Designing and Enforcing Charitable Gifts

Charity is a big business these days!

Most of us give a little each year to support charitable causes and we are happy to allow the charity to apply those gifts as they see fit without any specific agreement regarding how the funds should be used.  But, for a particularly large gift, it is extremely important to have a detailed agreement regarding how the funds should be used.

Many of today’s charitable donors desire to see their gifts used in a specific way or for a specific purpose by the charity.  Many times, though, the donor’s desires are not clearly delineated in writing when the gift is made, which often results in hard feelings between the donor and the charity.  The donor may be upset because the charity did not use the donated funds exactly as he or she intended and the charity is confused because it did not understand exactly what the donor wanted.

This is why it is usually in the donor’s best interest to have a detailed written agreement describing exactly how the donated funds should be used.  In addition, such an agreement often benefits the charity because the charity knows exactly what is expected.  Without a detailed agreement, the charity must often guess as to what the donor wanted, and sometimes it guesses wrong.  This upsets the donor and makes it much less likely the donor will make additional gifts to the charity.  Also, the donor may tell his or her friends about the disappointment, and this could significantly hamper the charity’s ability to raise funds in the future.

In drafting these charitable gift agreements, the following is a list of things to consider:

·                    Clearly State Restrictions.  If the restrictions on how the gift should be used are important to the donor, they should be clearly delineated in the agreement.  Do not assume that the charity will execute the gift with the donor’s intent as its first priority.  Also, do not assume that the charity even fully understands the donor’s intent.  These restrictions should be contained in the agreement and described in as much detail as possible.

·                    Use Your Leverage While You Have It.  Donors will have their most leverage before the gift has been made.  Accordingly, it is very important that the agreement be executed prior to the gift.  It is very common for donors to come to me after the gift has been made and want to add restrictions.  It can be very difficult to get the charity to agree to these restrictions after the fact, and it usually will only agree if there is a promise of future gifts.

·                    Require Regular and Detailed Reporting.  The agreement should require, especially for large gifts, the charity to provide regular and detailed reports about how the donated funds are being used and the status of any project to be completed with the funds.  Otherwise, the donor will have no way to monitor whether the restrictions are actually being followed.

·                    Do Not Make the Restrictions Too Narrow.  While it is important to be specific about the restrictions or the donated funds, it is also important that those restrictions not be too narrow or inflexible.  Otherwise, a situation can arise where the gift actually causes a detriment to the charity and not a benefit.   Under the common law, the only way to have such restrictions removed is through a court proceeding, which can be costly and not always successful.  Under more recent statutes, there may be a little more flexibility to change or expand a charitable purposes, but it is still very important to build in a way to change the restrictions on the gift if the restrictions become completely impractical.

·                    Enforceability of Restrictions.  A method of enforcing the restrictions should be included in the agreement.  First, the agreement should specifically reserve the right in the donor (or the donor’s heirs) to seek enforcement of the gift.  Under the common law, the donor generally does not have standing to enforce a gift (unless he or she specifically reserved the right), and the only person with the authority to sue is the Attorney General.  Accordingly, it is critically important to specifically reserve the donor’s right to enforce the restrictions.

In addition, the agreement should specifically state what happens if the charity does not comply with the restrictions.  Often, this should be that the funds will be distributed to a different charity.  Accordingly, it is prudent to designate a contingent successor charitable beneficiary.

·                    Don’t Forget About Taxes.  A contribution is deductible for federal tax purposes only if it is made “to or for the use of" a charitable organization.”  A donor may earmark a contribution to charity for a particular use without jeopardizing the charitable deduction, provided the restriction does not prevent the charity from freely using the transferred assets.  The Treasury Regulations provide examples of permissible restrictions, including the contribution of land to a city to be used as a public park, where the city intends to use the land for such purpose at the time of the gift; the creation of an endowment fund for a particular university department; and the donation of funds for the construction of a building sought to be built by an exempt organization.

If the gift is designated or earmarked for a non-charitable purpose, however, or even a charitable purpose that is outside of the donee organization's mission, the gift is not deductible. To ensure deductibility, the donor should utilize a gift agreement that specifically recognizes that the conditions placed upon the gift are in furtherance of, and consistent with, the donee's exempt purpose. For substantial gifts, a board resolution from the donee organization containing a similar acknowledgment might be considered.

