3. ELEMENTS AND TIMING OF A CHARITABLE GIFT, Part 1 of 2

3. ELEMENTS AND TIMING OF A CHARITABLE GIFT, Part 1 of 2

Article posted in General on 5 August 2015| comments
audience: National Publication, Russell N. James III, J.D., Ph.D., CFP | last updated: 5 August 2015
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Summary

We continue our journey through Visual Planned Giving, now visiting Part 1 of charitable income tax deductions.

VISUAL PLANNED GIVING:
An Introduction to the Law and Taxation
of Charitable Gift Planning

By: Russell James III, J.D., Ph.D.

3. ELEMENTS AND TIMING OF A CHARITABLE GIFT, Part 1 of 2

Links to previous sections of book are found at the end of each section.

Understanding what a charitable gift is and when a charitable gift is made seems like an obvious and simplistic task.  What could be easier?  As shown in this chapter, what initially appears to be a simple concept can become quite complex.  But, a fundamental competence required of anyone who will be advising donors about charitable gifts is to know what tax consequences such gifts will generate.  Charitable gifts can generate income tax deductions.  Applying that knowledge requires knowing what constitutes a charitable gift for tax purposes.  Regardless of its size or its benefit to a charity, any transfer that does not meet the definition of a charitable gift for tax purposes will generate no charitable deduction.  So, let’s begin by looking at what is a charitable gift for tax purposes and then consider examples of transfers that are not charitable gifts for tax purposes.

A deductible charitable gift occurs when the donor delivers money or valuable property to a charity or agent of the charity.  That’s it.  There is nothing particularly complicated about the definition (except perhaps the phrase “agent of the charity” which simply means a representative of the charity).  How then could things possibly become complicated when starting with such a simple definition?

The first example of an action that is not a charitable gift for income tax purposes is a promise to deliver money or valuable property in the future.  A promise is not a gift.  Even if the promise is a legally enforceable written contract, it is still just a promise, so it is not a gift – at least not yet.  Once the promise is fulfilled and the donor actually delivers money or valuable property to the charity (or agent of the charity), then – and only then – the definition for a gift is met.

Another example of an action that is not a completed gift is when a donor gives money or valuable property to the donor’s agent (i.e., the donor’s representative) with instructions to deliver the gift to a charity or agent of the charity.  Because the money or valuable property is still in the hands of the donor’s representative, it has not yet become a completed gift.  Once the money or valuable property is given to the charity (or the charity’s representative/agent), then – and only then – is there a deductible charitable gift.

Another example that does not qualify as a charitable gift for tax purposes is when the donor delivers money or valuable property to the charity, but still retains prohibited control over the money, even after the transfer to charity.  This retained control prevents the gift from being deductible until such time as the retained interests expire or are also given to the charity.  This area is a bit more complicated because there are specific retained interests that are permitted by the tax code.  Nevertheless, the general rule is that if a donor retains rights to control the money or get the money back, such a transfer is not (or, at least, not yet) a charitable gift.

The last example of a transfer that is not a deductible gift is when a donor delivers money or valuable property to a charity for delivery to a specific person.  A person is not a charity.  Any person, even a person in serious financial or medical need, is not a charity.  Giving money to a specific person is not a charitable gift for tax purposes.  This fundamental rule cannot be avoided by simply giving money to a charity with the requirement that the money must then be delivered to a specific person.  Such a transfer is treated as if it were a direct transfer to the person.  Since a person is not a charity, the transfer is not a deductible charitable gift.

To this point we have looked at the rules in their conceptual form.  Let’s now look at some examples applying these rules to actual gift scenarios.  Suppose a donor puts a cash gift in a stamped envelope addressed to the charity.  The donor then puts the envelope into a mailbox at the local United States Post Office on day one.  On day two, this cash arrives safely at the charity.  When did this transaction become a completed gift for tax purposes?

