How charitable gift annuities and pooled income funds work
Key takeaway
Charitable gift annuities combine a qualifying annuity with a deductible charitable portion, while pooled income funds combine donors' property with lifetime income interests and irrevocable charitable remainders.
The sections below explain the annuity tests, fund structure, remainder valuation and reporting. Ask an estate attorney or CPA to review the proposed agreement, beneficiaries and contributed property before signing.
Research notice: Based on primary sources listed below. Ask an estate attorney or CPA to confirm a gift structure, filing or deduction before acting.
The charitable gift annuity contract
A charitable gift annuity, as federal law defines it, is a qualifying annuity paired with a deductible charitable portion. A portion of the amount paid in connection with issuing the annuity must be allowable as a deduction under §170 or §2055, and the annuity must be described in §514(c)(5). The annuity's value must be less than 90 percent of the value of the property received in the exchange, and it must be payable over the life of one individual living when the annuity is issued or over the lives of two individuals living at that time. It must not guarantee a minimum amount of payments or specify a maximum amount of payments, and it must not adjust payments by reference to income received from the transferred property or any other property.
The charitable portion of a gift annuity purchased from a §170(c) organization is the excess of the amount paid over the annuity's value at the time of purchase. For deduction limits and property reductions, consult the charitable planning guide.
Ordinary annuity payments can include a recovery of the donor's investment under the §72 exclusion ratio. The excluded share of each payment equals the investment in the contract divided by the expected return under the contract, both measured at the annuity starting date, and the exclusion cannot exceed the unrecovered investment in the contract immediately before the payment. For IRA funding and its separate requirements, consult the question page linked under Related reading.
A bargain sale of property for an annuity can produce recognized gain. Where §1011(b) applies, meaning property is sold or exchanged in return for an obligation to pay an annuity and a §170 deduction is allowable by reason of the sale or exchange, the basis allocated to the sale equals the total adjusted basis multiplied by the amount realized and divided by the fair market value of the entire property. Gain on such an exchange is reported under the applicable Treasury regulation's life expectancy method when the annuity is nonassignable or assignable only to the charity that bought the property and the transferor is the only annuitant or the annuitants are the transferor and designated survivors. A survivor annuitant's life expectancy does not extend that reporting period.
Pooled income fund payments
A pooled income fund combines donors' property with lifetime income interests. Each donor must transfer property to the fund and retain for the donor or create for another beneficiary a life income interest in the transferred property. Every income beneficiary must be living at the time of the transfer, and the beneficiaries may share income concurrently, consecutively or both. The property must be commingled with, and invested or reinvested with, property from other donors who meet the same requirements. A fixed term alone does not satisfy the lifetime requirement. The charitable remainder requirements appear in the questions below.
Pooled fund payments reflect the fund's annual income and each interest's proportionate participation. Every income interest receives a proportionate share, or unit of participation, of the annual income the fund earns, based on the fair market value of the contributed property on the date of transfer. The governing instrument must direct the trustee to distribute income currently or within the first 65 days after the close of the taxable year in which it is earned. A payment within that period after the close of the year is treated as paid on the year's last day, and a statement attached to the fund's return must show the date and amount of those payments.
Pooled fund income generally excludes long term capital gains. Under an applicable state statute, income may be defined as or satisfied by a unitrust amount, or satisfied through the trustee's power to adjust between income and principal to fulfill the duty of impartiality, if the statute provides a reasonable apportionment of total return between income and remainder beneficiaries and meets the Treasury regulation's requirements for defining income. Under a power to adjust, the trustee must allocate to principal, not income, the proceeds from the sale or exchange of any asset contributed by a donor or purchased by the fund, at least up to the asset's fair market value on the contribution date or its purchase price.
Trusteeship and investment direction
A pooled income fund donor or income beneficiary cannot serve as trustee, and the governing instrument must prohibit it. The public charity that receives the remainder interest is excepted from the beneficiary prohibition. Being a trustee, officer, director or other official of that public charity ordinarily does not prevent the fund from meeting the requirements of §642(c)(5).
