Each year at this time, charities with pooled income fund (PIF) programs start receiving calls and emails from PIF beneficiaries who are agitated by the perceived “lateness” of their Form K-1 (by law, PIF K-1s are not due until April 15). Many beneficiaries receive fairly modest PIF incomes, and it is not uncommon for a PIF beneficiary to be waiting on a K-1 only to learn that their reportable annual income is less than $100. In the Venn diagram of PIF beneficiaries who receive scant annual income and also get angry about the perceived K-1 delay, there is an opportunity to present a voluntary severance from the PIF.
A voluntary severance means the PIF beneficiary signs a document renouncing their right to income for life. This releases the value of the PIF units attributable to their share of the PIF on the date they signed the severance document. It allows the charity to put that sum to work for the charitable purpose specified in the original instrument of transfer, which is often the organization’s general purposes. Once the beneficiary severs their income interest, they will no longer have reportable income from the PIF, and the “late” K-1 will no longer be a point of friction.
In addition, the PIF beneficiary, who may not have been the original PIF donor, is transformed into the donor of an outright gift. They receive an income tax deduction equivalent to the present value of their right to future income. This amount can also move the needle of the fundraising totals of your organization, as it is an outright gift with a cash value.
If the value of a PIF beneficiary’s income interest is greater than $5,000, they will need a qualified appraisal in order to make use of the deduction. However, if a PIF beneficiary is receiving less than $100 year, it is extremely unlikely that the value of their future income will exceed $5,000. Because the severance of a PIF is a capital asset with a zero-tax basis, the charitable deduction will be usable up to 30% of the PIF beneficiary’s adjusted gross income (AGI).
Consider creating a list of candidates for voluntary severance. This list would begin with any beneficiary who annually complains about the K-1 “delay” despite your best efforts to educate them about the K-1 timing. Add to this list any individuals who are younger than a typical life income beneficiary. There was a trend in the 80s and early 90s for grandparents to name a grandchild as the PIF’s second beneficiary. These individuals are often mystified by their PIF payments and respond enthusiastically to the option to release their income interest. Lastly, review the K-1s for individuals receiving less than $100 a year in income. They are also likely candidates for a voluntary severance, as the financial benefit of streamlining their income tax filing may be worth more than $100 to them.
Once you’ve identified the list of candidates, you can calculate the value of any potential severance. This is easily accomplished in PGM Anywhere using the Non-charitable Interest Actuarials chart. To do this calculation, you’ll need to know the PIF’s valuation rate for the year of severance (the PIF's highest annual rate of return of the last three years).
Your severance proposal letter should reflect the beneficiary’s relationship both to the gift and to your organization. If the beneficiary was also the original donor, they may be most receptive to an appeal that stresses the opportunity to see their gift go to work while alive, or to release the charity from this financial obligation in order to focus more on mission. If the beneficiary inherited this right to income, perhaps from a grandparent or other elder, the letter should educate them on the original donor’s commitment to your organization and offer them the opportunity to reaffirm their loved one’s commitment.
If through this outreach you learn your PIF beneficiaries are receptive to the idea of no longer having to wait for a K-1, but are not charitably inclined, you can also offer them the opportunity to “cash out” the value of their income interest.
Again, the beneficiary would sign a document relinquishing their right to life income, but instead of receiving an income tax deduction, they would be paid a lump sum. The amount of the cash payment typically is equal to the present value of the relinquished income interest.
There is no charitable deduction available for a cash out that is equal to the present value of the relinquished income interest, and the payment is generally taxable to the participant entirely as ordinary income. However, a PIF severance of any kind is a benefit to your organization. At the very least, it is one less angry phone call or email that your team must respond to, and at the best, it injects immediate outright cash into your charitable program.