Let’s Spend Time With Lead Trusts – Pt 6

Last time, we saw that there is the “plain vanilla” CLAT, for which the donor gets a gift tax charitable deduction but not an income tax charitable deduction. We also saw that it’s possible to set up a CLAT so that the donor does get an up-front income tax charitable deduction in addition to a gift tax charitable deduction. An income tax charitable deduction for the up-front present value of the payout to charity.

How is this done? It’s done by making the donor the owner of all trust assets and income for federal income tax purposes. In tax lingo, the CLAT is designed to be a “grantor trust.”

Wow, what does that mean? It means simply that the CLAT is set up in such a way that the donor has to report, each year, all trust income (dividends, interest, realized capital gains, etc.) on his or her personal income tax return … with no deduction for trust income paid to charity.

This can be done basically one of two ways. The first way is to set up the CLAT so that upon its termination, all CLAT assets are distributed back to the donor (or the donor’s estate). The problem with this approach is that the wealth transferred to the CLAT reverts to the donor, so there is no tax-saving wealth transfer downstream. The second way is a little funky but allows wealth to be transferred downstream. It’s to give some third party (maybe donor’s lawyer) the power to acquire trust assets by substituting other assets of equal value. The idea is not that this funky power will ever be exercised. The idea is that the mere existence of this power makes the CLAT a grantor trust. Even though the trust assets ultimately pass to children or other beneficiaries free or largely free of gift and estate taxes.

We’ve got to stop here to avoid getting too deep into the weeds. Please be assured, however, that wealthy, charitably motivated donors who have cracker-jack tax lawyers do set up this sort of funky CLAT … often using carefully designed insurance products. Insurance products are used in part because such products do not produce income to the CLAT for federal income tax purposes.

We’re going to leave CLATs at this point. If you’re interested in developing a strategy to market CLATs and want expert advice, be sure to be in touch with a Sharpe Group representative.

Read Pt 1 here
Read Pt 2 here
Read Pt 3 here
Read Pt 4 here
Read Pt 5 here

by: Jon Tidd

Let’s Spend Time With Lead Trusts – Pt 5

Last time, we looked at a Charitable Lead Annuity Trust example. An example of a 12-year CLAT funded with $1 million of cash, which is to pay $50,000 a year (a 5-percent payout) to charity and then distribute its assets to Donor’s daughter.

Question: How much will the daughter receive? No one knows for sure. It’s possible to make some assumptions, however, and get a picture of how things play out for the daughter under the assumptions. The simplest way to do this is to make one assumption, an assumption as to trust net earnings. If, for example, we assume 7 percent net earnings, the daughter will receive $1,357,769. If we assume 4 percent net earnings, the daughter will receive $849,742. And so on.

Question: Will there be any tax on the money distributed to the daughter? There won’t be any gift or estate tax; that was taken care of when the trust created. There will be income tax, however, on any amount the daughter receives which represents income of the trust for its final year on which income tax has not been paid. The daughter will pay this tax.

Question: What are trust net earnings? Basically, trust net earnings are equal to gross earnings (including both cash earnings and capital appreciation) minus expenses and taxes. Trust expenses typically include brokerage fees and the trustee’s commission.

Question: Does a CLAT pay any income taxes? It depends. Typically, the CLAT does pay income tax on its undistributed income for a year. This is true of a “plain vanilla” CLAT. If a plain vanilla CLAT has $55,000 net earnings of cash for a year and $12,000 of unrealized capital appreciation for the year, and the CLAT pays $50,000 cash to charity for the year, the CLAT will be allowed a deduction for the cash paid to charity and will be subject to tax only on the $5000 of undistributed cash. There will be no tax on the $12,000 unrealized, undistributed capital appreciation.

Question: What is a “non-plain vanilla” CLAT, and how does it work? We’ll look at all this next time.

Meantime, if you think there is an awful lot of detail to consider about CLATs, you’re right! There is. And prospective CLAT donors typically want to probe all the details. That gives you a clue as to the sort of person who is a typical CLAT donor.

by Jon Tidd

Read Pt 1 here
Read Pt 2 here
Read Pt 3 here
Read Pt 4 here
Read Pt 6 here

Let’s Spend Time With Lead Trusts – Pt 4

It’s now time for a CLAT example, to see how this thing works.

