PRACTICAL TIPS FOR CHARITABLE PLANNING

Transcription

1 PRACTICAL TIPS FOR CHARITABLE PLANNING CLINT T. SWANSON SWANSON LAW FIRM, PLLC 200 REUNION CENTER NINE EAST FOURTH STREET TULSA, OKLAHOMA I. CHARITABLE PLANNING A. Importance of Charitable Planning Charitable planning is often an important component of a well-designed estate plan. Through charitable planning it is possible to create a legacy of goodwill for the family that will last for generations. Charitable giving can zero out estate and gift taxes that would otherwise be paid to the government. Charitable planning can create an immediate income tax savings for clients through well timed charitable deductions. Charitable planning coupled with life insurance planning can be used to leverage up the value of an estate. Family art and collectibles can be shared with the public in a manner that preserves the collection and the family s ownership and control, while simultaneously creating an income tax deduction for the family. Family foundations and trusts can be used to maintain voting control of corporations and partnerships. B. What is Charitable Planning? Charitable Planning is the thoughtful transfer of a donor s wealth to one or more charitable organizations which are important to the donor in a manner that reduces or eliminates the transfer taxes, generates goodwill toward the family name, allows the continued management and control of the donated assets (if desired), and creates the largest possible income tax and wealth transfer tax deduction. C. Charitable Planning Options Direct charitable gifts during donor s lifetime; Direct charitable gifts at donor s death; Split interest gifts during life; Split interest gifts at death; Transfers of personal residence and farm land with retained life estate; Creation of private foundations and public charities; and Contributions through donor advised funds. 1

2 II. DIRECT CHARITABLE GIFTS A. Outright Gifts Outright gifts to a charity during the donor s life time will generally result in an income tax deduction for the gift. The availability and amount of the deduction will depend on the type of charity (public charity vs. private foundation), the type of gift (cash, publicly traded securities, non-publicly traded securities), the value and tax basis of the asset transferred, the timing of the gift, and the amount contributed by the donor in prior years. Cash Gifts1. Public Charities an individual may deduct up to 50% of the contribution base, which is his or her adjusted gross income ( AGI ). IRC 170(b)(1) Thus, if an individual has an AGI of $100,000 that individual may give up to $50,000 to public charities and may deduct the full amount. a. Public charities: Public charities are defined in IRC 170(b)(1)(A)(i) thru (viii) and include: churches, hospitals, nonprofits schools, charities that receive substantial public support (e.g. United Way, Salvation Army, American Red Cross, etc.). b. Private Operating Foundations: A private operating foundation is also eligible for the maximum 50% of AGI deduction. Private operating foundations must be actively engaged in the activities that constitute its charitable purpose. IRC 4942(j)(3). Examples include: research organizations and organizations that operate a facility for public use. c. Private Distributing Foundation: A private distributing foundation is a private foundation that distributes the contributions it receives to public charities within 2.5 months after the close of the year in which the contributions were made. IRC 170(b)(1)(A)(vii). By making these qualifying distributions the private distributing foundation qualifies for the maximum 50% of AGI deductions. 2. Private Foundations an individual may deduct up to 30% of his or her AGI for cash contributions to private foundations. a. Private Foundations: By default, all charitable organizations are private foundations unless they qualify as public charities under IRC 170(b)(1)(A). i. Private foundations are generally subject to various restrictions and limitations, such as: 1. Excise tax on investment income; 2. Prohibitions against self-dealing; 2

3 3. Investment limitations; and 4. A 5% distribution requirement. 3. Carryover of Excess Contributions Cash contributions in excess of the maximum deductible amount (50% of AGI) may be carried forward and deducted over the succeeding 5 years. IRC 170(d). Gifts of Property Other than Cash1. Ordinary Income Property Any property which if sold would produce ordinary income or short-term capital gain is ordinary income property. If such assets are contributed to charity the deduction is limited to the individual s tax basis in the property. IRC 170(e). Thus, no deduction is allowed for the appreciation in the value of the property over its basis. Ordinary income property includes: fully depreciated assets, and property held for less than one year. 2. Capital Gain Property Capital gain property is property that if sold would produce long-term capital gain (i.e. held for more than 1 year). In the case of capital gain property, the amount of the deduction will depend on the type of charitable organization and, with respect to tangible personal property (i.e. art work and collectibles), the use of the property. a. Contributions to Public Charities As a general rule, contributions of capital gain property to a public charity is deductible up to 30% of the individual s AGI. IRC 170(b)(1)(C). i. Example: Donor has $200,000 of AGI (i.e. contribution base). Donor contributes publicly traded securities to a public charity that she has held for more than 1 year which are currently worth $100,000 with a basis of $10,000. The amount of the charitable deduction will be $60,000 (30% of $200,000), with a carryover of $40,000 to the succeeding 5 years. b. Contributions to Private Foundations of Non-Publicly Traded Securities As a general rule, a contribution of long-term capital gain property to a private foundation is deductible up to the donor s basis in the property. IRC 170(e)(1)(B)(ii). i. Example: Donor has $200,000 of AGI. Donor contributes non-publicly traded long-term securities to a private foundation that have current value of $100,000 and a basis of $10,000. The amount of the charitable deduction is $10,000. c. Contributions to Private Foundations of Publicly Traded Securities There is an exception to the general rule for contributions to private foundations of publicly traded securities. 3

4 The full fair market value of the stock is deductible up to 20% of AGI. IRC 170(e)(5) & (b)(1)(d). d. Gifts of Tangible Personal Property Unrelated to the Charity s Purpose If the charity does not use a gift of tangible personal property (e.g. artwork, collectible, patent, or copyright) in a manner related to the purpose or function constituting the basis for the charity s tax exemption, then the deduction is limited to the taxpayer s basis in the property. i. Example: Taxpayer contributes artwork to a hospital. The artwork is worth $100,000 and the taxpayer s basis is $10,000. The hospital subsequently sells the artwork and uses the proceeds to purchase equipment. The taxpayer s deduction is limited to its basis or $10,000 up to 50% of AGI. e. Gifts of Tangible Personal Property Related to the Charity s Purpose If the charity does use a gift of tangible personal property (e.g. artwork, or collectible) in a manner related to the purpose or function constituting the basis for the charity s tax exemption, then the deduction is the full fair market value of the tangible personal property up 50% of the taxpayer s AGI. f. Carryover Deduction That portion of the value of any capital gain property which exceeds the limitations on deductibility in the current year (30% of Donor s AGI) may be carried over as a charitable deduction for the succeeding 5 years. B. Planning Opportunities Contributions of appreciated long-term capital gain property may result in significant tax savings, compared to gifts of cash or other assets. With the exception of gifts of tangible personal property for an unrelated use, the donor may deduct the full fair market value of the property (up to the maximum limits of AGI) for gifts to a public charity and pay no capital gains tax on the appreciation. Gifts of Appreciated Long-Term Capital Gain Property 1. Example: Donor owns securities that she has owned for more than 1 year. Donor paid $10,000 for the securities, and they are currently worth $150,000. Assume Donor is in the highest federal income tax bracket in the current year 43.4% (39.6% Medicare Surtax). Contributing the securities to charity will result in charitable deduction of $150,000 for income tax purposes and a potential tax savings of $65,100, for a net after tax cost of the contribution of $84,900 ($150,000 value of securities minus $65,100 tax savings). On the other hand, if the securities are sold then contributed to charity the capital gains tax would be approximately $28,000, and the net after tax cost of the contribution would be $112,900($150,000 value of securities plus $24,000 capital gains tax less 4

5 $65,100 tax savings). Bargain Sales of Appreciated Capital Gain Property to Charity Some taxpayers may want to consider selling an appreciated capital gain asset to a public charity for less than fair market value as an alternative to an outright gift of the asset. This will enable the taxpayer to recoup a portion of the asset s value and at the same time deduct the excess of the FMV over the selling price as a charitable contribution. 1. Example: Assume Donor owns appreciated real property that Donor purchased more than 1 year ago for $100,000. The land is currently worth $400,000. Donor wishes to contribute the land to a public charity, but would also like to recover his initial investment of $100,000. Donor sells the land to the charity for $100, % of the ($100,000/$400,000) of the $100,000 basis must be allocated to the portion sold, and the remaining 75% must be allocated to which was given away. IRC 1011(b). Thus, there is a $75,000 capital gain ($100,000 less $25,000) and a $300,000 charitable deduction. Caution: Such a sale should not be made to a private foundation, because it may be a disqualifying transaction that will result in the imposition of a penalty on the donor. IRC Deemed Sale for Contributions of Encumbered Property If the property contributed to a charity is encumbered, then the elimination of the liability is treated as proceeds from the sale of the property. Reg (b)(3). This rule applies to gifts of encumbered property regardless of whether the charity assumes the liability, whether the liability is recourse or nonrecourse, and whether the FMV of the property is less than the amount of liability. Rev. Rul , C.B III. ESTATE AND GIFT TAX CONSEQUENCES OF OUTRIGHT GIFTS A. Estate Tax Outright bequests to charities that are tax exempt are deductible from the gross estate in computing the net estate. IRC 2055(a). It is also possible for the decedent to specify that if a bequest is disclaimed it will go to charity and the disclaimed interest will be a charitable deduction from the gross estate. The amount of the estate tax deduction is the fair market value of the property transferred to the charity and available for its use. Notice there is no percentage ceiling for charitable deductions from the gross estate like there is for the income tax deduction. However, the charitable deduction is limited to the value of the transferred property that is includible in the gross estate. IRC 2055(d). B. Gift Tax There is an unlimited deduction for lifetime gifts to exempt charities. IRC There is no gift tax on charitable transfers. If the charitable gift exceeds the annual gift tax exclusion amount ($14,000), no gift tax return is necessary provided the gift is of the donor s entire interest in the property. IRC 6019(3)(A). A gift tax return must be filed for split interest 5

6 gifts. C. Lifetime vs. Testamentary Charitable Gifts Generally, it is more advantageous for the estate owner to make a charitable gift during life rather than at death. Lifetime gifts to charity provide a current income tax deduction and the value of the gift is not included as part of the decedent s estate. The income tax benefits are lost if the charitable contribution takes place at death. The Donor may not be willing to part with the cash or assets to make the contribution during the estate owner s lifetime. IV. SPLIT INTEREST GIFTS IN TRUST A split interest gift in trust allows a donor to transfer assets to a trust with both charitable and non-charitable beneficiaries. It is an excellent estate planning tool for the donor that wishes to retain an interest in the trust assets, provide for one or more charities, and generate an immediate income tax deduction. If the charitable interest is a remainder interest, then the trust is called a charitable remainder trust. If the charitable interest is the current interest, then the trust is called charitable lead trust. As a general rule, a charitable deduction for a split interest gift will not be allowed unless the trust qualifies as an annuity trust, unitrust, or a pooled income fund. An exception to the general rule is for transfers of remainder interests in a personal residence or farm. A remainder interest in a personal residence or farm in which the donor retains a life estate may be transferred to a charity and a charitable deduction will be allowed for such transfers without the transfer qualifying as an annuity trust, unitrust or pooled income fund. IRC 170(f)(3)(b). A. Charitable Remainder Trust A charitable remainder trust can be either a charitable remainder unitrust ( CRUT ) or a charitable remainder annuity trust ( CRAT ). Both CRUTs and CRATs must comply strictly with the requirements of IRC 664 and the corresponding treasury regulations. Sample provisions that meet the requirements of the IRC 664 and the corresponding regulations are contained in Rev. Proc ; C.B. 546, and Rev. Proc , C.B Several of the requirements are highlighted and discussed hereinafter. 1. CRAT the following is a summary of the key characteristics of CRAT. a. Non-charitable beneficiary receives a monthly, quarterly, or annual payment of either a fixed sum or based on a fixed percentage of the initial net fair market value of the trust assets. Reg (a)(1)(iii). b. The fixed percentage must be at least 5% but not more than 50% of the initial net fair market value of the assets transferred to the CRAT. IRC 664(d)(1)(A). c. The value of the remainder interest at the creation of the CRAT must be at least 10% of the initial fair market value of all assets initially contributed to the CRAT. IRC 664(d)(1)(D). 1. The purpose of this rule is to discourage the use of charitable remainder trusts for relatively young beneficiaries. 2. Additionally, the rule makes it difficult to create charitable 6

7 remainder trusts for joint lives. a. Example: A CRAT established in June of 2016 for the joint lives of husband and wife each of whom is 49 would be disqualified if the payout was more than 6.49% d. Example: Assume Donor creates a CRAT to which Donor contributes assets with a fair market value at the time of the contribution of $1,000,000. The CRAT provides that the Donor shall receive $50,000 per year during the donor s life time. On the donor s death, the assets held in the CRAT will be distributed to a qualified public charity. 2. CRUT- the following is a summary of the key characteristics of a CRUT. a. Non-charitable beneficiary receives a monthly, quarterly, or annual payment based on a fixed percentage of the net fair market value of the trust assets valued annually. b. The fixed percentage must be at least 5% but not more than 50% IRC 664(d)(2). c. The value of the remainder interest must be at least 10% of the initial fair market value of all property initially contributed to the CRUT. IRC 664(d)(2)(D). d. The trust instrument must include a provision that if the net fair market value is incorrectly determined then any deficiency in the unitrust payment resulting from underpayment must be paid to the beneficiary, and any overpayment resulting from overvaluation should be repaid to the trustee. Reg (a)(1)(iii). 3. Net Income CRUT a. Trustee is required to distribute to the non-charitable beneficiary only the actual income of the trust, if the amount of such income is less than the amount which otherwise would be payable by multiplying the stated fixed unitrust percentage by the net fair market value of the assets, valued annually. IRC 664(d)(3). b. The determination of what items are trust income is based on the provisions of the trust instrument and state law. IRC 643(b). c. Net Income with Make-up CRUT ( NIMCRUT ) is a variation of the Net Income CRUT which permits a Net Income CRUT to provide that if the trust income in any year is less than the unitrust amount any deficiencies may be made up in later years to the extent the trust income in later years exceeds the required unitrust pay-out in such later year. IRC 664(d)(3)(B); Rev. Rul C.B Example: Donor contributes $1,000,000 to the NIMCRUT with a 5% annual payout, and donor is the life-time non-charitable beneficiary. Assume, during the first year the actual net income is 7

