|Planned Giving for Yeshivos
by Martin M. Shenkman, Esq.
February 13, 2000
For more information see the website: www.laweasy.com
© Copyright 2000 Law Made Easy Press, LLC
C O N T E N T
Parents of most yeshiva students have been "tapped-out". There is only so much that they can give after the costs of covering tuition. New sources of funds have to be identified, and planned giving is a tool to accomplish this objective.
Planned giving encompasses charitable gifts that take effect in the future, such as deferred bequests under a will, current gifts structured through appreciated assets, gifts of business interests or gifts structured through complex trusts such as charitable lead or remainder trusts. By expanding a small portion of your yeshiva's fund raising efforts to focus on planned giving a broader array of donors and gift opportunities should generate greater funding for the long term benefit of your yeshiva.
In planning an expanded planned giving program, consideration to the following issues must be considered:
Donors are likely to be limited to parents and grandparents of current and past students, and to a far lesser extent, future students. The key to this category of donors is to expand the target audience as much as possible beyond just current parents.
A few donors may be identified that have a more general interest in Jewish education and continuity that do not have the direct tie indicated in the preceding paragraph. These are vital to your yeshivas future, because parents and other family are often limited in what they can give.
Some donor's may be identified or attracted based on joint efforts with other Jewish educational institutions.
Example: A prospective donor may be unwilling to commit substantial long-term resources to your yeshiva. However, perhaps the same donor can be enticed to form a charitable lead trust to benefit your yeshiva and other educational institutions -- particularly the institutions your prospective donor's family members will attend at different times.
Administration is a significant issue to address. Can your yeshiva afford the time and cost of establishing its own professional staff. Unlikely. Therefore, cooperation with other institutions is essential. The recommended approach is to coordinate with a public charity or a bank or trust company that can administer the programs without your yeshiva having to handle the administrative burdens. The ideal approach would be for a large group of yeshivas to jointly coordinate a program with a single public charity or institution. Organization on a broad scale, e.g. national organization for yeshivoth, would provide even greater economies of scale in that brochures, training materials, administration, etc. would be almost identical for all institutions. There would not only be limited overlap, but the benefits of joint programs by different levels (e.g. lower grade, high school, etc.) schools may actually enhance each institutions individual fund raising efforts.
Note: A national web-site as an inexpensive means of disseminating information which all institutions can take advantage of (e.g., summaries of recent tax legislation, new newsletters, etc.) could be extremely useful. See www.laweasy.com for some examples of charitable giving ideas.
Planned giving can be integrated into many existing committees and programs, thus minimizing the additional work and costs involved:
Planned giving is a long-term, small percentage win, approach to fund raising. While the dollars can often be substantial, the actual donors will be few in number. Will your yeshiva be patient enough to make the long term commitment with this understanding? Will current funds and volunteer efforts be committed to a program that cannot generate budgeted revenues for the foreseeable future?
To effectively identify the small number of donors in a cost effective manner the most tie-ins with existing and new programs possible is essential.
Have the Board and Executive Committee of your yeshiva set an example. EVERYONE in any significant position should strongly be encouraged to make some type of planned giving commitment. It does not matter how much or when, just something. For example, $1,000 contribution under a will. Each can be requested to sign a statement of intent. The purpose, far more than the money, which should be kept in strictest confidence, is to assure that all of the most active people understand, recognize and support this concept. It will also give tremendous credibility and a "jump-start" your yeshiva's planned giving society, discussed below.
Tip: A group of young dedicated couples can purchase second to die life insurance to fund their bequests at a very modest net of tax cost. This can enable the yeshiva to legitimately advertise that it has a large committed endowment when soliciting funds from others.
Begin and name an organization for your planned giving donors. For purposes of this booklet, the name "Dorot" is suggested, since the idea of enabling future generations, your children, grandchildren and others to afford the highest quality Jewish education is passing the light from generation to generation, dor l' dor.
Formal recognition society for anyone making a pledge, regardless of amount or when paid (now or deferred):
Any newsletters should include some mention of a planned giving opportunity. For example:
ESTATE PLANNING TIP: Save estate and gift taxes by paying a grandchild's yeshiva tuition directly.
EXPLANATION: A major consideration in structuring gift programs in many taxpayers (often grandparents) estate plans, is providing for the education of their heirs (often grandchildren). A common gift planning technique has been to pay for qualifying tuition expenses of an intended heir. When properly handled, by tuition payments made directly to a qualifying institution, such as your yeshiva, no gift tax would be due. This has been a favored technique of wealthy grandparents, for example, for many years. Where a large estate is involved, and there are several children, grandchildren, and perhaps even great-grandchildren, this can present a tremendous planning opportunity. These gifts will avoid any gift, estate or GST tax and will not use up any of your annual $10,000 (as indexed) gift tax exclusion, or your once-in-a-lifetime $675,000 (2000) applicable exclusion amount.
See "tip" on grandparents paying education expenses above. When tuition payments are received, any which are from other than parents should be copied and the name of the payor discreetly determined, the relationship to the student and the purpose of the payment obtained, in order to identify grandparents and potentially other wealthy relatives who could be ideal candidates for specific contact and parlor meetings. A grandparent paying tuition could mean a wealthy grandparent, with grandchildren in the yeshiva, who have sufficient sophistication (alone or through their tax advisor) to undertake such planning.
Tip: If the grandparent is successfully contacted, get the professionals involved even if they are not parents.