Let’s suppose Donor creates a CLAT with $1 million in cash. The CLAT is to pay $50,000 a year to Charity for 12 years and then distribute all of its assets to Donor’s daughter, Sue. This fact pattern is as plain vanilla as can be, which is good for teaching.

For federal gift tax purposes Donor has made two gifts: [1] a gift to Charity, and [2] a gift to Sue. These gifts are made on the day Donor funds the CLAT … on that day only.

The gift to Charity consists of the right to receive $50,000 a year for the next 12 years. The gift to Sue is the right to receive what remains in the CLAT at the end of the next 12 years. Each of these rights has a present value, which is a portion of the $1 million used to fund the trust.

If we assume a 2.0 percent IRS discount rate, the gift to Charity is $532,735, and the gift to Sue is $467,265. These two gifts add up, they must add up, to the $1 million used to fund the trust. If Donor has remaining at least $467,265 of his lifetime gift tax exemption ($5,450,000 for 2016), Donor will not incur any gift tax on the gift to Sue. The gift to Charity is not subject to federal gift tax, because of the unlimited gift tax charitable deduction. The calculated numbers, by the way, fall out of a computer.

Note that if we assume a 1.8 percent IRS discount rate, the rate for July 2016, the gift to Charity increases to $538,905, and the gift to Sue decreases to $461,095. The applicable IRS discount rate is what the IRS assumes on the day the trust is created the CLAT will earn for its entire 12 years. This assumption is made so that the gift tax consequences of creating the CLAT can be figured on the day the CLAT is created.

We’ll continue this example next time, when we’ll look at [1] how things play out for the trust itself over the 12 years, and [2] how Sue is treated from a tax standpoint when she receives all the trust assets at the end of 12 years.

by Jon Tidd

Read Pt 1 here
Read Pt 2 here
Read Pt 3 here
Read Pt 5 here
Read Pt 6 here

Let’s Spend Time With Lead Trusts – Pt 3

Last time, we drilled down into the charitable lead annuity trust (CLAT). We saw that

  • the CLAT may be set up to run for either a fixed term of years or an individual’s life (subject to restrictions);
  • the CLAT is used not only to fund a charitable project but also to transfer substantial assets downstream; and
  • the CLAT works especially well as a wealth-transfer mechanism in a low-interest-rate environment.

It works well in a low-interest-rate environment because in such an environment the present value of the annuity payout to charity is relatively large, which means the present value of the remainder interest given to the downstream family members is relatively small. These present values at the time the trust is created are what matter for federal gift and estate tax purposes. If the remainder value is small, the donor has made a small gift to the remainder beneficiaries. This is good, and important, if the donor is a wealthy individual who has to worry about estate and gift taxes.

It’s possible to “fine tune” a CLAT, so as to “dial down” the present value of the remainder interest and reduce the gift to the remainder beneficiaries. There are three basic ways to do this:

One is to wait to set up the CLAT until the donor believes interest rates have fallen as low as they’re going to go.

A second is to extend (make longer) the trust term; e.g., increase the term from 15 years to 20 years. This increases the present value of the annuity payout to charity, which decreases the present value of the remainder interest given to the kids or grandkids.

A third is to increase the annuity payout; e.g., from $50,000 a year to $60,000 a year. This also serves to increase the payout value and diminish the remainder value.

These three ways are like dials on a machine that dials up or down the gift and estate tax cost of transferring wealth downstream. It is possible to dial that cost down to zero with a CLAT.

More next time. Meantime, if you’re interested in exploring whether a CLAT might be suitable for one of your donors, contact your Sharpe rep.

By Jon Tidd

Read Pt 1 here
Read Pt 2 here
Read Pt 4 here
Read Pt 5 here
Read Pt 6 here

Let’s Spend Time With Lead Trusts – Pt 2

Time to take a closer look at the charitable lead annuity trust (CLAT). The CLAT comes in several flavors; we’re going to start with plain vanilla. The plain vanilla CLAT makes a fixed payout to charity at least annually (e.g., $25,000 a year) for a term prescribed by the donor and then, typically, distributes its assets to the donor’s children or grandchildren (these individuals are called the “remainder beneficiaries”).

What is a permissible CLAT term? A CLAT may make its payout for a fixed term of years (e.g., 15 years); for the life of the donor or the donor’s spouse; or, for example, for the life of the donor’s mother provided donor’s mother is an ancestor of each of the remainder beneficiaries.