When designing conditional gifts, reverter clauses are sometimes used. For example, if the city described in the Treasury Regulations ceased to use the donated property as a public park, the gift agreement or deed of gift could provide that ownership of the land would revert back to the donor’s family. Such reversionary provisions must be used with caution since they will cause the charitable transfer to be nondeductible unless the reversion is “so remote as to be negligible.”  In Briggs v. Commissioner, the Tax Court defined “so remote as to be negligible” as a “chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction” and “so highly improbable and remote as to be lacking in reason and substance.”

In Rev. Rul. 2003-28, the donor transferred a patent to a university on the condition that a designated faculty member remain on the faculty during the patent's fifteen-year remaining life. The IRS determined that the possibility the faculty member might not remain on the faculty was not so remote as to be negligible and no charitable deduction was allowed.  On the other hand, the city park example above illustrates that where the circumstances at the time of the gift indicate a strong likelihood that there will be no reversion, the charitable deduction will be permitted.

An alternative to reversions (and a much better option) is to provide in the gift agreement that if the primary purpose of the gift cannot be fulfilled, the gift will be used by the charity for an alternate purpose or transferred to another charitable organization.

Some commentators are also concerned that if the donor places too many restrictions on a gift, the IRS will not treat the gift as a contribution to the charity, but rather as the establishment of a separate charitable trust, subject to the private foundation rules. This would create tax headaches for both the donor and donee, due to the deduction limitations, as well as for the ongoing operation of the fund, which would then be subject to the strict restrictions imposed on private foundations.  Accordingly, one should be very careful to make sure that the conditions are not too extensive or limiting. 

·                    And One for the Charity – Naming Rights.  As stated above, a detailed agreement also benefits he charity.  One issue that has received a lot of atttention recently is naming rights.  Donors often want to establish lasting memorials by having buildings, scholarship funds and other things named after them.  What happens, though, when the donor is involved in a scandal or circumstances otherwise change where the charity does not want to be associated with the donor.  Under the common law, the result likely is that the charity must either keep the name or give the money back.  Accordingly, the charity should push for the agreement to include procedures where the charity can remove the name and keep the donated funds.

How to Prepare for Your Meeting with the Lawyer

One of the most frequent questions I get from new clients is "What do I need to bring to the initial meeting."  This is a very important question and one I typically raise on my own if the client has not already asked.  The answer to this question is anything that I need to see or will allow that meeting to be shorter.  Because, as we all know - time is (your) money.

There is some basic information that I will need that you can put together in advance.  This will save the time of gathering the information during the meeting.  This generally includes the following:

1.  Names and ages of you, your spouse and all of your children (and grandchildren, etc.).  Also, if it is not obvious from your child's name, please indicate whether your child is a boy or girl.  (In today's world, it is VERY common for girls to have names that were traditionally reserved for boys).  A complete family tree would also be nice, especially if you have a more complicated family (second marriage, step-children, etc.)

2.  A financial statement.  This is very important.  Sometimes clients will not bring this (even though I request it) and I suspect that it is because they don't want to spend the time pulling all the information together.  Fight this urge.  I will need a good sense of your finances before I can prepare your will, and if you don't prepare it prior to the meeting, then we will have to prepare it at the meeting.

On the financial statement, it also important to understand what I need.  It is not important for me to know that you have exactly $10,512.63 in your checking account.  If you tell me "about $10,000", that is close enough.  What is important for me to know is that it is a checking account, as opposed to a retirement account (401(k), IRA, etc.) or an insurance policy or something else.  Also, it is important for me to know how it is owned.  Ownership is very important. Whether it is titled in your name or jointly with a spouse or someone else can have drastic consequences when it comes to the distribution of your estate, and I need to know that.

3.  Think about who should be in charge of settling your estate if you should die.  There are several important people that are appointed in your will - executor, trustee, guardian and power of attorney.  You may not know exactly what each of these persons does prior to our meeting, but that is okay.  It helps though to at least have thought about the people who you would consider for these jobs.

4.  Should you bring previous wills?  It is certainly okay to bring them.  More information is better than not enough.  But, if you bring all the other information above, then previous wills are probably not needed.

I have a questionnaire that I send to clients in advance of our meeting that helps them pull this information together.  Fill it out.  It is important and will save you time and money.  This also something that a financial planner, if you have one, can help with.

When the Client is Wrong

The customer is always right.

Well, not always.  Sometimes the customer, or in my case the client, is wrong.  As a lawyer, how much and for how long do you push back before finally giving in to a client's demands.  This is a really tough question for a lawyer to answer, and inevitably, the answer is it depends.  

Of course, if the client is asking you to do something illegal or unethical, then as a lawyer you stop it right away, or if the client insists, you break-off the engagement.  But, I am not talking about that situation.  I am more interested in the situation where your experience and judgment make it clear that there is a better way to do something, but the client still insists on doing it another way.

In my practice, this problem can evidence itself in many ways, but one of most common involves the drafting of trust language.  For example, when creating a trust, the far better way to draft a trust that will last many years into the future (in TN this can be up to 360 years) is to make it as broad and flexible as possible.  Because none of us has a crystal ball, it is impossible to know what the circumstances may be in the future, and we want the trustee to have the flexibility to deal with any situation that arises.

Clients, though, occasionally have their owns thoughts.  And, sometimes, they want specific thresholds that must be met before a distribution can be made.  Things like - graduates from college, has a job, earns $X from his or her own efforts, gets married, etc., etc.  Also, the incentives can be negative - is not in jail or on drugs, etc.

Of course, as soon as you set-up these guidelines, you create problems.  What if a beneficiary has special needs and cannot attend college.  What is a beneficiary decides to be a schoolteacher or enter the clergy, both noble pursuits, but likely not financially rewarding.  What if the beneficiary is not in jail or on drugs, but is  a spendthrift and will blow any money given to him or her.  And on and on.

Most times I explain this to clients, they agree, and we do it my way.  Occasionally, though, the client is resolute.  So, what do you do?  My practice has been to make the best case I can as often as I can for the "best way" (read, my way) of doing something.  If the client will not budge, though, I generally will submit and follow the client's wishes.  After all, I am here to serve the client and, unless it is illegal or unethical, ultimately I will give the client what he or she wants.

NOTE TO CLIENTS - To all you clients or potential clients out there, LISTEN TO YOUR LAWYER.  You are paying me (a lot) for my expertise and experience.  Believe it or not, it is possible that somewhere in all my schooling and my working in this area everyday that I know more about this than you do.  If you ultimately decide that I don't know I'm talking about, then fine.  But, at least think long and hard about what your lawyer tells you.

And lawyers, always make notes to your file regarding the advice given and the decision the client finally made.  You will thank me for this later.

Where Do We Stand Six Months Later?

Alright, so it's been a while since I last posted;  things have been busy.  But, it's summer now and I have more time.  So, let's jump right in.

Last December, we estate planners got what we had long been waiting for - new estate tax legislation (if only for two years.)  Back then, there was a lot of speculation regarding how this new law would change everyday estate planning for people.  So, with that in mind, I thought it might be interesting to reflect back on the last six months to see what, if anything, has changed in my practice.

Here we go:

1.  People are making taxable gifts to use up more of their additional $4,000,000 ($8,000,000 for a married couple) exemption from the federal gift tax.  As most of you know, the new law increased the amount that can be given away during lifetime by a person without paying gift tax from $1,000,000 to $5,000,000.  Because it is almost always better to transfer assets during lifetime rather than waiting until death, some clients are taking the plunge and making taxable gifts.  The number clients of making taxable gifts (or at least considering taxable gifts) is significantly more than the last couple of years.  But, it's not like everyone is doing it either.

One reason why it takes a little "courage" so to speak for those of us lucky enough to live in TN is that TN has its own separate gift tax.  And, if a married couple decided to make an $8,000,000 gift, they would owe some $700,000 or so of TN gift tax (and that's a fair amount of change!).  There are ways to potentially avoid this TN tax (like finding some non-TN assets to give away), but it requires some planning.

2.  Planning for couples with retirement accounts is a little easier.  More and more often, my clients' single biggest asset is a retirement account.  Planning with a retirement account is extremely complex for married couples.  In the past, to take advantage of both spouses' exemption from the estate tax, you often had to leave the retirement account to the bypass trust, which is fraught with peril.

The new tax act has brought us portability, though, and it is no longer (at least for the next two years) necessary to create a bypass trust at the first death (subject, of course, to all necessary disclaimers).  This makes funding the bypass trust a non-issue and this type of planning much easier.

3.  More Bypass Trusts for TN Amount.  With the higher federal exemptions, fewer people need sophisticated federal estate tax planning.  But, the exemption from the TN inheritance tax is still only $1,000,000 and there is no portability.  Accordingly, it is still necessary for many married couples to establish a bypass trust at the first death to take advantage of both spouses' exemptions from the TN inheritance tax.

4.  More of the Same.  With the exception of the above, for the most part, nothing much has changed.  For wealthy taxpayers, GRATs (and other estate freezes) and valuation still are the most important transfer tax issues we deal with on a day-to-day basis.

That is my update for today.  More to come, I promise . . .