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CBO Estimates Deficits in 2009, 2010, 2011

Tax Quote of the Week

"Tax systems can have multiple goals. For example, in addition to the common goal of raising revenue for the government, goals can also include redistributing income, stabilizing the economy, and achieving various other social and economic objectives through the use of preferences. Generally speaking, the greater the number of goals, the more complex is the tax system."

-- The General Accounting Office

CBO Estimates Deficits in 2009, 2010, 2011

The Congressional Budget Office (CBO) released its August 2009 projections. The CBO periodically estimates the federal revenues, expenditures and budget for the next 10 years.

This estimate is based on the future tax rates for the federal government and enables it to project total revenue. The other major factors are expenditures for foreign and domestic programs and the rate of inflation.

For the next three years the deficit projections are:

Year 2009	$1.6 trillion
Year 2010	$1.4 trillion
Year 2011	$0.92 trillion

Federal deficits tend to be higher when the business cycle is down. Because of the recession in 2008, the CBO projection is that there will be larger deficits for 2009, 2010 and 2011.

When the business cycle is lower, federal payments for unemployment insurance and assistance to those in need are higher. In addition, both personal and tax revenue and corporate tax revenue are lower.

The CBO projections indicate that the economy will be functioning below its full potential for these three years. With slow and steady growth in the economy, the CBO estimates that the economy will be close to full potential by the end of 2011.

One Year Estate Tax Extension Predicted

In a financial planning webcast on September 2, 2009, John Buckley, Chief Tax Counsel for the House Ways and Means Committee, discussed the estate tax.

In response to a question on future plans for the estate tax he responded, "I think one reason you will probably see a one-year extension this year is statutory pay-go."

Mr. Buckley is referring to the Statutory Pay-As-You-Go Act of 2009 (H.R. 2920). This bill passed the House in June. If it is enacted, it exempts some expenditures and tax provisions, including the permanent extension of estate and gift taxes at 2009 levels.

However, because the Senate may not pass the bill, the permanent extension of the $3.5 million exemption and the 45% top estate tax rate would cost $233 billion over 10 years. With the current deficit, it is quite probable that the Senate will not pass a permanent estate tax extension but will instead extend the 2009 estate tax provisions for one more year.

Editor's Note: A one year "patch" still leaves the estate planning world in a state of uncertainty. With the large budget deficit numbers from CBO, there are senators who privately suggest that the estate exemption could revert to $1 million in 2011. While this does not seem to be a very likely action by the Senate, it continues to create uncertainty for estate planners.

Gift Annuities Subject to Federal Securities Law

In Warfield v. Bestgen, No. 07-15586; D.C. No. CV-03-02390-JAT (9th Cir., 24 June 2009), the Ninth Circuit Court of Appeals determined that gift annuities are subject to securities law.

Between 1996 and 2001, the Mid-America Foundation lead by President Robert Dillie offered charitable gift annuities. Mid-America worked through financial planners and paid a commission to financial planners who would encourage clients to create gift annuities with the Foundation.

Rather than placing the $55 million collected from 400 gift annuitants into a reserve fund and making payments, President Dillie used the funds improperly and Mid-America became bankrupt. Robert Dillie was sentenced to 121 months in prison for fraud.

Receiver Lawrence Warfield was appointed to recover assets and assist the 400 gift annuitants. He brought an action against the financial planners to recover the commissions they had received on placement of the gift annuities. His action was successful in District Court in Phoenix, Arizona, and assessments were levied against financial planners in the amounts of $31,900 to $109,900.

The financial planning defendants appealed. They claimed that gift annuities were not investment agreements subject to the Securities Act of 1933. In addition, they maintained that gift annuities and the planners were exempted from SEC regulation under the Philanthropy Protection Act of 1995.

The Court relied on the standard of SCC v. W.J. Howey Co., 328 U.S. 293 (1946). The Howey test indicates that a security is subject to the 1933 Securities Act if it is (i) an investment of money, (ii) in a common enterprise, and (iii) the investor has an expectation of profits.

With a charitable gift annuity, Mid-America did receive funds, transferred the $55 million into a common pool that was invested in stock and bonds and the annuitants did have an expectation of profits. The annuitants would profit particularly if they outlived their anticipated life expectancy. Therefore, the Howey test was met.

The Court also reviewed the promotional materials of the Mid-America Foundation and noted that its claim that to receive "the same return through the stock market, investors would have to find investments that pay dividends of 19.3%!" Other brochures claimed that the gift annuity was "the oldest and safest financial instrument available" and "the rate of return on a Mid-America Foundation gift annuity is hard to beat!"

Under the Philanthropy Protection Act of 1995 (PPA 1995), charities in compliance with the Act are exempted from registration. However, the Court indicated that even though the charity may be exempted from registration under PPA 1995, they would still be subject to the fraud provisions of the Securities Act. Therefore, because the gift annuities are investment contracts covered by the 1933 Securities Act, the fraud provisions are applicable.

The Court noted that PPA 1995 does not provide a securities registration exemption for organizations that pay a "commission or other special compensation based on the number of donations collected for the fund." Because Mid-America paid commissions to the financial planners, the PPA 1995 registration exemption does not apply. Finally, in response to the claim by the financial planners that a gift annuity is a gift because donors' charitable intent is not a security, the court indicated that the charitable motivation is laudable but does not remove the gift annuity from the application of the SCC anti-fraud provisions.

Therefore, the court determined that gift annuities are investment contracts, that the brokers are not exempted from registration and affirmed the lower court decision.

Editor's Note: This case highlights the importance of charitable gift annuity best practices. Most charities issuing gift annuities follow good practices. Many charities have reserve funds and endowments that far exceed potential annuity liabilities. Therefore, charities will continue to maintain and grow gift annuity programs. But all charities and boards of directors for charities should ensure that they are following these gift annuity best practices:

1. Promotional materials should use careful language.

2. In all written and electronic materials, emphasize fixed payments and the charitable gift.

3. Communicate accurately about income tax savings and partly tax-free income.

4. Maintain a substantial annuity reserve balance; many organizations voluntarily choose to transfer 100% of the gift amount to the reserve fund.

5. Follow state regulations on gift annuity registration, reserve requirements and investment requirements for the state of domicile of the annuitant.

6. Do not issue a gift annuity to an annuitant in a regulated state if the charity is not registered, even if it requires you to turn down a major gift.

7. Reinsure the gift annuity if your organization is unable to provide adequate financial security for the annuity reserve fund.

8. Do not ever pay a commission to a gift annuity representative.

Applicable Federal Rate of 3.4% for September -- Rev. Rul. 2009-29; 2009-37 IRB 1 (18 Aug. 2009)

The IRS has announced the Applicable Federal Rate (AFR) for September of 2009. The AFR under Sec. 7520 for the month of September will be 3.4%. The rates for August of 3.4% or July of 3.4% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2009, pooled income funds in existence less than three tax years must use a 4.8% deemed rate of return. Federal rates are available by clicking here.

PLR THIS WEEK

PLR - 200935402 Supporting Organization Converts to Private Foundation

Charity is classified as a Sec. 509(a)(3) supporting organization. Its purpose, as stated in the Articles of Incorporation, is to promote the health and well-being of Community residents by supporting the charitable activities of two specifically named 501(c)(3) hospitals. One of these named hospitals is L. Support provided by Charity includes financial assistance and services directly to the named hospitals. Charity and M, a Sec. 501(c)(3) hospital not named in Charity's Articles, entered into a joint venture agreement in which each contributes at least one Sec. 501(c)(3) hospital into a new Sec. 501(c)(3) organization known as System in exchange for a respective membership interest percentage. System is the parent hospital for subordinate nonprofit healthcare facilities such as L. Charity may nominate System directors subject to M's approval, but may not control operations or withdraw or transfer the interest to a third party. System has not and will not distribute income to Charity or M. Charity's revenue is entirely passive income. Charity proposes an amendment to its Articles of Incorporation eliminating the support of the specifically named hospitals in favor of a more general promotion of the health and well-being of Community residents.

