The Alarming Perils of the "Net-Proceeds" CGA

By: Russell N. James III, J.D., Ph.D., CFP®, Professor and Director of Graduate Studies in Charitable Financial Planning, Texas Tech University

INTRODUCTION

A common problem

We start with a common problem.  A donor wishes to donate an illiquid asset, for example real estate, in exchange for a Charitable Gift Annuity (CGA).  The donor has a qualified appraisal.  The charity could issue a CGA based upon that appraised value.  But, what if the property doesn’t actually sell for that much?  This is a serious concern for the charity.  The charity has already committed to pay an annuity based on the appraised value.  But, it might not actually net that much cash at a subsequent sale. 

There are some obvious solutions.  But, these create other problems.  The donor could sell the property first.  Then the donor could use the proceeds to buy a CGA.  This works for the charity, but not for the donor.  When the donor sells the property, the donor must pay capital gains taxes on the sale.  Donating the property instead of selling it avoids, or at least delays, these taxes.

The donor could find a buyer, but not sell it.  Instead, the charity could contract to sell to the buyer before the donor gives it.  At the closing, the donor gives the property to the charity, which sells it to the buyer as agreed.  The charity uses the proceeds to fund the gift annuity.  This works for the charity, but not for the donor.  Because of the binding contract, the donor will be treated as if he sold the property and then donated the proceeds.1   The donor must still pay capital gains taxes on the sale.

A typical solution

This leaves us with where we are today.  We can get close to the previous agreement, but we can’t make it binding.  The charity could find a willing buyer or two ahead of time.  It could then accept the gift in exchange for a fixed annuity.  It might then list the property for sale the next day, contact the willing buyer a day or two later, then sign a contract to sell the property.

This works for the charity and the donor.  Since the charity was not legally bound to sell it at the time of the gift, the donor will not be treated as if he sold property.  The donor avoids paying capital gains taxes.  The charity has little risk, because it doesn’t accept the property gift until it is confident of its ability to rapidly close a sale. 

A modest proposal

The “net-proceeds” CGA initially appears to be another reasonable approach to dealing with this common problem.  This is also called “Wait to Set the Annuity Rate.” 2

The idea is this.  The charity accepts the property gift.  It then enters into a gift agreement that provides something like this:

“The annuity payment will be determined by multiplying the agreed annuity rate (5.8% in this case) by the net proceeds realized by the charity from the sale of the property.”3

Variations might provide alternate outcomes if the property takes a long time to sell.  To avoid other issues, let’s assume that the agreement can only reduce the value of the annuity payment as compared with the appraised value of the property.4

What’s the problem?

Unfortunately, this ostensibly reasonable proposal results in series of problems.  These include the following.

I. CHARITY PROBLEMS

A. Because it violates IRC §514(c)(5), the transaction is subject to unrelated business income tax.
B. Because it violates IRC §514(c)(5), the transaction isn’t a charitable gift annuity as defined in IRC §501(m)(5).
C. Because it isn’t a isn’t a charitable gift annuity as defined in IRC §501(m)(5), it is a security subject to registration with and regulation by the SEC.
D. Because it isn’t a isn’t a charitable gift annuity as defined in IRC §501(m)(5), the federal antitrust exemption for organizations issuing charitable gift annuities does not apply.
E. In states that define their charitable gift annuity regulations by referencing IRC §501(m)(5), it isn’t exempted from state insurance and securities registration and regulation.

II. DONOR PROBLEMS

A. The donor retains an interest, via contract, in the donated property.  (This makes the initial transfer a nondeductible “partial interest” gift.)
B. When the retained interest is released, the charity has already executed, and fulfilled, a binding contract to sell the gifted property.  (This allows the IRS to treat the sale as income to the donor.)
C. The charity could sell the property for substantially less than the appraised value. (This could motivate aggrieved family members to report to consumer protection and securities enforcement agencies.) 

