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UT Austin Gift Planner – Aug. 20, 2008

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Welcome to The University of Texas at Austin Gift Planner, an online resource for professional advisors in the estate and financial planning industries. The Gift Planner provides practical information on gift planning issues, reports new developments in charitable giving techniques, connects you with leading professionals, and informs you about key events and resources at UT Austin.

Aug. 20, 2008
Vol. 2, No. 1

Charitable remainder trusts offer planning flexibility

Charitable remainder trusts (CRTs) are among the most flexible gift plans available because they can address multiple financial and family needs while helping a client make a significant gift to charity.

A CRT is an irrevocable trust as described in Internal Revenue Code section 664. A CRT can be created for one or more lives in being or a term of up to 20 years. Treas. Reg. §§ 1.664-2(a)(1)(i); 1.664-3(a)(5)(i). During the term, the CRT makes periodic distributions to named beneficiaries. The distribution rate cannot be less than 5% or more than 50%; the typical distribution rate is 5% or 6% annually. When the term has run, the remainder is distributed to one or more charitable organizations named in the trust instrument. CRTs are commonly created for the grantor’s life or for the lifetimes of the grantor and spouse, but several other terms are possible. Whatever the term, however, the remainder value to charity must be at least 10% of the funding amount for the trust to qualify as a CRT. I.R.C. §§ 664(d)(1), (2)(D).

Types of CRTs

There are two basic forms of a CRT. A donor may create a charitable remainder annuity trust (CRAT), which pays a fixed annual sum to named beneficiaries, or a charitable remainder unitrust (CRUT), which pays a variable sum based on the value of the trust, as calculated annually.

Tax benefits

Two tax deductions

A donor who creates a CRT is eligible for two charitable deductions: income tax and gift or estate tax. Due to the federal midterm rates calculated using I.R.C. section 7520, CRUTs currently may offer larger deductions than CRATs. Thus, now is a good time for a donor to create a CRUT, which is a more flexible planning vehicle than a CRAT. For instance, a donor may make additional contributions to an existing CRUT but not to a CRAT.

When a donor creates a CRT naming a public charity as the remainderman, the donor may claim an income tax deduction equal to the present value of the remainder interest given to charity subject to the 30%/50% deduction rules (depending on whether the donor contributes appreciated property or cash). Of course, any deductions not used in the year of contribution may be carried forward for the next five years.

Second, if the CRT is created and funded during the donor’s lifetime, he also may claim a gift tax deduction equal to the present value of the remainder interest given to charity. Alternatively, if the CRT is created via a testamentary document, the estate may claim an estate tax deduction for the same amount.

Reduced or no capital gains liability

Because a CRT is a tax-exempt trust, assets placed in the trust are not subject to capital gains tax when later sold. This is particularly beneficial if the donor funds the CRT with highly appreciated assets.

When in a client’s lifetime are CRTs useful planning tools?

Many people use a flip unitrust to augment their current retirement plans. By setting one up in a client’s peak earning years, the client can make contributions to the CRT and allow the CRT to grow while taking little, if any, income during the early years. The best assets to contribute are appreciated but low-yielding assets. In the taxable year of the “triggering event” (any non-discretionary event in the hands of the trustee or the income beneficiary) occurs, such as December 31 of the year the income beneficiary reaches a certain age, the CRT “flips” and begins making income distributions. The amount of the distribution is equal to the payout percentage multiplied by the value of the trust assets revalued annually. Unlike an IRA or 401(k) plan, there is no limit on how much a client can contribute to the CRT.

A CRT can be a great strategic tool when a client plans to sell an asset that has appreciated greatly in value, such as rental property For example, a donor may create a CRT, and — as long as there is no debt on the property — contribute the property that he no longer wants the burden of managing.

A CRT also works well when a client wants to provide for the care of someone with a financial, physical, or mental disability. Most attorneys prefer to create the CRT so that it makes distributions to a separate special needs trust that allows discretionary distributions for the support and care of the beneficiary. In 2002 the IRS issued a revenue ruling that set forth guidelines for CRTs that make payments to special needs trusts. Rev. Rul. 2002-20, 2002-17 IRB 794 (29 Apr 2002). The CRT may make distributions to a special needs trust if the CRT term is 20 years or less. However, if the CRT term is based upon a lifetime, the CRT must be for only one lifetime and the beneficiary must have a disability that renders him unable to manage personal financial affairs, as defined in Internal Revenue Code section 6511(b)(2)(A).

