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UT Austin Gift Planner — April 21, 2011

Giving News

UT Austin Gift Planner

April 21, 2011

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Register now for Professional Advisors Day

The University Development Office’s Gift Planning team and the Gift Planning Advisory Council will host the fourth annual Professional Advisors Day on Friday, May 13, 2011. Registration is now open on the event website at giving.utexas.edu/professional-advisors-day or by calling 512-475-9632.

This half-day seminar for professional legal and financial advisors includes two FREE hours of continuing education credit (CLE credit approved; CPE and CFP credit pending). Topics include:

“Can We Talk? Advising Your Clients about Family and Charitable Planning Under the New Tax Laws”

A panel discussion including:
Charles Thomson (Tom) Granger, III, Midwikis & Granger, P.C., Austin
Stephen Saunders, Saunders, Norval, Nichols & Atkins, LLP, Austin
Marjorie S. Schultz, Marjorie S. Schultz & Associates, Houston

and

“Modern Families, Modern Problems: Estate and Financial Planning for Unmarried Couples”
Featuring:
Rhonda Brink, Law Offices of Rhonda H. Brink, Austin
Anne Wynne, Ikard Wynne, LLP, Austin

Professional Advisors Day will take place in the NEW Student Activity Center on the UT campus, and the event includes lunch, an optional tour of the new building, and an insider’s look at the UT student experience.

For more information or to register, go to the event website at giving.utexas.edu/professional-advisors-day. Deadline for online registration is Monday, May 9, 2011.

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Are your clients deciding now about taking advantage of increased gift tax exemption before the end of 2012? How to use a charitable lead trust to leverage the exemption many times over


We are hearing from many estate planning professionals that their single clients with more than $5 million in assets or married couples with more than $10 million in assets are deciding right now whether to take advantage of the enormously increased gift tax exemption amount by making irrevocable transfers before the end of 2012. Dynasty trusts and grantor retained annuity trusts (GRATs) are being discussed, but this is also the perfect time to use charitable lead trusts to greatly multiply the amount that can be transferred for the future benefit of loved ones while minimizing transfer tax.

We hope that charitable lead trusts are being discussed with individuals who meet the following profile:

  • Are considering how and whether to make irrevocable transfers before the end of 2012 to reduce transfer taxes.
  • Have a track record of lifetime charitable giving or an interest in making a significant gift to one or more charitable organizations.
  • Own assets that are producing income that the owner or family/heirs would not miss for a period of years.
  • Want one or more living individuals who are a generation or more younger than the owner to receive some benefit from selected assets; may want younger individuals to receive the benefit before the end of the owner’s normal life expectancy (accelerate inheritance).

Income tax regulation section 20.2055-2(e)(2)(vi) provides that a qualified charitable lead trust must make an annual annuity (fixed dollar amount — a percentage of the original value of the contributed assets) or unitrust (fixed percentage of the value of the trust assets, revalued annually) distribution to one or more qualified charitable organizations. Unlike charitable remainder trusts, IRC section 664, there is no minimum annuity or unitrust payout percentage nor a maximum number of years for the trust term.

Income tax regulation section 25.2522(c)-3(c)(2) provides that the present value of the income stream to charity qualifies for a gift or estate tax deduction so long as the trust is organized and operates as a qualified charitable lead trust. The present value of the income stream is a function of four factors: (1) which version of the lead trust is being used, i.e. annuity or unitrust, (2) the length of the trust term, (3) the payout percentage, and (4) the IRC section 7520 midterm rate.

With the annuity version of lead trusts (fixed payout to charity) any of the following produce a higher present value of the income stream to charity and hence a larger charitable gift or estate tax charitable deduction:

  • Lower section 7520 midterm rate — 3 percent for March and April 2011 — between August 2003 and the end of 2008 the rate was higher than 3.0 percent.
  • Longer trust term.
  • Higher payout percentage.

Changes in the section 7520 rate do not significantly change the present value of the income stream to charity with the unitrust version of lead trusts (fixed payout percentage of the trust assets, revalued annually, to charity), but the length of the trust term and the payout percentage do.

Charitable lead trust for one generation younger

For illustration purposes, assume that your client is deciding how best to use $1 million of the additional $4 million gift tax exemption to benefit his or her children. Your client could make an outright gift to his or her children or transfer assets to an irrevocable trust for the benefit of the children. How much of the $1 million gift tax exemption would be used if he or she transferred the $1 million to a charitable lead annuity trust, usually the preferred version for transfers to the next generation? We will assume that the transfer is made when the section 7520 rate is 3.0 percent.