8 $40,000. At the end of the first year this is the amount that would have been paid to Donor; this amount is $10,000 less than the unitrust amount of $50,000 ($1,000,000 x 5%). The $10,000 deficiency is carried forward to subsequent years. Assume in year two the value of the NIMCRUT is $1,200,000 and the net income for the year is $70,000. The required unitrust payment for year two is $60,000 (5% of $1,200,000). However, donor will be entitled to receive $70,000 for year 2 representing all of the NIMCRUT s net income for year Flip Unitrust A donor may establish a flip unitrust which allows the trustee of the CRUT to convert a Net Income CRUT to an unitrust only CRUT. This type of CRUT is generally used when the donor transfers non-marketable assets that produce little or no income. Prior to the sale of these assets, the CRUT provides that the non-charitable beneficiary is to receive the lesser of the net income or the fixed unitrust percentage. However, once the non-marketable assets are sold the donor will usually want the non-charitable beneficiary to receive a fixed unitrust percentage payout. Thus, once the non-marketable securities are sold, the unitrust flips into a fixed percentage unitrust payout without any income limitations on the payout. Reg , , and a. Requirements for a Flip CRUT include: 1. The governing instrument must permit a one-time conversion from one of the income exception methods to the fixed percentage method of calculating the unitrust amount. 2. The date or event triggering the conversion must be outside the control of the trustee or any other person. Permissible events include: marriage, death, divorce, birth of a child or sale of unmarketable assets. Impermissible events include: request by a beneficiary, a financial advisor or sale of marketable securities. 3. The CRUT must switch exclusively to the fixed percentage method of calculating the unitrust amount beginning in the first taxable year following the year in which the date that the event trigging conversion occurs. 4. In the case of NIMCRUT, the non-charitable beneficiary must forfeit its right to any Net Income Make-up accumulations. 5. Fair Market Value of the Remainder Interest The rules for calculating the fair market value of the remainder interest in a CRUT for charitable deduction purposes are set out in Reg Rights to Distributions For either a CRAT or CRUT, the trustee must not be given any power whatsoever to make distributions in excess of the stated annuity or unitrust amount. This means the trustee cannot increase distributions to the non-charitable beneficiary even in the case of an emergency or other need. 8

9 7. Termination Upon termination of the life interest of either a CRAT or CRUT the entire charitable remainder interest must go to an exempt charitable organization. IRC 664(d)(1)(C) & (2)(c). 8. Term A non-charitable annuity or unitrust interest in a charitable remainder trust may last for a specified period of time not to exceed 20 years or for the life or lives of the non-charitable beneficiaries. 9. Additional contributions The trust instrument must prohibit additional contributions to charitable remainder trust after the initial transfer. Reg (b). Thus, each time the Donor wishes to make another contribution the donor should create a new CRT. 10. Income Taxation of the Annuity or Unitrust Amounts Neither a CRAT nor a CRUT is a taxable entity (unless it has unrelated business income tax UBIT ). IRC 664(c). However, the annuity payments or unitrust payments to the non-charitable beneficiary are taxable to the beneficiary. The type of income will be determined based on the following order: 1. Ordinary Income; 2. Short-term Capital Gains; 3. Lon-term Capital Gains; 4. Other Income (tax-exempt income); and 5. Nontaxable distribution of corpus. Reg (d)(1)(i). 11. Estate and Gift Tax when Spouse is Non-Charitable Beneficiary If a donor creates a CRUT or CRAT either during its lifetime or death with the spouse as the noncharitable beneficiary, then there is not estate or gift tax liability for the donor. The annuity or unitrust interest will qualify for a marital deduction under IRC 2056(b)(8) and 2523(g), and the remainder interest will qualify for the charitable deduction. 12. Estate Planning with Charitable Remainder Trusts Charitable remainder trusts can be used to great effect in estate planning. Often it is possible for the donor to contribute a significant amount to charity, receive immediate income tax deduction, and increase the income that would otherwise be available from the contributed assets. a. Avoiding Capital Gains Taxes Scenario 1 Assume Client is in a high-income tax bracket and wishes to retire next year. Following retirement his spendable income will substantially decrease. The Client has securities with a very low basis that pay a low or no dividend. If these securities are sold, Client will have to pay significant capital gains taxes, so that the net proceeds available for reinvestment in a higheryield asset will be significantly reduced. 1. Solution--- Client contributes low basis assets to a charitable remainder trust. Client obtains an immediate income tax 9