A CRT is also a powerful tool when combined with a charitable lead trust (CLT). The marriage of the two trusts produces significant current income tax savings, provides immediate income to the income beneficiaries designated in the CRT and to one or more charities and at the end of the term provides a lump sum that has grown tax free to one or more charities and a lump sum to the beneficiaries of the CLT, who take the assets at the trust’s tax basis and holding period.

A client may fund a CRT with an IRA at death for a surviving spouse or children. Placing the IRA in the CRT removes it from the estate, eliminates the income tax that the surviving spouse or children pay on the IRA, and diversifies the inheritance. Because the CRT is a tax-exempt trust, the trust can sell the IRA assets and not pay any tax. Then the proceeds can be invested to earn new income that will be distributed to the beneficiaries and reported at the beneficiaries’ lower tax rate.

Potential pitfalls

The biggest potential pitfalls are excess business holdings that result in unrelated business taxable income, placing debt encumbered property into the CRT and placing property for which a sale already has been arranged into the trust. However, there are exceptions for each of these issues, and the pitfalls can be avoided if the issue is recognized early.

If you have questions or would like to discuss any of the information presented in this article, please call our Gift Planning team at 866-4UTEXAS (866-488-3927).


Meet a colleague: Bob Dawson on charitable lead trusts

Bob DawsonBob Dawson graduated from the UT Austin School of Law in 1962 and has practiced law in Midland since then. He is a shareholder at Cotton Bledsoe Tighe & Dawson, P.C.

What do you like about estate planning?

Estate planning is perhaps the most creative field of law I have ever encountered. The law is not completely clear in many areas, so we are always looking for new ways to do things. It is a huge intellectual challenge, and we never stop learning in the practice.

How does a charitable lead trust work?

A charitable lead trust is an irrevocable split-interest trust created either during a person’s lifetime or at his death. The lead interest is owned by charity for either a term of years or for the donor’s life. The trustee pays income, in the form of a fixed or variable annuity, to a charitable organization every year for the designated term. The second interest is an individual interest — it can be owned by any living person other than a charity. At the expiration of the trust’s term, the trustee distributes the assets remaining within the trust to the named private individuals, such as the donor’s children, free of, or at greatly reduced, federal gift and estate tax.

What are the rules regarding payout percentages and terms, and how do they differ from those applicable to charitable remainder trusts?

In contrast to a charitable remainder trust, which is subject to strict rules about both the term and the rate of payout, a charitable lead trust does not have payout restrictions. It may pay as little as 1 percent or as much as 100 percent. The percentage used and the duration of the trust determine the size of the charitable deduction for gift or estate tax purposes. In addition, there is no maximum number of years a charitable lead trust can operate for federal tax purposes. However, state law may impose a limit.

How does a charitable lead trust affect gift and estate taxes?

Under the most commonly used form, an inter vivos non-grantor charitable lead trust, the donor receives a charitable deduction on his gift tax return for the amount of each annuity payment (discounted to its present value). Only the remainder value, or what is left after the charitable deduction is taken, constitutes a gift, so the amount of the gift is dramatically reduced. The same thing is true of a testamentary charitable lead trust. Only the remaining interest that will pass to individuals is treated as part of the donor’s taxable estate.

A charitable lead trust can be a unitrust or annuity trust. What is the difference, and how does it affect the generation skipping transfer tax?

When a donor forms a charitable lead trust to benefit a skip person, such as a grandchild, the trust becomes subject to generation skipping transfer tax. All charitable lead trusts allow a donor to use his generation skipping transfer tax exemption, but the inclusion ratio of a charitable lead annuity trust cannot be determined until the lead interest ends. In contrast, the inclusion ratio of a charitable lead unitrust is determined when the trust is established. Thus, when a donor wants to benefit grandchildren via a charitable lead trust, it is best to create a charitable lead unitrust.

Who benefits most from creating a charitable lead trust?

Generally, those clients who benefit from charitable lead trusts are the economically fortunate who own highly appreciated property that will attract a lot of gift tax or estate tax someday. However, the most important characteristic is that they have to be charitably inclined. People who don’t have some philanthropy in their hearts simply are not going to use charitable trusts. The tax benefits are there, but people are not going to do it. Finally, people must make financial provisions for their children or their other descendants outside the charitable lead trust because that money is not going to be available to the children or grandchildren for five, 10, or 20 years. People who have made their children and grandchildren financially secure either through lifetime gifts, irrevocable life insurance trusts, or other means of transferring wealth are the ones who will benefit most from the use of a charitable lead trust.

Which assets are best used for funding a charitable lead trust?