The answer depends on how long the trust lasts and the payout percentage.
With a 5 percent payout — 5 percent of $1 million = $50,000 paid to charity with end-of-the-year payments:

Trust term Charitable value Gift tax exemption used Total distributed to charity
10 years $426,510 $573,490 $500,000
15 years $596,900 $403,100 $750,000
20 years $743,870 $256,130 $1,000,000
25 years $870,660 $129,340 $1,250,000

With a 6 percent payout — 6 percent of $1 million = $60,000 paid to charity with end-of-the-year payments:

Trust term Charitable value Gift tax exemption used Total distributed to charity
10 years $511,810 $488,190 $ 600,000
15 years $716,280 $283,720 $900,000
20 years $892,650 $107,350 $1,200,000
25 years $1,000,000 $0 – none $1,500,000

Charitable lead trust to skip generations

Now assume that your client is deciding how best to use $1 million of the additional $4 million gift tax exemption to skip generations. How much of the $1 million gift tax exemption and of the generation-skipping transfer tax exemption would he or she use by transferring the $1 million to a charitable lead unitrust, usually the preferred version for transfers to skip persons? Again we assume that the transfer is made when the section 7520 rate is 3.0 percent.

That depends on how long the trust lasts and the payout percentage.

With a 5 percent payout:

Trust term Charitable value Gift tax exemption used
10 years $392,020 $607,980
15 years $525,940 $474,060
20 years $630,360 $369,640
25 years $711,780 $288,220
30 years $775,270 $224,730

With a 6 percent payout:

Trust term Charitable value Gift tax exemption used
10 years $451,290 $548,710
15 years $593,540 $406,460
20 years $698,910 $301,090
25 years $776,970 $223,030
30 years $834,790 $165,210

Charitable lead trust realities

With both types of charitable lead trusts the charitable value would be higher — and thus the amount exempt from gift tax also higher — if a higher payout percentage rate was chosen. But increasing the payout rate also increases the chances that value of the trust assets received by the individuals at the end of the trust term will be less than the original funding value.

Projected investment return for the intermediate term from investment opportunities that do not violate the jeopardizing investments prohibition that applies to charitable lead trusts, Internal Revenue Code section 4944, does not seem to support higher payout rates from lead trusts where the trustor/donor wants to maximize the eventual value of the trust assets distributed to individuals. For charitable lead trusts with longer terms, 15 years or more, historic investment returns may support a 5 percent or 6 percent trust payout with less risk of significant loss in the value of the trust assets that will be distributed.

Careful consideration should be given to the type of assets contributed to lead trusts, including the amount of unrealized capital appreciation and the current and projected investment return, because these are taxable trusts. The amount of annual net income, including realized capital gains, minus the amounts distributed to the charitable beneficiaries will be taxable to the trust. The sale and reinvestment of trust assets must be fine-tuned with the goals of (1) producing sufficient investment return net of trustee fees and trust expenses to make the annual distributions to the charitable beneficiaries, and (2) maintaining or increasing the value of the underlying trust assets for the benefit of the individuals who will receive the trust assets after the end of the trust term.

Strategies that have been employed to accomplish both of these goals include contributing cash or assets with minimal capital appreciation and selling only enough appreciated assets annually to produce sufficient revenue to pay trustee fees and trust expenses plus the distributions to the charitable beneficiaries.

Final thoughts

A discussion of super or defective charitable lead trusts that qualify as grantor lead trusts for income tax purposes — so that the income tax charitable deduction can be claimed — without causing the trust assets to be considered as part of the trustor/donor’s estate is beyond the scope of this article. Be aware that the charitable value for income tax purposes would be the same “charitable value” in the charts that appear earlier in this article.

Of course a charitable lead trust can split the annual distribution among several charities, which can help facilitate a donor’s multiple charitable interests.

The Gift Planning team at The University of Texas at Austin is happy to explore the subtleties of charitable lead trusts with professional advisors and to run multiple illustrations of charitable lead trusts at no cost or obligation. Please feel free to contact us at:

University Development Office
The University of Texas at Austin
Gift Planning team
P.O. Box 7458
Austin, Texas 78713-7458

Phone: 512-475-9632
Toll free: 866-4UTEXAS (866-488-3927)
Fax: 512-471-3439

Website: giving.utexas.edu/giftplanning/
Email: giftplan@www.utexas.edu

IRS Circular 230 Notice: The University of Texas at Austin does not provide legal, tax, or financial advice. Consequently we urge you to seek the advice of your own legal, tax, or financial professionals in connection with gift and planning matters. This communication (including any attachments) is not intended to be used and cannot be used for the purpose of avoiding tax-related penalties.

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