Home » Speaking Engagements » Lisa Newfield & Philip T. Temple, White Plains lawyers, Recent Developments in Charitable Gift Planning

Lisa Newfield & Philip T. Temple, White Plains lawyers, Recent Developments in Charitable Gift Planning

THE ORCHARD FOUNDATION
2003 WINTER SUMMIT
A MORNING OF PLANNED GIVING STUFF
WITH LISA AND PHIL
Wednesday, February 19, 2003
Country Inn and Suites
Fort Meyers, Florida
Lisa Newfield
Philip T. Temple
McCarthy, Fingar, Donovan, Drazen & Smith, LLP
White Plains, New YorkONE
THE GIFT AND ESTATE TAX
IMPLICATIONS OF PLANNED GIFTSI. BASICS OF ESTATE PLANNING
A. The Key Issues.
(1) Who gets it?
(2) Minor children.
(3) Administration of assets; probate.
(4) Estate and inheritance tax.
B. Avoiding Probate; The Revocable Living Trust.
C. The High Cost of Death.
(1) Using (not losing) the applicable exclusion amount (the credit shelter trust and other
ways).
(2) The marital deduction.
(3) Lifetime gifts.
(4) “Living well is the best revenge.”
(5) Charitable gifts; split-interest gifts.
D. Life Insurance.
(1) Getting it out of estate; the irrevocable life insurance trust.
(2) Investment or protection?
E. Assembling the Data.
II. ESTATE TAX LAWS
A. Saving taxes should be considered after, not before, your overall objectives are reviewed. First,
and most important, what is best for you and your family apart from the tax consequences? Then, how best can you
shape your plan to achieve the maximum tax and probate savings? The following background information will help
you better understand the savings available through wise planning.
B. Estate Tax Applicable Exclusion Amount -- Really a Credit.
(1) The Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Act”) resulted in
major changes in the estate tax laws. These changes are effective from January 1, 2002
through December 31, 2010, after which the estate tax law reverts back to existing law
without regard to the 2001 Act.
(2) Under the 2001 Act, the estate tax applicable exclusion amount will increase as follows:
$1,000,000 in 2002$1,500,000 in 2004
$2,000,000 in 2006
$3,500,000 in 2009
(3) The exemption is really a credit equal to the tax on the equivalent exemption amount.
(4) The estate tax is repealed for persons dying in 2010 and current estate tax law is reinstated
for persons dying in year 2011 and thereafter.
(5) Under the 2001 Act the top estate tax rate is 50% and is reduced by 1% each year until
2007 when it will remain at 45% until 2010.
C. Gross estate; all property in which decedent had interest at date of death including:
(1) Real property worldwide
(2) Cash, Stocks and Bonds
(3) Joint property
(i) Tenants by the entirety
(ii) Survivorship
(4) Annuities
(5) Life insurance proceeds in which decedent had any incident of ownership even if payable
to named beneficiary (IRC 2042) or interpolated terminal reserve value of policy owned by
decedent on another.
(6) Property over which decedent held retained life estate (IRC 2036), reversionary interest
(IRC 2037), general power of appointment (IRC 2041) or made a revocable transfer (IRC
2038).
D. Alternate Valuation (IRC 2032)
(1) Unless elected, all assets are valued as of decedent’s date of death.
(2) Alternate valuation may be elected on Form 706 even if filed late, but no later than one
year from due date, including extensions. Once elected, it is irrevocable.
(3) Can only be elected if both the value of the gross estate and the total net estate tax and
the generation-skipping transfer tax will be decreased.
(4) If elected, applies to all assets in gross estate.
(5) Alternate value is value of property on date of distribution, sale, exchange or other
disposition out of estate within 6 months of date of death or value of property remaining
in estate 6 months after date of death.
E. Estate Tax Deductions.
(1) Debts of Decedent.(2) Funeral and Administration Expenses.
(3) Charitable Gifts. Unlimited gift and estate tax charitable deductions are allowed. Thus,
charitable gifts and bequests fully deductible - no matter how large.
(4) Marital Deduction.
(i) Unlimited gift and estate tax marital deduction is allowed for transfers between
spouses.
(ii) Unlimited marital deduction also applies to transfers of commu nity property to
spouse.
(iii) Old law allowed no marital deduction for “terminable interest” given to spouse.
Thus, a trust which provided income to spouse, with remainder to children, did
not qualify for marital deduction, nor did a trust which gave spouse life estate
coupled with limited power of appointment. Exception: a trust which provided
life income to a spouse with general power of appointment did (and continues to)
qualify for marital deduction.
(iv) Law allows marital deduction for “qualified terminable interest,” a so-called Q-tip
interest.
(a) Generally, terminable interest is qualified if decedent's executor (or
donor) so elects and spouse receives qualifying income interest for life
which meets these conditions:
(1) Spouse must be entitled for life to all income from entire or
specified portion of interest, payable annually or more
frequently. Thus, income interests granted for term of years, or
life estates subject to termination upon remarriage or
occurrence of specified event, will not qualify. Qualifying
income interests are not limited to those placed in trust.
(2) No person (including spouse) may hold power to appoint any
part of property subject to qualifying income interest to any
person other than spouse during his or her life. This rule
permits trustee to invade corpus for benefit of spouse.
Creation or retention of any powers exercisable only at or after
death of spouse over all or a portion of corpus is also
permitted.
(b) If property subject to qualifying income interest is not disposed of
before death of surviving spouse, fair market value of property,
determined as of date of spouse's death (or alternate valuation date, if
so elected), will be included in spouse’s gross estate.
(c) Caution. In some cases, it may not be advisable to take full advantage
of marital deduction when increased exemption is taken into account
and combined estate tax on estates of both spouses is considered.
F. Special Use Valuation of Farms and Real Property Used in Closely Held Business.
(1) When tests are met, fair market value of qualified property includable in gross estate canbe significantly reduced.
(2) Potential recapture of tax savings if qualified real property ceases to be used for a
qualified use within 10 years after decedent's death. It appears from the 2001 Act that the
recapture provision will continue to apply after the repeal of the estate tax, to the estates
of decedents dying before January 1, 2010.
G. Payment of Estate Tax Attributable to Closely Held Business.
(1) Rules which allow payment of estate taxes in installments over period of years and at low
interest rates on unpaid balance are highly beneficial. However, under the 2001 Act, the
deferral period for paying the tax is reduced from 14 to 4 years after the normal 9-months-after-death due date for payment of the federal estate tax.
(2) Law provides for acceleration of payment of deferred tax balance if payment of any
installment is delinquent or if 50% or more of decedent's interest in closely held business
is disposed of or withdrawn.
(3) The 2001 Act increased the number of allowable partners and shareholders from 15 to 45.
Prior to the 2001 Act, a closely held business was defined as an interest in a partnership
carrying on a business if (a) 20% or more of the capital interest of the partnership is
included in the decedent's gross estate; or (b) the partnership had 15 or fewer partners.
