Federal Income Taxation of Charitable essay

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Where the charities were directly or indirectly involved in, through their officers in other ventures, the tax debts of such entities were estimated to be $15 million in additional tax debts, mostly payroll taxes. (United States Government Accountability Office, 2007)

There were instances where in spite of findings that the exempted entity was abusing the federal tax system, these organizations continued to have the exempt status. (United States Government Accountability Office, 2007) The rigidity of a trust and the changes in law are contradictory that creates a situation where the intervention of courts becomes necessary. In the case of institutions like the Barnes Foundation for example, the Institution owns art collection, amassed in the beginning of the century by Dr. Albert C. Barnes, has clauses in the establishing of the trust which has the creator's detailed instructions and some restrictions on the use of, the trust and its funds. Charitable trusts with tax incentives, and there fore are subject to comply with the laws of the land as opposed to the creator's rules. The question in this case is if it was legal to step out of the directives of the founder and alter the memorandum? (Eisenstein, 2003)

Negation of Tax Benefits, and Incidence of Tax:

There are cases were a tax payer will not be able to avail the provisions of the charity provisions where there has been an 'ear marked' donation. According to the administrative rulings of the Internal Revenue Service, persons who earmark funds for charitable contribution deduction do not get the benefit. This applies to "a transfer under section 170 of the Internal Revenue Code." (Buckles, 2002) Thus a beneficiary who directly receives the benefit of a charity that is directed to the entity or beneficiary removes the benefit of the donation from the donor and makes it taxable. (Buckles, 2002)


Beneficiaries can claim tax exemptions in certain cases and situations. This for example is found in the charitable remainder trusts. The taxation "of the trust system" with regard to the charitable reminder trust is such that the beneficiary is taxed for the income received from the trust. This is because there is no income tax on the trust for any income accruing to it provided the income is not from a business activity. Distributions from the trust are divided into the type of income as Ordinary, Capital Gain, Tax exempt and return from corpus fund. Based on how the income accrued to the trust the tax liability of the beneficiary can be decided. The income stream for example the donor may select a payout rate that could offer "income level with regard to life beneficiaries" or for a period of years. (Jordan; Quynn, 2002) This rate legally is between 5% and less than 50% of the donation and is usually based on bank rates. The donor charitable income tax rate reduces with the increase in the payout rate and vice versa. The greatest tax benefit to the donor will occur with a better payout rate and hence when determining the policy of the trust this must be ensured to be attractive to the donors. (Jordan; Quynn, 2002)

The aspect also shows that the charitable reminder trust will receive a tax reduction in income tax that would provide for significant savings. The amount of income tax deduction is based on the amount of reminder interest that is passing to charity. A person transferring assets that have appreciated or has attracted a capital gain, neither the transferor or donor nor the trust will have to pay capital gain. This also is applicable when the trustee sells the properties. Distributions to beneficiaries on the other hands classified as capital gains to the full extent as the trusts capital gains. Donors who fund a charity -- with gift annuity with an appreciated property held by them for over a year will have to pay capital gains tax. This tax could be 20%. The donor thus can use the exemption provided the asset was gifted away within the current assessment year and the charitable gift annuity will be eligible for gift tax exemption. (Jordan; Quynn, 2002)

In other cases where there is a charitable head and a request for a deduction of Income tax it can be allowed where there is a transfer of money to a charitable lead trust there is a possibility of the donation being accepted as charity and the donor being given tax benefits. Again it may also be rejected. The reason for this is that deductions are available for a lead trust based on income created for the trust- Firstly the income must be in the form of annuity interest or a unitrust interest. If this condition is met then a charitable deduction can be claimed for federal income, gifts, or estate tax. The qualification of a leading trust is changed and determined by the IRS from time to time. The second condition is that the donor must be treated by practice as the owner of the income, interest, and accruals and provisions in the trust laws must be so. (Hopkins, 2005)

The donor must also be the grantor. Thus the income accruing to the lead trust is taxed to the donor or grantor. The qualified charitable remainder trust thus is an entity exempt from federal tax. On the other had a charitable lead trust is not exempt from taxation. It will depend on the individual trust. Where the donor is treated or is the "trust owner, then in that case, the trust would not face taxation, however income" will be taxed as that of the owner. There are other limitations to the charitable lead trust. (Hopkins, 2005) For example a charitable lead trust is not entitled to the income tax deduction for payments made to other charitable associations in excess of the income interest payable under the trust agreement. (Hopkins, 2005)

The beneficiaries also benefit where the part of an interest in a trust can be assigned which results in the assignees becoming the owners of the specific beneficial interests in the trust. Where a life income beneficiary assigns a portion of the trust to his children the tax incidence then gets transferred to the donee children. Thus in a transfer of income to the assignees and beneficiaries become liable for the tax. (Abbin, 2008)

Sham Beneficiaries:

The incidence of taxation on a beneficiary is illustrated in the cases of "Frank Muhich, Virginia Muhich, and Midwest Portraits Corporation." ("Frank Muhich, Virginia Muhich, and Midwest Portraits Corporation, Petitioners-appellants, v. Commissioner of Internal Revenue, Respondent-appellee In the United States Court of Appeals For the Seventh Circuit - 238 F.3d 860 (7th Cir. 2001)," n. d.) "In the United States Court of Appeals For the Seventh Circuit - 238 F.3d 860 (7th Cir. 2001) Judges WILLIAMS, COFFEY, and DIANE P. WOOD" ruled that a trust that was set up to take care of the personal expenses of the donee was a sham transaction. In this case the appeal is against a notice of the Commissioner of Internal Revenue On August 6, 1997 which stated that "Frank and Virginia Muhich stating that they had understated their tax liabilities on their joint returns for the 1994 and 1995 tax years and another notice of deficiency to Midwest Portraits Corporation (Midwest) for the tax years ending on June 30, 1994, 1995, and 1996. Midwest Portraits was owned by the appellant. The Corporation (Midwest) worked exclusively with fire, rescue, and ambulance departments in Illinois, Iowa, Wisconsin, and Indiana taking pictures, assisting in soliciting donations, and handing out complimentary certificates." ("Frank Muhich, Virginia Muhich, and Midwest Portraits Corporation, Petitioners-appellants, v. Commissioner of Internal Revenue, Respondent-appellee In the United States Court of Appeals For the Seventh Circuit - 238 F.3d 860 (7th Cir. 2001)," n. d.)

The Heritage Assurance Group suggested a tax avoidance scheme by which an individual or individuals transfer their assets with a "right to receive income to a new family trust which in turn issues a certificate of beneficial interest -- CBI. A CBI thus gives the individual the right to receive any distributions that the trustee," sane owning individual makes. Through this trust all expenses of the beneficiary member is deducted and paid for by the trust. ("Frank Muhich, Virginia Muhich, and Midwest Portraits Corporation, Petitioners-appellants, v. Commissioner of Internal Revenue, Respondent-appellee In the United States Court of Appeals For the Seventh Circuit - 238 F.3d 860 (7th Cir. 2001)," n. d.) "The Muhichs created the Muhich Asset Management Trust (Asset Trust). Mrs. Muhich transferred virtually all of her property to her husband. In turn, Frank Muhich transferred all of his property to the Asset Trust, including the right to receive compensation for his services." ("Frank Muhich, Virginia Muhich, and Midwest Portraits Corporation, Petitioners-appellants, v. Commissioner of Internal Revenue, Respondent-appellee In the United States Court of Appeals For the Seventh Circuit - 238 F.3d 860 (7th Cir. 2001)," n. d.)…[continue]

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