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March 29, 2022

Lawyers, Guns, and Money: Charitable Planning Considerations

Recently, a judge blocked an attempt by the New York State attorney general to dissolve the National Rifle Association (NRA), following allegations that NRA executives engaged in excessive self-dealing, failed to provide proper oversight, and wasted or misspent NRA assets. While the dissolution request was denied, the judge did allow the attorney general to proceed with a lawsuit against the NRA executives accused of personally enriching themselves with NRA funds.

So what connection does a lawsuit involving the NRA have with someone’s estate plan? Perhaps none, but for individuals with a charitable inclination, more than one might imagine. In New York State, the attorney general (specifically, the Charities Bureau) oversees all not-for-profits established under New York State law. This oversight covers more than just an organization’s operations—it also extends to charitable bequests in wills and trust agreements, even if an organization was established and operates outside of New York State. The form of a charitable bequest in a will or trust determines whether or not the attorney general will be involved in the administration of an estate or trust.

For example, a will leaving a specific percentage of assets to charity (e.g., “I leave 15 percent of my estate to ABC Charity, Inc.”) will require approval by the attorney general prior to closing out and distributing the estate’s assets. In this case, the executor must prepare an accounting detailing the assets collected in the estate, the expenses paid, and the proposed final distribution based on the percentage payouts detailed in the will.

The attorney general reviews the accounting and verifies that the expenses paid were reasonable, that the estate’s assets have been carefully and competently managed during the administration process, and that each charitable beneficiary is receiving the correct amount as set forth in the will. If the attorney general believes the executor mismanaged the estate or a charity is not receiving the correct amount, it has the ability to file objections with the court and potentially seek the imposition of fines on the executor.

Contrast this with a specific dollar amount bequest in a will or trust (e.g., “I leave $50,000 to ABC Charity, Inc.”). Here, as long as the charity receives the amount specified, the attorney general does not have to approve the final settlement and distribution of an estate or trust. Should the estate or trust have insufficient funds to fully pay the bequest, then the attorney general will become involved to make sure the charity receives as much of the promised amount as possible.

In preparing an effective estate plan with charitable intent, careful consideration of the overall asset structure and plan objectives may provide opportunities for tax efficiencies without requiring the attorney general’s involvement. Assume an individual dies owning assets of $1 million individually, along with a pre-tax retirement plan of $500,000. The individual’s existing will leaves 50 percent of the assets to a charity and the remaining 50 percent to family members. The retirement plan, which passes outside of the will, names the family members as beneficiaries.

What is the end result? The charity will end up with $500,000 (50 percent of the $1 million), while the family members receive a total of $1 million (the other 50 percent of $1 million, plus the $500,000 retirement plan). But there is a catch; as the retirement plan is distributed out to the family members, they will pay income tax on the distributions. Depending on their other income, federal and state income taxes may erode up to 45 percent of the retirement plan’s value.

Furthermore, as the charity is receiving a percentage of the estate, the executor must formally prepare an accounting and obtain approval from the attorney general. The family member beneficiaries may not receive their entire bequest until the executor has received final approval.

A thoughtful plan might consider an alternative way to accomplish a similar objective. Rather than naming the charity as a beneficiary in the will, the client instead makes the charity the beneficiary of the pre-tax retirement plan. The new will leaves all of the individual assets to the family members.

Compared to the original structure, the charity ($500,000) and family members ($1 million) still receive the same amount, yet the after-tax results differ greatly. The charity will receive the full $500,000 from the retirement plan, without any reduction for income taxes, since the charity is a tax-exempt entity. And because of stepped-up cost basis for assets inherited at death, the family members do not have to pay income tax on the $1 million received through the estate. Finally, because the retirement plan passes directly to the charity, the estate does not have the attorney general’s involvement.

The attorney general oversees charities and charitable bequests to ensure that donations are used for proper purposes and charities receive the correct amount from charitably inclined individuals. In certain circumstances, considerations such as income tax savings and the minimization of administrative delays and costs may provide benefits that make an alternative structure attractive for clients. If you have any questions concerning charitable giving, please contact one of Barclay Damon’s trusts and estates attorneys.

If you have any questions regarding the content of this alert, please contact Tim Muck, partner, at tmuck@barclaydamon.com, or another member of the firm’s Trusts & Estates Practice Area.

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