The 2001 Act increased "15" to "45" for estates of decedents dying after December 31,
2001.
H. Form 706 -- U.S. Estate Tax Return (Appendix A for first three pages)
(1) Pickup adjusted taxable gifts made during lifetime.
(2) A brisk stroll through the first three pages.
III. GIFT TAX LAWS
A. Annual Gift Tax Exclusion.
(1) Gift tax annual exclusion is now $11,000 per donee (as of 2002), but only for gifts of
present, not future, interest. Indexed for inflation; rounded down to nearest $1,000. With
gift-splitting, spouses can transfer total of $22,000 (and more) per donee per year without
gift tax (regardless of which spouse’s property is used to make gift).
(2) Any amounts paid on behalf of any individual (a) as tuition to educational organization or
(b) as payment for individual's medical care will not be considered a gift. Exclusion for
medical expenses and tuition in addition to $11,000 annual gift tax exclusion and is
permitted without regard to relationship between donor and donee.
B. Taxable Gifts.
(1) 2001 Act does NOT repeal the gift tax.
(2) The gift tax applicable exclusion amount increased to $1,000,000 on January 1, 2002 and is
frozen at that level.
(3) Top gift tax rate decreases with estate tax rate, but in 2010 is reduced to 35%.(4) Gifts in trust after 2009 will be treated as completed gifts unless the trust is treated as
wholly owned by the Donor or the Donor's spouse.
C. Form 709 -- U.S. Gift Tax Return (Appendix B for first two pages).
(1) Transfer tax is cumulative.
(2) A quick walk through the gift tax calculation.
IV. GENERATION SKIPPING TAX LAWS
A. Generation Skipping Transfer Tax ("GST") Exemption.
(1) As of January 1, 2002, the GST exemption amount is increased to $1,100,000 due to the
inflation adjustment. Under the 2001 Act, the GST exemption amount will mirror the estate
tax applicable exclusion amount. This provision of the Act is effective for GST transfers
after December 31, 2003.
(2) The GST tax rate will mirror the top estate tax rate.
(3) The GST tax is repealed as of January 1, 2010.
B. A GST tax is imposed on transfers, either directly or through a trust, to a "skip" person (i.e. a
person in a generation more than one generation below that of the transferor non-related).
C. Three (3) types of transfers subject to GST tax:
(1) direct skips;
(2) taxable terminations; and
(3) taxable distribution.
V. THE TRANSFER TAX RULES FOR PLANNED GIFTS
1. Inter Vivos Charitable Remainder Trusts (“CRT”):
A. One life -- Donor is sole beneficiary. Gift Tax.
(1) Only gift is gift of remainder interest to charity.
(2) Report on Gift Tax Return and claim (unlimited) charitable deduction.
(3) No taxable gift.
AA. One life -- Donor is sole beneficiary. Estate Tax.
(1) Value of CRT assets at date of death (or alternate valuation date) includable in
gross estate.
(2) That value qualifies for unlimited estate tax charitable deduction; thus, it’s a
wash and no estate tax is attributable to CRT assets.B. One or more lives -- Donor is not the beneficiary. Gift Tax.
(1) Completed gift is made to the beneficiary (ies). Gift of present interest that
qualifies for annual exclusion.
(2) Amount of gift in excess of exclusion is taxable gift. Tentative tax may be offset
by available gift tax credit.
(3) If Donor retains right to revoke beneficiary's interest, no completed gift is made
on trust funding. Only the unitrust amount actually paid to the beneficiary each
year is a completed gift.
(4) If beneficiary is spouse:
(a) gift qualifies for gift tax marital deduction under special rule for qualified
remainder trust interests.
(b) if spouse is non-citizen, special rules apply. There’s no marital
deduction, but as of 2001, there was a $106,000 a year exclusion, which
is indexed for inflation.
(5) Gift of remainder is made to charity; qualifies for gift tax charitable deduction.
BB. One or more lives -- Donor is not a beneficiary. Estate Tax.
(1) If Donor did not retain right to revoke -- and he or she probably shouldn’t have -
then no part of CRT assets is includable in gross estate. But, amount of adjusted
taxable gift comes back for purposes of calculating estate tax.
(2) If, however, Donor did retain that right, then value of CRT assets includable in
gross estate.
(3) If spouse is only beneficiary, spouse’s interest qualifies for estate tax marital
deduction under special rule.
(4) Charitable remainder interest qualifies for estate tax charitable deduction.
C. Two life: CRT funded with Donor’s Separate Property -- Donor is first beneficiary. Gift
Tax.
(1) Successor Beneficiary is spouse.
(a) Completed gift for value of survivorship interest unless donor retains
right to revoke (by Will only) successor beneficiary’s right to payment.
No reason to do so for gift tax purposes.
(b) Gift to spouse qualifies for gift tax marital deduction under special rule.
(c) Be careful: To qualify for marital deduction, spouse must be the only
other beneficiary.
(d) Gift of remainder is made to charity; qualifies for gift tax charitable
deduction.
(2) Successor Beneficiary is not spouse.(a) Completed gift for value of survivorship interest is made to successor
beneficiary unless donor retains right (by Will only) to revoke that
beneficiary’s interest.
(b) Retained right does not change estate tax implications (see below).
(c) Gift of remainder is made to charity; qualifies for gift tax charitable
deduction.
CC. Two-life CRT: funded with Donor’s separate property -- Donor is first beneficiary. Estate
Tax.
(1) Value of CRT assets at Donor’s death includable in gross estate.
(2) If spouse is only successor beneficiary, spouse’s interest qualifies for estate tax
marital deduction. But, if spouse is non-citizen, there’s no marital deduction
unless special form of marital deduction trust (QDOT) is created.
(3) If successor beneficiary is someone other than spouse, then value of survivor
interest will wind up being part of taxable estate.
(4) Charitable remainder interest qualifies for estate tax charitable deduction.
D. Two life: CRT funded with jointly owned property -- Donors are spouses and are the only
beneficiaries. Gift Tax.
(1) Payments should be made jointly and then to survivor.
(2) Actuarially older spouse makes a gift to the actuarially younger spouse for the
value of the difference in their survivorship interests.
(3) Gift qualifies for the gift tax marital deduction.
(4) Gift of remainder is made to charity; qualifies for gift tax charitable deduction.
DD. Two-life: CRT funded with joint property and Donor-beneficiaries are spouses. Estate
Tax.
(1) Since it is qualified joint property (joint property held by spouses) only one-half
of value of CRT assets at death of first included in that spouse’s gross estate.
(2) Interest of surviving spouse qualifies for estate tax marital deduction.
(3) Charitable remainder interest qualifies for estate tax charitable deduction.
(4) No estate taxes attributable to trust assets.
(5) At date of death of surviving spouse, full value of CRT assets included in that
estate. But, it’s a wash because the full value of the CRT assets qualifies for the
charitable deduction.
