ELITE ADVISOR BEST PRACTICES

Elements and Timing of a Charitable Gift - Part Two

Unfulfilled promises, pledges and bounced checks at year-end can wreak havoc on clients’ tax returns and beneficiaries’ financial statements. Real-world examples explain more.

By Russell James III, J.D., Ph.D.

Key Takeaways:

  • Understanding the moment at which the transfer becomes a deductible gift creates a more precise understanding of the definition of a charitable gift for income tax purposes.
  • Unfulfilled promises, pledges and bounced checks at year-end can wreak havoc on clients’ tax returns and beneficiaries’ financial statements.
  • Real-world examples in this article show that timing is everything when it comes to tax treatment of charitable gifts.

In Part One of this article, we looked at the rules in their conceptual form. Let’s now look at some examples applying these rules to actual gift scenarios. Suppose a donor puts a cash gift in a stamped envelope addressed to the charity. The donor then puts the envelope into a mailbox at the local United States Post Office on Day One. On Day Two, this cash arrives safely at the charity. When did this transaction become a completed gift for tax purposes?

The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity. The tricky part is knowing that the United States Postal Service is considered an agent of the recipient. Even though the charity has not received the money on Day One, the charity’s agent has received the money. Consequently, the gift is a completed gift on Day One. (Note that only the United States Postal Service is considered an agent of the recipient. If the gift had been delivered, for example, by FedEx or UPS, it would be considered held by an agent of the donor until it arrived at the charity.)

Because the donor has delivered money to an agent of the charity (in this case, the United States Postal Service) on Day One, the gift was a completed gift for income tax purposes on Day One.

Next, consider another common situation. On Day One, the donor writes a check to a charity. On Day Two, the donor puts the check in the United States Postal Service mailbox and it is taken by the mail carrier. On Day Three, the charity receives the check in the mail. On Day Four, the charity deposits the check. Finally, on Day Five, the charity’s bank receives the funds and the charity is credited with the funds. On which of these days was the gift completed for income tax purposes?

The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity. The tricky part in this situation is to understand that a valid check is valuable property. Conceptually, the idea is that a valid check is not just a promise to pay but is a valuable negotiable instrument (sort of like a corporate bond), making it valuable property even prior to its deposit.

Because a valid check is considered valuable property, and because the Post Office is considered to be the agent of the charity, the charity’s agent receives valuable property on Day Two. Thus, the gift is complete for income tax purposes on Day Two.

Why is it important to know when, precisely, a transfer becomes a completed charitable gift for income tax purposes? Why is it important whether the gift is complete on Day One or on Day Five? The first answer is that this is a learning tool to understand what is and what is not a deductible charitable gift. Understanding the moment at which the transfer becomes a deductible gift creates a more precise understanding of the definition of a charitable gift for income tax purposes. Beyond this educational purpose, however, knowing the exact day can itself be quite important. There can be a big difference between one day and the next for tax purposes.

For example, a gift completed on December 31 can be deducted one year earlier than a gift completed the next day. Waiting for an additional year can be a substantial consequence of knowing precisely which day a gift becomes complete for income tax purposes.

Indeed, much more substantial consequences may result when the tax circumstances are different in the different years. The deductible gift may not be usable in the later year due to, for example, charitable deduction income limitations or use of the standard deduction. In such cases, knowing the exact date when the charitable gift is complete for income tax purposes can be the difference between a valuable deduction and a useless deduction.

The difference in the date on which a charitable gift becomes complete for income tax purposes may also have significance if the donor happens to die during the process.

Now consider some additional examples demonstrating when a deductible charitable gift occurs. Suppose there is a scenario identical to the previous example of a check mailed to a charity. However, in this case, the check bounces. How is this scenario handled under the income tax charitable deduction rules?

The answer, as always, is that the gift is complete when the donor delivers money or valuable property to the charity or agent of the charity. The key understanding in this case is that an invalid check was never considered to be valuable property. Because the donor never delivered valuable property to the charity, there was no charitable gift. (In a sense, the future knowledge that the check would bounce is attributed back to its date of origin, meaning that at no point was the check ever valuable property.)

How then should a postdated check be treated? In this case, the postdated check is delivered to the charity’s agent (the United States Postal Service) on December 26. However, the check cannot be deposited prior to January 1, because it is postdated to that day. So when is the gift completed?

The critical piece of information in this scenario is to understand that a postdated check is considered a promise to pay money in the future. Unlike a normal check, which is immediately considered to be valuable property, a postdated check is considered to be only a promise to pay in the future. A promise to give money or property to a charity in the future does not constitute a deductible gift. Thus, the postdated check is not a completed gift when it is transferred to the charity or the charity’s agent. Once the date of the check arrives, however, it immediately becomes valuable property. If at that time it has been delivered to the charity or the charity’s agent, then the gift is complete.

Thus, in this scenario, the gift is complete on January 1. That is the date on which the charity has received valuable property. On December 31, the charity did not have valuable property but instead had only a promise to pay. On January 1, the promise to pay was converted to a valuable negotiable instrument, and thus the gift was complete.

My book about this topic has more.


About the Author

Russell James, J.D., Ph.D., CFP®, is a professor in the Department of Personal Financial Planning at Texas Tech University. He directs the on-campus and online graduate program in Charitable Financial Planning. Additionally, he teaches Charitable Gift Planning at the Texas Tech University School of Law. He graduated, cum laude, from the University of Missouri School of Law where he was a member of the Missouri Law Review. While in law school he received the United Missouri Bank Award for Most Outstanding Work in Gift and Estate Taxation and Planning. He also holds a Ph.D. in consumer economics from the University of Missouri, where his dissertation was on charitable giving.