10 deduction equal to the value of the charitable remainder interest. The low basis assets are sold inside the charitable trust and reinvested in higher yield securities to enable it to make the required payout. Since the charity does not incur immediate capital gains tax, the principal is not reduced by such tax as it would have been if the client had made the sale. Thus, the full amount of the corpus is available to generate future income. b. Provide for Surviving Spouse Scenario 2 Assume Client wants to ensure that the surviving spouse has sufficient income after the Client s death. 1. Solution---The client can utilize the trust in the above example and provide that the payout continues over their joint lives. This will however reduce the amount of income tax deduction. Alternatively, Client could forgo creating the charitable remainder trust until his death. At death, the charitable remainder trust could be created with unitrust or annuity payments to the spouse for life. This trust would qualify for both the martial and charitable deductions from the estate tax. Thus, no portion of the value will be subject to the estate tax on either spouses death. c. Leveraging up an Estate Scenario 3 Assume client has a low basis security which neither he nor his spouse needs. Client would like to diversify the security but does not want to trigger significant capital gains taxes. Client contributes low basis security to a charitable remainder trust. Client obtains an immediate income tax deduction for the charitable remainder interest. Once the low basis stock is in trust, the stock is sold without triggering immediate capital gains taxes and reinvested across a diversified portfolio. Client contributes the annual unitrust distributions to an irrevocable life insurance trust which uses the payments to purchase joint and second to die life insurance on the client and his spouse. Upon the second to die, the children will receive significant life insurance proceeds worth more than the original stock. 13. Types of Assets that should not be Contributed to a CRT because the trust is taxexempt, great assets to transfer to a CRT include low-basis, highly appreciated assets such as marketable securities, C corporation stock and unencumbered real estate. The following assets should not be used to fund a CRT: a. Assets the trustee is obligated to sell. The IRS could treat this as if an asset were sold and cash donated to the trust. b. Tax-exempt securities. c. S corporation stock, since a CRT is not an eligible S corporation shareholder. d. Partnership interests, including publicly traded partnerships, since there is potential for unrelated business taxable income (UBTI), which could cause all of the CRT s income to be taxable for the year. e. The donor s personal residence, since living there is an act of self-dealing. f. Encumbered real estate. g. Tangible personal property. 10

11 h. Stock options. B. Charitable Lead Trust A charitable lead trust is the inverse of a charitable remainder trust. A charitable lead trust provides an immediate annuity or unitrust distribution ( lead interest) to a charitable beneficiary while a reversionary interest or remainder passes to a non-charitable beneficiary (donor, family or descendants). A charitable lead trust can be either a charitable lead annuity trust with fixed payment at least annually for a term of years, or a charitable lead unitrust with a fixed percentage payable at least annually for a term of years. At the end of the trust term the assets in trust are transferred to the non-charitable beneficiary(s) (e.g. Donor, Donor s spouse or family members). The Donor generally receives an immediate income tax deduction equal to the present value of stream of payment to the charitable beneficiary. Also by structuring the charitable lead trust to make payments to a charity for period of years, the donor can transfer significant wealth to the donor s family with minimal or no transfer taxes. Further if the transfer is made on death, the donor s family will receive a step-up in basis to the date of death fair market value at the time the assets are contributed to the charitable lead trust. 1. Charitable Lead Trust the following is a summary of the key characteristics of a charitable lead trust. a. Charitable beneficiary receives a monthly, quarterly, or annual payment of a fixed sum of the initial net fair market value of the trust assets (annuity) or fixed percentage of the net fair market value of the trust assets annually (unitrust). IRC 170(f)(2)(B); Reg (c)-(3)(b). b. There is no requirement that the annual payment to the charity be at least 5% of the value of the trust assets Types of lifetime Charitable Lead Trusts a. Grantor Charitable Lead Trust A Grantor charitable lead trust is a trust in which the grantor responsible for the income taxes for income generated by the trust. IRC This is usually the case if the reversionary interest exceeds 5% of the value of the value of the transfer to the trust. IRC 673(a). If the charitable lead trust satisfies these requirements the Donor will receive and immediate income tax deduction for the fair market value of the charitable annuity or unitrust interest, valued as of the date on which assets are contributed to the trust. b. Non-Grantor Charitable Lead Trust A non-grantor trust is a trust in which the charitable trust is taxable on the income, not the donor. The trust will then receive a deduction for that portion of the income paid to the charitable lead beneficiary. Any remaining income will be taxed to the trust itself. 3. Estate and Gift Tax Consequences of Charitable Lead Trusts a. An estate and gift tax deduction for transfers to a charitable lead trust is not contingent on whether the donor is taxed on the income. It is only necessary that the trust be a qualified annuity or unitrust. 11