E. Two life: CRT funded with jointly owned property -- Donors are not spouses. Gift Tax.(1) Payments should be made jointly and then to survivor.
(2) Actuarially older Donor makes a gift to the actuarially younger Donor for the
value of the difference in their survivorship interests.
(3) Since it’s gift of future interest, does not qualify for annual exclusion.
(4) Taxable gift can be avoided by each of the joint tenants retaining the right (by
Will only) to revoke the survivor’s interest income in one-half of the joint gift
property.
(5) Gift of remainder is made to charity; qualifies for gift tax charitable deduction.
EE. Two-life CRT funded with joint property and Donor-beneficiaries are not spouses (e.g.,
siblings). Estate Tax.
(1) Generally, there is rebuttable presumption that full value of joint assets belong in
the estate of the first of the joint tenants to die.
(2) However, once joint assets transferred to irrevocable trust, rule changes and
only one-half of the value of those assets will be included in the estate of the
first joint tenant to die.
(3) The survivorship interest of the other Donor-beneficiary will be part of the
taxable estate.
(4) Charitable remainder interest qualifies for estate tax charitable deduction.
(5) At later death of surviving joint tenant, one-half of the value of CRT assets
included in that estate, but estate will get fully offsetting estate tax charitable
deduction - resulting in wash.
2. Testamentary CRT: Estate tax:
A. Obviously no gift tax implications to creation of CRT at death.
B. Value of assets that will fund the CRT is, by definition, included in gross estate.
C. CRT for benefit of spouse:
(1) Interest of surviving spouse qualifies for estate tax marital deduction under
special rule.
(2) Charitable remainder interest qualifies for estate tax charitable deduction.
(3) No estate taxes attributable to trust assets.
(4) At later death of surviving spouse, full value of CRT assets included in that
estate. But, it’s a wash because the full value of the CRT assets qualifies for the
charitable deduction.
D. CRT for benefit of non-spouse.
(1) Charitable remainder interest qualifies for estate tax charitable deduction.(2) Value of beneficiary’s interest will be part of taxable assets.
3. Pooled Income Funds:
A. Rules very much the same as for CRTs; a pooled fund is a form of CRT.
B. Main difference only in treatment of spouse’s income interest.
C. There is no special provision allowing a gift tax and estate tax marital deduction. In order
to obtain that deduction, the Donor (in inter vivos situations) or the estate personal
representative (in testamentary situations) must elect QTIP treatment (see above).
4. Inter Vivos Charitable Gift Annuities:
A. One-life annuity: Donor is annuitant. Gift Tax.
(1) Gift to charity is gift of present interest. Therefore qualifies for both the annual
exclusion and the gift tax charitable deduction.
(2) Query: Does 1997 Act allow Donor to forego filing gift tax return if gift value
exceeds annual exclusion?
B. One life annuity -- Donor is not annuitant. Gift Tax.
(1) Gift to annuitant is a gift of a present interest and qualifies for annual exclusion.
Excess is taxable gift.
(2) If annuitant is Donor’s spouse, qualifies for marital deduction. If spouse is
noncitizen, no marital deduction but there is $100,000 a year exclusion.
(3) Gift to charity is gift of present interest. Therefore qualifies for both the annual
exclusion and the gift tax charitable deduction.
C. One life annuities. Estate Tax.
(1) Donor is sole annuitant; no amount is includable in gross estate.
(2) One-life annuity for someone other than annuitant; no amount is includable
in gross estate except that amount of adjusted taxable gift comes back for
purposes of calculating tentative estate tax.
D. Two-life annuity funded with Donor’s separate property; Donor is first annuitant. Gift
Tax.
(1) Two gifts made: one to charity for gift portion; other to survivor annuitant of
actuarial value of right to receive survivor annuity.
(2) If survivor annuitant is spouse, interest qualifies automatically for QTIP
treatment (if payment is joint and survivor) and marital deduction. Problem where
spouse is non-citizen.(3) If payment is not joint and survivor, unclear if marital deduction applies.
Therefore, best to retain right to revoke.
(4) If survivor annuitant is not spouse, gift is one of future interest and, therefore,
no annual exclusion.
(5) Can avoid taxable gift by Donor retaining right to revoke survivor annuitant’s
payments. Unlike rule for CRTs, right can be exercised by Will or during life.
E. Two-life annuity funded with Donor’s separate property; Donor is first annuitant. Estate
Tax.
(1) If survivor annuitant predeceases donor, no amount is included in Donor’s
gross estate.
(2) If the survivor annuitant does survive, include in Donor’s gross estate the
value of an annuity paying the provided amount to the survivor annuitant
(based on his or her age at death of Donor).
(3) If survivor is spouse, that value qualifies for the marital deduction
automatically under QTIP. But see caution above re non-joint and survivor
annuities.
F. Two-life annuity funded with joint property: annuitants are Donors. Gift Tax.
(1) Again, two gifts made: one to charity for gift portion; other to younger
annuitant by older annuitant of difference in actuarial values of right to
receive survivor annuity.
(2) If survivor annuitant is spouse, interest qualifies automatically for QTIP
treatment (if payment is joint and survivor) and marital deduction. Problem where
spouse is non-citizen.
G. Two-life annuity funded with joint property: annuitants are Donors. Estate Tax.
(1) At death of first, included in estate of first is value of one-half of survivor
annuity.
(2) If survivor annuitant is spouse, interest qualifies automatically for QTIP
treatment (if payment is joint and survivor) and marital deduction. Problem
where spouse is non-citizen.
H. Two-life annuity funded with joint property; annuitants are not donors and receive
payments successively. Gift Tax.
(1) Again, two gifts made: one to charity for gift portion; other to annuitants
for value of right to receive annuity.
(2) Gift to first annuitant qualifies for annual exclusion. Gift to survivor
annuitant is one of future interest and does not qualify for annual
exclusion.
I. Two-life annuity funded with joint property; annuitants are not donors. Estate Tax.
No amount is includable in gross estate except that amount of adjusted taxable gift
comes back for purposes of calculating tentative estate tax.5. Testamentary Gift Annuities -- Estate Tax:
A. The difference between the amount bequeathed to charity and the actuarial value of
the deferred annuity (calculated in the same manner as for inter vivos annuity)
qualifies for the estate tax charitable deduction.
B. If annuitant is spouse, personal representative can elect QTIP and claim marital
deduction.
C. If QTIP elected, value of annuity interest would be included in spouse’s estate, but
for fact that value is zero because it terminates at spouse’s death.
6. Inter-Vivos Deferred Payment Gift Annuities -- Gift Tax:
A. One-life: Donor is annuitant.
(1) Gift to charity qualifies for gift tax charitable deduction.
(2) It’s a gift of a present interest; so, f i charitable gift exceeds $11,000
exclusion, does gift tax return have to be filed? We say no, but caution may
dictate filing.
B. One-life: Donor is not annuitant.
(1) Two gifts made: one to charity for gift portion; other to annuitant for
present value of right to annuity.
(2) Gift to charity is gift of present interest and qualifies for annual exclusion;
excess qualifies for gift tax charitable deduction.
(3) Gift to annuitant is gift of future interest; therefore, there should be no
annual exclusion.
(4) If annuitant is Donor’s spouse, not eligible for marital deduction because
spouse’s right to “income” is not immediate.
(5) Planning thought: Consider making gift to spouse; then spouse makes
annuity gift.
C. Two-life deferred annuity funded with Donor’s separate property where Donor is
first annuitant.
(1) Again, two gifts are made: one to charity for gift portion; other to survivor
annuitant.
(2) Gift to charity qualifies for annual exclusion and excess for charitable
deduction. Problem where spouse is non-citizen.
(3) Gift to survivor annuitant is gift of future interest and doesn’t qualify for
annual exclusion -- nor does it qualify for marital deduction.
(4) Donor can retain right to revoke survivor annuitant’s right to annuity to
avoid gift tax implication.D. Two-life deferred annuity funded with joint property:
(1) Actuarially older annuitant makes gift to actuarially younger annuitant for
value of difference in their respective survivor interests.
(2) To avoid gift tax implications, each Donor should reserve right to revoke
other annuitant’s survivor interest.
(3) Gift to charity -- same as above.
(4) Even if Donors are spouses, gift tax treatment is same and right to revoke
should be retained.
7. Inter-Vivos Deferred Gift Annuities -- Estate Tax:
A. The difference between the amount bequeathed to charity and the actuarial value of
the deferred annuity (calculated in the same manner as for inter vivos annuity)
qualifies for the estate tax charitable deduction.
B. If annuitant is spouse, personal representative should be able to elect QTIP and
claim marital deduction.
C. If QTIP elected, value of annuity interest would be included in spouse’s estate, but
for fact that value is zero because it terminates at spouse’s death.
8. Irrevocable Transfer of Remainder Interest In Personal Residence or Farm:
A. Gift and estate tax rules should be the same as for CRTs, with the life tenant’s
interest and the charitable remainder interest treated as those interests are treated in
the CRT area.
B. Caveat: In some states, be careful that a mere right to occupancy given to a
surviving spouse may not be considered a true life estate qualifying for the marital
deduction.
9. Charitable Lead Trusts (“CLT”) -- Gift Tax:
A. Remember, most lead trusts are not created to generate income tax charitable
deduction because they are not grantor trusts; the remainder, after the charitable
lead interest, passes on to family members or others.
B. Inter-vivos CLT -- Donor retains reversionary interest.
(1) Gift is made to charity for value of lead interest.
(2) Gift is one of present interest and qualifies for annual exclusion; excess
qualifies for charitable deduction; therefore no gift tax implications.
C. Inter-vivos CLT -- Donor doesn’t retain reversion.
(1) Two gifts are made: First, gift of lead interest; then, gift of non-charitable
remainder interest.
(2) Charitable gift of value of lead interest qualifies for annual exclusion andgift tax charitable deduction.
(3) Remainder gift is gift of future interest that does not qualify for annual
exclusion.
(4) Depending upon discount rate in effect, if the lead term and payout is long
enough and high enough, can eliminate taxable gift by making the
charitable lead interest equal 100%.
(5) If Donor retains power to select charitable beneficiaries, gift is not
complete. If someone else, for example the trustee, is given that power, the
gift is complete but a charitable deduction is allowed; so it’s a wash.
10. Charitable Lead Trusts -- Estate Tax:
A. Inter-vivos CLT where Donor retained the reversion: Donor’s gross estate will
include only the value of the reversionary interest. The shorter the balance of the
trust term, the greater is the amount included.
B. Inter-vivos CLT where Donor did not retain reversion: No part of trust assets
included in gross estate. But value of the noncharitable remainder on the date of gift
is included in adjusted taxable gifts and, therefore, comes into play for purposes of
calculating the tentative estate tax.
C. Caveat: If Donor retains certain rights: (i) power to designate charitable
beneficiaries; (ii) power to vote stock transferred to CLT; or (iii) is officer or director
of a private foundation to which the lead interest is payable -- then entire value of
CLT assets included in gross estate. Estate gets a charitable deduction for then
value of lead interest.
11. Testamentary Lead Trusts:
A. Obviously no reversion can be kept.
B. Assets that will fund the CLT are, by definition, included in gross estate.
C. Estate gets estate tax charitable deduction for value of lead interest; thus only value
of remainder is in taxable estate.
D. Assets get a stepped up basis eliminating much of capital gains concerns from
assets in CLT.
12. Generation-Skipping Transfer Tax:
A. Nobody understands it.
B. Know that if a non-charitable beneficiary or remainderman is a skip person, get help.
13. A. Generation Skipping Transfer Tax ("GST") Exemption.
(1) As of January 1, 2002, the GST exemption amount is increased to $1,100,000 due
to the inflation adjustment. Under the 2001 Act, the GST exemption amount will
mirror the estate tax applicable exclusion amount. This provision of the Act is
effective for GST transfers after December 31, 2003.(2) The GST tax rate will mirror the top estate tax rate.
(3) The GST tax is repealed as of January 1, 2010.
B. A GST tax is imposed on transfers, either directly or through a trust, to a "skip" person
(i.e. a person in a generation more than one generation below that of the transferor non-related).
C. Three (3) types of transfers subject to GST tax:
(1) direct skips;
(2) taxable terminations; and
(3) taxable distribution.CASE STUDY
Example where H dies in 2002 and W dies in 2005.