Caution: If a scheme to claim tax deductions for tuition is uncovered, what is the schools obligation? Strong consideration should be given to stamping all tuition checks as part of the deposit stamp "TUITION PAYMENT - NOT TAX DEDUCTIBLE". It is essential that all yeshivas avoid any taint of encouraging or participating in any such scheme.
Good prospects should be invited to parlor meetings where planning opportunities can be explained. It should be clear that no solicitation will be made. They should be encouraged to bring their tax and legal advisers. The program chair should endeavor to invite the advisors directly.
As indicated above, and as illustrated in the context of the charitable lead trust discussion below, cross marketing with other Jewish institutions could enhance, rather than reduce, donations and planned gifts in particular, to your yeshiva.
The more community out-reach and chesed projects the students are involved in the more likely prospective donors will have exposure to your yeshiva.
Example: An attorney met with a terminally ill client in the hospital to update his will. The attorney asked the client if he would consider some charitable gifts. The client listed a handful of charities, including a particular yeshiva he had never given a donation to. Why? While in the hospital, students on a bicur cholim committee visited the sick, including this particular patient, giving them small care packages for Shabbos, including a small kugel. The kugel bought back memories of his youth. He explained how he hadn't had kugel in more than fifty years. The reward -- $18,000 for the yeshiva!
The simplest form of planned gift is merely to have a prospective donor make a bequest under his or her will. Even if this is only a contingent bequest (e.g., only to be made if the primary beneficiaries, such as family, are deceased) its important -- its still a commitment to your yeshiva.
The Chofetz Chaim specifically encouraged that large charitable gifts be made under one's will. Ahavas Chessed, 3:4.
The Jewish scholar and commentator, the Rambam, said the following about charity:
We are obligated to be careful about fulfilling the Mitzvah of charity more than any other Commandment because the righteous descendants of Abraham are identified through the giving of Charity...The Jewish people will not be redeemed except through the giving of charity.
There has been a custom to give 1/10 of a persons' wealth to charity. While there is a dispute as to whether this is merely a custom, a mandate of the Torah, or a Rabbinic decree, the point is apparent. Giving charity is clearly an important part of your life, and one, which it behooves you to teach to your children. Charitable giving as part of your estate plan can, subject to addressing the Halachic issues of a charitable bequest under your will, provide an excellent opportunity to inculcate this important Torah value in your heirs.
There are two major types of charitable trusts. Charitable remainder trusts discussed in a later section, and charitable lead trusts discussed in this section.
A charitable lead trust ("CLT") is also called a front trust, because the charitable beneficiary receives its income in "front" of the ultimate beneficiaries ("remaindermen" or "remainder beneficiaries") receiving their share. Typically the remaindermen are your children, although other beneficiaries can be named. While there can be many reasons for setting up a CLT, the primary one is to make transfers to the remaindermen at a substantially reduced gift or estate tax cost. The reduction in tax cost is achieved by virtue of the fact that the remaindermen must wait to receive the property until the expiration of the charitable beneficiary's interest. The concept can be illustrated with a simple example.
Example: You give $100,000 to a charitable trust. A designated charity will receive annual payments (usually in the form of an annuity or unitrust amount) for each year of the trust. Following the end of the trust, which will occur after the number of years you determined when setting it up (usually 10-years, 20-years, and sometimes longer), your children will receive the trust assets (this may be $100,000 or something more or less depending on the investment results during the period the charity received payments -- most hope to double the amount outside of the reach of the estate and gift tax system in 20-25 years even after paying the charity its annual payments). The benefits of this technique are that the value of the gift you are making to your children, for purposes of calculating the gift tax due on the transfer, is reduced dramatically by the value of the income interest paid for the specified term of years to the charity. Thus, if the term of the charitable interest is made long enough, the value of the gift to your children can be reduced to nearly zero for purposes of the gift tax. Appreciate above payments made to the charity are outside the estate. Most importantly, in the context of raising money for your yeshiva, if the CLT technique is combined with a donor advised fund, then the donor or the donor's children, can direct the annual payments to the yeshiva of their choice. As the donor's grandchildren, for example, mature, the annual payments can track them from yeshiva to yeshiva.
The CLT described above, is basically the opposite of a charitable remainder trust ("CRT") arrangement. In a CRT, you, your spouse, and possibly other persons, can receive an annuity for life and following your death one or more charities receive the remaining trust assets. A CRT is the opposite of a CLT in that in a CRT the non-charitable beneficiary precedes the charitable beneficiary. There are several important differences in the technical requirements for these two types of trusts (CLT versus CLT), some of which will be pointed out in the discussions below. For example, the payments to the initial beneficiary under each type of charitable trust are the same.
Comparison of CLTs and CRTs
Type of Trust
Type of payment to initial beneficiary
Charitable Lead Unitrust (CLUT)
Charity receives unitrust payment based on percentage of value of assets in trust each year.
Non-charitable beneficiaries, usually your adult children.
Charitable Lead Annuity Trust (CLAT)
Charity receives an annuity payment based on a fixed percentage of the value of the assets when the trust was formed.
Non-charitable beneficiaries, usually your adult children.
Charitable Remainder Unitrust (CRUT)
You or other non-charitable beneficiaries receive unitrust payments based on percentage of value of assets in trust each year. A minimum 5% payout is required.
One or more charitable beneficiaries.
Charitable Remainder Annuity Trust (CRAT)
You or other non-charitable beneficiaries receive an annuity payment based on a fixed percentage of the value of the assets when the trust was formed. A minimum 5% payout is required.
One or more charitable beneficiaries.
a. Inter-vivos or Testamentary
You can form a CLT while you are alive (inter-vivos). This was illustrated in the previous example. A key purpose for an inter-vivos CLT is to reduce the gift tax on the gift to children or other remainder beneficiaries. Where a CLT is to be formed during your lifetime, you should be certain that neither you, nor your family or dependents, will have need for income during the term of the trust. A CLT can also be a testamentary trust -- formed under your will.
b. Grantor or Non-Grantor Trust.
A CLT is usually structured as a non-grantor trust. This means that the transfer of assets to the CLT is a completed transfer at the inception of the trust for purposes of calculating any gift tax. Since the trust is not a grantor trust, you will not be taxable on the income earned by the trust during its term. Similarly, you will not receive an income tax deduction for any charitable payments made by the CLT during its term.
Where the CLT is structured instead as a grantor trust, you will be taxable on the income earned by the trust (unless the income is primarily tax exempt bond income). This income should largely be offset by deductions for the charitable contributions made by the CLT.
The CLT can be a valuable, and appropriate, estate planning tool where you have:
a. Charitable intent.
The use of a CLT can provide numerous benefits, including:
a. Remove Substantial Assets from Your Estate.
Appreciation on the property transferred to the CLT will ultimately pass to your designated remainder beneficiaries if the property is able to produce the required return to the charity during the term of the CLT so that the principal does not have to be invaded. This appreciation in the property transferred to the CLT, following the date of the transfer, will pass free of any further gift or estate taxes.
Tip: A CLT will have the most tax advantage where an asset is expected to have unusually large appreciation compared to the interest rates assumed in the applicable Treasury tables used in making the calculations. Therefore, the ideal property to be used for a gift to a CLT is property most likely to appreciate.
Example: You fund a CLT for a 20-year term with $100,000. The CLT instrument requires the payout of a 6% annuity amount (CLAT) to the charitable beneficiary in each year. The funds are invested in high yield corporate bonds which return 7.4% per year. There is no default during the term of the trust and the bonds mature at the termination of the trust. The trust corpus which will pass to the remainder beneficiaries will be more than the $100,000 invested since it has grown by 1.4% (7.4% - 6%) per annum, compounded (assuming the cash was invested elsewhere).
Example: There is certainly no assurance that the beneficiary will receive an appreciated trust corpus. If in the above example, the funds were invested in a diversified mutual fund which had in the past returned a current yield of 7.4%, but over the 20 year term of the trust returned only 5.8%, the value of the trust corpus passing to the remainder beneficiary would actually decline. This is because the $100,000 principal would have to be invaded to make-up for the .2% shortfall (6% - 5.8%). Depreciation in the value of the underlying securities could also cause the remaindermen to receive less than anticipated.
Thus, income in excess of that required to make the requisite charitable contributions is also removed from your estate (e.g. the 1.4% excess in the prior example). When the long terms of most CLTs are considered, even modest annual growth in the principal above that needed to pay the charity, can compound to huge value being removed from your estate with no transfer tax cost.
b. Meet Charitable Goals.
You can meet long term charitable giving objectives. Establishing a CLT will assure annual distributions of a specified amount (where an annuity arrangement is used) to designated charities for a specified number of years.
c. CLTs Can Be Coordinated with your Prospective Donor's Overall Estate Plans.
The duration for which a CLT lasts can be coordinated with other estate and financial planning to assure your children or other heirs the availability of assets for a long-term time horizon.
Example: Taxpayer establishes a trust under his will to pay income annually to his child. Principal is to be paid out of the trust fund in approximately one-third equal amounts when the child attains ages 30, 35 and 40. The child is presently age 22. If Taxpayer establishes a CLT for a duration of 23 years [(40 - 22) + 5] the child will receive the assets of the CLT at age 45. This is timed to continue the five year payment sequence with the hopes of distributing assets in stages to both protect the remaining assets as well as to minimize the potentially adverse consequences of the child receiving too much wealth at one time.
Example: Taxpayer has a Child age 22 who is presently single, and in medical school. Taxpayer is concerned that as a result of the high rate of divorce and the risks of potential malpractice claims that Taxpayer wishes to secure some portion of Child's inheritance for future use. Taxpayer establishes a 25 year CLT. The hope is that in 25 years Child's marital status will be stable and Child's career more secure.
d. Gift Tax Can Be Removed from your Estate.
Any gift tax paid on the formation of the CLT can be excluded from your estate.
e. Avoid Charitable Contribution Limits.
If your charitable contributions are so large that you cannot qualify to deduct them currently as a result of the limitations on the portion of your income which can be given to charity, the use of a CLT may help avoid these restrictions. Charitable contribution deductions are limited to specified percentages of the donor's income. Gifts (excluding capital gain property) to charitable organizations characterized as 50% limit organizations (generally public charities) can't exceed 50% of adjusted gross income. This includes: public charities; certain private operating foundations; private non-operating foundations that make qualifying distributions of 100 percent of the contribution within 2 1/2 months following the close of the tax year in which they receive the contribution; certain private foundations whose contributions are pooled in a common fund and the earnings of which are then paid to public charities. Certain organizations which have over a four-year period received a substantial amount of their donations from public sources may also qualify. The following contributions are subject to the 30% limit: (i) contributions to private charities and other qualified organizations which do not qualify as 50% limit organizations; (ii) contributions for the use of a charity are limited to 30%. A contribution of an income interest in property, whether or not in a trust format, is characterized as a contribution "for the use of" the charity; and (iii) contributions of capital gain property (where the taxpayer claims a deduction for the fair market value of the property) to 50% limit organizations. Note that where the contribution is to a 20% limit charitable organization, this lower limit will apply. Contribution of property capital gain property (most real estate except that owned by a dealer), to organizations which do not qualify as 50% limit organizations, is limited to 20% of the donor's adjusted gross income. Where these limitations apply, you can effectively circumvent them through the use of a CLT. This is because the contributions made to charity by the CLT will apply to offset the CLT's income without regard to your personal limitations on deducting contributions.
