Tax Information: What Is Irs Section 664?

Section 664 allows an individual to bypass estate taxes and capital gains taxes by donating their stock portfolio to charity.

In 1969, the U.S. Congress passed IRS Section 664, which created a trust designed to help charities and not-for-profit organizations. It can help an individual increase retirement income, avoid capital gains and estate taxes, and decrease current income tax liability while passing on an estate to heirs and making a substantial gift to a family foundation or charity. This type of trust is known as a Charitable Remainder Trust (CRT).

The basic premise is easy. If you have a substantial stock portfolio that you intend to leave to your heirs upon your death, the capital gains and estate taxes could feasibly eat up two-thirds of the proceeds. That is a lot of dollars to turn over to the IRS.

Instead, set up a CRT, designating yourself trustee and donate the portfolio to the trust. The investment income from the portfolio can still be paid to you, and you would report it as taxable income on your personal tax return. In fact, the IRS requires the CRT to make a distribution of at least 5% of the net fair market value (FMV) of its assets. The good news is if you don't need the income in one year, you can defer the income to a future year, but in the end, net distributions must be at least 5%. This is one reason a CRT is often used as a retirement plan. During the pre-retirement years, income can be deferred until you retire.

If the trust does not earn a current income, you would not be paid, and the trust would continue to grow tax deferred. This type of tax-deferred trust is often used to fund employee retirement plans.

Also, you can take the donation as a charitable deduction on your tax return, reducing your tax liability for the year in which the donation is made. Upon your death, the trust balance would go to the charity, which can then sell the stocks, capital gains free.

Another option is to set up a family foundation and pass on the trust proceeds to it rather than an outside charity or not-for-profit organization. The advantage to this approach is it will allow the family more control over how the funds are distributed to charitable projects. There is also a certain amount of prestige that can be passed on from generation to generation in this type of arrangement.

Concerned the family will not directly reap the rewards of your portfolio? Consider a $500,000 portfolio. When the IRS collects capital gains and estate taxes, your legacy could be reduced to roughly $155,000. It may be more prudent to purchase a life insurance policy for that amount, which can be structured to escape estate taxes. This would leave your stock portfolio in tact. When you set up a CRT and take the charity deduction, your personal deduction would come close to matching the $155,000.

All told, you may have saved $300,000 in capital gains and estates taxes, plus gained a $155,000 charitable deduction. For the price of a life insurance policy, your heirs may break even monetarily, and the charity of your choice has come out the biggest winner, having received a $500,000 donation.

So, which would you prefer? Pay the IRS or help the underprivileged? If you prefer the second option, check with your accounting professional about how a Section 664 may help you.

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