H has $3,000,000 estate. His wife W has a $3,000,000 estate of her own. H gives an amount equal to the equivalent
exemption to his children and the balance of his estate is set up in such a way as to obtain the unlimited marital
deduction. H dies in 2002; his wife then dies later in 2005, leaving her entire estate to their children. Here is what the
estate tax computations would look like:
H’s Estate
Gross estate $3,000,000
Less: Estimated
expenses -- at 5% $ 150,000
Marital deduction --
balance of estate less
$1,000,000 equivalent
exemption $1,850,000 $2,000,000
Taxable estate $1,000,000
Tentative federal estate tax $ 345,800
Less: Applicable credit amount $ 345,800
Federal estate tax -0-
W’s Estate
Her separate assets $3,000,000
Marital share from H $1,850,000
Gross Estate $4,850,000
Less: Estimated expenses -- at 5% $ 242,500
Less: NY State Estate Tax* $ 347,640
Taxable estate $4,259,860
Tentative federal estate tax $1,842,934
Less: Applicable credit amount $ 555,800
Federal estate tax $1,287,134
NY State estate tax $ 347,640
Total Tax $1,634,774
* As of 2005 the state death tax credit is repealed after which there will be a deduction for death taxes actually paid
to the state.Integrating Split-Interest Charitable Gifts Into the Estate Plan to Save Estate Tax
Assume that W is charitably inclined. Her Will divides her estate into two parts. With the first part, she creates a 6%
charitable remainder unitrust (furnishing a potential hedge against inflation) providing payments to her children in
equal shares for a term of 20 years after her death. The other half is placed in a charitable lead trust providing for
payment of 8.5% of the initial value of the assets (a guaranteed annuity) to charity for a term of 20 years with the
remainder payable to children (or grandchildren) at the end of the 20 year term. Here is what the estate tax calculation
in W’s estate would look like using the July 2002 discount rate of 5.6%:
Gross estate $4,850,000
Less: Estimated expenses -- at 5% $ 242,500
Charitable deduction:
Gross principal into unitrust
of $2,303,750 x 30.403% factor $ 697,391.20
into lead annuity trust of
$2,303,750 x 100% factor $2,303,750.00
$3,001,141.20
Less: Federal estate tax payable* $ 87,594.20
Net charitable deduction $2,913,547
NYS estate tax deduction** $ 77,565
Total deductions: $3,233,612
Taxable estate: $1,616,388
Tentative federal estate tax $ 608,175
Less: Applicable credit amount $ 555,800
Federal estate tax $ 52,375
NY State estate tax $ 77,565
Total Tax $ 129,939
The estate tax savings is $1,504,835
* Tax attributable to non-charitable portion of unitrust. Gross principal of each trust is reduced by ½ of estate
tax, thereby reducing charitable deduction for each trust. Estate tax is determined by interrelated calculation.
** As of 2005 the state death tax credit is repealed after which there will be a deduction for death taxes actually
paid to the state.APPENDIX AAPPENDIX BTWO
USES OF SPLIT INTEREST TRUSTS1. Overview of Various Life Income Arrangements
A. Unitrust agreements.
(1) Standard unitrust -- pays stated percentage (at least 5% and no more than 50%) of
net fair market value of trust assets, revalued at least annually, out of income and, if
income is insufficient, out of principal. Excess income is retained in trust.
(2) Net income with makeup unitrust (the NIMCRUT) -- pays lesser of (i) stated
percentage of annual net fair market value and (ii) actual trust income. Deficiencies
in distributions from an earlier year are made up in any later year in which trust
income exceeds stated percentage. Then excess income retained in trust.
(3) Net income without makeup unitrust -- pays lesser of (i) stated percentage of annual
net fair market value and (ii) actual trust income. Deficiencies in distributions from an
earlier year are not made up. Excess income is retained in trust.
(4) In net income unitrust, agreement can provide that realized capital
gain -- but only that portion representing post-gift appreciation -- can
be treated as income for purposes of distribution.
(5) Hybrid agreement (the “Flip” unitrust). Net income unitrust becomes
standard unitrust on sale of, i.e., closely held corporate stock. First,
unpublished PLR said O.K. Then, IRS said it doesn’t work. PLRs
9506015 and 9516040. Then proposed §664 Regs again said O.K.
Final Regs confirmed viability of Flip - - but significantly broadened events that
trigger flip.
(6) Why the Flip?
(a) In NIMCRUT, once non-income producing asset is sold,
there is expectation that Trustee will invest so as to achieve
ordinary income at the stated percentage payout rate. Not easy
to do.
(b) Once crut flips and becomes standard crut, can invest for
total return. Easier to achieve payout percentage and some
reasonable growth in trust assets.
(c) Can use flip to defer income.
(7) Some Specific Items Regarding Nimcruts.
(a) Excess income in earlier year cannot be used to make up
deficiency in later year.
(b) What is income? Generally state law governs. Be careful
of specific unique situations; i.e., assets such as timber; assets
that have periodic large amounts of income. Defining income
to include realized gain attributable to post-gift appreciation.
(c) Net income provision does not change calculation of
charitable deduction for income, gift or estate tax purposes.B. Annuity trusts.
(1) Annuity amount couched in terms of stated dollars; trustee directed to pay X dollars
a year out of income and, if income is insufficient, out of principal. Any excess
income is retained in trust.
(2) Annuity amount couched in terms of a percentage of initial fair market value of
assets transferred to trust. Once amount determined, stays constant for trust term.
(3) In either case annuity amount must be at least 5% (but no more than
50%) of initial value of assets transferred to trust.
C. Pooled income fund.
Donor irrevocably transfers money, long-term marketable securities or both to qualified
charity's separately maintained pooled income fund, where it is invested together with
transfers of others who make similar life income gifts. Donor (or other designated beneficiary)
receives his share of pooled income fund earnings each year. On donor's death (or death of
other designated beneficiary) payments terminate and charity removes donor's gift from
pooled fund and uses for charitable purposes.
D. Charitable gift annuities.
(1) Immediate payment. Donor transfers money or property to charity in exchange for
promise to pay fixed amount annually to donor (and survivor, if desired) for life.
Transfer is part gift and part purchase of annuity. Annual income (rate of return)
paid by charity depends upon beneficiary's (annuitant's) age at time of gift. Annual
rate of return remains constant for life.
(2) Deferred payment. Donor makes gift to charitable institution in exchange for
charity's promise to pay him guaranteed life income starting at retirement (or any
other date specified).
(3) Regulation in New York by Insurance Department.
E. Charitable lead trusts.
(1) Donor can avoid tax on income paid to charity, but the trust must not provide
reversion for donor or spouse. Trust should be lead unitrust or lead annuity trust.
Otherwise, value of charity's income interest will be subject to Federal gift tax. And,
if donor dies before property reverts to him, there will be no estate tax charitable
deduction.
(2) Main drawback of law is that donor cannot get income tax charitable deduction unless
trust so drawn that he is taxed on income paid to charity -- a grantor trust. Thus, except
for very wealthy individuals, charitable lead trust created during lifetime is generally not
advantageous. Some create trust with tax-exempt bonds so that income is not taxable.
(3) Lead trusts paying income to charity are advantageous when created by donor's will.
Estate tax charitable deduction allowed for value of income stream paid to charity
under lead trust created by donor's will. To get estate tax deduction, income interest
must be guaranteed annuity (annuity trust) or fixed percent of net fair market value
of trust assets, determined yearly (unitrust).(4) The Jackie O Lead Trust: Illusionary? But, still wonderful story.
2. Basic Tax Implications
A. Income tax charitable contribution deduction allowed for charitable remainder interest or other
gift element. In order to qualify, value of remainder must be at least 10%.
B. Capital gain avoidance; the problem of prearranged sales.
(1) Palmer still lives. [Palmer v. Commissioner, 62 T.C. 684 (1974), aff'd on other grounds, 523
F.2d 1308 (8th Cir. 1975)]; Rev. Rul. 78-197, 1978-1 CB 83; Letter Ruling 8639046.
(2) What about Blake? [Blake v. Commissioner, 42 T.C.M. 1336 (1981), aff'd 697 F.2d 473 (2nd
Cir. 1982)].
C. Gift tax charitable deduction (unlimited) allowed for remainder interest.
D. Estate tax charitable deduction (unlimited) allowed for charitable remainder interest.
E. Taxation of remainder trust beneficiary -- four-tier system - - WIFO basis.
(1) Ordinary income.
(2) Capital gain income; first short-term, then long-term.
(3) Other income, including tax-exempt interest.
(4) Return of principal.
4. The Lifetime Uses of a NIMCRUT
A. Use of securities.
(1) Highly appreciated, but low-income stock to fund "net income with makeup"
unitrust.
(a) Provide low percentage payout -- but, at least 5% -- to increase charitable
deduction.
(b) By retaining securities with high appreciation potential but low income,
reduce income paid to donor when in higher income bracket and less need
for income.
(c) Trust sells later when securities appreciated and invests proceeds in high
yield securities paying stated percentage of increased value plus make-up
of deficiencies from earlier years; donor now possibly in lower tax bracket
(say, at retirement) or needs greater income.
(2) Transfer of closely held corporate stock (charitable stock bailout) to charity.
(a) Donor transfers stock of close corporation to charity generating deduction
for fair market value with no tax on appreciation.(b) Corporation, although not legally obligated to do, redeems stock from
charity. Palmer; Rev. Rul. 78-197; but see Blake.
(c) Transfer to charitable remainder trust.
(i) Generally not good idea unless trust can sell without violating
self-dealing prohibitions.
(ii) A way out: Offer to redeem all stock is made.
(iii) Query: Is close corporation stock a "prudent" trust investment?
B. Use of zero coupon bonds.
(1) Basic rules.
(2) Watch state law on questions of whether trust can make interest income on
redemption or sale principal.
(3) Flexibility of timing.
C. "The Spigot Trust." Use of commercial tax deferred annuity contract.
(1) Donors funded a net income with makeup unitrust with appreciated common stock;
the trustee plans to reinvest the trust assets in a commercial deferred annuity
contract.
(2) Regular annuity payment tax rules don't apply (payments partially excludable; IRC
'72(b)(1)); because contract not held by natural person, it's all ordinary income -- but,
that's good. Trustee will be able to use entire later payments to make up deficits.
Also, Donors can “control” when they will begin to receive income.
(3) IRS made noise that “retirement unitrusts” are suspect. Then in T.A.M. (LTR
9825001), IRS ruled in technical advice that purchase of deferred annuity contracts
doesn’t adversely affect qualification of unitrust and would not be considered an act
of self-dealing.
D. Funding Charitable Remainder Trust With Individual Retirement Account (IRA).
(1) The general rules on "income in respect of a decedent."
(2) Other tax problems on IRAs and like plans.
(3) IRS Private Letter Ruling. (LTR 9237020)
(a) D has Individual Retirement Account. She plans to create testamentary
CRUT for son's benefit. To fund trust, D will name CRUT as beneficiary of
her IRA.
(b) IRS rules. Trust will qualify and entitle D's estate to estate tax charitable
deduction for value of remainder interest. Any IRD received by CRUT will
have same character in its hands as it would have had in D's hands, had she
lived and received it.(c) IRS also said that trust won't be taxable on its income unless it has
unrelated business income. This, CRUT won't be taxable on IRD; instead,
that income will be taxed to son piecemeal as it's paid to him in satisfaction
of annual unitrust amounts under four-tier provisions of IRC '664(b).
(d) Generous individuals often disappointed to learn that IRAs and other
pension plans can't be "rolled over" tax-free into charitable remainder trusts
during lifetime. Resulting income is taxed to donor in year of transfer,
reducing funds available for trust. However, by funding testamentary
unitrust with her IRA, D has avoided up-front income tax. And unitrust
payments based on a percentage of assets in CRUT, as revalued each year.
Thus, the more (untaxed) assets pass to trust, higher payments will be -
and more pre-tax funds will be available for reinvestment.
(4) Current ruling -- LTR 9901023. IRS confirmed its holding in above
ruling, but made it clear that income tax deduction for estate tax
attributable to IRD belongs to CRT not its beneficiaries. Extent of
adverse impact?
E. Wealth Replacement
(1) Create CRT
(2) Use tax savings and/or increased income stream to purchase life insurance to
replace amount transferred to CRT. Perhaps use life insurance trust to hold
insurance.
4. Some Potential Pitfalls
A. Transfer of mortgaged property to remainder trust.
(1) Don't do it.
(2) Some possible outs.
(a) Pay off mortgage or get lien released.
(b) Sale to charity of undivided interest. Donor uses proceeds to pay debt and
transfers balance of his interest to CRT. Caveat: The undivided interest
problem and self-dealing.
B. Installment obligations.
(1) Transfer triggers unreported gain.
(2) Better to use testamentary gifts.
C. S Corporation stock.
D. The Accelerated Unitrust; the “Chutzpah Trust”THREE
CHARITABLE GIFTS OF UNUSUAL ASSETSI. Gifts of Closely Held Corporate Stock
1. Background on Corporate Income Taxation.
A. Generally, corporate income is subject to double taxation. First, the corporation pays
corporate income tax on its net income. Then, the corporate shareholders pay income tax on receipt of
dividends or on distributions of corporate assets when the corporation terminates. There is some relief from
double taxation for S corporations, as discussed below.
B. Example: Jane Donor created a corporation some years ago and made a capital
contribution of $10,000.00. The closely held corporation has assets worth $200,000 with a tax basis of only
$40,000. Jane believes that her stock is worth $200,000 - - the value of the corporate assets. However, if the
corporation sold those assets and liquidated, the IRS would collect approximately $81,520 of income tax and
Jane would be left approximately $108,500.
Corporation: Sells assets worth $200,000
Tax basis 40,000
Taxable gain $160,000
Corporate tax (assuming 34%
tax bracket) 54,400
Proceeds left for shareholder
(Sales proceeds of $200,000 less
$54,400 tax) = $145,600
Shareholder: Liquidating distribution of net
proceeds $145,600
Less: Jane’s cost basis 10,000
Long-term capital gain $135,600
Capital gains tax (20%) 27,120
Net proceeds to Jane $108,480
C. The result would be the same if the corporation merely distributed its assets to the
shareholder because the law requires the corporation to pay income tax as if it had sold its assets and the
shareholder is treated as if she had sold her stock.
The tax burden would be even worse if the distribution of assets were treated as a
dividend to the shareholder because then the corporation still pays income tax as if it had sold the assets
but the shareholder pays ordinary income tax on the value of the assets received rather than the more
beneficial long-term capital gain rate.
D. Clear Conclusion: Keep appreciated assets, such as real estate, out of a C corporation.
The problem is that the gift planner must deal with that fact because the shareholder/donor has already
placed assets inside the corporation.
E. The corporation itself can contribute assets to a charity or a charitable remainder trust and
avoid the tax on the assets’ growth if sold by the charity or the trust but, if a trust is established, the income
stream would be paid to the corporation, taxed to the corporation at its rates and then, when distributed to
the shareholders, would generate regular income tax as a dividend.2. Gifts of Closely Held Stock.