There are several important negative considerations to the use of a CLT which you should carefully consider prior to committing to a CLT as part of your overall estate and financial planning strategy:
a. Cost and Complexity.
A CLT is a creature of statute. The many tax and other benefits outlined above can only be realized if the CLT meets all applicable tax law requirements, operations and activities conform with the trust instrument and applicable law, and the governing trust instrument complies with IRS and other requirements. These requirements can be burdensome, costly and difficult for many taxpayers to deal with.
b. Private Foundation Restrictions Can Affect CLTs.
CLTs can be subject to the rules concerning self-dealing, excess business holdings, jeopardy investments, etc. of private foundations.
c. CLT Taxable on Certain Property Sales.
A special tax is imposed on a CLT which sells or exchanges property within two years after the property was transferred to the CLT. When this rule applies, the CLT is taxed at your (i.e. the grantor's) income tax rate on certain gains from the property, which was sold within two years of its transfer to the CLT, and before your death. The objective of this provision is to prevent you from gaining a tax advantage by transferring property intended for sale to a trust and then having the trust make the sale. The amount of gain, which the CLT has to recognize, is the lesser of the actual gain the CLT recognized on its sale of the property and the excess of the fair market value of the property over the CLT's tax basis immediately after the transfer of the property to the CLT. This special rule treats the transaction as if you sold the property and then transferred the proceeds, net of the applicable tax cost, to the CLT. When the trust is formed on death, or is a charitable remainder trust, for example, this special tax does not apply. Special rules apply in several circumstances, such as when there is an installment sale, or where there are net operating losses.
d. CLT Taxation Generally.
Many taxpayers assume that the CLT is a tax exempt trust, since it benefits one or more charities. However, this is unfortunately not correct. The CLT is a taxable entity, and can, depending on the outcome of property and other transactions, be liable for an income tax. A CLT only avoids taxation where the amounts paid to charity, and hence deductible by the CLT, are sufficient to offset any income tax otherwise due by the CLT.
e. Gifts to CLTs Do Not Qualify for the Annual Exclusion.
You can give away up to $10,000, to any person, in any tax year, without incurring a gift tax. Gifts to CLTs do not qualify for the gift tax annual exclusion. Thus, except to the extent that the gift tax charitable contribution deduction can offset the value of the property transferred, a current gift tax (or use of your $600,000 unified credit) will be due.
f. CLTs Create Complications for GST Planning.
A basic principal of using trusts to plan for the generation skipping transfer (GST) is to plan a trust so that it has an inclusion ratio of zero. This means that none of the trust assets will be subject to the GST. This rule gets quite tricky to apply when planning for CLTs. Should the calculation be made when the trust is formed, or when the non-charitable beneficiaries receive their interests? This is critical because the gift tax value of the trust when formed is always quite small because it is reduced by the value of the charity's interest. When the non-charitable beneficiaries receive the trust assets there is no reduction since no charity will have any interest in the assets any longer.
The tax laws contain a special rule applicable to the determination of a CLATs GST tax inclusion ratio so that the determination cannot be made until such time as the charitable interest ends. Thus, if a 20 year CLAT is used the determination will be made at the end of year 20. When this calculation is made, the fraction used is the "adjusted GST amount" divided by the value of the trust at such time. The "adjusted GST amount" is the amount of the GST exemption (up to the maximum $1 million, indexed) allocated to the trust, increased by the applicable Code Section 7520 rate for the period of the charitable term, compounded annually. If the fraction would have been one (i.e. then one minus the applicable fraction would have been zero, so that the inclusion ratio would be zero) if the value of the investments (corpus) of the CLAT grew at the same Code Section 7520 rate, the inclusion ratio would remain zero. If the assets grew at a faster rate (which is the hope) then the inclusion ratio would not be zero and a GST tax could be due at the end of the term. Although may people have criticized this view, it is not certain that the IRS will change its position. If it is certain that based on the size of the estate that this will not be a significant issue, a CLAT is used it could still be significant depending on the growth of the CLAT assets. If no other bequests to grandchildren occur you could allocate your entire GST exemption amount to the CLAT even though less than $1 million is used to fund the CLAT. This over allocation could increase the likelihood of avoiding any GST on the termination of the CLAT's charitable interest. Another option is to use a CLUT since the allocation of the GST amount can occur on funding of the trust (death). When a CLUT is used the applicable fraction is the amount of GST exemption allocated at that time divided by the fair market value of CLUT assets reduced by the estate tax charitable contribution deduction (if a long term is used as intended and the charitable beneficiaries have been limited to qualified charities this deduction should be significant).
g. Grantor or Non-Grantor Trust Status of CLT.
