Week 4 Flashcards
A donor has a growing asset. The donor cares about making contributions to charity and also wants to transfer wealth to children free of transfer tax. Which tool would be an appropriate recommendation?
A) Charitable Remainder Unitrust (CRUT)
B) Charitable Gift Annuity (CGA)
C) Charitable Lead Trust (CLT)
D) Charitable Remainder Annuity Trust (CRAT)
C) Charitable Lead Trust (CLT)
The correct answer is C. CRTs provide income tax benefits to the donor, an income stream to the donor, and a remainder to charity. But a CRT does not provide for the balance to go to heirs, nor does a gift annuity. The CLT does help charity first, and the remainder can go to the heirs.
A client wants to set up a charitable lead trust so that it pays into his own foundation. The client is concerned about keeping control of as much as he can. Specifically, the client wants to be the trustee of the CLT and also to be the sole person making grant decisions at the foundation. What statement would be appropriate to make to such a client, assuming you are not the client’s attorney or CPA?
A) “No way you can do this. It is a prohibited act of self-dealing.”
B) “We may be able to do some version of this, but you will likely have to give up something. You very likely can’t control both entities. Let us talk with your advisors, who can research this for us.”
C) “This can be done; we just have to work out the details.”
D) “Let’s get the entities set up and work through the fine points later.”
B) “We may be able to do some version of this, but you will likely have to give up something. You very likely can’t control both entities. Let us talk with your advisors, who can research this for us.”
The correct answer is B. A CLT can pay the charitable income stream to a private foundation, but both the trust and the foundation are subject to the private foundation rules. These rules are best interpreted by the client’s own tax and legal advisors. The likely result is that the client will have to give up control of the foundation and/or the trust.
With respect to a charitable lead trust, which of these statements is (are) true?
I. A charitable lead annuity trust (CLAT) provides a fixed percentage payout to charity based on the assets in the trust, as revalued annually.
II. A charitable lead unitrust (CLUT) provides a fixed percentage payout to charity, based on the value of the original contribution to the trust.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
D) Neither I nor II
The correct answer is D. A CLAT pays a fixed dollar amount each year, expressed as a dollar amount or as a fraction or percentage of the trust’s initial value. A CLUT pays a fixed percentage of the fair market value of the trust, determined annually.
Each of these situations might be appropriate for a nongrantor CLT, EXCEPT:
A) The donor has a significant taxable estate, has done basic estate planning, wants to reduce size of estate, and has significant charitable interests.
B) The donor has a significant taxable estate, wants to reduce estate tax, is highly illiquid, has a concentrated position in one stock, wants to diversify in a tax-favored way, and wants to get an income to support his or her lifestyle.
C) The donor is considering a private foundation to make grants to charity and to reduce taxable estate. The donor also wants, if possible, to pass significant wealth transfer tax-free to children.
D) The donor is making significant annual gifts to charity and has hit the AGI limits, has an income-producing portfolio, and wants to make additional gifts to charity over many years, with the best possible tax result.
B) The donor has a significant taxable estate, wants to reduce estate tax, is highly illiquid, has a concentrated position in one stock, wants to diversify in a tax-favored way, and wants to get an income to support his or her lifestyle.
The correct answer is B. The CLT will not produce income back to the donor. Situation (B) would call, more likely, for a CRT. The other situations are promising for a CLT, since the CLT reduces the estate, moves assets to heirs eventually, and can provide gifts to charity over a number of years. For clients who have hit the AGI limits, giving a portfolio of income-producing assets to a CLT gets those assets out of the AGI calculation for the client. The trust itself can then give 100% of the income to charity, all deductible to the trust.
All of the following statements about CLTs in general are true, EXCEPT:
A) The trustee in a CLT may be empowered to choose various charitable income beneficiaries of the trust from year to year.
B) A CLT may, if appropriately set up, distribute annual income payments to a private foundation created by the CLT donor, assuming the donor does not control both entities.
C) Different rules are applied to charitable lead annuity trusts and charitable lead unitrusts when determining the generation-skipping transfer tax consequences of a trust’s funding and operation.
D) A CLT is often used to sell an asset without paying capital gains tax.
D) A CLT is often used to sell an asset without paying capital gains tax.
The correct answer is D. A CRT, not a CLT, is used to sell an asset without paying capital gains tax. A CLT is a taxable trust.
A charitable lead trust (CLT) document should contain a specific prohibition against all of the following, except
A) reversionary interests
B) self-dealing
C) jeopardy investments
D) taxable expenditures
A) reversionary interests
The correct answer is A. Having the property revert to the grantor is an option (thereby making the trust a grantor CLT). The other items refer to private foundation rules that apply to CLTs and should be referenced in the trust instrument.
All of the following statements about a grantor CLT are true, EXCEPT:
A) A grantor CLT creates “phantom income” to the donor during the term of the trust.
B) The funding of a qualified grantor CLT usually results in a charitable income tax deduction for the donor in the year funding occurs.
C) A grantor CLT is allowed a charitable deduction for all sums it distributes to a charitable income beneficiary each year.
D) The donor of a grantor CLT can avoid “phantom income” by purchasing only tax-exempt bonds when only cash is used to fund the CLT.
C) A grantor CLT is allowed a charitable deduction for all sums it distributes to a charitable income beneficiary each year.
