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GS 849 Charitable Strategies > Assignment 3: Charitable Remainder Trusts, CGAs, and Single-Premium Immediate Life Income Annuities > Flashcards

Assignment 3: Charitable Remainder Trusts, CGAs, and Single-Premium Immediate Life Income Annuities Flashcards

1
Q

Financial Benefits of a CRT

A
  • CRT sells asset without paying capital gain
  • Growth and income within CRT are not taxed until paid out as income
  • Diversification of holdings
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2
Q

CRT Types

A

CRAT–Charitable Remainder Annuity Trust

CRUT–Charitable Remainder Unitrust Trust

  • SCRUT (Standard CRUT)
  • NICRUT (Net Income CRUT)
  • NIMCRUT (Net Income with Make-Up CRUT)
  • FLIP CRUT
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3
Q

CRTs: Creation and Tax Deduction

A

Testamentary (at death)

  • date of death
  • Estate entitled to an estate tax charitable deduction for the present value of the remainder interest passing to charity

Inter Vivos (during lifetime)

  • Date it receives funding
  • Donor entitled to an income tax charitable deduction for the present value of the future interest that will pass to charity
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4
Q

CRUTs: Payout, Frequency, Contributions, Duration, Beneficiary

A
  • Payout based on a % of the FMV of trust assets
  • Payout min. 5%, max 50%
  • Revalued annually; date determined in trust documents
  • Payout at least annually, but usually quarterly
  • Can make additional contributions
  • Term of years, not exceeding 20 years, or for the lifetime of one or more recipients; joint lives for multiple beneficiaries
  • Can be to a named beneficiary, as long as there is at least one non-charitable beneficiary
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5
Q

CRATs: Payout, Frequency, Contributions, Duration, Beneficiary

A
  • Payout is a fixed amount determined at inception
  • Min payout 5%
  • Payout never changes
  • Payout at least annually, but usually quarterly
  • Cannot make additional contributions
  • Term of years, not exceeding 20 years, or for the lifetime of one or more recipients; joint lives for multiple beneficiaries
  • Can be to a named beneficiary, as long as there is at least one non-charitable beneficiary
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6
Q

CRTs & Charities

A
  • When income interest terminates, the remaining trust assets must be paid to one or more qualified charities
  • Donor can retain right to change charitable beneficiaries
  • No requirement that the named charity be made aware of the impending gift
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7
Q

CRTs: 10% Rule

A
  • all CRTs must have AT LEAST a 10% remainder interest, calculated by actuarial factors, at the time the trust is established
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8
Q

CRAT: 5% Probability Test

A
  • CRAT must pass both the 5% probability test and the 10% rule.
  • 5% test means there can be no more than a 5% chance the CRAT will exhaust, based on actuarial factors at the time the trust is established.
  • In reality though, the trust will grow and shrink based on real investment returns and may indeed exhaust
  • A CRUT always meets this test because a CRUT pays a percentage of the remaining balance–so it would dwindle but not exhaust
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9
Q

CRAT/CRUT Planning

A
  • When the 7520 rate is very low, difficult to get CRATS to qualify for a life income except for older donors
  • CGAs or CRUTs may better serve older donors
  • Donor can also choose a payout term of up to 20 years, a short enough payout period may allow the trust to qualify
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10
Q

CRTs: 4 Tier Taxation (4-Tier Accounting Rules)

A

1st: Ordinary Income
- Interest
- Qualified dividends

2nd: Capital Gain
- Short term cap gain
- Long term cap gain

3rd: Other income:
- Tax exempt interest

4th : Corpus/Return of Capital
- Basis

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11
Q

Pre-Contribution Capital Gain

A
  • Gain inside the asset given becomes capital gain inside the trust, once that asset is sold inside the trust
  • Trust defers, but does not eliminate, the tax on the gain
  • Trust does not pay tax on the gain, but rather the donor does as income comes out to the donor–subject to 4-tier accounting rules
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12
Q

Net Investment Income

A
  • CRT distributions include amounts subject, for high income earners, to the 3.8% surtax on Net Investment Income (NII)
  • CRT trustees report this to income beneficiaries annually on Schedule K-1
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13
Q

Capital Gains Red Flag

A
  • Donor gives appreciated property, wants tax-free income
  • Even if trustees invests in tax-free bonds, there will still be tax until the capital gains in exhausted
  • So not tax free income until capital gains is paid
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14
Q

SCRUT

A

Standard CRUT
- Pays fixed percentage based on how much the trust has grown or shrunk; income varies

  • Additional contributions are allowed
  • Must pass the 10% remainder test
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15
Q

NICRUT

A

Net Income CRUT
- Pays the lesser of payout percentage or distributable net income (DNI)

  • DNI includes rent, dividends, interest, and royalties
  • Trust document may include capital gains realized post-funding in DNI definition, if state law allows
  • Pre-funding capital gains may not be included in DNI, even if realized post-funding
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16
Q

NIMCRUT

A

Net Income with Make-up CRUT
- A special NICRUT that builds up an account of undistributed payout from previous years

  • May make-up the payout from previous years, when income is available inside the trust to pay it
  • Trust document may include post-contribution gains in DNI definition, if state law allows
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17
Q

SPIGOT NIMCRUT

A
  • Defers distribution of cash to the income beneficiary until they need it (retirement or college)
  • CRT asset management strategies control the flow of income
  • Income control methods:
  • Variable annuity contracts
  • Zero coupon bonds
  • Zero dividend stock

Donor cannot turn income on or off, but trustee can.

Because of IRS scrutiny, don’t see many SPIGOT trusts anymore, but they are not forbidden.

Make sure donor understands the nuances of DNI calculations and how much the donor will receive if the assets grow or shrink

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18
Q

FLIP CRUT

A
  • NICRUT or NIMCRUT can convert (or “flip) to a SCRUT
    upon the occurence of a triggering event specificied in the trust.
  • No income is paid out when no income is available
  • Good for gifts of land which initially produce no income
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19
Q

Examples of Triggering Events

A
  • Sale of an unmarketable asset (real estate)
  • Specified date
  • Birth or death or one or more specified persons
  • Marriage of divorce of specified persons
  • Event outside of control of trustees or any other persons
  • Retirement planning
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20
Q

Choosing a Trust Format

A

Things to consider:

  • Income needs of income beneficiaries
  • Risk tolerance of income beneficiaries
  • Age and health
  • Prevailing interest rates (7520 rate)
  • Nature of the funding assets (marketable or not?)
  • Needs of the heirs (will they feel disinherited if the remainder goes to charity? Might they need the money? Have the parents communicated their plans to the heirs?)
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21
Q

CRT with Income to Heirs

A

There are tax consequences of continuing income:

  • Present value of income to children subject to transfer tax at set-up, if arrangement is irrevocable
  • Subject to transfer tax in estate of the parent, if child’s interest can be changed before parent’s death

Consider life insurance to replace some or all of the asset for heirs (assuming parents are insurable)

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22
Q

Assets

A

Choice of assets depends upon the type of CRT, client’s asset structure, donor’s planning objectives

  • appreciated publicly traded securities (good)
  • Unencumbered real estate can work (real estate gifts always require special handling–experts needed)
23
Q

Asset to avoid

A

Debt-encumbered property

  • Can raise bargain sale issues, UBTI issues (unrelated business taxable income), and can disqualify the trust if the donor continues to pay the note
  • “Tell me more about the property”–good way to look for red flags

Assets donor is obligated to sell
- Will be treated as if the donor had sold it prior to giving the gift, resulting in taxable gain to donor even though asset is in the trust

Personal residence
- Donor cannot live in donated residence without committing self dealing

24
Q

S-Corp Stock

A

Not a good idea!

  • If given to a CRT, the S election is revoked
  • Income taxable to trust
  • Gain on sale is taxable to the trust
  • Important not to do this inadvertently
25
Q

Avoid UBTI Producing Assets

A
  • An interest in an active trade or business (regardless of whether it is classified as a sole proprietorship, a general partnership interest, a limited partnership interest, or an LLC interest)
  • A working interest in an oil and gas well
  • Unrelated debt-financed income from trading on margin or other borrowing
26
Q

Limitations on Transfer of Assets

A
  • Contractual or regulatory requirements must be met (E.g. restricted stock is subject to SEC rules and disclosure requirements, as well as contractual limitations which may delay effective date of transfer)
  • Timeliness is important to avoid significant fluctuations in value of funding assets
27
Q

Asset Sale and Management

A
  • Asset management strategy must be developed prior to funding
  • Asset sale, if required, must be planned and accomplished in a timely manner
  • All technical, legal and administrative requiremenets must be met in a timely way.

**Might require an appraisal so consider this in your timing

28
Q

Issues in Choice of Payout

A
  • Expected investment performance
  • Needs of income beneficiaries
  • Risk tolerance of income beneficiaries
  • Charitable remainder desired
  • Type of trust
29
Q

Who Bears Investment Risk?

A

CRATS–shift risk to remainder beneficiary

CRUTS–distribute risk more evenly between income and remainder beneficiaries

30
Q

Trustee Investment Considerations

A
  • Trustees are fiduciary to BOTH income and remainder beneficiary
  • Subject to state law and provisions of the trust
  • Generally, a prudent investor standard applies (modern portfolio theory)
  • Trustees have been sued by charitable remainder beneficiaries

**Not a good idea for the donor to be trustee

31
Q

Income Tax–AGI Limits

A

Charitable beneficiary: Public/Private

  • Cash Gifts: 60%/30%
  • Qualified appreciated stock: 30%/20%
  • Other appreciated stock: 30%/basis up to 20%
32
Q

Taxes: Inter Vivos (lifetime)

A

Income Tax: Donor receives an income tax deduction when property is placed in trust (subject to AGI limits)

Gift Tax: Donor giving income interest to a non-charitable beneficiary other than self or spouse–it is a taxable gift

  • Applicable credit offsets tax
  • Applicable exclusion amount for transfers during life or death ($11.58M in 2020, usually $0 because of estate tax exclusion)

Estate Tax: If non-charitable beneficiary is someone other than donor, the trust’s remainder is generally not included in donor’s estate. If it is the donor, then it is included in donor’s estate.

  • Income to spouse may be excluded from decedent’s estate
  • If included, it is offset by donor’s estate tax charitable deduction
33
Q

Taxes: Testamentary

A

Income Tax: Does not generate an income tax deduction for decedent or decedent’s estate

Gift Tax: Assets are included in the decedent’s taxable estate, so gift tax is not an issue

Estate Tax: Qualifies for an estate tax charitable deduction equal to the value of the remainder interest
- If the only non-charitable beneficiary is the donor’s spouse, the transfer of that interest qualifies as an estate tax marital deduction

34
Q

Administrative Concerns for CRTs

A

Strict federal and state reporting requirements

  • Form 5227 (split interest trust info return)
  • Schedule K-1

Income distributions must be timely

Requires available funds to pay distribution

If liquid funds are unavailable, required payment of in-kind assets

** Trustee must always be watching investment income

35
Q

Terminating or Fixing CRTs

A

Reasons CRT might need to be terminated or changed:

  • Donors no longer have the same income needs
  • Donor wishes to add to the CRUT
  • Charitable beneficiary would like funds now and donor wishes to accelerate the charity’s interest
  • Division in a divorce

Terminating:
- Consider state laws, gain recognition, life expectancy of the income beneficiary

Recision: (Cancel or voiding)

  • Must undo it through a court proceeding “release from further obligation”
  • Both parties must agree
36
Q

Examples to review with sample gift illustrations

A

Run these scenarios:

  • What happens to a charitable deduction for CRAT when 7520 rate rises? When it falls?
  • What happens to a deduction for CRUT when 7520 rate rises and falls?
  • What happens to a deduction when the payout period increases from 10 to 20 years?
  • When the payout rate increases?
  • What happens when a 35-year-old wants a 9% CRAT payout for life?
37
Q

Charitable Gift Annuities: How it works

A
  1. Donor gifts cash or assets to a charity; property transferred is a charitable contribution and an investment in annuity contract
  2. Charity provides for a guaranteed fixed income annuity to the donor or to someone the donor designates
  3. Donor gets a deduction for the remainder interest
  4. Income back to donor is taxed with basis, capital gain, and income pro rata “blended”
38
Q

CGA donor-friendly language

A

A charitable gift annuity is a way you can make a gift to your favorite charity and receive fixed payments for life in return.

The payments can begin immediately or be deffered to a future date which you choose .

You may also establish a gift annuity for someone else; however, the total number of annuitants associated with any one gift cannot exceed two.

The terms of the contract are set forth in a contract signed by you and the charity. The arrangement terminates on the death of the annuitants, at which point the charity uses the remaining funds on its mission.

39
Q

CGA–Essentials

A
  • One or two lives
  • Not a term of years
  • Annuity payments are FIXED and are not based on the charity’s own return
  • Charity must receive at least 10% of the initial net FMV of the property transferred
40
Q

CGA: Income Beneficiary

A
  • Single life (usually the donor)
  • Two lives in succession
  • Joint and survivor
  • Any individual can be named, but other than the donor or the donor’s spouse, a transfer taxable gift occurs (the donor effectively made a gift to the other person)
41
Q

CGA: Payout

A
  • Based on income beneficiary’s age at time of gift
  • Charity is free to set its own rates
  • Uniform (suggested) rates set by American Council on Gift Annuities (ACGA)
  • ACGA rates designed to retain 50% of gift for charity at life expectancy, with a present value of no less than 20% of the original contribution
42
Q

CGA Residuum–What does charity get from all this?