Another planning twist for CLTs is determining how your CLT will be taxed for income (as distinguished from estate, gift and GST tax purposes). The issue is whether your CLT should be characterized as a "grantor" trust. The consequences of your CLT being characterized as a grantor trust are discussed below. Where the CLT is structured as a grantor trust (you're taxable on trust income), which is not the usual situation, you can obtain current income tax deductions.
Note: Because most CLTs are structured as non-grantor trusts (i.e. you are not taxable on the income of the trust) there will not be a current income tax deduction based on the payments to be made to the charity (i.e. based on the present worth in today's dollars of the future contributions to be made). Thus, a current income tax deduction is rarely a factor to be considered in evaluating a CLT.
If your CLT has certain characteristics, it will be classified as a grantor trust. If it does not have these characteristics, it will not be a grantor trust.
Tip: The characteristics which cause a CLT to be treated as a grantor trust (or not) are within your control and that of the attorney drafting the document. Determine the desired tax status in advance, and proceed accordingly.
If you create a CLT where you have retained the right under the terms of the trust agreement to any of the following items your CLT could be characterized as a grantor trust:
ILLUSTRATION OF CHARITABLE LEAD TRUST
Deferred Gift Through CLT
Gift Tax $38,267
$250,000 Charitable Lead Trust $16,250 to Your Yeshiva
25 Years Later
Effective Tax Rate:
If you use a Charitable Remainder Trust ("CRT"), you donate property (real property, stock, business interests, and so forth) to a charity and receive a charitable contribution tax deduction in the year of the donation. The charity will only receive the full benefit of the property at some future time. For example, you can reserve an income interest in the charitable remainder trust for your life and the life of your spouse as the income beneficiaries. If this is done, the income generated from the donated property will be paid to you for your life and thereafter to your spouse for her life. After the death of the last of you and your spouse the charity will obtain full use and benefit of the donated property.
The savings in income taxes, federal gift or estate tax, state inheritance tax, and probate and administrative costs, can enable you to transfer substantial benefit to a deserving charity at a very favorable cost.
A CRT can be a tremendous estate and financial planning vehicle. An example can illustrate.
Example: Ira Investor purchased XYZ, Inc. stock in 1989 for $1.00 per share. The value per share is now $100.00 per share. The stock pays almost no dividends. Ira is retiring and needs more income to cover living expenses. He also wishes to diversify his XYZ, Inc. holdings because they have become such a substantial portion of his estate. However, to sell XYZ, Inc. stock would trigger a substantial capital gains. Ira could instead donate the stock to a CRT and receive back a monthly payment for life (and even for the life of his wife as well). The charity could sell the stock and invest in a diversified portfolio geared to generate income. The charity should not have to recognize any capital gains tax on sale. As a result, Ira can effectively have the entire investment, undiminished by capital gains tax, working to generate his monthly income. The financial benefits are potentially tremendous.
If you have some charitable intent, but don't wish to part entirely with the benefits of your property (e.g. the income it generates) presently, a CRT as illustrated above, may be appropriate.
Where the gift of a remainder interest is made in trust it must be in the form of a annuity trust or unitrust payment. These are thus the two types of CRTs available. With the exception of gifts of a remainder interest in a personal residence or farm property, you cannot qualify for an income, gift and estate tax deduction for a donation to a charitable remainder trust, unless the donation is in a trust which qualifies as either an annuity trust or a unitrust. These two types of trusts are both explained in greater detail below.
a. Charitable Remainder Annuity Trust ("CRAT").
A Charitable Remainder Annuity Trust ("CRAT") will provide a fixed annuity to yourself, or the people you designate in the trust agreement, as the income beneficiaries. The minimum rate of return to them cannot be less than five percent and it must be a fixed or determinable amount. The beneficiaries' income is calculated based on the fair market value of the property transferred to the trust. Once the trust is established no further contributions can be made to it. Where the trust income is insufficient to meet the required annual return, principal must be invaded.
b. Charitable Remainder UniTrust.
A Charitable Remainder Unitrust ("CRUT") provides a form of variable annuity benefit to its income beneficiaries. The minimum rate of return to the income beneficiaries must be five percent. This rate of return is calculated on the fair market value of the property determined on an annual basis. This requires an annual appraisal, which for any property, which is difficult to value (e.g. closely held business interests and real estate), could be prohibitively expensive. For this reason, an annuity trust approach is likely to prove more appropriate when such assets are to be contributed. The trust may provide that if the annual income earned by the trust property is insufficient to meet the required distribution to the income beneficiaries, principal may be invaded. If principal is not required to be invaded, than the trust must provide that the deficit will be made up in later years. Once a unitrust is established additional contributions may be made in later years under certain conditions.
The valuation of the remainder interest of the unitrust is determined under methods provided for in the Treasury regulations. The valuation considers the value of the property transferred to the trust, the age of the income beneficiary, and the pay-out rate from the trust (e.g. 5% or some greater figure).
When a charitable remainder trust is used for the donation to a charity, the donor transfers property (real property in this instance, although publicly traded securities, stock in a closely held business, and other assets may also be used) to the charity. The donor then receives a charitable contribution income tax deduction in the year of the donation.
The donor reserve for the income beneficiaries an income interests in the CRUT for the beneficiaries' lives. This means that a portion of the income generated from the donated property will be paid to the donor for his life and concurrently to his spouse (when the spouse is the second beneficiary) for her life.
On the death of the donors, there will be no estate tax from the value of the life income interest retained by the donor since it is exactly offset by the estate tax charitable contribution deduction. If the only other beneficiary is the decedent's spouse, there will be not tax on the income interest passing to her as a result of the unlimited estate tax marital deduction.
The charitable remainder beneficiary only receives the full benefit of the property (i.e. the principal of the charitable remainder trust) upon the death of the last of the designated income beneficiaries.
The donor of property to a charitable remainder trust is entitled to a deduction for income and estate or gift tax purposes. The deduction is based on the present value of the charitable remainder interest. For income tax purposes, the gift of a remainder interest to a charity is treated as a gift "to" the remainderman. If the remainderman charity is a public charity the maximum deduction is allowed up to either 30 percent or 50 percent of the donor's adjusted gross income. The amount of the charitable contribution deduction is equal to the fair market value of the property at the time of the donation to the CRT, less the present value of the income interest retained by you (or you and your spouse if she is named a beneficiary). This contribution deduction is calculated using IRS tables and some rather complex formula. These methods consider the value of the property transferred, the age of the income beneficiaries, and the pay-out rate. The actual value of the tax deduction will depend no numerous factors, including: the marginal tax bracket of the donor, the income interest reserved to the donor (and others), the income level of the donor relative to the tax deduction (which will affect the applicability of the charitable contribution percentage limitations), and other factors.
b. Gift and Estate Tax Consequences of a CRT.
In addition to the current income tax deduction you may also receive a valuable estate tax benefit as well. If you are one of the income beneficiaries of the charitable trust the value of the trust will be included in your gross estate when you die. However, since the interest will pass to the charity there will be an offsetting estate tax charitable contribution deduction. Thus, the value of the property donated will be effectively removed from your estate.
Assuming the donor predeceases his spouse the value of the CRT will be included in his gross estate when he dies because he will have owned at his death an income interest for his life from the CRT. However, since the interest will pass to the deceased donor's spouse, there will be an offsetting estate tax marital deduction. Thus, the value of the property donated will be effectively removed from the donor's estate.
Similarly, upon the death of the surviving spouse's the value of the charitable remainder trust will be included in her gross estate. However, since the interest will pass to a qualified charity, there will be an offsetting estate tax charitable contribution deduction. Hence, the value of the donated property will effectively be removed from the spouses estate as well.
c. How Beneficiaries are Taxed on CRT Income.
The amount paid to a trust beneficiary under a charitable remainder trust retain the character they had in the trust. Regular trusts characterize payments based on the trust's income and other activities during the particular year. A charitable remainder trust characterizes payments based on the trust's income and other activities with reference to the entire history of the trust. Thus the non-charitable income beneficiary of a charitable remainder unitrust or annuity trust is taxed as ordinary income to the extent of the trust's current and prior undistributed income.
After all ordinary income is exhausted; amounts will be taxed as follows:
(1) As short term capital gain to the extent of current and past undistributed short-term capital gains.
The trust will generally be exempt from tax. However, where the trust generates unrelated business taxable income ("UBTI") it can be subject to tax. This can be an issue where trust assets are debt financed, stock in an active business is contributed, etc. These rules are extremely complex and require professional assistance.
a. Combining Insurance with the Charitable Remainder Trust.
The reason why insurance planning is so frequently combined charitable remainder trust planning is to replace the value of the property donated to the charity with insurance passing to the your heirs. The concept is quite simple. You fund a CRT with appreciated assets and receive an income stream back. You then use some portion of the increased income stream to establish and fund an irrevocable life insurance trust for the benefit of your heirs (e.g. children). Where all works as hoped for in an ideal world, the following goals can be achieved:
Example: Donor owns real estate worth $1 million with an adjusted cost basis of $200,000. Transferring the property to a charitable remainder trust could generate a $400,000 contribution deduction. This could provide an income tax savings of approximately $140,000. Further, the Donor will avoid approximately a $220,000 capital gain on the sale of the property. The trustee may be able to pay the Donor an annual income of $60,000. The Donor can make an annual gift, with his spouse, to their son and daughter-in-law totaling $40,000 under the annual gift tax exclusion. This amount can be used to purchase life insurance on the Donor's life of $1 million, sufficient to replace the $1 million worth of real estate transferred to the charitable remainder trust. The son will receive the same $1 million on the parents death which he would have received had the planning not been undertaken. However, had no planning been undertaken, the $1 million real estate which the son would have received may have been reduced by a 55% marginal estate tax. Thus, the son may actually receive more then double where this charitable/insurance plan is implemented.
Life insurance can be used in a somewhat different manner in planning for charitable remainder trusts as well. The charitable remainder trust techniques assume that an income stream will be paid to a life-beneficiary for some period of time. Should the sole life-beneficiary die prematurely, the family unit will have effectively been denied the benefit of the expected income stream. In the appropriate circumstances, the charitable remainder technique can be combined with a life insurance policy on the life of the income or life-beneficiary of the charitable remainder trust. Where this life-beneficiary dies prematurely, the insurance proceeds can supplement the income stream which the family unit will have lost. This could be done, for example, with a life insurance trust for the benefit of the children or spouse of the named life-beneficiary. The life insurance trust should be structured to assure that the proceeds are not included in the estate of the life-beneficiary. In some cases, an insurance arrangement providing for decreasing coverage (to approximate the decline in the lost of expected income as the life-beneficiary lives through the intended term of the trust), can be used.
b. CRT as a Retirement Plan: The Income Only Uni-Trust Option of CRT.
A modified form of charitable remainder unitrust (CRUT) can be used where the income beneficiary receives what is called an "income only arrangement". In this type of CRUT, the income beneficiary would only receive the actual trust income if the income is less than the fixed percentage payment required (e.g. 5% of principal of the trust). This type of trust can also include a "make-up provision". In early years actual income is less than the 5% required CRUT payment. In later years, when the net income of the trust exceeds the specified percentage of trust assets required to be paid (e.g. 5%), this excess can then be paid to the income beneficiary to make up for the shortfall in prior years. The shortfall is determined based on the difference between the amounts actually paid in prior years, and the amounts that were required to have been paid based on the fixed percentage. This concept can best be illustrated with an example.
Example: Donor has a substantial income, is getting on in years, and wishes to provide for his favorite charity. Donor is getting on in years, and expects to retire in five years. Upon retirement, Donor expects his income to drop, and to be in a lower tax bracket. Donor establishes an income-only charitable remainder unitrust arrangement with a make-up provision. Donor funds the trust with a $1 million initial contribution, which is invested in low-dividend paying growth stocks. The unitrust percentage is set at the lowest permissible five percent amount. The dividends on the stock portfolio produce a mere .75 percent return, or $7,500 which is paid to donor. After year five, Donor retires. The stock portfolio, which has appreciated to $1.5 million, is liquidated and invested in high yielding bond instruments. These bonds produce a return of eight percent, or $120,000. The Donor would be entitled to five percent of the $1.5 million asset value based on the unitrust amount provided, or $75,000. However, as a result of the make-up provision, the Donor can be paid additional amounts in each of the remaining years of the trust to make-up for the shortfall in prior, pre-retirement years. If the shortfall may have totaled $212,500 [(5 years x $50,000) - (5 years x $7,500)] Donor will be entitled to all of the income from the income-only unitrust for a number of years to come.
Caution: A fallacy of the income-only unitrust approach in the above example is the assumption of lower tax rates upon retirement. The type of client, which would engage in such a sophisticated transaction, is likely to have a substantial income at present, and in the future, even if the future post-retirement income is expected to be lower. For such a client, it is likely that the maximum tax rates may apply both pre- and post-retirement. Further, many tax practitioners anticipate increases in future tax rates, not decreases.
c. Generation Skipping Transfers and Charitable Remainder Trust Planning.
While the generation skipping transfer tax (GST tax) will not apply to charitable gifts, GST tax considerations are important where your grandchild (or another skip person) is made the life or income-beneficiary of the charitable remainder trust (or the remainder beneficiary of a charitable lead trust, see below). Where such a situation occurs, the donor must carefully plan the allocation of any of his remaining GST lifetime $1 million (as indexed) exemption to the trust.
Example: Assume that the donor transferred $500,000 into a charitable remainder unitrust. The value of the remainder interest is $275,000. Assume further that the donor has $450,000 of his GST tax exemption still available. The donor could allocate $225,000 [$500,000 total value - $275,000 charitable remainder value] of his remaining GST tax exemption to the trust. The trust will thus have an inclusion ratio of zero, and no GST tax will be due.
d. Charitable Gifts and The Closely Held Corporation.
Charitable remainder trusts can have special use when a key asset is stock in a closely held business. A charitable bail-out of a closely held business' stock can address important planning problems for a closely held business owner. Stock in a closely held corporation can be difficult, or impossible, to sell. This is because any outsider will generally be very reluctant to own a minority interest in a close corporation. Another problem could relate to the type of corporation involved. Assume that the corporation is a C corporation (i.e. not an S corporation) and has available cash, which you would like to donate to charity. However, it may not be practical to make a dividend distribution to provide the cash for such donation since a dividend distribution will result in double taxation (the corporation first pays tax on the earnings and then you pay tax again on the receipt of the net earnings in the form of a dividend). Another common problem scenario for a closely held business is when a parent owns stock in a close corporation and wishes to transfer control to a child without triggering income tax on a redemption. One possible solution for this latter scenario is called a "stock bail-out". You can make a gift of any portion of the stock in your corporation to a charity. At some later date, the charity may in its sole discretion, sell some of the stock, which it then owns, back to the corporation. This provides you with a charitable contribution deduction for income tax purposes for the stock donated. The charity can eventually receive a cash amount for the contribution. When the corporation redeems the stock, the interest of the children owning stock will increase. This is because the charitable bail-out/redemption of your stock will increase their relative ownership interest.
There are several drawbacks and problems to the charitable bail-out arrangement. The charity cannot be obligated to sell any portion of the stock back to the corporation. Where a pre-arranged plan for the re-sale of the stock exists, it can be difficult to draw the line as to whether or not the charity was so obligated. Where the charity is in fact under no legal obligation to resell the stock it receives, there is a possibility that it could sell the stock to another, vote the shares in manner which is not consistent with the donor's desires, etc. The alternative minimum tax could reduce the value of the gift. This technique can be quite beneficial in the appropriate circumstances. However, it is quite complex and should be carefully planned for with specialized estate planning professionals.
e. Combining Charitable and Marital Trusts.
Another twist on the use of a charitable remainder trust is to combine a CRT with the marital trusts available. Special rules apply if you wish to transfer property to both your spouse and a charity. These rules can permit you to take advantage of both charitable contribution deductions and the marital deduction, and thus they can provide valuable planning benefits in the appropriate circumstances. For example, assume that you transfer property to a charitable remainder trust. You and your spouse are the sole income beneficiaries. The only other beneficiary is a charitable remainder beneficiary. On your death, your estate will qualify for both a charitable contribution deduction and an estate tax marital deduction. This assures no tax as a result of any interest you had in the CRT on death.
