Charitable Lead Trusts

Transcription

1 Charitable Lead Trusts Michael V. Bourland and Jeffrey N. Myers Michael V. Bourland is the founding shareholder of Bourland, Wall & Wenzel, P.C., a Fort Worth, Texas law firm which represent individuals, closely held and family businesses, professional practices and charitable organizations within its areas of legal practice. Mr. Bourland was born in Fort Worth, Texas on October 2, He earned a B.A. from Baylor University and his J.D. from Baylor University School of Law. He earned his LL.M. in Taxation from University of Miami, Florida. Additionally, he was a Captain in JAGC, USAF, Mr. Bourland was admitted to practice law in Texas in 1969 and is Board Certified in Estate Planning and Probate Law (Texas Board of Legal Specialization). He is a member of the American Bar Association; State Bar of Texas and its Real Estate, Probate and Trust Law Section (Real Estate, Probate and Trust Law Council, ); Tarrant County Bar Association (Director, ); Tarrant County Probate Bar Association; Fort Worth Business and Estate Council (Chair, ); and a Fellow of the American College of Trust and Estate Counsel. Mr. Bourland s practice is directed to business, tax, estate planning, probate, charitable entity and charitable giving law. Mr. Bourland is a guest lecturer in estate planning at Baylor University School of Law, Baylor University School of Business, Southern Methodist University School of Law, University of Texas School of Law and The Center for American and International Law. He speaks regularly throughout the United States on subjects within his practice areas at seminars conducted by, among others, American Bar Association, American Law Institute-American Bar Association, Texas Bar Association, Texas Society of CPAs and Notre Dame, Duke and Tulane Universities. Jeffrey N. Myers is a shareholder of Bourland, Wall & Wenzel, P.C., and engages in a broad range of estate planning, charitable gift planning and sophisticated transfer tax planning, including utilization of trusts, life insurance, business entities, retirement, beneficiary designation planning, coordination with planning for public charities and private foundations, and coordination with planning for family or closely held businesses. He is active in the Estate Planning and Probate, Tax and Business Planning and Non- Profit Organizations practice areas of the firm. Mr. Myers works with numerous charities and families and closely held businesses within his and the firm s areas of expertise. The authors would like to thank John W. Conner for his contributions to this outline.. ALI CLE Estate Planning Course Materials Journal 25

2 26 ALI CLE Estate Planning Course Materials Journal October 2015 I. BASICS OF CHARITABLE LEAD TRUST A. Types of Charitable Lead Trusts ( CLT ). In general, there are three types of CLTs and each provide different tax benefits to those persons seeking to make use of charitable deductions: 1. Qualifying Non-Grantor CLT. This type of CLT will pay a guaranteed annuity or unitrust lead interest to a certain qualified charity or charities. See Paragraph II.A. for further discussion. The tax benefits available to the grantor depend on whether the Qualifying Non-Grantor CLT is an inter vivos CLT or a testamentary CLT. In either case, however, the taxable value of the remainder interest that passes to the grantor s heirs is reduced, thus reducing the grantor s transfer tax liability. See T.M. Portfolio 866-2nd: Charitable Lead Trusts. It is important to note, however, that in the case of the Qualifying Non-Grantor CLT, the grantor will not be entitled to an income tax charitable deduction. 2. Qualifying Grantor CLT. This type of CLT is structured so as to make the grantor taxable as to the income of the trust as per the grantor trust rules contained in the Internal Revenue Code. See 671 et seq; see also Paragraphs III and IV.B. One of the biggest differences between a Non-Grantor CLT and a Grantor CLT is that in the case of a Grantor CLT, the grantor is entitled to an immediate income tax deduction equal to the value of the lead interest passing to the charity. However, the grantor remains taxable as to all income generated by the trust. See Paragraph IV.B. It is important to note that a Grantor CLT must be an inter vivos trust. Additionally, grantors should be aware that the corpus of the trust may be includable in the grantor s estate of estate tax purposes. 3. Non-Qualifying Non-Grantor CLT. This is a special type of inter vivos CLT in which the governing instrument does not provide for a guaranteed annuity or unitrust charitable lead interest. The advantage of this type of trust, however, is that the trust will qualify for annual charitable income tax deductions, and such a trust will avoid alternative minimum tax and private foundation restrictions. See Paragraphs III.C & V for further discussion. II. CONSTRUCTION OF CHARITABLE LEAD TRUSTS A. Payment Charitable Lead Interest Annual (or more often) payments to charitable beneficiary for a number of years or for a life or lives in being at the trust s creation. But see discussion below regarding proposed regulations limiting permissible term. 1. Annuity Trust. Annual payment of a fixed dollar amount or a fixed percentage of the initial net fair market value of the trust assets. I.R.C. 2522(c)(2), 2055(e)(2) and 170(c); Treas. Reg (c)(3) and 1.170A-6(c).

