The Time is Right To Consider Charitable Lead Trusts

Transcription

1 The Time is Right To Consider Charitable Lead Trusts May 13, Day Pitney LLP

2 Planned Giving Group of New England Jennifer M. Pagnillo, Esq. Day Pitney LLP 24 Field Point Road Greenwich, CT (203) Jaclyn S. O Leary, Esq. Day Pitney LLP One International Place Boston, MA (617) joleary@daypitney.com Page 2 5/13/2016

3 Basic Concepts The strategy: Charity receives an income stream For some period of time At the end of the time period the remaining property passes to non charitable beneficiaries Page 3 5/13/2016

4 Basic Concepts The income stream to charity is either: An annuity interest A unitrust interest No minimum or maximum payout to charity No hybrid Page 4 5/13/2016

5 Basic Concepts Intervivos vs. Testamentary Intervivos: trust established and funded during the lifetime of the grantor Testamentary: trust established under will or revocable trust and effective and funded upon death Page 5 5/13/2016

6 Basic Concepts The period of time: Term of years Measuring life Both? Term may be influenced by identity of remainder beneficiaries Page 6 5/13/2016

7 Basic Concepts Example: Donor transfers $10,000,000 to a 20 year CLT Assets grow at 5% annually Each year the CLT pays to charity 4% ($400,000) At the end of the term, $13,300,000 passes to non charitable beneficiaries Donor makes a gift of $3,331,400 on funding the CLAT $10,000, year CLT Noncharitable beneficiaries $400,000 annually ($8,000,000 over 20 years) $13,300,000 Charity Page 7 5/13/2016

8 Basic Concepts Backloading Step Lead Trust Escalating payments over the term of the trust Not available with unitrust Benefits Low starting payout rate allows for accumulation of income and more appreciation of trust property in early years Potential for more assets to remainder beneficiaries Page 8 5/13/2016

9 Basic Concepts Example 2: Same as before, but the annuity starts at 0.43% ($43,000) and increases by 20% each year This leaves more property in the trust in early years to grow Donor makes a gift of $3,896,500 on funding the CLAT $10,000,000 $43,000 the first year, increasing to $1,373,788 in year 20 - $8,027,000 total $16,303,000 Page 9 5/13/2016

10 Basic Concepts Additional Contributions Contributions made to a unitrust at any time after the initial contribution In order to be within the safe harbor, the governing instrument of an annuity trust must prohibit additional contributions Page 10 5/13/2016

11 Basic Concepts Who can be trustee? The donor? The donor s spouse? Independent Trustee Page 11 5/13/2016

12 Basic Concepts Selecting the Charitable Beneficiary Public Charities Private Foundations Donor Advised Funds Multiple charitable beneficiaries Consider income tax limitations Page 12 5/13/2016

13 Private Foundation Restrictions Self dealing (IRC 4941) Any direct or indirect financial transaction between the charitable lead trust and a disqualified person Sales, leases, loans, furnishing of goods/services, compensation/reimbursement of expenses Page 13 5/13/2016

14 Private Foundation Restrictions Self dealing Disqualified person includes: Contributor Trustee Family member Exceptions: Market rate compensation for necessary services No cost goods/services to the trust Subject to excise taxes Page 14 5/13/2016

15 Private Foundation Restrictions Taxable expenditures (IRC 4945) Includes transfers for non-charitable purposes Also includes transfers to private foundations unless the charitable lead trust exercises expenditure responsibility Subject to excise taxes Page 15 5/13/2016

16 Private Foundation Restrictions Excess business holdings (IRC 4943) Imposed if the charitable deduction exceeds 60% of the trust s value Prohibition on holding more than 20% of the voting stock of an active business (reduced by the holdings of disqualified persons) Page 16 5/13/2016

17 Private Foundation Restrictions Excess business holdings Active business Generally must be divested within five years Subject to excise taxes Page 17 5/13/2016

18 Private Foundation Restrictions Jeopardy investments (IRC 4944) Any investment which would jeopardize the fulfillment of the trust s charitable purpose Charitable lead trusts are prohibited from purchasing and retaining such investments Subject to excise taxes Page 18 5/13/2016

19 Income Tax Considerations Grantor Trust Income taxed to the donor during the term of the trust Immediate charitable income tax deduction for the present value of the interest being paid to charity Donor s payment of income taxes during the term provides for larger potential remainder for non charitable beneficiaries Page 19 5/13/2016

20 Income Tax Considerations Grantor Trust If the donor dies during the term, a portion of the deduction is recaptured and taxed as ordinary income to the donor Sale of appreciated property in the trust or use of appreciated property to pay the annuity triggers gain to the donor Page 20 5/13/2016

21 Income Tax Considerations Non Grantor Trust Trust pays income taxes (with a deduction for charitable lead payments) No income tax charitable deduction for donor Unlimited income tax charitable deduction for trust UBTI limits the trust s income tax charitable deduction Use of appreciated property to pay the annuity triggers gain to the trust with a corresponding charitable income tax deduction Page 21 5/13/2016

22 How to Create a Grantor CLT Power to substitute property Independent trustee power to add remainder beneficiaries Power to purchase life insurance on donor Page 22 5/13/2016

23 How to Create a Grantor CLT The following powers may create a grantor trust but may also result in estate tax inclusion in the donor s estate Reversionary Interest Retained Power to Control Beneficial Enjoyment Administrative Powers Page 23 5/13/2016

24 Gift Tax Consequences If the gift is complete, there is a gift tax deduction for the income interest passing to charity Taxable gift is the present value of the remainder interest Must be reported on a gift tax return Page 24 5/13/2016

25 Zeroed Out CLAT Example: Donor transfers $10,000,000 to a 20 year CLT Assets grow at 5% annually Each year the CLT pays to charity 5.999% ($599,900), the rate required to zero out the CLT At the end of the term, $6,696,711 passes to non charitable beneficiaries, gift tax free $10,000, year CLT Noncharitable beneficiaries $599,900 annually ($11,998,000 over 20 years) $6,696,711 Charity Page 25 5/13/2016

26 Zeroed Out and Backloaded CLAT Example 2: Same as before, but the annuity increases by 20% each year This leaves more property in the trust in early years to grow $10,000,000 $70,500 the first year, increasing to $2,252,330 in year 20 - $13,161,485 total $9,761,377 Page 26 5/13/2016

27 Estate Tax Consequences Testamentary CLT Estate tax deduction for the value of the lead interest Inter vivos CLT (if donor dies during the term) Incomplete gift: the remainder interest is included in the donor s estate Completed gift: not included in the donor s estate unless the donor retained certain rights Page 27 5/13/2016

28 Estate Tax Consequences Estate tax is imposed on non charitable remainder interests, if any A donor s private foundation as beneficiary requires segregation A donor s donor advised fund is different because of the donor can only make advisory recommendations Page 28 5/13/2016

29 GST Tax Considerations For unitrusts, GST exemption can be allocated on funding to make the trust fully GST exempt For annuity trusts, it is not possible to calculate the exact amount of GST exemption needed until the end of the term Page 29 5/13/2016

30 Target Audience? Donors who: Have appreciated assets Have little or no exemption remaining Have a shortened life expectancy (but not terminally ill) Have an asset likely to greatly appreciate Could use a large income tax deduction OR Have no ability to use a charitable deduction Have no current need for income Are charitably inclined! Page 30 5/13/2016

31 Funding Considerations Low basis assets If sold in CLT or used to pay the annuity, this triggers gain that is paid by the CLT or donor If you keep the low basis assets in the CLT until the end of the term, the remainder beneficiaries take assets at donor s basis Page 31 5/13/2016

32 Funding Considerations Closely held business interests or S-Corporation stock Consider excess business holdings rules Consider self dealing issues Possible UBTI May require multiple valuations Consider whether the asset generates sufficient income to pay the lead interest S-Corporation stock requires a grantor CLT Page 32 5/13/2016

33 Funding Considerations Real estate May require multiple valuations Consider whether the real estate generates sufficient income to pay the lead interest If the real estate is subject to a mortgage, additional considerations apply (including UBTI) Page 33 5/13/2016

34 Case Study: Prefund Charitable Gifts Donna Donor routinely gives $25,000 to Dana Farber Cancer Institute each year Donna can establish a zeroed-out grantor CLAT with $330,000 to pre-fund her gifts to Dana Farber for the next 15 years at no current gift tax cost With 5% growth, $140,000 passes to her children Donna $330, year CLT $25,301 annually ($379,500 over 15 years) Dana Farber $140,000 Children Page 34 5/13/2016

35 Case Study: AGI Limitation on Deduction Bill Benefactor wants to make a significant gift to The Red Sox Foundation. His charitable giving is already in excess of his AGI limits, even with the five year carry forward Bill can fund a non grantor, zeroed out CLAT with $1,000,000 and a 20 year term With 5% growth, $670,000 passes to his children Bill $1,000, year CLT $59,990 annually ($1,200,000 over 20 years) Red Sox Foundation $670,000 Children Page 35 5/13/2016

36 Case Study: Estate to Charity and Children Tom Testator has a $20,000,000 estate, and wants to give ½ of his estate to MSPCA-Angell and ½ of his estate to his children If Tom leaves $10,000,000 to MSPCA-Angell and $10,000,000 to his children, at his death his children will receive approximately $7,500,000 after federal and MA estate tax If Tom instead funds a 20 year zeroed out testamentary CLAT, at the end of the term his children will receive $13,400,000 Tom $20,000, year CLT $1,199,800 annually ($23,996,000 over 20 years) MSPCA- Angell $13,400,000 Children Page 36 5/13/2016

37 Case Study: Small Business Owner Bonnie Businessowner owns an interest in a small family business valued at $13,000,000. The business generates significant annual income, and Bonnie s interest is eligible for valuation discounts for marketability and control Bonnie would like to support her alma mater Boston College Bonnie creates a 20 year CLAT with a lead interest of %, making a taxable gift of $4,165,000 on funding the trust Bonnie $10,000, year CLT $350,000 annually ($7,000,000 over 20 years) Boston College $14,960,000 Children Page 37 5/13/2016

38 Case Study: Appreciating Asset Val Venture has an asset that is worth $2,000,000 now, which she believes may triple in value during the next 10 years Val has already exhausted her lifetime gift tax exemption and does not want to make taxable gifts Val is a frequent visitor of the Museum of Fine Arts, and establishes a 10 year zeroed out CLAT with backloaded payments Val $2,000, year CLT $3,800,000 $87,100 the first year, increasing to $449,400 in year 10 - $2,261,000 total Museum of Fine Arts Children Page 38 5/13/2016