Why might an individual create a CLAT? The usual reasons are (a) to fund some charitable project over time, and (b) to transfer significant assets to downstream family members at little or even no gift tax or estate tax cost. The individual who creates a CLAT is almost always quite wealthy; he or she may be of any age.

How does a CLAT serve to transfer assets downstream at little or no tax cost? In setting up a CLAT for the eventual benefit of the donor’s children, let’s say, the donor is deemed to confer a financial benefit on the children. Therefore, the donor is deemed to make a gift to the children for federal gift and estate tax purposes. If the donor funds the lead trust with $1,000,000, the gift (deemed to be made at the moment the trust is created) is equal to $1,000,000 minus the present value of the annuity payout to charity (designated here as “PVA”).

PVA is a function of (a) the annual annuity payment, (b) the trust term, and (c) the IRS discount rate in effect when the CLAT is created.

If the CLAT is to pay out $50,000 a year to charity for 15 years, here’s how the numbers play out:

IRS Discount Rate              PVA                        Gift to Children

2.0%                                       $647,280              $352,720

2.4%                                       $629,260              $370,740

2.6%                                       $620,500              $379,500

As seen from the table of numbers, the donor’s gift to the children rises and falls with the IRS discount rate. The lower the discount rate, the lower the gift to the children. More about all this next time.

By Jon Tidd

Read Pt 1 here
Read Pt 3 here
Read Pt 4 here
Read Pt 5 here
Read Pt 6 here

Let’s Spend Time with Lead Trusts – Pt 1

A lead trust is a trust that [1] makes payments to one or more charities for a donor-prescribed period, and then [2] distributes its assets to one or more persons. It’s called a lead trust because the charitable interest in the trust leads, or precedes in time, the non-charitable interest.

Certain lead trusts work well from a tax standpoint in a low interest rate environment. Other lead trusts work well as a way to transfer assets to grandchildren. To understand the details here is to possess sophisticated gift planning knowledge.

To understand the detailed hows and whys of lead trusts, we need to narrow our focus. Let’s do that first by looking at the two kinds of lead trusts.

Lead trusts come in these basic flavors:

  1. the charitable lead annuity trust (CLAT), and
  1. the charitable lead unitrust (CLUT).

Note: These are the only two flavors allowed by federal tax law.

The CLAT makes fixed annuity-type payments to charities for a donor-prescribed period (e.g., $50,000 a year for 15 years), and then distributes its assets to one or more persons (e.g., the donor’s children). The CLUT works the same basic way except that the payout to charity is a unitrust payout (e.g., the trust pays to charity each year 5% of its annually determined asset value).

Note: There is no minimum or maximum payout rate for a CLAT or a CLUT.

Over the years, far more CLATs than CLUTs have been created. The reason, believe it or not, has to do with interest rates. It turns out that the CLAT provides greater bang-for-the-buck in a low interest rate environment. Such as the environment that currently exists in the U.S. (and worldwide).

This is where we’ll pick up next time, when we’ll begin to develop a pretty good understanding of the CLAT.

By Jon Tidd

Read Pt 2 here
Read Pt 3 here
Read Pt 4 here
Read Pt 5 here
Read Pt 6 here

What Is an Inherited IRA?

By Jon Tidd

This question is important for several reasons. One is that charities named as IRA beneficiaries are often required by IRA custodian financial institutions to establish inherited IRAs in order to receive the benefit to which the charity is entitled.

The answer is provided by section 408(d)(3)(C)(ii) of the Internal Revenue Code:

(ii) Inherited individual retirement account or annuity
An individual retirement account or individual retirement annuity shall be treated as inherited if—
(I) the individual for whose benefit the account or annuity is maintained acquired such account by reason of the death of another individual, and
(II) such individual was not the surviving spouse of such other individual.

The language of this Code section clearly indicates that the term “inherited individual retirement account” is an IRA acquired by an individual. So how can a charity, which is not an individual, establish an inherited IRA? The writer doesn’t know.

It turns out some financial institutions, either as a matter of practice or upon being pressed, will make a direct distribution from an IRA to a charitable beneficiary of the IRA.

Given that IRAs are trusts, the trustee of which must be a bank or other qualified party, a direct distribution to a charitable IRA beneficiary makes sense. Trustees make trust distributions to trust beneficiaries all the time.

