120 / May a charitable contribution deduction be taken for the gift of a life insurance policy or premium? May a charitable contribution deduction be taken for the gift of a maturing annuity or endowment contract?

Yes, subject to the limits on deductions for gifts to charities.

The amount of any charitable contribution must be reduced by the amount of gain that would have represented ordinary income to the donor had the donor sold the property at its fair market value.¹ Gain realized from the sale of a life insurance contract is taxed to the seller as ordinary income ( Q 36). Therefore, the deduction for a gift of a life insurance policy to a charity is restricted to the donor’s cost basis in the contract when the value of the contract exceeds the premium payments. Thus, if a policy owner assigns the policy itself to a qualified charity, or to a trustee with a charity as irrevocable beneficiary, the amount deductible as a charitable contribution is either the value of the policy or the policy owner’s cost basis, whichever is less ( Q 144).² It is not necessary, however, to reduce the amount of the contribution when, by reason of the transfer, ordinary income is recognized by the donor in the same taxable year in which the contribution is made.³ Letter Ruling 9110016, in which the IRS denied a charitable deduction when a policy was assigned to a charity that had no insurable interest under state law, was revoked after the taxpayer decided not to proceed with the transaction.⁴

Premium payments also are deductible charitable contributions if a charitable organization or a trustee of an irrevocable charitable trust owns the policy.⁵ It is not settled whether premium payments made by the donor to the insurer to maintain a policy given to the charity, instead of making cash payments directly to the charity in the amount of the premiums, are gifts to the charity or merely gifts for the use of the charity. The difference is important when the donor wishes to take a charitable deduction of more than 30 percent of the donor’s adjusted gross income. When the policy is merely assigned to a charitable organization as security for a note, the premiums are not deductible even though the note is equal to the face value of the policy and is payable from the proceeds at either the insured’s death or the maturity of the policy. The reason is that the note could be paid off and the policy recovered after the insured has obtained charitable deductions for the premium payments. A corporation, as well as an individual, can take a charitable contribution deduction for payment of premiums on a policy that has been assigned to a charitable organization.⁶

Planning Point: For a number of reasons, including concerns over the rules limiting a tax deduction to the lesser of fair market value or basis and because of the uncertainty regarding tax consequences of premium payments made by the donor directly to the insurance company on a policy owned by a charity, it is generally preferable for a donor to make cash gifts to a charity and allow the charity to pay premiums on policies owned by the charity. It is important, however, not to require that the cash gifts be used for premium payments.

1.     IRC § 170(e)(1)(A).