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Charitable Planned Giving

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Learn about Charitable Lead Trusts, Charitable Remainder Trusts and various planning considerations.

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Charitable Planned Giving

  1. 1. Debra Scott, JD, MPH The Scott Practice, LLC Charitable Trusts
  2. 2. Charitable Split Interest Trusts Charitable Lead Trusts Charitable Remainder Trusts of text goes here Charitable Planning Considerations line of text goes here The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Presentation Agenda
  3. 3. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice WHAT IS A CHARITABLE SPLIT- INTEREST TRUST? Irrevocable trust arrangement funded by a donor where the interests in the trust are divided between at least one non-charity beneficiary and a qualifying charity.
  4. 4. WHAT IS A CHARITABLE SPLIT- INTEREST TRUST? Charitable Lead Trust - is an irrevocable trust arrangement funded by a donor which provides periodic distributions to a charity, followed by a final distribution to a non-charitable beneficiary. Charitable Remainder Trust - is an irrevocable trust arrangement funded by a donor which provides periodic distributions to a non-charitable beneficiary, followed by a final distribution to a charity. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice
  5. 5. CHARITABLE LEAD TRUST A Charitable Lead Trust (CLT) allows a donor to provide a significant contribution to charity with the potential to reduce or eliminate gift or estate taxation if properly structured. A lead trust makes distributions to charity each year (the “lead interest”) and then upon termination distributes its remaining assets to individuals. As such, a charitable lead trust can be an excellent tool for a donor with significant assets to make a large charitable gift, and also benefit his or her descendants. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice
  6. 6. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice CHARITABLE LEAD TRUST Currently, CLTs have grown in popularity among estate planners because of the Applicable Federal Rate (AFR) continues to be at a historical low 2 percent. A low AFR means a higher gift or estate tax charitable deduction, which translates into the potential for a wealthy donor to ultimately pass more assets to descendants free of gift and estate taxation. Also, CLTs have no minimum or maximum payout requirements, unlike charitable remainder trust which require a five percent minimum and fifty percent maximum payout.
  7. 7. Grantor versus Non-Grantor CLTs  Creates present interest to charity and a remainder interest to the donor.  Creates present interest to charity and a remainder interest to donor’s beneficiary Grantor CLT Non-Grantor CLT The distinction between the two forms of trust is critical.
  8. 8. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Grantor versus Non-Grantor CLTs A CLT is not considered a tax-exempt entity for tax purposes. The taxability of a CLT is based on whether the trust is a grantor or non-grantor trust. If the provisions of the trust qualifies the trust as a “grantor trust” for tax purposes, then the donor will be taxed on all earned trust taxable income during the period trust disbursements are made to the named charity.
  9. 9. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Grantor versus Non-Grantor CLTsThe donor is entitled to an income tax deduction only at the time of funding. No income tax deduction is allowed for the annual payments from the trust to the named charity. As a result, the income tax benefit the donor received at the time of funding may be eroded over time because of annual recognition of income
  10. 10. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Grantor versus Non-Grantor CLTs On the other hand, an income tax charitable deduction under section 642( c)(1) is available each year for non-grantor CLT. Hence, any taxable income earned by the trust can be offset by the charitable deduction available for the annual amount distributed to charity. This can result in the lead trust owning no income tax. A trade off is that the donor does not receive an income tax charitable deduction at the time of funding or anytime thereafter. However, because it is a non-grantor trust, the donor does not report the trust’s earned income.
  11. 11. Two Types of CLTs  an annuity payment is distributed to charity, established at the time of trust funding.  the payment amount is a predetermined percentage of the trust’s value and is revalued each year. Charitable Lead Annuity Trust Charitable Lead Unitrust The distinction between the two forms of trust is critical.
  12. 12. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Two Types of CLTs Both trusts are irrevocable – thus upon funding the trust, the grantor removes assets funding the trust from his or her gross estate for gift and estate tax purposes. Again, there is a significant planning distinction between the type of payment charity receives – annuity versus unitrust.
  13. 13. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Two Types of CLTs How Taxable Gift Transfer Calculated: An inter vivos CLT earns a gift tax deduction for the present value of the payments to the charity. The taxable gift from the donor is equal to the difference between the present value (of the annuity/unitrust payments) and the funding amount of the trust. Funding amount – present value of annuity/unitrust (gift tax charitable deduction) = Taxable Gift
  14. 14. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Two Types of CLTs The goal in structuring the CLT is to avoid to the greatest extent allowable gift taxes. Thus, we want the present value of the annuity payment to be as large as possible so that we potentially can move the greatest amount to the donor’s beneficiaries tax free.
  15. 15. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Two Types of CLTs Only a CRAT can be structured so that the present value of the annuity payments to the charity is equal to the property funding the CLAT. The annuity payment are precisely calculated so that the present value of such payments exactly equals the value of the assets originally funding the trust. This is referred to as a 100 percent deduction CLAT or a “zero-out” CLAT.
  16. 16. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Two Types of CLTs Gift Amount Gift Date and AFR Term of Years Payment to Charity Initial Percentage $2,000,000 7/17/2014 AFR 2.2% 20Annual 6.24% (A) Annual Annuity Amount $124,700 (B) IRS Factor Pub 1457 Table B x Feq Adj 1x 16.0402 (C ) Payout Feq Adj 16.0402 (D) Present Value of Annuity (C )x(A) ~ $2,000,000 (E) Initial Funding Amount $2,000,000 (F) Taxable Gift (E)-(D) $0
  17. 17. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Two Types of CLTs In a low interest rate environment, a CLAT is an excellent vehicle for charitable gifts for the right donor. However, in a high interest rate environment, less or possibly nothing may ultimately pass to non-charitable beneficiaries if a CLAT is structured. CLUTs are generally not sensitivity to interest rates so they are used most often in a high interest rate environment.