These statutory consequences are not accidental. If the statutes actually did permit such transactions, they could be used to violate important principles of charitable tax policy and consumer protection policy. 

III. CHARITABLE TAX POLICY PROBLEMS

IV. CONSUMER PROTECTION POLICY PROBLEMS

I. CHARITY PROBLEMS

A. Because it violates IRC §514(c)(5), the transaction is subject to unrelated business income tax.

IRC §514 defines unrelated business taxable income with regard to debt-financed income.  Normally, these rules would include income resulting from an exchange requiring annuity payments.  However, an obligation to pay a charitable gift annuity is specifically excluded from this tax in IRC §514(c)(5).  Among other things, an excluded annuity, under IRC §514(c)(5)(C)(ii),

“does not provide for any adjustment of the amount of the annuity payments by reference to the income received from the transferred property or any other property.”

The “net-proceeds” CGA violates the requirements of IRC §514(c)(5)(C)(ii).  It adjusts the amount of the annuity payments based upon income from the sale of the transferred property.  At the transfer of the property by the donor, the donor receives an agreement stating a maximum possible annuity payment amount.  However, this annuity payment amount is subject to a later adjustment.  This adjustment is determined by the income received from the sale of the transferred property. 

The “net-proceeds” CGA appears specifically designed to mirror the prohibition of IRC §514(c)(5)(C)(ii).  The only apparent argument that it does not do so is to claim that “income received from the transferred property” excludes income received from the sale of the transferred property.  (Presumably, income might still include interest, dividends, royalties, and rents?)   To begin, there exists no authority, or even commentary, to support such an exclusion with regard specifically to IRC §514(c)(5)(C)(ii).

Making the claim for such an exclusion from income contradicts the treatment of the term throughout §514.  In its guidance for §514, the Internal Revenue Service explains,

“Debt-financed property is any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness.  IRC Section 514(b); Rev. Rul. 81-138.  Debt-financed property includes rental real estate, tangible personal property, and corporate stock held to produce income such as interest, dividends, royalties, rents, capital gains, etc. [emphasis added]”5  

Interpreting §514(c)(5)(C)(ii) to exclude income from the sale of the transferred property leads to nonsense results.  Suppose the transferred property was non-dividend paying growth stock.  Under this interpretation, it would be impossible to receive income from that transferred property.  Thus, it would be impossible to violate §514(c)(5)(C)(ii) with such property.  Even an explicit contractual adjustment of the annuity payments based on future investment returns received from the transferred non-dividend paying stock would be permitted, because those investment returns would not include dividends.  Indeed, the section – interpreted in this way – would permit future adjustments to annuity payments based on investment returns for any assets so long as that calculation excluded references to rent, interest, royalties, and dividends.

This exclusionary interpretation not only contradicts the text, but it also suggests a statute with no conceivable policy justification (i.e., prohibiting the variation of annuity payments based on returns from dividends and rents, but permitting the identical variation if based on returns realized from a sale).  In contrast, the obvious interpretation (i.e., “income received from the transferred property” does not exclude income received from the sale of the transferred property) precisely matches consumer protection public policy expressed in federal securities regulations of other annuities (discussed below). 

There appears neither authority nor reason to support a reading of §514(c)(5)(C)(ii) such that “income received from the transferred property” excludes income received from the sale of the transferred property.  As such, the “net-proceeds” CGA violates §514(c)(5)(C)(ii).  This results in a series of potentially dire consequences for the issuing charity.

The immediate consequence is that the annuity is treated as “acquisition indebtedness” and the transaction results in unrelated business income to the charity.  However, the payment of unrelated business income taxes is a relatively minor issue compared with the other consequences of violating IRC §514(c)(5)(C)(ii).  These consequences result because of the following.

B. Because it violates IRC §514(c)(5), the transaction isn’t a charitable gift annuity as defined in IRC §501(m)(5).

IRC §501(m)(5) provides,

(5) Charitable gift annuity
For purposes of paragraph (3)(E), the term “charitable gift annuity” means an annuity if—

(A) a portion of the amount paid in connection with the issuance of the annuity is allowable as a deduction under section 170 or 2055, and
(B) the annuity is described in section 514(c)(5) (determined as if any amount paid in cash in connection with such issuance were property).

Violating §514(c)(5)(C)(ii) means that the transaction is not an annuity “described in section 514(c)(5)” as required by IRC §501(m)(5)(B).  As such, the transaction is not a charitable gift annuity as defined by IRC §501(m)(5).  As an initial result, the transaction is “commercial type insurance” and is taxed accordingly.  (In other words, IRC §501(m)(3)(E) does not exclude its treatment as “commercial type insurance.”) 

If a “substantial part” of its activities consists of providing such “commercial-type insurance” the charity will lose its tax-exempt status under IRC §501(m)(1).  However, the consequences start well before these transactions become a “substantial part” of the charity’s activities, resulting in the loss of its tax-exempt status.

C. Because it isn’t a isn’t a charitable gift annuity as defined in IRC §501(m)(5), it is a security subject to registration with and regulation by the SEC.

Charitable gift annuities are securities that, absent an exemption, are subject to registration and regulation by the Securities and Exchange Commission (SEC).  The amended Investment Company Act of 19406,  exempts charitable gift annuities at 15 U.S.C. §80a-3(c)(10)(B)(iii).  However, 15 U.S.C. §80a-3(c)(10)(D)(vi) defines charitable gift annuity for purposes of the exemption as follows,

“the term “charitable gift annuity” means an annuity issued by a charitable organization that is described in section 501(m)(5) of title 26.” 

As mentioned, the proposed transaction does not meet the definition of a charitable gift annuity described in IRC §501(m)(5) because it violates IRC §514(c)(5)(C)(ii).  The transaction is thus not exempted as a charitable gift annuity.

What is the result?  One possibility is that the transaction would be considered simply the issuance of commercial type insurance as a fixed life annuity.  This would trigger state insurance licensure and regulation requirements, but would be exempted from federal securities regulations under the safe harbor in 17 C.F.R. §230.151.  However, this favorable treatment seems unlikely.

More plausible is that it would instead be treated as a security, triggering federal securities licensure and regulation requirements. 

Some factors support this likely treatment as a security.  Among commercial annuities, variability in the payment tied to an investment, such as in variable annuities, results in their classification as securities.7   The safe-harbor provision preventing classification of fixed annuities as securities provided in 17 C.F.R. §230.151 requires that

“The value of the contract does not vary according to the investment experience of a separate account.”8  

The “net-proceeds” CGA varies the value of the annuity contract according to the eventual sale price of a separate asset.  This would seem to exclude it from the safe-harbor protection. 

This safe-harbor provision for fixed annuities also requires that

“The insurer assumes the investment risk under the contract”.9  

Up to the point of sale, the “net-proceeds” CGA places the investment risk on the consumer, not the insuring charity.  This would seem to exclude it from the safe-harbor protection. 

The consumer protection policy motivation expressed in this safe-harbor rule for commercial annuities matches that expressed by §514(c)(5)(C)(ii) for charitable gift annuities.  The “net-proceeds” CGA violates not only the plain language of §514(c)(5)(C)(ii), but also the public policy that motivates §514(c)(5)(C)(ii), discussed in more detail below.

Separately, in other circumstances where CGA rules were violated, the SEC has pursued action rather than leaving the matter to state insurance regulators.  The SEC has claimed such jurisdiction on the basis that “The interests in the CGAs were investment contracts, which are securities under federal law.”10

At a minimum, the issuance of a “net-proceeds” CGA would warrant requesting a No Action Letter from the SEC,11  as has been obtained for other CGA variations.12

D. Because it isn’t a isn’t a charitable gift annuity as defined in IRC §501(m)(5), the federal antitrust exemption for organizations issuing charitable gift annuities does not apply.

The modern exemption for charitable gifts annuities from both federal securities regulation and federal anti-trust liability is provided by the Philanthropy Protection Act and the Charitable Gift Annuity Antitrust Relief Act.13   Both acts define a charitable gift annuity using IRC §501(m)(5).  The antitrust exemption from The Charitable Gift Annuity Antitrust Relief Act14  provides in 15 U.S.C. §37a(3) that, “The term “charitable gift annuity” has the meaning given it in section 501(m)(5) of title 26.” 

As mentioned, the proposed transaction does not meet the definition of a charitable gift annuity described in IRC §501(m)(5) because it violates IRC §514(c)(5)(C)(ii).  The transaction is thus not exempted from federal antitrust laws as a charitable gift annuity.

E. In states that define their charitable gift annuity regulations by referencing IRC §501(m)(5), it isn’t exempted from state insurance and securities registration and regulation.

The specific reference to IRC §501(m)(5) within a state statute may not be a relevant issue due to federal preemption.  For example, if the transaction is not exempted as either a charitable gift annuity or a commercial fixed annuity under federal law, then it is a security subject to federal regulation by the SEC.  Accordingly, several state statutes explicitly use IRC §501(m)(5) to define transactions that qualify for special exemptions under state securities and insurance laws as charitable gift annuities.  See, e.g., Colorado (Colo. Rev. Stat. 10-1-102(4)(a)), Virginia (Va. Code. §38.2-106.1), and West Virginia (W. Va. Code §33-13B-1(c)).  In such cases, the proposed transaction would not qualify under state law for these charitable gift annuity exemptions.

II. DONOR PROBLEMS

The “net-proceeds” CGA may result in a series of potentially dire consequences for the issuing charity.  However, separate from these results, the potential consequences for the donor may also be problematic.

A. The donor retains an interest, via contract, in the donated property.  (This makes the initial transfer a nondeductible “partial interest” gift.)

If a donor contributes less than his or her entire interest in property, that contribution is generally not deductible under IRC §170(f)(3).15   The only exceptions are specifically delineated in the statutes, such as with a Charitable Remainder Trust, Charitable Lead Trust, Pooled Income Fund, Retained Life Estate, or Qualified Conservation Easement.

In the “net-proceeds” CGA, the donor retains an interest, via contract, in the donated property.  Specifically, at the point of transfer of the property, the donor receives a contract obligating the charity to return a share of the future sale price of the donated property, paid as a lifetime annuity.  The donor has not yet released all of his or her financial interests in the donated property.  Quite the opposite.  The donor retains contractual rights to financial payments.  Those payments depend upon the future income (or “net-proceeds”) received from the eventual sale of the property.

If, for example, the property value is subsequently impaired by some intervening negative event, the donor will receive a much smaller financial benefit (a smaller annuity contract).  The donor’s payments are tied to the future returns (“net-proceeds”) generated by the property. 

The donor retains an interest, via contract, in the future of the donated property.  Is the result altered because the format of the retained interest is through a gift agreement, rather than by, for example, a deed, mortgage, or stock option?  No.  In other treatments of retained future interests in donated property, the regulations are intentionally broad, encompassing any “understanding, arrangement, agreement, etc., whether written or oral”.16

An argument that the “net-proceeds” CGA contract could only benefit the charity – compared with a typical CGA funded with property – does not change this result.  Revenue Ruling 88-37 clarifies, “The scope of section 170(f)(3) thus extends beyond situations in which there is actual or probable manipulation of the non-charitable interest to the detriment of the charitable interest”.

At the point of the property transfer, there is a retained interest.  Consequently, no deduction would be allowed at that point.  At the point of sale by the charity, that retained interest is released.  At this second point, the donor releases his remaining interests in the property.  One might argue that this release, constituting all remaining interests of the donor, could be deductible.17   However, the deductible gift would be only the release of the contract right in the property’s net proceeds, not the original gift of the property itself.  The amount of the annuity would not be less than the value of this released contract right, thus resulting in no deduction.

This also creates a completely separate argument for violation of IRC §514(c)(5).  IRC §514(c)(5)(A), requires that

“at the time of the exchange, the value of the annuity is less than 90 percent of the value of the property received in the exchange,”

If the “time of the exchange” occurs at the subsequent sale of the property, i.e., when the donor releases his contract rights in the property and makes his first deductible transfer via that release, then this rule may be violated.  In that case, the value of the property received “at the time of the exchange” is merely the release of the donor’s contract rights related to the sale of the property in exchange for a fixed annuity.  The value of this remaining partial interest would not exceed the value of the annuity granted by the charity.

B. When the retained interest is released, the charity has already executed, and fulfilled, a binding contract to sell the gifted property.  (This allows the IRS to treat the sale as income to the donor.)

The exchange involves two points of transfer.

1. A transfer of property with a retained contractual interest in the property, followed by
2. A subsequent sale of the property resulting in a release of the retained contractual interest in the property.

Under this treatment, the first transfer is not deductible.  The second transfer could be deductible, but would not exceed the value of the annuity contract offered by the charity.

26 CFR §1.170A-7(1)(2)(ii) allows for a deduction even if the separate interests alone would not be deductible by themselves, so long as all interests are transferred to charities.  Unfortunately for the proposed transaction, this section specifically references all such interests being transferred on the same date, which is precisely what the proposed arrangement seeks to avoid. 

IRC §170(a)(3) does allow for contributions of future interests in tangible personal property. In such a case, the gift is made “only when all intervening interests in … the property have expired.”

This points the second issue with the transfer.  Even if we could collapse the two points of transfer into a single gift, the gift is not complete until the future interest in the property is released.  The date of the gift cannot be the earlier date on which the donor still retains a future interest in the property.  Even in this best case scenario, the date of a completed gift arises only when the donor’s intervening interests in the property have expired.  This occurs only after the charity has executed (and fulfilled) a binding contract to sell the gifted property.  When a charity has executed a binding contract to sell the gifted property prior to the date of the completed gift, the taxpayer is treated as having sold the property prior to the gift and is immediately charged with any capital gains taxes.18

C. The charity could sell the property for substantially less than the appraised value.  (This could motivate aggrieved family members to report to consumer protection and securities enforcement agencies.)

The “net-proceeds” CGA appears attractive for a charity.  It can accept a gift of property in exchange for a gift annuity, without any risk that the sale of the property will not generate sufficient funds.  However, this risk does not disappear.  Instead, it is simply given to the donor.  If the property sale goes poorly, the charity still wins.  Its annuity obligation drops with the sale price.  However, the donor loses.  The donor receives smaller annuity payments.

This potential for substantial economic loss also holds the potential for an unhappy donor.  Even if the fundraiser is able to maintain good relations with the donor, it holds the potential for unhappy family members of the donor.  The average age of CGA annuitants is 79.19   Any CGA removes an asset from the estate of the donor.  This, by itself, may cause some unhappiness from expectant heirs who don’t hold similar charitable interests.  A perceived mismanagement of the asset resulting in lower payments could compound these feelings.  A low sales price could easily be attributed to the incompetence of the charity.  The essence of the potential emotions involved here are captured in the subtitle to Robert Sobol’s article in the Journal of Investment Compliance, “The Securities Law Implications of Pooled Income Fund Sales: Who Is Taking Grandma’s Money and Why are They Wearing Suspenders?”20

Where could aggrieved family members turn in such a case?  A natural first step would be to contact consumer protection agencies which could facilitate a complaint to state or federal securities regulators.  This would contravene arguments that “net-proceeds” CGAs, even if statutory violations, are difficult for regulators to detect so long as they are closed within the same fiscal year (or, alternately, reported as if they were closed within the same fiscal year).

III. CHARITABLE TAX POLICY PROBLEMS

If the “net-proceeds” CGA was indeed allowed by tax law, with the claimed tax effects, it could be used abusively.  The proposed transaction suggests the following:

1. A donor transfers property to charity at time point 1. 
2. The gifted property is valued using the full appraised value at time 1 (valued as if the donor retained no contractual interests in the future sale proceeds of property). 
3. At time 2 the charity sells the property.
4. The annuity payment is then set using the net-proceeds from the charity’s sale of the property at time 2 (presumably capped by the appraised value at time 1).
5. The donor deducts the full appraised property value at time 1 one less the value of the annuity payment set at time 2.

Separately, the donor/charity may seek to ensure time 1 and time 2 occur in the same tax year, so that it appears to government officials as if the charitable gift annuity transaction was not separated into these steps.  In an extreme case, the charity may even offer to backdate the final annuity agreement to the time of initial transfer (time 1) using the payment value established at the time of sale (time 2).  If the donor reports such later-established annuity payment amounts as if they were actually known at the time of transfer (time 1), then the sale need not occur until “the due date of the tax return on which the gift will be reported, since the annuity amount will be known by that time.”21

Some would argue that the proposed transaction, setting aside efforts to conceal the two-step nature of the transaction from government officials, has its heart in the right place.  It’s not trying to cheat anyone.  It’s not trying to be abusive.  The only outcome compared with the typical transaction is that the charity makes lower payments to the donor.  Although this is clearly a problem for consumer protection policy in annuities, discussed below, what could be the problem for tax policy?

This problem is that it allows the donor to separate the timing of the valuation of the property from the timing of the valuation of the annuity payments for charitable tax deduction purposes. 

Consider the case of Mr. A.  Suppose Mr. A is completely uncharitable, but he has an unusual piece of real estate (or closely held stock).  The property is currently valued at $3 million.  The problem is Mr. A knows of a hidden risk that, if revealed, will drop the value to $1 million. 

You can imagine your own downside risk story.  Maybe a new landfill will be locating next door.  Maybe the one factory in a small town is planning to shut down.  Maybe little Blue Star Airlines is about to get sued for some nefarious behavior. 

Whatever it is, Mr. A wants to sell.  But, there’s a problem.  It’s an unusual asset.  It has a thin market.  It’s hard to sell and nearly impossible to sell quickly.  Suppose over the next 6 months, there is a 50% chance he can sell it for $3 million.  There is also a 50% chance that the hidden risk will become apparent, and the value will drop to $1 million.

His expected return equals (50% x $3 million) + (50% x $1 million) = $2 million.

He could donate it today.  If he can use the deduction this could net him $3 million X 37% = $1.11 million.  But, that’s not more money than he would expect from attempting to sell it, and he’s not charitable.  He rejects this.

He would be happy to exchange it for a charitable gift annuity worth up to 90% of the $3 million appraised value.  Of course, no reasonable charity would accept that until a buyer is found.  At that point, he could just sell it to the buyer and receive the $3 million cash.  This CGA doesn’t give him more money than selling it, and he’s not charitable.  He rejects this.

However, a charity would be happy to offer a “net proceeds” CGA.  He makes a gift valued at $3 million.  He has a 50% chance of getting an annuity worth about 90% of $3 million and a 50% chance of getting an annuity worth about 90% of $1 million.  If he gets the bigger annuity, he also gets a tax deduction worth $300,000 X 37% = $111,000.  That’s a total upside worth $2,811,000. 

Here is the problem for tax policy.  If he gets the smaller annuity, worth about $900,000, he also gets a tax deduction worth $2.1 million X 37% = $777,000.  That’s a downside worth $1,677,000.

Using the “net proceeds” CGA his estimated return equals (50% x $2.811 million) + (50% x $1.677 million) = $2.244 million.  He’s not charitable, but that’s more money than selling it (estimated return of $2 million).  He takes a tiny hit on his upside ($2.811 million vs. $3 million), but gains a huge benefit on his downside ($1.677 million vs. $1 million).  That money, of course, comes from the treasury.

We can even get the treasury to throw in some extra bonuses.  He can avoid or postpone capital gains taxes.  He gets a deduction for state income taxes.   

Charitable tax policy does not allow charitable deductions when the donor still retains a contractual interest in the future sales price of donated property, except in the standard authorized exceptions.  This isn’t accidental.

Could Mr. A pull this same trick with an authorized exception like a Charitable Remainder Trust (CRT)?  No.  The value of the CRT payment is established at the time of the transfer.  If the asset later sells for less, it doesn’t create a bigger tax deduction.  It just creates smaller payments.

You can’t backdate when you set the value of a CRT payment.  And you can’t backdate when you set a CGA payment, either.22

IV. CONSUMER PROTECTION PROBLEMS

A reasonable application of the tax code eliminates the tax benefits from a “net proceeds” CGA.  Once these tax benefits are eliminated, leaving the donor with smaller than expected payments (resulting from a lower sales price) isn’t a problem for tax policy.  It is, however, a major problem for consumer protection policy.

State insurance agencies regulate standard annuities.  However, the SEC fought for the right to regulate variable annuities, winning this in 1959 in the U.S. Supreme Court.23   The essential reasoning of the court was that because the payments could vary with investment returns, this greater consumer risk warranted much more strict regulation of the products as securities. 

In 1967, a later Supreme Court case applied this same analysis, and reached the same result, for a product where the consumer was subject to market returns initially, but then converted to a fixed-payment annuity based upon those returns.24   This is precisely the essence of the “net proceeds” CGA.  The consumer donates the property and then faces the initial downside risk of a negative outcome resulting from a low sales price of the asset.  Once the asset is finally sold, the consumer receives a fixed payment annuity based upon that sales price.  Although transferring this initial risk may be attractive to the organization, it is precisely the kind of risk transference the Supreme Court has identified as worthy of the heightened regulation provided by the SEC.

The consumer protection justification underlying the Supreme Court decisions matches the current safe-harbor requirements protecting fixed payment annuities from being regulated by the SEC as variable annuities.  As discussed above, the “net proceeds” CGA violates these safe-harbor requirements.  The SEC regulation of products designed like the “net proceeds” CGA is not merely an unintended result of the text of the statute.  This same justification matches the plain reading of the language of IRC §514(c)(5)(C)(ii).

Thus, the statutory consequences of “net proceeds” CGAs leading to unrelated business income tax, commercial insurance treatment, loss of tax exempt status, and regulation as either commercial insurance under state law or, more likely, as unregistered securities under federal law, is an intentional result stemming from a long history of well-established consumer protection policy purposefully expressed in the plain language of the statutes.

