UJA-FEDERATION OF NEW YORK
36th SIDNEY KESS ANNUAL ESTATE, TAX & FINANCIAL
THE CHARITABLE LEAD TRUST
A POTENT ESTATE PLANNING TOOL
Thursday, September 15, 2005
Marriott Marquis Hotel
New York, New York
PHILIP T. TEMPLE, ESQ.
McCarthy Fingar LLP
White Plains, New York
A. Charitable lead trusts. An individual (“grantor”) can transfer assets to a charitable lead trust that is either a grantor or non-grantor lead trust.
(1) If, for example, the Grantor provides a reversion for himself or his spouse, he will be taxed on the trust income during the trust term (a “grantor” trust) even though it is paid to charity, but he will be able to claim an income tax charitable contribution deduction for the calculated value of the charitable lead interest provided the trust is either:
(a) a lead annuity trust paying charity a fixed annual sum for the trust term; or
(b) a lead unitrust paying charity a fixed percentage of the value of the trust assets as revalued each year.
The Grantor will also be entitled to a gift tax charitable deduction for the charitable lead interest.
(2) Main drawback of law is that Donor cannot get the 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) If charitable beneficiary is public charity, ceiling is 30% of adjusted gross income with a five year – 30% carry-over for any excess contribution.
B. Testamentary or Inter Vivos Lead Trusts. Lead trusts paying income to charity are advantageous when created by Donor's will or during life time where there is no reversion to Donor or his spouse (a “non-grantor” lead trust) but the assets pass to others (i.e., children) at the end of the trust term. Donor gets a gift tax charitable deduction for the charitable lead interest thereby passing significant asset value to the ultimate beneficiaries at minimum transfer tax cost. Similarly, an estate tax charitable deduction is allowed for value of income stream paid to charity under lead trust created by Donor's will. Again, to get the gift or estate tax charitable deduction, charitable income interest must be guaranteed annuity (lead annuity trust) or fixed percent of net fair market value of trust assets, determined yearly (lead unitrust).
C. The JOLT -- Jackie Onassis lead trust. What she did for family, friends and charity.
(1) Entire residuary estate to a charitable lead trust:
(a) Term: 24 years (with provision not to violate Rule Against Perpetuities).
(b) Payout: 8% of initial fair market value.
(c) Beneficiaries: Such qualified charities as independent trustees shall select.
(d) Remainderman: Grandchildren in equal shares.
(2) Charitable deduction—approximately 96% of amount transferred.
(3) Taking care of family too.
(a) Trustee’s commissions.
(b) Learn Philanthropy.
(4) Illusionary - - but still great story.
D. Leveraging the Charitable Deduction for GST Purposes.
(1) You determine the GST by multiplying the top federal estate tax rate at the time the taxable event by an “inclusion ratio.”
(2) The inclusion ratio is:
1 minus exemption allocated to transfer value of property minus death taxes
minus charitable deduction
Ideally, donors should try to make the applicable fraction equal 1/1 so that, when subtracted from 1, the inclusion ratio will be 0. Or, if the denominator of the applicable fraction is larger than the donor’s exemption, the donor should make the fraction as large as possible, thereby reducing the rate of tax imposed. Allocating the exemption early in the game can, in effect, often shield appreciation on the trust property by locking in an inclusion ratio based on the lower initial value. Because the charitable deduction reduces the denominator, it
can provide a significant GST tax savings when used in connection with the GST exemption.
The major issue concerning the numerator is the timing of the allocation of the $1.5 million exemption. Valuation of the property transferred determines the denominator. When the inclusion ratio is zero, a transfer is exempt from the GST tax and when it’s one, the entire transfer is subject to the tax. Once you value the property transferred to a trust, for example, you can compute the denominator and allocate the GST exemption to produce an inclusion ratio of zero and a GST tax of zero.
E. See case study attached.
1. Case Study. An extremely simplified example of the horrific estate tax on the death of a surviving spouse (or, for that matter, a single person).
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 February 2005; his wife then dies later in 2005, leaving her entire estate to their children. Here is what the estate tax computations would look like:
Gross estate $3,000,000
expenses -- at 5% $ 150,000
Marital deduction --
balance of estate less
exemption amount* $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-
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
Taxable estate $4,607,500
Tentative federal estate tax $2,006,325
Less: Applicable credit amount $ 555,800
*No state death tax credit available as of 2005 _________
Federal estate tax $1,450,525
NYS Death tax $ 354,360
Total Estate Taxes $1,804,885
* limit exemption in this scenario to NYS maximum
exemption amount which is $1,000,000 in order to
defer payment of NYS estate tax.
2. 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 7.7% 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 January 2005 discount rate of 4.6%:
Gross estate $4,850,000
expenses -- at 5% $ 242,500
Gross charitable deduction computation:
Gross principal into unitrust
of $2,303,750 x 30.052% factor $ 692,323
into lead annuity trust of
$2,303,750 x 100% factor $2,303,750
Less: Estate tax payable* $ 225,359
Net charitable deduction $2,770,715
Total deductions: $3,013,215
Taxable estate: $1,836,785
Tentative federal estate tax $ 750,350
Less: Applicable credit amount $ 555,800
Federal estate tax $ 194,550
NYS death tax $ 102,078
Total taxes paid $ 296,628
The estate tax savings is $1,508,257
*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.