  18. 18. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Two Types of CLTs Also, if the donor has remaining lifetime gift tax exemption, then the CLAT can be structured to receive a less than 100% charitable gift tax deduction. This will result in more funds within the CLAT, with a greater probability of assets remaining for non-charitable beneficiaries on termination of the CLAT.
  19. 19. Step CLATs & Shark Fin Trusts  amount of the annuity uniformly escalates during the annuity term.  trust makes small payments each year to the charity and then a final balloon payment Step CLATs Shark Fin Trust These two trusts are considered more aggressive charitable planning
  20. 20. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Step CLATs & Shark Fin Trusts The standard CLAT is a straight-line annuity payment, where the amount of the annuity does not change during the annuity term. The disadvantage of a straight annuity is that each year the rate of return on trust assets generally must outperform the annuity amount in order for there to be a healthy amount remaining for beneficiaries.
  21. 21. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Step CLATs & Shark Fin Trusts However, if the charity receives a lower amount at the beginning of the trust term with escalating payments, there is a higher earning potential for the trust overall. The Internal Revenue Service (IRS) has provided some guidance on structuring a CLAT such that the payments to charity begin small but increase each year by a certain percentage.
  22. 22. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Step CLATs & Shark Fin Trusts Under Private Letter Ruling 201216045 found at http://www.irs.gov/pub/irs-wd/1216045.pdf - the IRS allowed a variable ascending annuity payments and stated that such payments “satisfied the requirements of Section 2055(e)(2) for a guaranteed annuity interest.” Under PLR 201216045, the testator created a 10-year testamentary lead annuity trust with annuity payments to charity that increased twenty percent per year.
  23. 23. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Step CLATs & Shark Fin Trusts The idea of the Shark Fin to defer distributions for the greatest period possible in order to maximize performance of the trust. A shark fin lead trust generally is known to outperform standard straight annuity CLATs.
  24. 24. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Charitable Remainder Trusts A charitable remainder trust (CRT) is essentially the opposite of a charitable lead trust (CLT) in that the annuity or unitrust payments are first made to a non- charitable beneficiary with the remainder interest distributed to charity.
  25. 25. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Charitable Remainder Trusts However, unlike a CLT, there is a minimum payout requirement of 5 percent with respect to the annuity or unitrust payments and a maximum requirement of 50%. There is also a 20 year term limitation for CRTs, but there is no such requirement for CLTs. Similar to CLTs, the annual payout to the non-charity beneficiary is either in the form of an annuity payment or unitrust payment.
  26. 26. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice CRATs CRAT- a trust arrangement where a fixed sum (not less than 5 percent of the initial trust value) is paid to one or more persons at least annually for a term of years not to exceed twenty years or for the life or lives of the non-charity beneficiary or beneficiaries. A key distinction with respect to a CRAT is that the annuity percentage is fixed and with level payments exclusive of trust performance. Also, additional contributions to the CRAT is not permitted.
  27. 27. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice CRUTs CRUT – a trust arrangement where trust distributions are made on a periodic basis not less than annually which equal at least 5 percent of the net fair market value of the trust assets, valued annually. Additional contributions to the CRUT are permitted. Under a standard CRUT, when income and gain is not sufficient to meet the required unitrust payment, the trustee is required to distribute principal to make up the difference.
  28. 28. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Net Income Option A CRUT can be structured as a Net Income CRUT. Under this type of arrangement, the trustee can pay the lesser of the full unitrust amount and trust income. What is essential here is how the trust and state law define trust income.
  29. 29. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Net Income Option The IRS has stated under Reg. Section 1.643(b)-1, that “any trust which departs fundamentally from concepts of local law in the determination of what constitutes income are not recognized for federal tax purposes.” Therefore, it is important that the trust document’s terminology regarding trust income is consistent with state law.
  30. 30. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Net Income Unitrust with Make-upA step beyond the Net Income Unitrust is the NIMCRAT. Under this arrangement, the trustee is directed to make-up past deficiencies from prior years by distributing the excess income earned in the current year. Thus the trustee pays trust income in excess of that year’s full unitrust amount if the aggregate of amounts paid in prior years is less than the aggregate unitrust amount in prior years. Unitrust Amount in Prior Year – Amount Paid in Prior Year = Difference can be Made Up
  31. 31. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice FLIP Unitrust IRS regulations allow the trust instrument to pride a one-time conversion from one of the income exception methods to the standard CRUT method upon a triggering event such as the sale of an illiquid or unmarketable asset. Unmarketable assets are defined as assets other than cash, cash equivalents, or marketable securities.
  32. 32. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Planning Considerations Because CRAT requires a fixed distribution with no ability to make additional contributions to the trust, it is less flexible than a CRUT. If the CRAT is funded with assets with wide fluctuations in value, it may be difficult to recover for a loss of principal under a CRAT because payments are fixed, potentially creating a higher reduction in principal.
  33. 33. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Planning Considerations The annuity structure is generally best for low risk assets and for persons with a short investment horizon. Unitrust are best if the assets used to fund the trust are illiquid non-income producing assets because the trust can be structured as a Net Income Only trust.
  34. 34. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Planning Considerations NIMCRUT- the trustee is not obligated to make distributions when trust cash flow is insufficient to meet the unitrust payout. If the return on investment outperforms the unitrust payout from year to year, then the trust principal has time to appreciate and can potentially payout larger unitrust amounts to the non-charity beneficiary in later years.
  35. 35. The Scott Practice, LLC Copyright 2014 All rights reserved Not Considered Legal Advice Thank you For Questions Please Contact Debra Scott, JD, MPH The Scott Practice, LLC debra@scottpractice.com

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