Don’t Run FASB Liability Calculations for Lead Trusts and Perpetual Charitable Trusts

PG Calc provides software for calculating the estimated Financial Accounting Standards Board (FASB) liabilities for life income gifts. We also offer a service whereby we will run the calculations for the charity. These estimates of future payment obligations make sense for life income gift arrangements – charitable gift annuities (CGAs), charitable remainder trusts (CRTs), and pooled income funds (PIFs). For each of these gift vehicles, the charity has an obligation to make payments either for a number of years or for a person’s remaining lifetime. However, we also see charities that record future payments from lead trusts and perpetual trusts as obligations of the charity. Does this make sense? Let’s explore this question.

The charity certainly has a need to estimate the future payment liability on life income gifts, for internal planning purposes, but equally important, the charity is required to provide such numbers in its public financial disclosures. Standard accounting practices dictate the manner in which future liabilities are to be estimated, and how those amounts – which are basically payables on the charity’s balance sheet – must be disclosed to the public.

When a charity receives an outright gift of $50,000 in the form of a check, the organization simply counts that as a positive change to its assets. But when the charity accepts $50,000 in the form of a check, representing the funding for a CGA, the organization runs calculations to determine the income tax charitable deduction in accordance with IRS methodology. The donor does not get a deduction for the full amount, because a gift annuity is a life income gift. Instead, the donor gets a deduction for a portion of the funding amount. The deduction represents the estimated value of the eventual benefit to the charity.

Many gift planning professionals are unaware of this, but in running the deduction calculations, the gift planner is also running an estimate of the total payment obligation associated with the gift annuity. The difference between the charitable deduction and the funding amount is called the “Investment in Contract” (it may also be referred to as the “Value of Annuity”). It is the total amount of payments expected to be made to the annuitant, based on life expectancy, which is then discounted to present value. Using our example above for a $50,000 gift annuity, if the charitable deduction is $22,000, the investment in contract would be $28,000. The charity books the $50,000 gift as an addition to its assets, but at the same time, it records a liability of $28,000 on the payables side of its balance sheet.

In most cases, organizations need to run calculations for estimating payment liabilities on an annual basis, typically as of the last day of their fiscal year. All CGAs, CRTs, and PIF participations involve the charity and / or its agent making payments to individuals, over many years. The organization needs to report its estimated payables as part of its published financial reports. As part of the annual reporting process, the organization typically engages the services of an accounting company to perform an audit of its financial reports. Questions and concerns about calculating estimated liabilities frequently come up in conjunction with that annual audit.

As we have already explained, the computation of estimated payment obligations – the FASB liabilities – make sense for any split interest gift that is a life income gift. The ongoing maintenance of CGAs, CRTs, and PIFs warrant the annual calculations of payment liabilities. But what about charitable lead trusts? And what about perpetual “charitable trusts?”

We have seen many organizations running or requesting FASB liability calculations for those other gift vehicles, but are they appropriate? The auditors may be requesting those calculations because they are on some kind of list, and the gift planning professionals may be in the practice of running them “because we’ve always done it that way.” But let’s think about that for a minute. With a charitable lead trust or a perpetual charitable trust, the charity is set up only to receive money; the charity has no payment obligation, either now or in the future. Why would the charity run calculations of payment liabilities, and why would those numbers be reported in the organization’s annual financial reports to the public?

It might be helpful to look at a theoretical example – we’ll focus on the charitable lead trust. Let’s say the donor contributes $1 million to establish a charitable lead annuity trust, with a payout rate of 5%, and a term of 20 years. That means the charity will receive $50,000 each year, for 20 years, with payments totaling $1 million. How should the charity book the initial receipt of the trust, and how should the charity report the trust each year on its financial reports to the public? The answer depends on whether the charity is serving as Trustee of the lead trust.

While there are a few larger organizations who will serve as Trustee for charitable lead trusts, in most cases, the Trustee will be the donor or someone the donor is already working with. If the charity is not the Trustee, the charity should not book the $1 million as part of its assets; it has no control over the management of the trust, and it simply serves as the lucky recipient of $50,000 each year. Should anything be listed on the charity’s financial reports reporting the future payments as liabilities? No. The charity is not responsible for paying anything out of the trust – the charity is only responsible for receiving money from the trust.

The same argument would apply to a perpetual charitable trust. If there is a trust that pays the charity a specific amount – or the net income – each year, the charity has no business listing any kind of payment liability. The charity only serves as the recipient of cash disbursements. Reporting any kind of payment liability for the lead trust and the perpetual charitable trust essentially lists a negative payment as a payable on the organization’s books, for which there is no corresponding receipt of assets. This would result in the charity reporting a lower total value for its assets than what is truly the case – because the total has been distorted with “false negatives.”

Just because “it’s always been done this way” does not mean that it is correct. We’re not going to comment about how a one-time adjustment to the charity’s financial reports should be explained – that is a question for the auditors. But we strongly recommend that the charity stop listing the future payment amounts for lead trusts and perpetual charitable trusts as negative amounts. If they are to be included in any way on the charity’s financial reports, they should be listed as receivables, not payables.