• 1. See Rev. Rul. 78-197; Blake v. Commissioner 697 F.2d 473 (2nd Cir. 1982)
• 2. See section IV(C) of Charitable Gifts of Real Property, https://www.pgdc.com/pgdc/charitable-gifts-real-property
• 3. Id.
• 4. Otherwise the donor might get an annuity worth more than 90% of the original appraised value of the gift, potentially disqualifying the transfer as a charitable arrangement. See IRC §514(c)(5)(A)
• 5. IRS. (2019, Sept. 20). Unrelated Business Income from Debt-Financed Property under IRC Section 514, https://www.irs.gov/charities-non-profits/unrelated-business-income-from...
• 6. Philanthropy Protection Act of 1995, Pub. L. No. 104-62 (1995) (“Section 2. Amendments to the Investment Company Act of 1940.”)
• 7. See SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65 (1959) (holding variable annuities are securities); SEC v. United Benefit Life Ins. Co., 387 U.S. 202 (1967) (holding prematurity phase of flexible fund annuities are securities).
• 8. 17 C.F.R. § 230.151(b)(1)
• 9. 17 C.F.R. § 230.151(a)(2)
• 10. Securities and Exchange Commission v. We The People, Inc. of the United States, Complaint, Section IV. 32., https://www.sec.gov/litigation/complaints/2013/comp-pr2013-19-wtp.pdf
• 11. See https://www.sec.gov/fast-answers/answersnoactionhtm.html
• 12. See, e.g., University of Minn. Found., SEC No-Action Letter, [1981 Transfer Binder] Fed. Sec. L. Rep. (CCH) T 76,792 at 77,206 (Dec. 24, 1980) and Christ Church of Wash., SEC No-Action Letter, 1974 WL 9979 (SEC), (June 17, 1974) cited in Timothy L. Horner & Hugh H. Makens, Nonprofit Symposium: Securities Regulation of Fundraising Activities of Religious and Other Nonprofit Organizations, 27 Stetson Law Review 473, 513 fn 232. See also, New Life Corporation, 1999 SEC No-Act. LEXIS 326 (March 16, 1999).
• 13. See Timothy L. Horner & Hugh H. Makens, Nonprofit Symposium: Securities Regulation of Fundraising Activities of Religious and Other Nonprofit Organizations, 27 Stetson Law Review 473, 506 fn 203: Sanford J. Schlesinger, New Legislative Protection for Charitable Giving Vehicles, 23 Est. Plan. 392 (1996) ("The statutes afford protection to charitable gift annuities and other charitable vehicles"); Jacques T. Schlenger et al., New Statutes Exempt Charitable Gift Annuities from Antitrust and Securities Laws, 23 Est. Plan. 135 (1996); Dennis I. Belcher, Charitable Gift Annuity Legislation, Q250 A.L.I.A.B.A. 17, 21 (March 28, 1996) ("The Act exempts from the Investment Company Act of 1940 the following funds 'maintained' by a charitable organization: (a) general endowment funds, (b) pooled income funds, (c) charitable gift annuities, (d) charitable remainder trusts, and (e) charitable lead trusts")
• 14. Charitable Gift Annuity Antitrust Relief Act of 1995, Pub. L. No. 104-63 (1995).
• 15. See also, 26 CFR §1.170A-7(a)(1)
• 16. 26 CFR § 1.170A-5(a)(4)
• 17. See, 26 CFR §1.170A-7(a)(2). Note that this should not be disqualified under §1.170A-7(a)(2) providing “…If, however, the property in which such partial interest exists was divided in order to create such interest and thus avoid section 170(f)(3)(A), the deduction will not be allowed,” because both partial interests are contributed to charity.
• 18. See Rev. Rul. 78-197; Blake v. Commissioner 697 F.2d 473 (2nd Cir. 1982)
• 19. American Council on Charitable Gift Annuities. (2018). 2017 Survey of Charitable Gift Annuities.
• 20. Sobol, Robert N. (2004). The securities law implications of pooled income fund sales: Who is taking grandma’s money and why are they wearing suspenders? Journal of Investment Compliance, Fall, 71-84.
• 21. See IV(C)(2) of Charitable Gifts of Real Property, https://www.pgdc.com/pgdc/charitable-gifts-real-property
• 22. Suppose for a moment that we pretended that donor retained no contractual interests in the future sale proceeds of property and that the time of the exchange was the date of the initial property transfer by the donor and not the later date of the sale. The transaction still wouldn’t work, because if the time of the exchange was the date of the initial property transfer by the donor it would not then be possible to calculate the value of the annuity at the time of the exchange as required by 26 CFR § 1.514(c)-1(e), stating “(2) Valuation. For purposes of this paragraph, the value of an annuity at the time of exchange shall be computed in accordance with section 1011(b), § 1.1011-2(e)(1)(iii)(b)(2), and section 3 of Rev. Rul. 62-216, C.B. 1962-2, 30.” At best, we could calculate only the maximum value of the annuity payments.
• 23. Securities and Exchange Commission v. Variable Annuity Life Insurance Co. and the Equity Annuity Life Insurance Co., 359 U. S. 65 (1959).
• 24. Securities and Exchange Commission v. United Benefit Life Insurance Co., 387 U. S. 202 (1967)