The correct answer is C. A grantor CLT creates a deduction in the year of the gift, along with taxable income to the grantor (phantom income) for each year the trust has income. The trust does not get a deduction in the years in which it streams payments to the charity. Rather, the trust has income, no deduction, and passes that phantom income to the grantor. The overall arrangement, then, provides an up-front deduction, followed by taxable income to the grantor over the term of the trust.
A “super lead trust” could appropriately be described to a donor in marketing language in which of these ways?
A) A super lead trust, if appropriately set up, may be able to reduce your income tax now, move money to heirs with little or no transfer tax, while also providing a stream of payments to the charities you support. This is an advanced concept, and will require first-rate legal counsel.
B) A lead trust can be a super idea for someone in your position who wants to sell an appreciated asset without current income tax and to receive an income for life.
C) A super lead trust will reduce your income tax now and move money to heirs with little or no transfer tax, while also providing a stream of payments to both you and the charities you support.
D) A super lead trust will not reduce your income tax, but it will help charities during your lifetime or at death, with a stream of payments to them. It may also greatly reduce your taxable estate. We should get legal counsel before moving ahead.
A) A super lead trust, if appropriately set up, may be able to reduce your income tax now, move money to heirs with little or no transfer tax, while also providing a stream of payments to the charities you support. This is an advanced concept, and will require first-rate legal counsel.
The correct answer is A. The “super lead trust” has the benefits described in (A), but is an advanced technique which, when applied to a client’s situation, would require first-rate independent legal counsel. (B) seems to be describing a CRT. (C) wrongly states that the donor will get some income back. (D) incorrectly states that a super lead trust will not reduce current income tax. In fact, if the technique works, it should reduce both income tax and transfer tax.
As assets inside a grantor CLT grow and throw off taxable income, to whom or what are the income and capital gains taxed?
A) Grantor
B) Trust
C) Heirs
D) Charitable beneficiaries
A) Grantor
The correct answer is A. The grantor must recognize all of the trust income or “phantom income.”
Which is the best description of a “shark fin CLAT”?
A) A shark fin CLAT is another term for a super lead annuity trust.
B) A shark fin CLAT is an IRS-approved format in which the grantor gives cash to a defective grantor charitable lead annuity trust, which then invests in tax-free bonds and life insurance. The trust pays little to charity until the death of the insured grantor, at which time the payment to charity balloons. The grantor receives income tax benefits at inception, with little or no phantom income in the future. Transfer taxes will also be reduced.
C) A shark fin CLAT is a controversial technique in which the grantor gives cash to a grantor charitable lead annuity trust, which then invests in tax-free bonds and life insurance. The trust pays little to charity until the death of the insured grantor, at which time the payment to charity balloons. If the technique works as advertised, the grantor receives income tax benefits at inception, with little or no phantom income in the future. Transfer taxes may also be reduced.
D) A shark fin CLAT provides payments to a wealth replacement trust funded with life insurance to replace the gift assets.
C) A shark fin CLAT is a controversial technique in which the grantor gives cash to a grantor charitable lead annuity trust, which then invests in tax-free bonds and life insurance. The trust pays little to charity until the death of the insured grantor, at which time the payment to charity balloons. If the technique works as advertised, the grantor receives income tax benefits at inception, with little or no phantom income in the future. Transfer taxes may also be reduced.
The correct answer is C. The technique is controversial, with the purported benefits as described.
With respect to a charitable lead trust, which of the following statements is (are) true?
I. A charitable lead trust must pay out at least annually
II. A charitable lead trust must meet the 10% minimum charitable interest test
A) I only
B) II only
C) Both I and II
D) Neither I nor II
A) I only
The correct answer is A. A CLT has no minimum or maximum distribution amount. Therefore, it does not have to meet the 5% probability test, nor the 10% minimum charitable interest test as CRTs must.
A CLT can provide which of the following nontax benefits to donors?
I. It can offer the satisfaction of providing ongoing support of charities during the donor’s lifetime, or can start at death.
II. It can position the family as wielding influence in the charitable community.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
C) Both I and II
The correct answer is C. Both statements are true.
A client, aged 55 and in good health, establishes a CLT to benefit charity for 20 years, starting at the client’s death. Even after establishing the CLT, the client will have a taxable estate. The heirs will wait from now until the client dies, then 20 more years, to receive anything from the trust. Which of the following would be a suitable suggestion to the donor?
I. Consider life insurance on the donor’s life owned outside the estate, payable to the heirs.
II. Consider life insurance inside the estate, paid to the estate, with the estate then passing the proceeds to the heirs.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
A) I only
The correct answer is A. Setting the insurance up outside the estate, in an insurance trust, can prevent the proceeds from being exposed to estate tax. By contrast, setting the insurance up so it is paid to the estate would expose the proceeds to estate tax and could provide money to the heirs at the parent’s death.
In a “non-reversionary” CLT, to whom or what do the trust assets go at the end of the trust term?
A) Grantor
B) Trustee
C) Non-charitable beneficiary, such as the heirs
D) Charity
C) Non-charitable beneficiary, such as the heirs
The correct answer is C. In a nonreversionary CLT, the assets do not revert to donor. They go to the non-charitable beneficiary, usually the donor’s heirs.
With respect to nonqualified charitable lead trusts, which statement or statements are true?
I. They do not qualify for estate tax benefits or income tax benefits.
II. CLATs and CLUTs are examples of nonqualified CLTs.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
A) I only
The correct answer is A. To get the benefits associated with CLTs, the trust has to qualify under the IRS rules. CLAT and CLUT formats do qualify.