If a donor or beneficiary other than the remainder public charity directly or indirectly has general responsibilities with respect to the fund that a trustee ordinarily exercises, the fund does not meet the requirements of §642(c)(5). Ask an estate attorney to review any proposed donor role in investment decisions.
Investment holdings and contributed property
A pooled income fund cannot accept or invest in securities whose income is exempt from tax under subtitle A of the Code, and the governing instrument must specifically prohibit accepting or investing in them. No gain or loss is generally recognized to the donor on a transfer of property to the fund, but that nonrecognition does not apply where the donor also receives property from the fund or transfers property subject to an indebtedness.
Valuing the pooled fund remainder
The remainder value of a pooled income fund gift is the fair market value of the transferred property on the valuation date minus the present value of the lifetime income interest. A deduction claimed on a return must be supported by an attached statement showing the computation of that present value. For a fund with at least three preceding taxable years, the discount rate is the highest yearly rate of return of the fund for the three taxable years immediately preceding the year of transfer.
A fund with fewer than three preceding taxable years uses a deemed rate equal to one percentage point below the highest annual average of the monthly §7520 rates for the three preceding calendar years, rounded to the nearest 0.2 percentage point. The same newer fund method applies when facts and circumstances show that the fund's returns were purposely manipulated to be substantially lower than reasonably anticipated in order to obtain an excessive deduction. The deemed rate is recomputed annually and is not indexed for inflation.
Gift annuity acknowledgments
When a taxpayer purchases an annuity from a charitable organization and claims a charitable contribution deduction of $250 or more for the excess paid over the annuity's value, the contemporaneous written acknowledgment must state whether the taxpayer received any goods or services in addition to the annuity. That threshold is fixed and not indexed. The acknowledgment need not include a good faith estimate of the annuity's value, and it does not replace the donor's valuation calculation.
Resources to check out
- American Council on Gift Annuities: About Gift Annuities: Introductory reading and questions to discuss with an issuing charity.
- ACGA Suggested Gift Annuity Rates: Suggested payout schedules and their underlying assumptions.
- Federal Pooled Income Fund Requirements: Source text for fund structure, control and income requirements.
- Pooled Income Fund Deduction Calculations: Source text for remainder valuation and return assumptions.
- IRS Instructions for Form 1041: Filing instructions and beneficiary reporting information.
Common questions
What reporting does a pooled income fund involve?
A pooled income fund files Form 1041 and generally also files Form 5227, while income beneficiaries report distributed income with the same tax character it had in the fund's hands. The Form 5227 exception requires the trust to have been created before the cutoff specified in the Form 5227 instructions and either all corpus transfers to have occurred before that cutoff or no deduction under any provision listed in §4947(a)(2) to have been allowed for each and every later corpus transfer. A later deductible corpus transfer ends the exception.
Who must receive the remainder of a pooled income fund?
A public charity must receive an irrevocable remainder interest contributed to it or for its use, and a contingent remainder does not qualify. Generally, the same public charity must maintain the fund. A national organization that carries out its purposes through local organizations, chapters or auxiliary bodies with which it has an identity of aims and purposes may maintain an otherwise qualifying fund naming those local public charities as remainder recipients.
What gift tax issue accompanies naming other income beneficiaries?
The gift tax issue is whether the gift of another person's income interest is complete, which depends on the donor's retained powers to change its disposition. A gift is complete as to property, or an interest in it, when the donor has parted with dominion and control so as to leave no power to change its disposition, whether for the donor's benefit or another's. If the donor reserves any power over disposition, the gift may be wholly incomplete, or partially complete and partially incomplete, depending on all the facts. A pooled income fund donor may retain a power exercisable only by will to revoke or terminate the income interest of a designated beneficiary other than the public charity. Ask an estate attorney to review the retained powers and any claimed annual exclusion or spousal exemption.