A. Gift of appreciated publicly traded stock to charity - - whether a public charity or a private
foundation - - will still generate a double tax benefit: A charitable contribution deduction based on the fair
market value of the stock with no realization of capital gain income.
B. However, the benefits obtained on a gift of closely held corporate stock will depend upon
the charitable donee:
(1) If the gift is to a public charity, the deduction is still at fair market value with no
realization of capital gain income;
(2) If the gift is to a private foundation, the deduction is for cost basis only;
(3) There are also higher ceiling limitations for gifts to a public charity than to a
private foundation as follows:
Cash or Long Term
Kind of Charity Ord. Inc. Prop. Cap. Gain Prop.
Public Charity 50% of AGI 30% of AGI
Private Non-Operating
Foundation 30% of AGI 20% of AGI
Private Operating Foundation 50% of AGI 30% of AGI
A five year carryover for any “excess” contribution is allowed in each case.
C. Qualified appraisal required. See below for discussion of valuation and substantion rules.
3. Life Income Arrangements.
A. If publicly traded securities are transferred to, for example, a charitable remainder trust, the
results are clear and there are ordinarily no problems with a deduction for the remainder value calculated on
the full fair market with no imputing of the gain to the donor and generating an income stream which will
generally increase the donor’s income.
B. Using closely held C corporation stock. Example: John and Jane Donor, both age 65, are
about to sell their corporate business for $10,000,000 that they started many years ago and which has
basically a zero cost basis. Before the sale is a binding obligation, they transfer $1,000,000 of that stock to a
charitable remainder unitrust at 7% retaining the income stream jointly and for the survivor of them. The
below chart shows that, by avoiding capital gains tax, they receive an income stream of $70,000 rather than
$56,000, an increase of 25%. And, they have generated an income tax charitable contribution deduction of
approximately 25% of the value of their gift or $250,000 which is money in their pockets and which can be
used for themselves or their heirs.Sell the Stock Transfer Stock to
Personally CRUT Which Sells
Sales Price $1,000,000 $1,000,000
Cost Basis 0 0
Capital Gain $1,000,000 $1,000,000
Tax (20%) 200,000 0
Net Proceeds $ 800,000 $1,000,000
Invest at 7%
Annual Income $ 56,000 $ 70,000
A wealth replacement life insurance policy coupled, where appropriate, with an irrevocable life
insurance trust will even more significantly increase the ultimate benefit to their heirs.
C. Often, a gift followed by a redemption by the corporation will achieve the same results.
And, in corporations that have concern regarding the accumulated earnings tax, a charitable gift of stock in
that corporation followed by a redemption can result in the corporation having less undistributed cash;
therefore, it is less likely subject to the accumulated earnings tax and, of course, there are the other tax
benefits already discussed.
D. Be careful in arranging the corporate redemption.
(1) Avoid imposition of the self-dealing rules; generally, it would appear that the
corporation is itself a disqualified person that would not be able to purchase the stock from the
trust. However, Code Section 4941(d)(2)(f) provides an exception to the self-dealing rules where
the corporation makes an offer on the same terms to all shareholders of the same class and the
terms of the offer provide for receipt of no less than fair market value.
E. Beware of the pre-arranged sale.
(1) The threshold case: Palmer v. Commissioner, 62 T.C.684(1974), Aff’d on another
issue, 523 F.2d 1308(8 Cir. 1975).
(a) Donor had voting control of both a closely held corporation and a tax-exempt
private foundation. Pursuant to what appeared to be a single plan, donor
contributed shares of corporation’s stock to foundation and then caused the corporation
to redeem the stock from the foundation.
(b) IRS wanted to impute gain to Palmer.
(c) Tax Court, affirmed by the Appeals Court, held that transfer of stock to
foundation was valid gift and gain not taxed to Palmer on the following grounds:
(i) Foundation was not bound to go through with redemption at
the time it received title to the shares, and
(ii) Corporation’s right to redeem is based upon a purchase at fair
market value.
(d) IRS has acquiesced in Palmer. Rev. Rul., 78-197, 1978-1 CB 83.
Redemption proceeds of stock under facts similar to those of Palmer will impute gain tothe donor only if the donee is legally bound or can be compelled by the corporation to
surrender the shares for redemption.
(2) However, see Blake v. Commissioner, 697, F2d. 473 (2d Cir. 1982). A “chutzpah”
case.
II. S Corporation Stock
1. Background: Generally, S corporation does not pay income tax. It is a pass through entity (like a
partnership) and corporation’s income is taxed directly to shareholders. This avoids double
taxation of income that often occurs with C corporations.
2. Charity can now be eligible S corporation shareholder. Code Section 1361(c)(6),
effective January 1, 1998.
A. Charitable deduction is often less than full fair market value of stock because of reduction
rule of Code Section 170(e), which requires that the income tax
deduction for a gift of appreciated long-term capital gain property is generally reduced by the amount of
“ordinary income” that the donor would have realized had he sold the property. With an S corporation,
often Code Section 751 rules regarding certain assets such as (1) “unrealized receivables,” (2) “inventory,”
(3) “depreciation recapture,” may have impact on deductible amount.
B. Watch out for phantom income.
C. Charity will be subject to unrelated business income tax (UBIT) on its portion of S
corporation’s accounting income. Also, unlike almost every other capital gain asset, the gain from the sale
of S corporation stock by the charity will also be subject to UBIT. Code Section 512(e)(1)(B)(ii).
3. But, the above rule does not apply to a transfer that is not an outright transfer to charity, such as a
transfer to a charitable remainder trust. Such a transfer will still automatically terminate the S
corporation election. Often, that can have adverse tax implications to the donor who contributes
such stock.
4. A way out: S corporation creates the charitable remainder trust.
A. S corporation transfers appreciated assets to the CRT; corporation gets
the income tax charitable deduction; passes deduction through to its shareholders; problem - -
deduction that can be claimed by the shareholder is limited to his or her basis in the S corporation
stock which is generally minimal.
B. But the charitable remainder trust can sell and invest the appreciated assets without
capital gains tax and reinvest the full sales proceeds to generate the income stream.
C. Trust term can only be for term of years - - not to exceed 20.
D. Potential problems where there are multiple shareholders of the S corporation with
different agendas.
III. Family Limited Partnerships - - The Charitable FLP
1. Background: Family limited partnership generally used in estate planning to manage the family
wealth and create discounts for marketable securities and
other assets where discounts are not generally allowable.A. Husband and wife, for example, create limited partnership; retain general partnership
interests so that they maintain control, as well as limited partnership interests.
B. Make gifts to, say, children of limited partnership interest; take deep discounts for lack of
marketability and minority interest.
C. Internal Revenue Service getting more aggressive in fighting deep discounts of, say, 50%;
but the planning still works if taxpayer is not too greedy.