12 b. The amount of the gift or estate tax deduction for an annuity trust is calculated, by using the valuation tables set forth in Reg or , and for a unitrust by using the tables in the regulations under IRC Example: Assume that Donor is single. Further assume that the Donor s trust provides that on Donor s death the maximum amount that can be transferred tax free will pass through a credit shelter trust to Donor and any remaining amounts will pass to a charitable lead annuity trust for the benefit of 3 public charities for 20 years and the remainder to the Donor s family. The current value of the Donor s estate is $10.9 million. The Donor has not used any of her unified credit amount. Thus, at her death $5.45 million will pass to the credit shelter trust for the immediate benefit of her children. The CLAT provides that 6% of the value of the bequest ($5.45 million) is to be paid annually to the designated charities for 20 years. Assuming, the IRC 7520 rate (120% of the applicable federal rate AFR ) in the month of the Donor s death is 1.6% the estate tax deduction will be $5.45 million, leaving a taxable estate of zero. If the CLAT grows at a rate of 6.5% over the 20-year period, then the Donor s children will receive $6.5 million at the end of the 20-year period. During 20 year term the charities will have received total distributions of $6.5 million dollars. The main disadvantage is the that children s enjoyment is deferred until the lead trust term ends. The advantage is that not transfer taxes are paid to government; the family is able to create a legacy of goodwill; the assets receive a stepped-up basis; and the assets come back to the family at the end of the term. If the Grantor had simply paid the estate tax at her death and transferred the money to her family, after taxes the family would have received $3,324,200 ($5,450,000 less $2,125,800). If the family had invested this amount for 20 years with average return of 6.5% the value at the end of the 20-year period would be $11,713,301. This assumes that the trust principal remains intact and none of the beneficiaries consume any part of the corpus during the 20-year term. 4. Clients who should consider using Charitable Lead Trust a. Wealthy clients who want to utilize the current charitable deduction to reduce taxes (for example, in a year with unusually high AGI) should use a grantor CLT but only if they are willing to pay tax on all trust income. b. Clients who don t want to give up control of the assets just yet but still want the benefits of the tax deductions. 12

13 c. Clients who are willing to forgo current cash flow and whose heirs can wait until the end of the trust term to receive the assets (possibly to meet a dependent s future needs). d. Clients who want to take advantage of a low-interest-rate environment, since the lead or charitable income interest is given a higher value when the section 7520 rate is low. To the extent the asset can grow faster than the section 7520 rate, more assets will inure to the donor s heirs at a lower gift tax cost. e. Clients who want to reduce estate and gift taxes. Since the gift or estate tax value is determined based on the date the trust is funded, all future appreciation escapes estate and gift taxation. f. In all cases, clients who want to make gifts of assets that currently have a low or discounted value but that the client expects will appreciate significantly in the future. With an inter vivos CLT, however, the donor must be willing to forgo the possibility of a step-up of basis at the date of death. Any assets remaining in the trust will take a carryover basis (rather than a stepped-up basis, which would occur at death). The loss of the basis step-up should be considered before placing the asset in the trust. If the asset will be sold during the trust term, this may not be a factor. See, Charitable Planning: CRTs, CLTs and the increasing payment CLAT, Journal of Accountancy (July 2010) 13

14 Charitable Planning Techniques Below are some examples of Charitable Planning Techniques the author has used in the past. Example 1: Estate Before Planning Joint Liquid Assets Brokerage Account Illiquid Assets Residence Other Real Property Total Values Taxes, Debts, Cost of Administration 3,500, , ,000, Total 3,500, , ,000, ,000, , Total Gross Estate 7,760, Tentative Estate Tax 3,049, Applicable Credit against Estate Tax 4,305, Estate Tax Liability Net Estate Remaining Taxes as % of Total Estate 7,760, % 14

15 Facts: Clients are ages 63 and 65. Clients are in the highest income tax bracket. Husband received a gift of approximately $600,000 of stock. Husband received a carryover basis in the stock of $100,000 Clients would like to diversify the stock without triggering Capital Gains Tax Clients do not need the stock Clients provides annual support to a public charity. Goals: Avoid Capital Gains Tax. Provide for Charity Maximize the Amount Passing to their descendants. Strategy: Contribute Stock to a CRUT Once the stock is inside the CRUT sell the stock and diversify the proceeds. Use the unitrust distributions to fund the purchase of second to die life insurance inside an ILIT Create an ILIT for the benefit of the children. Trustee of ILIT purchases Second to Die Life Insurance with $1,000,000 Death Benefit. $30,000 is gifted to the ILIT annually to pay the life insurance premiums. Benefits: Clients can diversify the stock inside CRUT without triggering immediate Capital Gains Tax. Clients get an immediate income tax deduction of approximately $173,000, which can be carried forward for up to 5 years. Based on growth and income assumptions of 5.5% the charity will receive approximately $600,000 following the death of the surviving spouse. Because the money is permanently set aside in a CRUT, the clients benefit from the goodwill created by the charitable gift. Children will receive $1,000,000 instead of $600,000 upon the death of the surviving spouse. 15