The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity.  The tricky part is knowing that the United States Postal Service is considered to be an agent of the recipient.  Even though the charity has not received the money on day one, the charity’s agent has received the money.  Consequently, the gift is a completed gift on day one.  (Note that only the United States Postal Service is considered to be an agent of the recipient.  If the gift had been delivered, for example, by FedEx or UPS, it would be considered as held by an agent of the donor until it arrived at the charity.)

Because the donor has delivered money to an agent of the charity (in this case, the United States Postal Service) on day one, the gift was a completed gift for income tax purposes on day one.

Next, consider another common situation.  On day one, the donor writes a check to a charity.  On day two the donor puts the check in the United States Postal Service mailbox and it is taken by the mail carrier.  On day three, the charity receives the check in the mail.  On day four, the charity deposits the check.  Finally, on day five, the charity’s bank receives the funds and the charity is credited with the funds.  On which of these days was the gift completed for income tax purposes?

The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity.  The tricky part in this situation is to understand that a valid check is valuable property.  Conceptually, the idea is that a valid check is not just a promise to pay, but is a valuable negotiable instrument (sort of like a corporate bond) making it valuable property even prior to its deposit.

Because a valid check is considered to be valuable property, and because the post office is considered to be the agent of the charity, the charity’s agent receives valuable property on day two.  Thus, the gift is complete for income tax purposes on day two.

Why is it important to know when, precisely, a transfer becomes a completed charitable gift for income tax purposes?  Why is it important if the gift is complete on day one or day five?  The first answer is that this is a learning tool to understand what is and what is not a deductible charitable gift.  Understanding the moment at which the transfer becomes a deductible gift, creates a more precise understanding of the definition of a charitable gift for income tax purposes.  Beyond this educational purpose, however, knowing the exact day can itself be quite important.  There can be a big difference between one day and the next for tax purposes.

For example, a gift completed on December 31 can be deducted one year earlier than a gift completed the next day.  Waiting for an additional year can be a substantial consequence of knowing precisely which day a gift becomes complete for income tax purposes. 

Indeed, much more substantial consequences may result when the tax circumstances are different in the different years.  The deductible gift may not be usable in the later year due to, for example, charitable deduction income limitations or use of the standard deduction.  In such cases, knowing the exact date when the charitable gift is complete for income tax purposes can be the difference between a valuable deduction and a useless deduction.

The difference in the date on which a charitable gift becomes complete for income tax purposes may also have significance if the donor happens to die during the process.

Now consider some additional examples demonstrating when a deductible charitable gift occurs.  Suppose there is a scenario identical to the previous example of a check mailed to a charity.  However, in this case, the check bounces.  How is this scenario handled under the income tax charitable deduction rules?

The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity.  The key understanding in this case is that an invalid check was never considered to be valuable property.  Because the donor never delivered valuable property to the charity, there was no charitable gift.  (In a sense, the future knowledge that the check would bounce is attributed back to its date of origin, meaning that at no point was the check ever valuable property.)

Because the donor never delivered valuable property to the charity, at no point did a charitable gift occur for income tax purposes.

How then should a post-dated check be treated?  In this case, the post-dated check is delivered to the charity’s agent (the United States Postal Service) on December 26.  However, the check cannot be deposited prior to January 1, because it is post-dated to that day.  So, when is the gift completed?

The critical piece of information in this scenario is to understand that a post-dated check is considered to be a promise to pay money in the future.  Unlike a normal check, which is immediately considered to be valuable property, a post-dated check is considered to be only a promise to pay in the future.  A promise to give money or property to a charity in the future does not constitute a deductible gift.  Thus, the post-dated check is not a completed gift when it is transferred to the charity or the charity’s agent.  Once, however, the date of the check arrives, it immediately becomes valuable property.  If, at that time, it has been delivered to the charity or the charity’s agent, then the gift is complete.

Thus, in this scenario, the gift is complete on January 1.  That is the date on which the charity has received valuable property.  On December 31, the charity did not have valuable property, but instead had only a promise to pay.  On January 1, the promise to pay was converted to a valuable negotiable instrument, and thus the gift was complete.

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