Does the Patriot Act require a U.S. charity to establish an inherited IRA in order to receive its beneficiary distribution? No. There is no such requirement in the Patriot Act.

The Emergence of Blended Gifts

The term “blended gift” generally refers to different ways individuals can make significant charitable gifts. As the baby boomers first began to approach the age range when most charitable gifts are planned and implemented, they were more inclined to structure larger charitable gifts differently from previous generations. They used “blended gifts” in an effort to provide both near term and future benefits for charitable recipients, while also serving as a welcome component of plans to help ensure the long-term financial security of a client and/or loved ones. Robert F. Sharpe, Jr. predicted this trend in 1995 after analyzing the differences in this generation vs. previous generations.

But how do you structure blended gifts to maximize long-term gift potential for the organization, and income, gift and estate tax savings for donors? Take a look at Robert Sharpe’s recent Trusts & Estates article that explores various ways to structure blended gifts, as well as the historical and demographic contributors to this trend in giving. This article is particularly useful for professional advisors who are looking for ways to help their clients understand and make blended gifts.

Click here for the Trusts & Estates article.

What Are the Charitable Contribution Carryover Rules?

By Jon Tidd

Sometimes a charitable gift is too large to be fully deductible for the year in which it’s made. This is because the law imposes limits on the federal income tax charitable deduction. In this situation, the donor may be able to carry the excess part of the gift forward as a deduction for up to five years.

For example, Donor’s 2016 adjusted gross income (AGI) is $150,000. Donor’s maximum federal income tax charitable deduction for 2016 is $75,000 (50% of AGI). Donor’s 2016 cash donations can be deducted up to this limit, provided the donations are all made to “public charities” (such as schools, colleges, religious organizations and hospitals). Any cash donations Donor makes in 2016 to private foundations are subject to a lower limit of $45,000 (30% of AGI). Appreciated stock gifts to “public charities” are also subject to a 30% limit on deductibility. Appreciated stock gifts to private foundations are subject to a 20% limit on deductibility. These appreciated stock limits apply to stock held long-term (at least a year and a day).

Excess gifts to “public charities” are subject to a five-year carryover rule. So, for example, if the donor we’ve been considering gives $60,000 in cash and $20,000 in appreciated long-term stock to “public charities” in 2016, he or she is limited to a $75,000 charitable deduction for 2016. The cash gifts of $60,000 are taken into account first and are fully deductible for 2016. The stock gifts, taken into account second, are deductible only to the extent of $15,000, so there is a $5,000 appreciated stock carryover to 2017, subject to the 30% limitation. No carryover is allowed for excess gifts to private foundations.

For 2017, Donor will first take into account 2017 cash donations to “public charities;” will take into account second any 2017 appreciated stock donations to “public charities;” will take into account third any cash carryover from a prior year; then will take into account appreciated stock carryovers from prior years, including the $5,000 carryover from 2016.

If your head is spinning at this point, it should be. And we’ve just scratched the surface of the carryover rules. If you have questions about these rules, be sure to contact a Sharpe Group representative.

How Now Dow?

by: Barlow Mann

wall street

The Dow Jones Industrial Average rose to 2016 highs on April 14 and was within 2% of reaching an all-time record high.

In 2015 the Dow was basically flat for the year and actually closed out with a small loss when compared to the close in 2014.

Over the past 12 months, the DJIA has ranged from a high of 18,322 to a low of 15,660 in February of 2016. Since then the Dow has rallied more than 2,000 points and could test previous highs in spite of economic uncertainty. Many people are expecting continuing market volatility with wide spreads in prices over the year.

From a gift planning stand point this volatility provides both challenges and opportunities. Major donors should consider funding gifts with highly appreciated stocks and bonds when prices are high. This is particularly true for wealthy individuals in the highest income and capital gains tax brackets. Charitable gift planning options should also be considered by individuals who are “under diversified” because of the appreciation of one- or two-star performers in their portfolios. In these instances, a charitable remainder trust can be particularly attractive by allowing the sale and reinvestment of the proceeds in a tax-free environment within the CRT.

Consider informing your donors about this time-sensitive opportunity to make gifts of securities. Sharpe Group offers several publications designed for the purpose of informing donors, fundraisers and advisers about these gifts. Click each title for more information: