Just what are the Tax Advantages of Community Support Organizations?

"Doing well, while doing good!"

Community Support Organizations (CSOs) are your opportunity to "do well, while doing good."  

CSOs provide the Donor with the opportunity to move funds and assets into a qualified §501(c)(3) organization at times and in a manner that provides the Donor with the maximum income and estate tax advantage, grow the funds on a tax-exempt basis, and then to distribute those funds and assets on an entirely different schedule.

CSOs provide the opportunity for qualified parties to provide needed health care, educational, scientific and religious services to a community on a tax-exempt basis, while enjoying the additional benefits of utilizing a CSO for personal financial planning and asset protection purposes.

CSOs provide charitable organizations the opportunity to provide anonymity to Donors, to accumulate endowment funds, to establish

CSOs provide the Donor with very important advantages over a Private Foundation

Community Support Organizations (CSOs) provide you with the opportunity to "do well, while doing good!"  They are often promoted as the opportunity to establish “a tax exempt family bank that is funded with tax-deductible dollars over which you maintain effective control and which are not subjected to the onerous self-dealing rules imposed on private foundations.”     CSOs provide you the opportunity to maximize the value and impact your gifting through utilizing the unique tax advantages that are not available to other structures used for gifting.

The tax advantages of a CSO are derived from the tax status of the public charity, or class of charity, that it was organized to support.  This means that a CSO has the opportunity to be approved to receive tax-deductible contributions as a qualified IRC 501(c)(3) organization.  

The result of being qualified as a 501(c)(3) is:

(a)    Cash gifts are deductible at up to 50 percent of the donor’s adjusted gross income, with a five-year carry forward.

(b)    Non-cash gifts are deductible at fair market value and at up to 30 percent of the donor’s adjusted gross income, with a five-year carry forward.

(c)    Long-term capital gain assets may be deductible at fair market value, without recovery of depreciation, limited to 30 percent of the donor’s adjusted gross income with a five-year carry forward.

(d)     No excise taxes are imposed

(e)     No corpus distribution is required.

 The advantages indicated were intended by Congress to encourage taxpayers to support the activities of public charities, including faith-based charities.   This is accomplished by allowing donors to a CSO the same tax treatment for their gifts as if they had made their gift directly to the supported organization without their gifts being co-mingled with the assets of the supported organization.   The important result is that a donor may increase the amount of the gift without a corresponding reduction in cash flow or accessible funds as is experienced when utilizing other type entities; and the donor is allowed to have greater influence over the use of the gift than might otherwise be experienced.

As the donor or donor’s heirs do not dominate a CSO, although they may have effective control, the self-dealing rules that are imposed on private foundations do not apply.  The result is that a CSO may make interest-bearing loans to the donor who may tax deduct the interest paid to the CSO, according to normal rules for interest deductibility, yet create no tax liability for the CSO.   The CSO may also do business with family members, own family businesses, and provide employment to family members.  All self-dealing must, of course, be carefully documented, properly approved, must be at market terms and must not involve inordinate risks.

CSOs v. Private Foundations

The following example will illustrate some of the tax advantages of a CSO as compared to a private foundation.  The example begins with the owner of a Sub-S corporation who wants to sell his business.   The business has a sale value of $2,000,000, which includes land and buildings worth $600,000.   The land and buildings have a cost $450,000 and an adjusted basis of $250,000.   The owner’s basis in the business, including the land and buildings is $400,000.  He and his wife have an AGI, for this example, of $200,000 and $30,000 of itemized deductions, excluding any deductible contributions.

(The above illustration is not designed to present an exhaustive analysis of all the options available with the case presented.

We acknowledge there may be alternative methods of handling the above transaction.)

The clear benefit presented by the CSO is further enhanced by the ability, for this example, to sell the property with no tax consequences and to then utilize those funds to make secured and unsecured loans to the donor.  Interest paid on those loans would be deductible according to typical rules, but would not be taxable income to the CSO.

Other options that might be considered include the following:

(1)   The CSO Trustees may chooses to invest in the business venture owned or controlled by the donor – usually limited to a maximum of 35% of the venture’s ownership.

(2)   The donor may gift life insurance policies being purchased with after-tax dollars to the CSO and then pay the premiums from within the CSO, which becomes the owner and beneficiary.   CSO’s may loan money to the donor’s family for the payment of estate taxes.

(3)   Purchase specialized life insurance within the CSO that develops low cash values (ITR) in the initial years, then the donor or a FLLC/FLP/ILIT set up by the donor purchases the policy for the ITR (a non-taxable transaction) thereby moving the policy outside of the CSO and outside of the client’s estate.  If the donor purchases the policy out of the CSO and retains ownership personally, the result could be the production of a tax-free retirement income from the internal cash values ultimately developed within the policy (which was purchased with pre-tax dollars).

CSOs v. Charitable Remainder Trusts

 CSOs provide a more advantageous financial and gifting vehicle than any of the Charitable Remainder Trust (CRT) options.   The advantage of a CRT lies in the opportunity to shelter the profits on the sale of an asset, to shelter the earnings on the funds received through the sale or utilization of that asset, and to provide an income stream for the donor and certain designated heir(s) over a period of time, with some amount (not less than 10% of the fund) going to the designated charity at a future date or upon a future event.   The value of the tax deduction received for the gift to the CRT is reduced to approximately the present value of the anticipated future gift to the charitable beneficiary and is impacted by the type organization chosen as the final beneficiary.  Consequently, the number and anticipated mortality of the income beneficiaries has a significant impact on the allowable deduction.

 By contrast, the deduction allowed a CSO donor is based on the fair market value of the gift, at the time of the gift.   The amount deductible in the year of the gift is determined by the type of gift and the type of organization supported by the CSO, with a five-year carry-forward.

 Although the CSO could not be utilized to establish a payment program as is established with a CRT, it may do the following: 

a)        Provide employment to any person (although this should normally exclude the donor) and pay them a reasonable compensation;

b)       Pay trustee fees and the expenses incurred by the trustees in the operation of the CSO and the furtherance of its mission;

c)        Make secured and unsecured loans to any person or organization on market terms, including the donors,

d)       Choose to invest in any type business in anticipation of a return on its investment;

e)        Purchase life insurance policies on the lives of the donors and subsequently sell these plans to the donors for the ITR.  With proper planning, this could result in a tax-free retirement income to the donors from the cash values developed within the plan;

f)          May be organized to allow the donor(s) to serve as trustees and to appoint their own successors, in perpetuity, although they would not dominate the board of trustees, rather than having a predictable termination and final distribution date; and

g)       May provide a tax-exempt housing allowance to the donor, when organized to perform certain specific functions of a local religious body and when the CSO also meets the conditions required for qualification as an integrated auxiliary of that body.

The chart below illustrates compares the impact of gifts to a CSO versus the same gift to a CRUT (unitrust) for a couple ages 65 and 63.   The CRUT has a 5.6% payout with a 7520 rate of 5.6%.   The final beneficiary is a 501(c)(3) (50% organization).    The gift is appreciated capital gains property used in a business that reports for tax purposes as a Sub-S corporation. 

(Note:   The amount reflected as the annual economic benefit to the donor and donor’s heirs in the above illustration does not reflect the intrinsic value to the community of the activities supported or the values of the opportunity to utilize the funds in the CSO for loans to the donors or for investments in business activities of the donor.  The real value of benefits received by the donor and the donor’s heirs should be substantially larger than shown.

The value of the CSO after 20 years reflected above assumes the CSO is expending the sum of its growth and income during the period.  The CSO will generally, although it is not required to do so, expend a minimum of 85% of its income or 1% of its asset base each year, but does not expend any portion of unrealized gains.  The CSO is income tax exempt, as it will be qualified as a 501(c)(3) organization.

The above illustration is not designed to present an exhaustive analysis of all the options available with the case presented.  We acknowledge there may be alternative methods of handling the above transaction.)

Clearly, the economic and social benefits of utilizing a CSO far exceed those available through the use of a private foundation or the CRT family of trusts.  The flexibility of CSO’s presents a wide variety of powerful estate planning, capital transfer and asset protection advantages.  Through careful planning, the CSO may become the centerpiece of a family’s financial plan and provide a legacy that will have an impact for generations to come.