3 Charitable Lead Trusts Unitrust. Annual payment of a fixed percentage of the net fair market value of the trust assets determined annually. I.R.C. 2522(c)(2), 2055(e)(2) and 170(c); Treas. Reg (c)(3) and 1.170A-6(c). The Annuity Trust has traditionally been the preferred form of a CLT because remaindermen benefit from appreciation of the trust assets without gift or estate taxation (but with potential generation-skipping transfer taxation) and the assets do not need to be revalued each year for determining the charitable payment. However, the I.R.C. now requires the assets of the Annuity Trust (but not the Unitrust) to be valued for Generation Skipping Transfer Tax ( GSTT ) purposes (denominator) at the end of the charitable term and compare it with the GST Exemption applied at the time of funding the trust to the non-charitable remainder interest, increased by applying the interest rate used for valuing the charitable interest at the time of funding the trust and compounded annually. I.R.C. 2642(e). (See GST Paragraph below.) It is important to note that a CLT will only qualify for a charitable deduction if the payment is a guaranteed annuity or a guaranteed unitrust payment (i.e. a CLT cannot be part annuity and part unitrust). See T.M. Portfolio 866-2nd: Charitable Lead Trusts. 3. Formula Clauses. The Service has allowed the use of a formula clause as long as the gift is determinable at the time of the transfer. Planning Idea: make the formula have one variable (either the term or the payment amount) calculated to result in a certain gift amount. 4. Distributions in Satisfaction of Annuity or Unitrust Payment. The CLT instrument may provide for the payment of the annuity or unitrust interest to be made in cash or in kind. If the trust distributes appreciated property in satisfaction of the annuity trust or unitrust payment, the trust will realize capital gains on the assets distributed in kind to satisfy the annuity or unitrust payment. Rev. Rul , C.B See also Priv. Ltr. Rul (Oct. 7, 1991) applying Rev. Rul to the income tax treatment of distributions of appreciated stock in satisfaction of a lead unitrust payment. Planning Opportunity: Establish the trust with appreciated stock and distribute stock to satisfy the annuity or unitrust payment. The CLT will recognize the gain and the CLT will receive an income tax charitable deduction for the appreciated stock distributed to charity. (See discussion of income tax treatment of the nongrantor and grantor charitable lead trusts below.) B. Completed Gift In order for a grantor to receive a gift tax charitable deduction, a completed gift must occur. Therefore, it is important to consider what powers, as trustee or in another capacity, the grantor retains over the property that is contributed to the CLT. For example, if the grantor is serving as trustee with a power to change the charitable beneficiary, then the gift is not complete (and the gift tax charitable deduction is not available) until the grantor exercises or

