609 / What are the tax consequences to the obligor in a charitable annuity transaction?

Property transferred in return for a charitable gift annuity could fall into the general definition of “debt financed property” in IRC Section 514(b)(1) because the charity acquires the gift subject to the promise to pay the donor an annuity. This result would be problematic, because it could be treated as unrelated business taxable income and trigger an associated unrelated business income tax for the charity.

However, in a private letter ruling, the IRS decided that issuing a charitable gift annuity will not result in income from an unrelated trade or business and that income earned by the charitable organization from investing the charitable gift annuity funds will not be considered unrelated debt-financed income.¹

A charity’s obligation to pay an annuity will be exempt from the debt financed property rules of IRC Section 514 if the following conditions are met:

(1)     the annuity must be the sole consideration paid for the property transferred;

(2)     the present value of the annuity must be less than 90 percent of the value of the property received in exchange;

(3)     it must be payable over the lives of one or two annuitants;

(4)     the contract must not guarantee a minimum number of payments or specify a maximum number of payments; and

(5)     the contract must not provide for adjustments to the amount of annuity paid based on income earned by the transferred property or any other property.²

Issuing charitable gift annuities does not affect the tax-exempt status of the organization if the annuity meets the requirements above and a portion of the amount transferred in return for the annuity is allowable as a charitable deduction.³