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Saturday February 24, 2018

Case of the Week

Dying to Deduct, Part 2


Abigail was a wonderful and spirited 80-year-old woman. Even as an octogenarian, she still worked in her garden, handled all of her finances and played golf each weekend. In addition to her busy schedule, she also made time to help at a local homeless shelter. She believed that whenever you can lend assistance to your fellow neighbor it is your responsibility to do so. Because of this belief, she gave her time, love and money to the shelter. Abigail's normal practice was to give $5,000 each year to the homeless shelter. However, she wanted to make a more significant gift to the shelter this year.

So, in January of this year, she decided to establish a $100,000 charitable gift annuity for her and her sister. The payments would go to Abigail for life, then to her sister for life. She liked the high fixed payments, large tax deduction and simplicity of the arrangement. Because Abigail funded the CGA with cash, a large portion of each payment was tax-free. But of course, what she loved most was the eventual gift to the shelter.

Sadly, Abigail suffered a heart attack in March and died soon after. It was a terrible loss to the community. Now several months have passed and Abigail's family and CPA are winding-up Abigail's financial affairs. The CPA knows he can deduct Abigail's charitable tax deduction on Abigail's final income tax return. He also knows that if a person who funds a gift annuity dies prematurely he or she may claim an additional tax deduction for any unrecovered investment. (See "Dying to Deduct, Part 1). However, in this case, Abigail's sister is still remaining on the gift annuity contract. Thus, the CPA wonders how this affects the unrecovered investment issue.


Since Abigail died prematurely, does she get another tax deduction? Does the fact that this is a two-life gift annuity affect the outcome?


The income from Abigail's gift annuity, as mentioned above, was partially tax-free. This tax-free component is essentially a return of principal or investment, and it would last for the lifetime of both Abigail and her sister.

Normally, the premature death of an annuitant would trigger an additional income tax deduction on the decedent's final income tax return. See Section 72(b)(4). However, in this case, the annuity continues for the life of Abigail's sister. Furthermore, the tax-free payments continue on to her sister. Abigail's sister, in essence, will step into Abigail's "shoes" and reap the benefits of tax-free payments.

Consequently, there is no unrecovered investment in the annuity contract at the time of Abigail's death, because Abigail's sister is still "recovering" it. As a result, Abigail's executor is not entitled to an additional income tax deduction on her final income tax return.

Editor's Note: If an additional income tax deduction was allowable, it would not be a charitable income tax deduction, but rather an "other miscellaneous deduction" (not subject to the 2% floor). This deduction can be claimed on Schedule A of Form 1040.

Published March 3, 2017
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Previous Articles

Dying to Deduct

Living on the Edge, Part 6

Living on the Edge, Part 5