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GiftLaw Pro Home   >  Chapter 9 - Tax References  >  9.5 Private Letter Rulings  >  Flexible Deferred Annuity

Private Letter Rulings - Flexible Deferred Annuity

GiftLaw Note:
Deferred annuities are merely annuity contracts in which the payment is deferred for one year or longer. However, many deferred annuitants would like a flexible choice of dates for starting the payment. The concept is relatively simple - the annuitant sets a preferred payout age, such as 65, and a printout is prepared for payout ages from perhaps age 60 to age 90. If the annuitant decides to take the payout earlier, he or she will receive a smaller payout. Conversely, by deciding to wait and take the payout at a later date, the donor will receive a larger annual payout amount.

Crescendo Program 55 includes the flexible annuity option as one of the available strategies. A desired payout date and a payout range of up to 32 years may be selected for the flexible annuity option.

Dear Sir or Madam:

This is in reference to a ruling request dated February 20, 1997, concerning the federal tax consequences of the proposed transaction described below.

The information provided indicates that you (the "Foundation") are a charitable organization described in section 501(c)(3) of the Internal Revenue Code. The Foundation proposes to offer an annuity contract to B, an individual.

The proposed annuity contract would establish a deferred gift annuity, under which a donor makes a charitable contribution of $25,000 to the Foundation in exchange for the obligation of the Foundation to pay an annuity to B or other annuitant in fixed amounts over the life of the annuitant, with the beginning date for payment deferred to some date in the future.

The annuity contract allows the annuitant to elect the commencement date of the payments under the annuity, at any time after the annuitant, who is currently age 50, reaches age 55. When the election is made by the annuitant, the annual annuity payment will be determined based on the age of the annuitant in accordance with pre-existing tables.

In a written acknowledgement to be provided to the donor at the time of the contribution, the Foundation will: (1) state the amount of cash contributed; (2) state that the Foundation provided something in return; (3) inform the donor that the amount of the contribution that is deductible is limited to the excess of money contributed over the value of the goods and services to the donor; and, (4) provide an estimated value of B's charitable contribution at an amount that reflects the maximum possible non-charitable value of the annuity, even though the donor may decide to defer the starting date of the annuity which could reduce the non-charitable value of the annuity contract.

Section 170(a)(1) of the Code allows as a deduction any charitable contribution (as defined in section 170(c)) payment of which is made within the taxable year.

Section 170(c) of the Code defines a "charitable contribution" as a contribution or gift to or for the use of a qualified charity.

Section 1.170A-1(d)(1) of the Income Tax Regulations states that in the case of an annuity purchased from a qualified charity, there shall be allowed as a deduction the excess of the amount paid over the value at the time of purchase of the annuity.

Section 170(f)(8) of the Code states that no deduction shall be allowed under section 170(a) for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the donee organization.

Section 1.170A-13(f)(16) of the regulations states that if a taxpayer purchases an annuity from a charitable organization and claims a charitable contribution deduction of $250 or more for the excess of the amount paid over the value of the annuity, the contemporaneous written acknowledgment must state whether any goods or services in addition to the annuity were provided to the taxpayer.

Section 511 of the Code imposes a tax upon the unrelated trade or business income of tax-exempt organizations.

Section 513(a) of the Code provides that the term "unrelated trade or business" means any trade or business, the conduct of which is not substantially related (aside from the need of an organization for funds) to the exercise or performance by such organization of its charitable, educational or other function which constitutes the basis for its exemption.

Section 1.513-1(d)(2) of the regulations provides that a trade or business is related to exempt purposes in the relevant sense, only where the conduct of the business activity has a causal relationship to the achievement of exempt purposes (other than through production of income) and is "substantially related" only if the causal relationship is a substantial one. The activity from which income is derived must contribute importantly to the accomplishment of exempt purposes.

Section 512(b)(1) of the Code excludes interest income from the computation of the tax on unrelated trade or business income.

Section 514(a)(1) of the Code states that in computing the unrelated business income tax under section 512, income derived from debt-financed property should be included.

Section 514(c)(5) provides that the rules concerning debt- financed property should not apply to the sale of annuities where (1) the annuity is the sole consideration issued in exchange for the property if, at the time of the exchange, the value of the property is less than 90 percent of the value of the property received in the exchange, (2) the annuity is payable over the life of one individual in being at the time the annuity is issued or over the life of two individuals in being at such time, and (3) the annuity is payable under a contract which does not guarantee a minimum amount of payments and does not provide for any adjustment of the amount of the annuity payment by reference to the income received from the transferred property or any other property.