16 Estate After Planning H Liquid Assets Brokerage Account Illiquid Assets Residence Other Real Property Total Values Taxes, Debts, Cost of Administration Joint 3,500, , ,000, Total 3,500, , ,000, ,000, , Total Gross Estate 7,760, Tentative Estate Tax 3,049, Applicable Credit against Estate Tax 4,305, Estate Tax Liability - Net Estate Remaining 7,760, ILIT Total Passing to Children 1,000, ,760, Taxes as % of Total Estate 0.00% 16

17 CRUT Illustration 2016 Charitable Remainder Unitrust Trust Type: Life Transfer Date: 12/ Rate: 1.80% FMV of Trust: $600,000 Growth Rate: 2.00% Income Rate: 3.50% Percentage Payout: 5.500% Payment Period: Quarterly Months Val. Precedes Payout: 3 Lives: 2 Ages: 65, 63 CRUT Type: Normal Payout Sequence Factor: Adjusted Payout Rate: 5.439% Interpolation: Factor at 5.4%: Factor at 5.6%: Difference: (5.439% - 5.4%) / 0.2% = X / ; Therefore X = Life Remainder Factor = Factor at 5.4% Less X: Present Value of Remainder Interest = $600, x : $173, Donor's Deduction: $173, Donor's Deduction as Percentage of Amount Transferred: % Present Value of Succeeding Noncharitable Interests: $76, Deduction as Percentage of Amount Transferred Non-deductible 71.01% Deductible 28.99% 17

18 2016 Charitable Remainder Unitrust Beginning Principal Income Year Principal Growth Rec'd/Accr'd Distribution Remainder 1 $600, $11, $20, $33, $599, $599, $11, $20, $32, $599, $599, $11, $20, $32, $598, $598, $11, $20, $32, $598, $598, $11, $20, $32, $597, $597, $11, $20, $32, $597, $597, $11, $20, $32, $596, $596, $11, $20, $32, $596, $596, $11, $20, $32, $595, $595, $11, $20, $32, $595, $595, $11, $20, $32, $594, $594, $11, $20, $32, $594, $594, $11, $20, $32, $593, $593, $11, $20, $32, $593, $593, $11, $20, $32, $592, $592, $11, $20, $32, $592, $592, $11, $20, $32, $592, $592, $11, $20, $32, $591, $591, $11, $20, $32, $591, $591, $11, $20, $32, $590, $590, $11, $20, $32, $590, $590, $11, $20, $32, $589, $589, $11, $20, $32, $589, Summary: $600, $267, $473, $752, $589,

19 Example 2. Estate Before Planning H Liquid Assets H's Brokerage Account W's Brokerage Account W Joint 16,000, Illiquid Assets Residence Other Real Property Total Values 2,000, , ,000, Total 16,000, ,000, , ,000, ,800, Taxes, Debts, Cost of Administration (1,200,000.00) Total Gross Estate 22,600, Tentative Estate Tax 8,985, Applicable Credit against Estate Tax 4,305, Estate Tax Liability 4,680, Net Estate Remaining Taxes as % of Total Estate 17,920, % 19

20 Assumptions: Joint effective income tax rate 21.9%. H's basis in the bulk of his $16 million of publicly traded securities is $1.00 per share. Clients annual AGI is $1,500,0000. Client Goals: Clients want to maintain their annual income at $1.5 million through their joint lives Clients want to maintain the trust corpus and only live on the income. Financial Advisor has advised clients to diversify holdings to avoid single stock risk. Diversifying the portfolio would result in after tax haircut of 25.3%. Client's want to maximize amount passing to their heirs. Strategy: Husband and wife create an Irrevocable Life Insurance Trust ("ILIT") Trustee of ILIT purchases Second to Die Life Insurance with $4,000,000 Death Benefit. Annual life insurance premiums are $120,000. Husband transfers $6,000,000 to a Charitable Remainder Unitrust (CRUT) The CRUT pays distributions of $330,600 or 5.51% of the trust corpus annually for their joint lives. The increased distributions represent approximately $120,000 per year more to clients which is enough to offset the annual life insurance premium expense. The transfer to the CRUT generates an immediate income tax charitable deduction of $2,750,000. Based on Client's current AGI of $1.5 million and current effective tax rate of 21.9%, clients will enjoy income tax savings of approximately $50,000 per year for the current and succeeding 5 years. Taxable portion of the clients estate passes to a testamentary Charitable Lead Annuity Trust on the Surviving spouse's death; the CLAT remainder interest passes to the Children and Grandchildren at the end of a 20-year term. 20

