The Highest IRS Discount Rate Is Not Always the Best
For almost 30 years, the IRS has announced each month the interest rate for computing the deduction for gift annuities, charitable remainder trusts, and most other split interest gifts. We call this rate the IRS discount rate. The donor has the option to use the rate for the month of gift or either of the two previous months.
Ever since the monthly IRS discount rate went into effect, most gift planners have been in the habit of computing gift annuity deductions for their donors based on the highest of the three IRS discount rates available on the date of gift. They’ve done this because choosing the highest available IRS discount rate maximizes the charitable deduction available to their donors. There is a flip side to this outcome, though. Choosing the highest available IRS discount rate also minimizes the portion of the gift annuity payments that will be tax-free during the annuitant’s life expectancy.
Some gift planners have long recognized the trade-off between the charitable deduction and tax-free portion and made it their practice to make their gift annuity donors aware of it. They then ask their gift annuity donors which value they want to maximize, the charitable deduction or the tax-free portion of the annuity payments.
The New Tax Law Raises the Stakes
The tax law that went into effect at the beginning of 2018 made several changes that will motivate many more taxpayers to take the standard deduction rather than itemize their deductions. The Joint Committee on Taxation estimates that the number of itemizers will decline from 30% in 2017 to about 12% in 2018.
For donors who choose to take the standard deduction, their charitable deductions will provide no tax benefit. Some gift annuity donors will surely be among the nearly 90% of taxpayers in this category. For them, choosing the lowest IRS discount rate will be the most beneficial. Doing so will minimize the tax on their annuity payments for many years and those tax savings won’t depend on their itemizing deductions.
Ask Your Gift Annuity Donors if They Plan to Itemize
Perhaps the simplest way to ask your gift annuity donors which IRS discount rate they want to use is to ask whether they expect to itemize their deductions on their tax return. If a donor expects to take the standard deduction rather than itemize, then you know you should use the lowest available IRS discount rate when providing that donor with calculations. If the donor does expect to itemize, then you can follow-up by asking which is more important to her, minimizing taxes in the year of the gift or minimizing taxes on the annuity payments for years to come. If the donor prefers to minimize her current tax bill, use the highest IRS discount rate. If she prefers to minimize the tax on the annuity payments, use the lowest IRS discount rate. If the donor is unsure, show her both results and ask her to choose. In all cases, encourage your donors to consult with their tax advisors before they make their decision.