An alternative approach to consider using is simply to establish a qualified terminable interest property ("QTIP") trust for your spouse, with the remainder interest on your spouse's death to go to a specified charity. A QTIP trust generally permits your spouse to receive all of the income from the trust, and on her death, the trust asset go to the persons, or in this case the charity, which you designate. While this approach is simpler, there can be no income tax deduction with a QTIP with a charitable remainder, as there would be available where a charitable remainder trust is used with you and your spouse being named as income beneficiaries. There is more flexibility in planning the payment of income under the charitable remainder trust approach, as compared to the approach of using a QTIP with a charitable remainder beneficiary. This is because the charitable remainder trust need not require the payment of income at least annually, as does the QTIP trust.
a. Choice of Trustee.
While you, as the grantor, may be named as trustee, you should not serve as sole trustee if the assets of the trust do not have a reasonably determinable market value (e.g. interests in a closely held business). At minimum, name a co-trustee to address all valuation issues.
b. Restrictions On Investments.
A trust can be disqualified as being a charitable remainder trust where the trust document restricts the trustee from investing in a manner, which could result in the realization of reasonable income or gain.
Example: A trustee was required to retain certain antiques for the life of the non-charitable income beneficiary, the trust was prevented from investing in income producing assets and was therefore disqualified. Since the antiques obviously could not produce any income it was impossible for the trust to pay the required annual amounts to the beneficiaries.
While investments in real estate and growth securities may not necessarily jeopardize the trust status, caution should be exercised. Thus, within reason, and with proper drafting, the trustee of a charitable remainder trust can exercise control over the investment selection process to control the income where the private non-charitable income beneficiary is in a high tax bracket, or not in need of funds.
Properly structured, a charitable remainder trust can be funded with tax exempt securities. The donor would receive a potentially substantial tax deduction, tax freed annual payments, and thus realize a potential advantageous economic return on the transaction.
c. Designating The Charitable Remainder Beneficiary.
The remainder of the trust must be paid over to a charity, which is described in the tax law provisions governing charitable contribution deductions. Multiple charities can be used so long as it is clear what the relative shares of each charity is upon termination of the trust. Consideration should be given to naming one or more fall-back charities in the trust agreement in the event that the named charity is no longer in existence, or is in existence but is no longer qualified for an unlimited estate tax charitable contribution deduction. A private foundation can be named as the charitable remainder beneficiary, but the possible affects of the 30 percent limitation rule described above should be considered. Where a private foundation is involved, a host of restrictions may apply.
Where a cash contribution is made to a qualified charitable organization, the value of the cash at the time of the contribution, subject to the percentage limitation rules described below, is deductible.
Where a contribution of property is made to, or for the use of, a qualified charitable contribution, a deduction equal to the fair market value of the property, subject to the percentage limitations outlined below, is deductible. Donations of depreciated property are generally not advisable in that no loss deduction will be available for the difference between the fair market value of the property and the adjusted basis of the property. Consideration should be given to selling the property and donating the net proceeds. However, the costs of sale can minimize the additional benefit of such an alternative approach.
Where the value of the donated property exceeds the taxpayer's adjusted tax basis in the property, additional limitations and adjustments may apply. The limitations and rules which must be applied depend on whether the property is real property, personal property, tangible or intangible property. Selected rules only are discussed below.
a. Capital Gain Property.
Generally, a taxpayer donating appreciated capital gain property will be entitled to deduct the full fair market value of the donated property. Capital gain property is property which, had it been sold instead of being donated to the charity, would have generated capital gain. However, where the taxpayer deducts the entire fair market value of the property (thus avoiding tax on the appreciation where the alternative minimum tax does not apply), the amount of the charitable deduction is limited to 30% of his adjusted gross income.
b. Special Election To Avoid 30% Limitation on Deduction of Appreciated Property Donation.
To avoid the application of this 30 percent limitation the donor can make a special election. Where this election is made the fair market value of the donated property will have to be reduced by the appreciation. When this is done, however, the taxpayer may claim a deduction of up to 50 percent of his adjusted gross income.
The following factors should be considered in making this election:
(1) How much appreciation has been realized on the property.
(2) What impact on the tax calculation does each option have? Where the amounts are significant retain an accountant to make projections under various scenarios.
(3) Will the taxpayer be subject to the alternative minimum tax? If this question cannot be answered readily, again, it is advisable to retain an accountant to make projections. Where a taxpayer is subject to the alternative minimum tax, the appreciation in the gift will be included in the AMT base (i.e. as a tax preference item). Where the taxpayer makes the special election, no deduction is claimed for the appreciation in the property donated so the AMT implications disappear.
c. Ordinary Income Property.
Where the taxpayer donates property, which if sold would have generated ordinary income or short term capital gain, the charitable contribution deduction is limited to the fair market value of the property reduced by the ordinary income or short term capital gain portion.
Example: A taxpayer is a dealer in real estate. She has a lot which she purchased five months earlier for $250,000 and which she held for sale in the ordinary course of her business. If she sold the lot she, as a dealer, would realize ordinary income. She donates the lot to a synagogue to use for overflow parking. The lot is presently valued at $320,000. Her charitable contribution deduction is limited to her $250,000 adjusted tax basis.