21 Estate After Planning Liquid Assets H's Brokerage Account W's Brokerage Account H 10,000, Illiquid Assets Residence Other Real Property Total Values W Joint 2,000, , ,000, Total 10,000, ,000, , ,000, ,800, Taxes, Debts, Cost of Administration (1,200,000.00) Total Gross Estate 16,600, Charitable Deduction for 20 Yr. Testamentary CLAT (5,700,000.00) Taxable Estate 10,900, Tentative Estate Tax 4,305, Applicable Credit against Estate Tax 4,305, Estate Tax Liability - Net Estate Remaining 10,900, ILIT Amount Passing Immediately to Children 4,000, ,900, yr. Testamentary CLAT Total Estate Passing to Children Net Increase 6,800, $21,700, ,780, Taxes as % for Total Estate 0.00% Amount Passing to Charity CRUT 5,900, yr. Testamentary CLAT 6,800, $12,700,

22 Charitable Remainder Unitrust 2016 Trust Type: Life Transfer Date: 12/ Rate: 1.80% FMV of Trust: $6,000,000 Growth Rate: 2.00% Income Rate: 3.50% Percentage Payout: 5.510% Payment Period: Quarterly Months Val. Precedes Payout: 3 Lives: 2 Ages: 75, 75 CRUT Type: Normal Payout Sequence Factor: Adjusted Payout Rate: 5.449% Interpolation: Factor at 5.4%: Factor at 5.6%: Difference: (5.449% - 5.4%) / 0.2% = X / ; Therefore X = Life Remainder Factor = Factor at 5.4% Less X: Present Value of Remainder Interest = $6,000, x : $2,750, Donor's Deduction: $2,750, Donor's Deduction as Percentage of Amount Transferred: Present Value of Succeeding Noncharitable Interests: % $687, Deduction as Percentage of Amount Transferred Non-deductible 54.17% Deductible 45.83% 22

23 Charitable Remainder Unitrust 2016 Beginning Principal Year Principal Growth Distribution Remainder 1 $6,000, $117, $330, $5,994, $5,994, $117, $207, $5,989, $5,989, $117, $330, $5,983, $5,983, $117, $329, $5,978, $5,978, $117, $329, $5,973, $5,973, $116, $206, $5,968, $5,968, $116, $328, $5,962, $5,962, $116, $328, $5,957, $5,957, $116, $328, $5,952, $5,952, $116, $327, $5,946, $5,946, $116, $327, $5,941, $5,941, $116, $327, $5,936, $5,936, $116, $327, $5,930, $5,930, $116, $326, $5,925, $6,000, $1,635, $4,601, $5,925, Summary: 23

24 CLAT Illustration 2016 Charitable Lead Annuity Trust Trust Type: Term Transfer Date: 12/ Rate: 1.60% FMV of Trust: $5,700, Growth of Trust: 6.50% Percentage Payout: 6.000% Payment Period: Annual Payment Timing: End Term: Total Number of Payments: 20 Exhaustion Method: IRS Vary Annuity Payments? No 20 Annual Payout: Annual Payment: Term Certain Annuity Factor: Payout Frequency Factor: Present Value of Annuity Limited by 7520 Regs: $5,700, Remainder Interest = FMV of Trust less PV of Annuity: $0.00 Charitable Deduction for Income Interest: $5,700, Donor's Deduction as Percentage of Amount Transferred: % Deduction as Percentage of Amount Transferred Non-Deductible 0.00% Deductible % 24

25 CLAT Illustration 2016 Charitable Lead Annuity Trust Beginning 6.50% Year Principal Growth Payment Remainder 1 $5,700, $370, $5,728, $5,728, $372, $5,758, $5,758, $374, $5,791, $5,791, $376, $5,825, $5,825, $378, $5,862, $5,862, $381, $5,901, $5,901, $383, $5,942, $5,942, $386, $5,987, $5,987, $389, $6,034, $6,034, $392, $6,084, $6,084, $395, $6,138, $6,138, $398, $6,195, $6,195, $402, $6,255, $6,255, $406, $6,320, $6,320, $410, $6,389, $6,389, $415, $6,462, $6,462, $420, $6,540, $6,540, $425, $6,623, $6,623, $430, $6,712, $6,712, $436, $6,806,