4 28 ALI CLE Estate Planning Course Materials Journal October 2015 terminates the power. Treas. Reg (b),(c). Additionally, a gift will not be complete if the grantor has the power to remove the current trustee and appoint another trustee, including the grantor. Treas. Reg (c). C. Qualified Beneficiaries A CLT is required to have at least one charitable income beneficiary (i.e. the charitable lead interest) and at least one noncharitable remainder beneficiary. However, a CLT will still qualify even though the governing interest does not name a specific charitable income beneficiary. See PLR It should be noted, however, that if the grantor has the power to change beneficiaries (charitable or remainder) the corpus will be included in the grantor s estate for estate tax purposes. Additionally, a charitable lead interest generally will not qualify as an annuity or unitrust payment if the payment may be made for a private purpose before the end of the charitable lead term. Treas. Regs A-6(c)(2)(i)(E), (e)(2)(vi)(f), (c)(2)(vi)(f). There are, however, two exceptions to this rule: 1) an amount may be paid to a non-charitable beneficiary if the amount is in the form of a guaranteed annuity or unitrust payment, as applicable, and the trust does not provide for any preference or priority of the non-charitable beneficiary over the charitable beneficiary; and 2) an amount may be paid for a private purpose if the trust provides that such amount is payable only from assets specifically set aside for the private purpose. See T.M. Portfolio 866-2nd: Charitable Lead Trusts and Treas. Reg A-6(c)(2)(i)(E) and 1.170A-6(c)(2) (ii)(d). Additionally, the Treasury Regulations provide that payments for full and adequate consideration are not considered to be paid for a private purpose. See 1.170A-6(c)(2)(i)(E) and 1.170A-6(c)(2)(ii)(D); see also John R. Strohmeyer, Charitable Lead Trusts and Charitable Remainder Trusts: Tax Benefits and Administration Issues, Estate Planning Seminar, Midland College and the Midland Memorial Hospital Foundation, Presented May 7, D. Term Payments can continue for the life or lives of one or more individuals, all of who must be living when the trust is created, or for a term of years (limited only by the applicable rule against perpetuities). Treas. Reg A-6(c)(2)(i)(A) and (ii)(a); Treas. Reg (e)(2)(v) and (vi)(a); Treas. Reg (c)-3(c)(2)(v) and (vi)(a). However, the Service issued proposed regulations on April 5, 2000, (Proposed Reg , 65 Fed. Reg (Apr. 5, 2000) and Final Regulations, effective January 5, 2001, whereby the permissible term for charitable lead trusts is defined so as to prevent abuse in obtaining inflated charitable deductions. The problem: taxpayers have been using an unrelated individual s measuring life as the term of the charitable lead trust where that unrelated individual is seriously ill, but not terminally ill as defined under I.R.C and the Regulations thereunder. (See, for example, Treas. Reg (b)(3)). The value of the charitable interest is calculated under the applicable actuarial tables, which are based upon the average life expectancies of individuals of the same age as the measuring life. However, the life expectancy of the

5 Charitable Lead Trusts 29 measuring life involved is, in fact, much shorter than the life expectancy of individuals set forth in the actuarial tables. If the individual dies prematurely (which is expected), the charity s interest is terminated resulting in the remainder beneficiaries receiving their interest sooner than anticipated by the tables at a reduced gift or estate tax of that based upon the lives of those provided in the tables. The measuring life individual is paid a fee for allowing the trust creator to use such individual as the measuring life. The Service believes that this type of charitable lead trust is abusive and frustrates the Congressional intent of allowing deductions for certain split-interest trusts and further that the marketing of such is against public policy. The Service s Solution: the final regulations limit the permissible term for a guaranteed annuity interest and unitrust interest to a specified term of years, or the life of certain individuals living at the date of the transfer, such individuals being limited to one or more of the grantor, the grantor s spouse, or a lineal ancestor or spouse of a lineal ancestor of all of the remainder beneficiaries. Additionally, an interest payable for a specified term of years will also qualify where the governing instrument contains a savings clause that is intended to qualify with the rule against perpetuities. A trust will satisfy the requirement that all of the noncharitable remainder beneficiaries are lineal descendants of the measuring life individual (or the spouse of the measuring life individual), if there is less than a 15% probability (computed based upon the current applicable Life Table under Treas. Reg at the time the property is transferred to the trust, taking into account interest of all primary and contingent remainder beneficiaries living at that time) that individuals who are not lineal descendants will receive any trust corpus. Treas. Dec. 8923; see also Treas. Reg A-6(c)(2)(i)(A). If a transfer is made to a trust on or after April 4, 2000, and such trust uses an individual other than a permitted measuring life individual, the trust may be reformed to satisfy the rule or may be rescinded for a transfer made on or before March 6, See Treas. Reg (c)-3(e). The final regulations apply to transfers to inter vivos charitable lead trusts made on or after April 4, 2000, and to testamentary type transfers where the creator dies on or after such date. Although comments to the proposed regulations pointed out that the limitations on the measuring lives, although not a bad thing, were too narrow and precluded many situations where the beneficiaries are not related to the creators of the charitable lead trust, the Service did not adopt any of such suggestions, except as they further broadened the class of the measuring lives as described above. E. Remainder Interest The remainder interest, after payment of the charitable lead amount, is distributed to the noncharitable beneficiary or beneficiaries, which may include (but is not limited to) the