRS Publication 526.
Between $250 and $500
The charity provides the donor with a contemporaneous written acknowledgement of the contribution showing the same information listed above. The same additional records must also be kept.
Between $500 and $5,000
The requirements for noncash gifts of greater than $250 are met, more detailed additional records are kept, and the donor must complete Section A of IRS Form 8283, which provides:
- the charity’s name and address;
- a description of property;
- how and when the donor acquired the property;
- basis;
- fair market value;
- method by which the property was valued.
More than $5,000
The requirements for noncash gifts of greater than $500 must be met and a “qualified appraisal” is required. Under Code section 170(f)(11)(E) neither the donor nor the insurance agent (or insurer who issued the policy) can perform this appraisal. Section B of IRS Form 8283 must be completed.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM