Life and Death Planning for Retirement Benefits

Chapter 7: Charitable Giving

407

The Code gives special favorable treatment to distributions of employer stock from a qualified plan. Any increase in value of such stock, occurring while the stock is in the plan, over the plan’s “cost basis” in the stock is called “net unrealized appreciation” ( NUA). Under certain circumstances, NUA is not taxed at the time of the distribution; rather, taxation is postponed until the stock is later sold. See ¶ 2.5 . A retired employee who holds stock with not-yet-taxed NUA apparently has the same options that other individuals owning appreciated stock have when they wish to diversify their investments and/or increase the income from their portfolios: Either sell the stock, pay the capital gain tax, and reinvest the net proceeds; or, contribute the stock to a Charitable Remainder Trust ( ¶ 7.5.04 ) reserving a life income, thus avoiding the capital gain tax and generating an income tax deduction besides. It is advisable to obtain an IRS ruling if using this technique; see PLRs 1999- 19039, 2000-38050, and 2002-15032 for examples of use of this technique. “NUA” is not the only special tax deal available for qualifying lump sum distributions (LSDs). An LSD to a participant who was born before January 2, 1936 (or to the beneficiaries of such a participant) qualifies for a special tax treatment under which the distribution is excluded from the recipient’s gross income and taxed under a separate rate schedule. This schedule would typically produce a lower-than-normal tax on LSDs up to a few hundred thousand dollars. See ¶ 2.4.06 . The special tax treatment for LSDs has a mixed effect on charitable giving. The effect may be favorable: Since the LSD is excluded from the recipient’s gross income, the recipient may be able to pay the low LSD rate on the distribution, give the distribution to charity, and deduct the gift from his other income, thus saving taxes at his regular income tax rate. Or the effect may be unfavorable: If the distribution is large enough, excluding it from gross income may cause a large charitable gift to exceed the percentage-of-AGI limits on charitable deductions ( ¶ 7.7.01 (A)). The Code allows a business owner, if various requirements are met, to sell stock of his company to an “employee stock ownership plan” (ESOP), then reinvest the proceeds in marketable securities (“qualified replacement property”), without paying income tax on the sale. § 1042 . The untaxed gain carries over to the qualified replacement property and the capital gain tax thus deferred will be paid when the taxpayer “disposes of” the qualified replacement property. A disposition of the qualified replacement property “by gift” does not trigger this recapture provision, but since the Code doesn’t define “gift,” there is some question whether transferring qualified replacement property to a Charitable Remainder Trust (which is not totally a gift if the donor retains an income interest) is considered a gift for this purpose. PLR 9732023 answered this question favorably to the taxpayer involved in that ruling, concluding that “the contribution of the qualified replacement property to the charitable remainder unitrust will not cause a recapture of the gain deferred by the Taxpayers under section 1042(a)....” Unfortunately, even aside from the fact that a private letter ruling cannot be relied on as precedent, the language of the ruling is ambiguous and limited. It says: “In the present case, the transfer of the [qualified replacement property] to the charitable remainder unitrust constitutes a disposition of such property within the meaning of section 1042(e) of the Code. However under the facts of the present case, no gain is realized by the Taxpayers on the transfer...,” with no Gift of other low-tax lump sum distribution Give ESOP qualified replacement property to CRT