A

Residuum has gone down over the years.

1999: 97%
2009: 82%
2013: 64%
2017: 62%

Depends on how well investment does

43
Q

Types of CGAs

A

Immediate

  • Starts immediately
  • Guaranteed for life of donor(s)
  • Provides income tax deduction for the donor based on gift amount minus present value of income payments
  • Capital gain and basis in the original property gifted is spread over life of donor

Deferred

  • Later year determined by the donor
  • Tax deduction is taken at time of gift, based on age, payment, and start date of annuity

Flexible

  • Gift made now, income starts later
  • Donor decides later when it will start
  • Charitable deduction is taken at inception
  • Payments are lower when the start date is sooner, and higher if it is later
44
Q

CGA Prospects

A
  • 79 is average age of donor for immediate payment annuitants; 82% were 75+
  • One life: 70%; two life: 30%
  • 54% female; 46% male
  • Average size of immediate payment annuity accounts: $64,592 in 2017 (up from $50,056 in 2013)
  • 27% of deferred payment annuitants are 55 or younger (up from 15% in 2013)
  • Competes with a CD
  • Charitable element; income is generally less than with a commercial life income contract
  • CGAs are popular when there is a low interest rate environment
45
Q

CGA Advantages to Donor

A
  • Easy to understand; established with a short, simple document
  • Provides donor with guaranteed life income
  • Can be funded with cash or appreciated assets
  • Can be funded with small amounts
  • Provides income tax charitable deduction in year of gift
  • Beneficial capital gains treatment for donor
  • Benefits one charity
  • Nominal cost to set up
  • Can remain anonymous to the public, but not to the sponsor organization
46
Q

CGA: Charity’s Management Issues

A
  • Secured by the issuing charity
  • Return is guaranteed by the charity
  • Annuity payment is not conditioned upon a return received by charity
47
Q

CGA Reinsurance

A
  • Subject to state law
  • charities more likely to insure if it is a small gift annuity pool, if they are risk-adverse or if there is a large gift
  • Can select which gift(s) or a portion of a gift to insure
  • Charity purchases a guarantee from an insurance company to cover the original annuity payment obligation
  • Payments can be made directly to the donor or to the charity
  • Charity is protected against the donor’s living for a very long time
  • Charity shifts the investment risk to the carrier
  • Per ACGA, 93% of charities surveyed to not reinsure at all; only 6% reinsure some, and only 1% reinsure all
48
Q

CGA Cautions

A
  • Charity closes its doors before the donor dies? Donor is left as a general creditor
  • State laws govern; some require registration; differs widely
  • Not all charities offer these
  • Look for a STRONG, STABLE organization
49
Q

CGA: Philanthropy Protection Act of 1995 (PPA)

A
  • Charity must provide a disclosure statement, both during solicitation and to existing annuitants, using a letter or pamphlet
  • PPA requires exempt charitable organizations that commingle investment assets to provide donors with written information describing the material terms of the operation of the fund
  • PPA prohibits the payment of commissions of remuneration to anyone based on the value of a charitable gift annuity given to a public charity
50
Q

Commercial Single Premium Income Annuities (SPIA)

A
  • Immediate Income Annuities
  • Offered by a life insurance company
  • No charitable component
  • CASH ONLY
  • Lump sum to insurance company
  • Income back to client
  • Term of years
  • For life
  • For two lives
  • Can also have a guarantee–life, but not less than ten years; Life, but not less than put into the contract; other variations
51
Q

SPIA Exclusion Ratio

A
  • Each payment from a SPIA is composed of both principal and interest (blended)
  • The portion representing principal is excluded from taxation and received income-tax free
  • At life expectancy, all basis has been returned, and all the entire income amount is treated as ordinary income, subject to tax
52
Q

SPIA Payout beats Charitable Tools

A
  • Payout is higher, because there is no charitable element
  • Beats CRAT and CGA
  • Note: Insurance company can accept ONLY cash, not appreciate securities, land or other assets
  • If donor starts with an appreciated asset, the “gap” between payout from SPIA and a charitable tool is less
53
Q

Outlook for CGAs

A
  • Demographics are favorable as boomers age
  • CGAs appeal to smaller donors
  • Fewer will itemize
  • Estate tax no longer and issue for most
  • Tax advantages for CGAs are not as attractive as they once were, but may still be attractive for modest means donors

GS 849 Charitable Strategies (9 decks)

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