Section 501(m) was added to the Code by the Tax Reform Act of 1986, Pub. L. 99-514 (1986). The section states that an organization described in section 501(c)(3) or section 501(c)(4) of the Code may be exempt from tax under section 501(a) only if no substantial part of its activities consists of providing "commercial- type insurance." Section 501(m)(3) sets forth a list of items deemed not to be "commercial-type insurance." Section 501(m)(4) provides that the issuance of annuity contracts shall be treated as providing insurance.

Section 501(m)(2) of the Code provides that an organization that provides insurance as an insubstantial part of its activities shall be treated as an insurance company for purposes of applying Subchapter L (Insurance Companies) with respect to such activity.

The Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647 (1988) amended section 501(m) by adding 501(m)(3)(E) which adds the term "charitable gift annuities" to the list of exceptions from commercial-type insurance. Section 501(m)(5) provides that for purposes of 501(m)(3)(E) the term "charitable gift annuity" means an annuity if (A) a portion of the amount paid in connection with the issuance of the annuity is allowable as a deduction under section 170 or 2055, and (B) the annuity is described in section 514(c)(5) (determined as if any amount paid in cash in connection with such issuance were property).

The legislative history accompanying the 1988 Act provides that " t he present-law exception to the debt-financed property rules has historically exempted from tax ANY income resulting from the issuance of charitable gift annuities." H.R. Rep. No. 795, 100th Cong., 2d Sess. 116 (1988) emphasis supplied.

Section 6115(a) of the Code states that if a qualified charity receives a quid pro quo contribution in excess of $75, the charity shall, in connection with the solicitation or receipt of the contribution, provide a written statement that informs the donor that the amount of the contribution that is deductible for federal income tax purposes is limited to the excess of the amount of any money and the value of any property other than money contributed by the donor over the value of the goods or services provided by the organization, and provide the donor with a good faith estimate of the value of the goods or services.

Section 6115(b) of the Code defines quid pro quo contribution as a payment made partly as a contribution and partly in consideration for goods or services provided to the payor by the donee organization.

The regulations under section 170 of the Code allow a deduction for the excess of the amount paid by B over the value of the annuity provided by the Foundation. As the preamble to the final regulations under sections 170(f)(8) and 6115 states, " t here is no single correct way to determine fair market value; a charitable organization may use any reasonable methodology." The Foundation's proposed method of estimating the value of the annuity is not unreasonable.

Moreover, it appears that the issuance of "charitable gift annuities" has historically been treated as a borrowing of money by the issuing organization and the sales aspect of the transaction has been ignored. Section 514(c)(5) of the Code specifically exempts "charitable gift annuities" from being considered "acquisition indebtedness" and thereby ensures that the interest, rents or dividends secured by the educational institution from the investment of the proceeds it receives from issuing these annuities will not be subject to unrelated business income tax. This exception from the debt-financed income provisions of the unrelated business income tax would be virtually useless if the proceeds themselves were subject to the unrelated business income tax.

Accordingly, we rule as follows:
  1. The issuance of a deferred charitable gift annuity, as described above, will not result in income from an unrelated trade or business as defined in sections 511-513 of the Code.
  2. The income earned by the Foundation from investment of charitable gift annuity funds will not be unrelated debt-financed income within the meaning of section 514 of the Code.
  3. The annuity contract issued by the Foundation, as described above, is a charitable gift annuity within the meaning of section 501(m)(5) of the Code, as long as the value of the annuity is less than 90% of the value of the property received by the Foundation.
  4. The proposed gift acknowledgement will meet the requirements of section 170(f)(8)(B) of the Code.
  5. The proposed gift acknowledgement will meet the requirements of section 6115(a) of the Code.
This letter is directed only to the organization that requested it. Section 6110(j)(3) of the Internal Revenue Code provides that this letter may not be used or cited by others as precedent.

We are informing your key District Director of this ruling. Because this letter could help resolve any questions about your exempt status and foundation status, you should keep it in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

Sincerely,
____
Edward K. Karcher
Chief, Exempt Organizations
Technical Branch 3


Related Topics On Flexible Deferred Annuity

3.4.2  Flexible Annuity:    With a standard deferred annuity, the payout is deferred for one or more years. However, there is a fixed date for payout. The disadvantage of the standard deferred annuity is that the annuitant is locked in to a specific payment date and amount. If he or she desires to retire earlier or later, the standard deferred annuity does not change. Deferred annuities would be more attractive to donors if there were greater flexibility, similar to the options available with a commercial annuity.


6.3.4  Flexible Deferred Gift Annuity:    In PLR 9743054, the Service approved the use of a flexible deferred gift annuity. A flexible deferred annuity allows a donor to select a target date and when the annuity payments will begin.