The Service ruled that the proposed amendment to the Articles of Incorporation will not change Charity's exempt status but will cause reclassification from a supporting organization to a private foundation. Under Sec. 501(c)(3), exemption from federal income taxation requires that the organization operate exclusively for charitable purposes and that no part of net earnings insures to the benefit of any private party. Reg. 1.501(c)(3)-1(c)(1) states that an organization satisfies this requirement if it engages primarily in activities that accomplish at least one Sec. 501(c)(3) purpose and fails if more than an insubstantial part of its activities are not in furtherance of an exempt purpose. The amended Articles also disqualify Charity from Supporting Organization status under Sec. 509(a)(3) because Charity eliminated its support of the two specifically named hospitals.

To view the full PLR Click Here.

ARTICLE OF THE MONTH

Current Planned Gifts III - Life Estates

Under Sec. 170(f)(2) of the Internal Revenue Code, a person may give a remainder interest in a personal residence or farm to a charity and reserve the right to live there for one or two lives. But what if circumstances change and the donor no longer desires to live in the home? Or perhaps mother and father created a two-life estate and father passes away? Are there options that mother should now consider? Fortunately, there are several potential flexibility options for a life estate donor.

Assume that John and Mary Jones, both age 75, transfer the remainder interest in their $300,000 home to charity. As owners, they agree to be responsible for the maintenance, insurance and taxes. To make certain that both John and Mary understand their obligations, they sign a Maintenance, Insurance and Taxes (M.I.T.) agreement with the charity.

One caution must be emphasized with respect to the "M.I.T." agreement - the charity must have a life estate in the home and there can be no prearranged obligation to select any of the possible flexibility options. The IRS will deny the charitable income tax deduction if any binding obligation exists. In any case, the purpose of having flexibility options is enhanced by not choosing one until the time for a later change of ownership.

To view the full Article of the Month Click Here.

CASE OF THE WEEK

The Values-Based Lead Trust

Stacy Powers, 40, has led an interesting life. At the age of 1, Stacy was put up for adoption. Stacy's mother was a homeless woman with little resources to care for a young child. Soon thereafter, Dr. and Mrs. John Powers adopted Stacy. The Powers were very affluent and educated, but sadly were unable to have their own children. Not surprisingly, the adoption of little Stacy was a dream come true for the Powers.

Over the next 20 years of Stacy's life, the Powers smothered Stacy with love, affection, time and money. Stacy was a long way from her humble and tough beginnings. Stacy soon became very accustomed to the constant "spoiling" and financial support of her parents. As a result, Stacy possessed little drive and initiative. In fact, her idea of a productive day consisted of shopping trips and hours at the salon. Over the next 20 years, Stacy continued on this path. While a good person with a good heart, the Powers felt that Stacy did not develop and mature as an adult.

During a visit with their estate planning attorney, the Powers expressed their concerns about Stacy. The Powers did not want to leave their entire estate to Stacy fearing that she would simply spend it away. Instead, the Powers wanted an estate plan that provided retirement security, financial responsibility, and a love of philanthropy.

What planned gift would give Stacy philanthropic involvement? How could this planned gift be structured to provide Stacy with retirement security and financial responsibility?

To view the solution to this Case of the Week Click Here.

Note:Case studies, articles, commentary and other materials in the GiftLaw system are included solely as educational information. Articles and editorial comments are offered as an educational service to friends of this organization, and may not always reflect our official position on any issue. Since case studies or articles may not always reflect the current AFR or tax law, it may be necessary to run any illustration with a current version of Crescendo to obtain updated information. If professional services are required, all persons shall consult with their qualified professional advisors. Tax Quotes are courtesy of Jeffery L. Yablon, Washington, D.C.

Indiana Community Foundations

September 7, 2009

Thank you for your interest in the Community Foundation of Grant County. To contact us, please call 765.662.0065 or check out our website at www.comfdn.org.

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Thank you for your continued interest in a better quality of life in Grant County.

Yours in Philanthropy,

Elizabeth A. Wright and Dawn M. Brown...
on behalf of the entire Community Foundation Team