Charitable Tax Planning Consulting

√ Charitable Planning Should Address Personal Goals

Charitable giving is too often focused on tax benefits or legal decisions. Practitioners can help clients refocus on “people” decisions. This is especially important for testamentary bequests since so few clients will face an estate tax that few will realize any estate tax benefit from chartable planning. Only 3-4,000 decedents/year will pay a federal estate tax. For the vast majority of clients estate planning will refocus on non-estate tax factors, including income tax minimization and human aspects of planning. However, even lifetime gifts can provide important personal as well as income tax planning benefits.

√ Help Clients Plan Donations to Enhance Personal Objectives

There are many ways, depending on the client’s particular interest and goals, who is affected, and with what, to tailor a donation to meet client personal objectives. A key step in many cases is to structure a donor agreement between the donor and the charity in advance of the charitable gift. Consider the following:

• Specify how the donation will be used.

• For long term gifts (e.g., a fund that will continue for decades, or an agreement to donate a set amount each year for many years) what investment management or other fees might the charity charge the fund? Will the charity allocate a portion of the initial gift or each year’s withdrawals to general charitable administrative expenses? Can that fee be negotiated so that more of the donation is applied to the objectives the client is hoping to achieve?

• Reach an agreement as to how a gift/bequest will be named, what prominence will be given, how it will be displayed, what happens if the facility moves. Should the client/donor’s name be on a plaque inside the building, prominently on the outside of the building? What is agreeable?

• What happens if the purpose of the gift is no longer relevant?

• Address other issues to assure client’s objectives are met.

√ Example of Donation Coordinated with Personal Goals.

Example: For prostate cancer the overall 5-year relative survival for 2003-2009 from 18 SEER geographic areas was 99.2%. The median age at diagnosis for cancer of the prostate was 66 years of age. Purchasing a charitable gift annuity that will benefit the American Cancer Society and provide an annuity for life, for these older clients, may be a simple and ideal planning step to address cash flow needs in retirement, charitable intent and more for this group of clients.

For pancreatic cancer the overall 5-year relative survival for 2003-2009 from 18 SEER geographic areas was only 6.0%. For a client diagnosed with pancreatic cancer, creating a QTIP trust with a remainder to the American Cancer Society may provide the personal goal of ultimately benefiting the American Cancer Society, but assuring no matter what, maximum protection for a surviving spouse.

√ Simple Bequest

A very common charitable gift is a bequest under the client’s will. Even though there may be no estate tax benefit, bequests will remain common as many clients for personal reason wish to make a last bequest to charity. These gifts can also be used to create a powerful message for heirs.  Estate planning is not only about the transmission of wealth, but about the transmission of values. A simple bequest to a charity in a will can demonstrate commitment, values and more. A personal letter of instruction can help.

Example: Dear children, I wanted to explain to you that after my father’s miraculous struggle with pancreatic cancer, I have made a bequest in my will to the Charity Name to fund research that will hopefully [describe objective]. I also hope by this bequest to encourage you to each find ways to give back to charity to demonstrate gratitude.

Example: Add phrase to the testamentary bequest, “I have made this bequest to charity to demonstrate the importance to my heirs of making a contribution back to society,” or whatever drives home the client’s point.

√ Charitable Gift Annuities Help Meet Personal Goals and Charitable Goals

A gift annuity is a contract between the donor and his or her favorite charity in which the client gives the charity a one-time payment and receives a contractual commitment for a periodic payment, an annuity, for life. The amount of the annuity is determined at inception, without modification (worries) about investment performance/volatility. If your client, or a loved one, is facing the challenges of aging generally, or a specific health challenge, committing some component of his/her investments and expenses to a charitable gift annuity can put some of their finances on auto-pilot, can provide certainty and simplicity.

Example: Client was diagnosed with breast cancer and her physician has recommended a treatment plan to include surgery followed by chemo-therapy. While the overall 5-year relative survival for 2003-2009 from 18 SEER geographic areas was 89.2%, the challenges for a number of years will be significant. The difficulty dealing with financial matters has increased. Sufficient gift annuities are purchased so that the monthly payment covers her recurring expenses. Funds are deposited automatically into her bank account and mortgage, utilities and tax bills are all on auto-pay. On your client’s death the American Cancer Society will receive the funds that remain for its charitable purposes.

√ Charitable Remainder Trust

A charitable remainder trust (CRT) can be more advantageous post ATRA. The new Medicare tax on passive income that became effective 1/1/13 does not apply to charitable remainder trusts (CRTs). Instead as payments are made to your client/donor they are taxable subject to the CRT tier system.  Using CRTs might shift net investment income (“NII”) to the trust and thereby defer the new 3.8% Medicare tax, generate an income tax deduction of some benefit, and defer the new higher capital gains tax. Better tax results might, however, be achieved. The CRT can defer income over many future years and thereby facilitate keeping the client’s marginal taxable income below the threshold for application of the NII tax. Therefore, making a gift to a CRT could effectively avoid any application of the NII tax to the client. While interest rates are quite low it is difficult for clients who are not sufficiently old to meet the requirements for a CRT. However, as interest rates rise CRTs will continue to grow in popularity to address client charitable goals, the desire for regular cash flow in retirement, and to minimize higher income and capital gain taxes.

√ Evaluate Existing CRTs for New Donation Opportunities

Your client may have created a CRT in the past and may no longer need the cash flow from the annuity provided, or perhaps the client would like to benefit the named charitable beneficiary now. The client can terminate the CRT so that the charity will receive the current value of its remainder interest. If a CRT is terminated early, the client, as the non-charitable beneficiary, will report capital gain based on the value of the assets distributed to him or her as a taxable exchange under IRC Sec. 1001. PLR 200314021 and 200733014.  When a CRT is terminated early the client would be treated as selling his or her interest in the CRT to the charity as remainder beneficiary. Practitioners should coordinate such a termination, if feasible, in a tax year when the client is in a lower tax bracket.

√ CRT as a Retirement Plan

The most common CRT is structured as an annuity trust called a “CRAT.” If the initial gift to the CRT was $200,000 and the payout rate was 5% then the CRT would pay $10,000/year to the donor/annuitant for its term. A charitable remainder trust can also be structured as a unitrust called a “CRUT.” If $200,000 were given to a CRT paying 5% it too would payout $10,000 in the first year. If the value of the assets increased to $220,000 by the second year the payout would be based on the payout rate of 5% of the then value of the assets or $11,000. Thus, a CRUT can provide an inflation hedge on its payments to the client/donor. This can be incredibly important in planning a CRT for cash flow for a long duration. Additional variations on the CRT theme can further help practitioners tailor charitable planning to not only achieve the income tax benefits a CRT can afford, but to better achieve client economic goals. If a CRUT is created it can be specified that the unitrust payments will only be made from income; NI-CRUT “net income-only arrangement.” Using this type of CRUT the client/donor, as income beneficiary, will only receive the actual trust income if the income is less than the fixed percentage payment required. This NI-CRUT technique can be applied in a manner to facilitate a CRT being used to provide a result analogous to a “retirement plan.” IRC Sec. 664(d)(3)(A); Treas. Reg. § 1.664-3(a)(1)(i)(b)(1). One additional step might be advantageous in structuring a CRT to achieve retirement plan-like results. A NIM-CRUT is a spin on the NI-CRUT.  The “M” is for “make-up.”

Example: Assume your client has a non-income producing asset, such as raw land, that she wants to donate to charity. The CRT will not produce income until the charity sells the property. In a NIM-CRUT, if the income in any year is less than the unitrust amount for that year, the shortfall is made up in future years in which trust income exceeds the unitrust amount.  It is as if the payments due to the client/donor are accrued and will be paid in a future year. The maximum payout in later years is the sum of the CRUT amount due to the client/donor in each of the prior years, plus the amount necessary to make up for any shortfalls in prior lean years. A NIM-CRUT may be the ideal CRT for a client/donor planning for retirement because it addresses the risks to cash flow of future inflation.

√ Charitable Lead Trust and Personal Goals

Charitable lead trusts (“CLTs”) are the opposite of CRTs with the charity receiving the payments from the trust during the trust term and the designated heirs, typically a client/donor’s children, receiving the remainder interest. While CLTs have typically been used to minimize gift or estate taxes (A CLT is not income tax exempt like a CRT)) the technique can be adapted to meet personal goals. Assume that a client has an adult child with a health challenge that will limit the child’s work expectancy. The client could establish a CLT which concludes at the ill child’s anticipated retirement date. The back end of the CLT would be a trust for that particular child which would name trustees and include dispositive provisions which were consistent with the financial concerns facing that child.

Example: Daughter is a single mother with two children. At age 40 she was diagnosed with cervical cancer. The overall 5-year relative survival for 2003-2009 for Localized (confined to primary site) cancer of the cervix is over 90%. While the prognosis is positive, Daughter is very worried about supporting her children, in the event the outcome is negative. Parents establish a 15 year CLUT for $1 million. The CLUT pays out 6% for the 15 year period which the Daughter will direct to meet various charitable projects supporting cancer research. The payment to the charity for 15 years will reduce the gift tax value of the transfer from $1 million to $397,213. If the invested funds earn 7.5% over the 15 year period Daughter’s children will receive a nest egg of $1.2 million when the CLT ends. The CLT plan empowers Daughter to be proactive to fight cancer while giving her assurance of her children’s security.

√ QTIP and Charitable Remainder

If a client’s spouse faces the challenges of aging or illness the well spouse could create an estate plan that provides protection for that spouse and an eventual charitable bequest. The client could establish inter-vivos (while alive) marital trust (“QTIP”) to protect ill spouse. A QTIP trust can protect the ill spouse by providing professional management of the assets in the trust, trustees who can his pay bills and handle other matters for spouse if/when necessary, protection from lawsuits and claims, and other benefits. The QTIP trustees can invade the principal of the trust and use it to pay any or all of it for the care of the spouse. No estate tax will be due on the well-spouse/transferor’s death. Following the death of surviving spouse, whatever assets remain in the QTIP trust can be contributed to charity, since the charity can be named as the remainder beneficiary of this trust.

√ Bequest of Closely Held Business with Hedge Against IRS Challenge of Valuation

This technique involves a charity to backstop a defined value clause on the sale of assets to a grantor trust. President Obama has repeatedly proposed eliminating this technique by causing estate inclusion. The use of a defined value mechanism may dissuade the IRS from challenging the value of closely held business, real estate or other hard to value interest transferred, especially if the excess is paid over to a charity. A prospective donor may structure a substantial sale to a defective grantor dynasty trust (intentionally defective irrevocable trust (IDIT)), or even just a gift using the current $5.25 million (2013) gift exemption if concerned about possible valuation challenges in the event of an audit of hard to value assets, e.g. a closely held business. Transfer documents limit sale (gift) to the IDIT to a dollar value of the assets sold, keyed into the intended purchase price using the defined value clause. The excess of the gift as valued by the IRS on audit, over the defined value of the gift (the intended gift amount) passes as a result of the defined value clause to charity. While IRS incentives to audit would be adversely effected, the charity’s interests should be protected by the state AG’s involvement and fiduciary duties of the executor. The IRS has argued the rationale of the landmark decision in Commissioner of Internal Revenue v. Procter, 4th Circuit 1944. Procter held that mechanisms that render an audit ineffectual will not work if they create a condition subsequent. This creates a public policy problem since to enforce it renders the issue moot. McCord v. Commissioner of Internal Revenue, 120 TC 358 (2003), rev'd and rem'd, 461 F3d 614 (5th Cir. 2006). Taxpayers transferred partnership interests to children and charities using a formula clause that transferred approximately $6.9 M to children and trusts for children, $134,000 value of partnership interests to one charity, and the balance to a second charity. Donees (children and two charities) were required to determine the value of the partnership interests, and to allocate the gift among themselves, based on the price at which the assigned partnership interest would change hands as of the date of this assignment between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant acts. The donees entered into a settlement agreement allocating the gift based on an independent appraisal. Some suggest that the case implies that no charitable beneficiary is necessary, but is relying on the desired approach. In the Estate of Christiansen the Tax Court upheld a valuation adjustment clause structured as a form of disclaimer. The decedent's will bequeathed her net estate to her daughter. If any assets were disclaimed, 25% would pass to a charitable foundation and 75 percent to a twenty-year charitable lead annuity trust (CLAT). The daughter was a remainder beneficiary of the charitable lead annuity trust. The daughter disclaimed a fractional share of the estate, equal to the excess of the estate over $6.35 million. The Tax Court found that the disclaimer passing to the lead trust was not a qualified disclaimer, because Christine had not disclaimed her interest in the lead trust. The court stated that revaluation clauses that depend for their effectiveness on a condition subsequent are ineffective. The Tax Court also rejected the IRS argument that the disclaimer's adjustment clause was void on public policy grounds, because it would discourage the IRS from auditing estate tax returns. Estate of Christiansen v. Commissioner of Internal Revenue, 130 TC 1 (2008). Wandry v. Commissioner, T.C. Memo. 2012-88. In Christiansen, Petter and McCord the defined value clauses used all had a charitable component. The Wandry Court explained that in these cases, “This factor contributed to our conclusion, but it was not determinative.” In Wandry even though there was no charity involved the Court ruled in favor of the taxpayer, noting that the documents clearly indicated that the gift was of a fixed dollar amount and not of a percentage interest in the LLC. While some practitioners suggest that you no longer need a charity or a pay-over mechanism in a defined value clause, many practitioners prefer that approach.

√  Bequest to Charitable Lead Trust (CLT) to Minimize Audit Risk on Large Estate

Using a testamentary CLT reduces audit incentive if audit adjustment won’t increase tax revenue but rather increase the amount going to charity using a defined value clause Example: “I bequeath $1M of the Family Widget Business to my daughter Jane. If the value as finally determined for federal estate tax purposes exceeds $1M, the excess shall be bequeathed to the Jane 15 year 6% Charitable Lead Trust.” “Lids”: The above concepts are being expanded by some practitioners to use as caps or Charitable “lids” on the value of any type of estate planning transfer.

√ Charitable Bail Out

The client could donate a portion of his or her business or the real estate to a charitable remainder trust (CRT). When the business is later sold, or the business redeems the equity held by the CRT, the CRT would invest the proceeds, which could pay the client a monthly annuity for life (or for the client’s life and the life of another beneficiary or beneficiaries). This annuity may cover a significant portion or all of your client’s living expenses. As with gift annuities, your client must be cautious about how much you commit to a CRT, because you cannot access the principal in the event of an emergency.  Thus, in certain plans, a portion of the asset may be sold and a portion contributed to a CRT. On your client’s death, the money remaining in the CRT will be given to the charities named. Your client can also reserve the right in the CRT agreement to designate new charities in his or her will.