D. Discounts can also apply for estate tax purposes reducing the value of the estate.
2. Charitable FLP: too good to be true? IRS has taken hard look. See Wall Street Journal article of
July 13, 1999; Chronicle of Philanthropy article of July 15, 1999.
A. The mechanics.
(1) John Donor creates family limited partnership comprised of general partnership
interest and one or more levels of limited partnership interests.
(2) He puts business and other appreciated assets and cash into FLP.
(3) As general partner, donor retains a management fee for operating the
partnership. The fee generally ranges from 3% to 10% of partnership income. This enables donor
to keep all or almost all of the firm’s cash flow or, perhaps, trickle out token amount to limited
partners at discretion of donor as general partner. General partner also retains the right to borrow
partnership assets for personal needs at competitive interest rates.
(4) Donor makes gift of, say, 97% of limited partnership interest to charity. This
generates large income tax charitable deduction.
(a) Even when majority of all the limited partnership interests are conveyed
to charity, those interests carry limited, if any, control and, often, no marketability, and
must, therefore, be discounted considerably for valuation of the charitable deduction.
(b) Charitable gift is made, but subject to a “put” enabling the charity to
force a buyback of the limited partnership interests - - typically, at significant discount
from their value when received by charity.
(5) Donor makes a simultaneous gift of remaining 3% of limited partnership units to
children and/or grandchildren. Gift tax valuation of those interests also takes into account lack of
control and marketability and so a relatively large valuation discount for gift tax purposes is also
taken.
(6) As part of transaction, partnership purchases life insurance on donor’s life to
fund the later buyout. The partnership itself splits the premium dollars with an irrevocable trust
representing the interests of its beneficiaries, the limited partners of the 3% interest. Therefore,
indirectly, since charity holds 97% of the limited partnership interests, charity is paying most of the
insurance premiums. In one variation on this theme, charity, through its “put,” can sell its interest
to the irrevocable life insurance trust. Thus, charity’s dollars have been helping to fund life
insurance that will be used to buyout its interest - - at a substantial discount - - and the trust then
receives the partnership interests with a stepped up basis benefiting the family members.
Further, if there is sale of partnership assets during donor’s life and beforecharity exercises its right to demand a purchase of its interest, approximately 97% of the gain on sale is attributable to
the charitable partner. Thus, donor’s family pays tax on only the 3% balance, a small fraction of the gain.
(7) At the specified “put” date, charity exercises its option to force the purchase - -
at pennies on the dollar - - of the limited partnership interest charity holds. It receives cash in
return for the interest, which has been sold back, either to the partnership itself or to the 3%
owners or to the irrevocable life insurance trust. Thus, the family business and other holdings of
the limited partnership (together with any appreciation on the relatively untaxed capital gains
sheltered by the charity’s exempt status) comes back into the family’s control.
B. So, where’s the gift? Donor and his advisors try to convince charity that it will make some
money on the transaction in return for allowing the donor and his family to receive tremendous benefits from
the transaction. They receive a disproportionate benefit and facilitate their personal estate planning
objectives. Remember Blake? This may be another classic example of using charity to serve a private rather
than public purpose.
C. The IRS likely position.
(1) The agreement of the parties from the beginning was based on an unwritten - -
but very real - - understanding between the donor and charity that, after a relatively short period of
time, charity will sell its interest back to the partnership or the other partners and receive only a
small portion of what the underlying assets and, therefore, the charity’s limited partnership interest,
is worth.
(a) IRS could argue that what charity received at the time of contribution
was only the sum of the future right to receive the “put” price and the present value of
minimal income distributions for, say, five years.
(b) More likely, IRS will argue that there is no allowable income or gift tax
deduction because the reality is that what the donor gave was a possible but uncertain
stream of dollars over a period of years.
(2) The donor and his advisors would likely argue that the “put” is merely an option and that there
was never a legal obligation on the charity to sell. Therefore, the contribution of the 97% interest in the limited
partnership must be respected. However, in the more egregious and aggressive cases, would the transaction ever
have been entered into had the parties not “known” from the beginning that the charity would have no practical
choice but to exercise its “put.”
D. Does it ever work? Yes, if there is donative intent, the family limited partnership is entered
into to achieve other family planning objectives and there is not the overreaching present in the type of
“charitable” family partnership described above.
IV. Stock Options; Restricted Stock
1. Stock Options - - Definition: A contractual right given by a corporation to an employee (and
sometimes, to an independent contractor) to purchase stock in the corporation at a stated price per
share for a stated period of time. There are two basic types of options.
A. Nonstatutory (“Nonqualified”) Options (IRC §83).
(1) Generally, this type of option is not taxable to an employee when granted, unless
the option has a readily ascertainable value (i.e., it is actually
traded on an established securities market), at the time of grant.(2) Compensation is realized when the option is exercised or “otherwise disposed
of.” Compensation is equal to the difference between the fair market value of the stock at the time
of exercise and the exercise price.
(3) An employee may choose to recognize compensation income on grant by making
an IRC ?83(b) election. Seldom done because of difficulty in ascertaining value of options. No
income will then be realized on subsequent exercise.
B. Statutory Options
(1) Includes incentive stock options (“ISOs”), employee stock purchase plans,
qualified stock options and restricted stock options.
(2) General Tax Treatment:
(a) The employee does not recognize taxable compensation income at the
time the option is granted or at the time the option is exercised (unless exercised more than
three months after leaving employment). The price for such avoidance is that the
employee must not dispose of the stock until two years from the date the option was
granted and one year from the date the employee received the shares upon exercise.
Code ?422(a)(1). A disposition includes a sale, exchange or gift.
(b) If the employee disposes of the stock before the holding period is up,
he must recognize as compensation income the difference between the option exercise
price and the fair market value of the stock at the time of the option exercise. In addition,
he will recognize income equal to the difference between his basis in the stock (the
exercise price increased by the amount included in gross income as compensation) and
the amount he receives in the disposition.
(c) If the employee waits to dispose of the stock until after the holding
period, there will be no compensation income, but there will be capital gain, if any (short or
long-term, depending on how long the stock is held). The capital gain would be the
difference between the amount received in the disposition over the basis in the stock (i.e.,
the amount the employee paid when exercising the option).
(3) Alternative Minimum Tax (“AMT”) for ISOs: While the exercise of an ISO does
not result in current taxable ncome, i there are implications with regard to the AMT. When
calculating income for AMT purposes, the difference between the fair market value and the exercise
price will be considered part of AMT income.
(4) Where does cash for exercise come from?
(a) Other assets;
(b) Brokerage loan and sale;
(c) Sale in same year.
C. Disposition of Option Stock
(1) Definition: Generally, a disposition is any sale, exchange, gift or transfer of legal
title of the stock. IRC §424(c) provides certain exceptions.
(a) Transfer from a decedent who held ISO stock to an estate, or a transferby bequest or inheritance.
(b) Exchange of ISO stock in certain nonrecognition transactions (e.g., reorganization).