The assets that are best used to fund a charitable lead trust are those with growth potential or assets subject to valuation discounts, such as discounts for lack of marketability or lack of control. For example, depressed stocks, real estate, or discounted assets such as partnership interests work well. We encourage all of our clients who have good securities portfolios or limited partnerships to consider charitable lead trusts. We also use family limited partnerships in many of our estate plans. Limited partnership interests that generate cash flow to the limited partners are wonderful assets to use in charitable lead trusts because the partnership interests are subject to one or more of the valuation discounts.

What are the pitfalls?

It is important to make certain that the lead trust does not have unrelated business taxable income under Internal Revenue Code section 512, or it will be restricted to a 50 percent charitable income tax deduction under Internal Revenue Code section 170 or section 681. It is also important for the donor to avoid retaining any powers that would pull the value of the charitable lead trust back into his estate under Internal Revenue Code sections 2036 or 2038.

Why are living or inter vivos charitable lead trusts especially timely now?

In 2007 the Internal Revenue Service published its first set of sample charitable lead trust documents. Now we practitioners can see the language the IRS thinks should be in a lead trust, which gives us a comfort level we have never had before. Second, charitable lead trusts thrive in a low interest rate environment, and the federal midterm interest rate is set rather low right now. Third, we have a stock market where financially sound stocks nevertheless are depressed because of the cloud of bad economic news hanging over our country right now. Finally, the IRS in July 2008 published new regulations relating to Internal Revenue Code section 2036 that give us information about how to make calculations for trusts with a front-end interest followed by a remainder to family. This is a good time for charitable lead trusts, and we are actively contacting our clients and saying, “This is not going to last forever; let’s get something done now.”


Everyday Excellence: Doctoral candidate explores sign language in autistic children

One of President Bill Powers’ priorities is recruiting and retaining top graduate students. Here is the story of one such graduate student, Aaron Shield.

Aaron ShieldA scribble in the margin of an old notebook gave linguistics doctoral student Aaron Shield the idea that became his dissertation topic: the use of sign language in autistic children.

What drew you to your current area of research?

I have been fascinated by sign language since the time I first saw deaf kids signing when I was only 5 years old. After that I begged my parents for sign language lessons. Later, I went on to study a number of spoken languages, which I also loved, — especially Italian. When I came to UT I was reintroduced to that early interest. The American Sign Language program is housed within the linguistics department, so there were signers around me all the time, as well as several deaf graduate students. To study signed languages from a theoretical linguistics framework is still very cutting-edge; signed languages challenge our assumptions about what human languages are. They possess many of the same characteristics as spoken languages yet show obvious differences due to the visual-spatial modality. In any case, I rediscovered sign language at UT and have been working on various issues in sign linguistics since then.

How did this evolve into a focus on autism?

At first, because of all the attention in the media. I started thinking about how closely certain social behaviors — such as facial expression and eye contact — are related to linguistic meaning in signed languages. And I started wondering how autism might impair sign language in ways that wouldn’t be apparent in spoken languages. As it turns out, linguists don’t know very much about autism, and people who study autism don’t tend to know much about linguistics. So I’m trying to bridge that gap in some way.

Where do you get your best ideas?

My subconscious. It sounds new age, I know, but it’s true. I struggled for well over a year before I came to my dissertation topic: sign language in deaf and hearing autistic children. Yet when I looked back in my notebooks from the year prior, I found that I had scribbled “deaf autistics” in the margin. It was a doodle from class, yet it contained the seed of the idea that I am most deeply involved in and committed to now. The idea was there all along, and it had emerged in the form of a daydreamy doodle. If only I had reread my scribbles a year earlier!

What advice do you have for people entering graduate school?

Don’t participate in the competitive kvetch — people complaining about how much work they have. It’s a huge pastime in graduate school, and also a huge waste of time, and it only makes you feel nervous that other people might be working harder than you. Just focus on your own stuff and don’t worry about what anyone else is doing.

If you weren’t in grad school what would you be doing?

Med school. My parents still would ask me if I didn’t want to maybe go to medical school until well into my third year of graduate school. Lucky for me my brother is now a second-year medical student, so my parents will get to have a doctor son after all.

What’s your definition of intelligence?

Curiosity and the ability to think critically. Curiosity about the world, curiosity about other people — the constant desire to want to know why things are the way they are. It’s a fascinating world and there is so much to learn, always. I find myself most impressed with people who ask questions that come from a genuine place of wanting to know. And critical thinking is perhaps the most difficult but most important skill of all. The ability to ask: How do I know the things that I think I know? Why do I think I know these things? What are the alternatives? These questions are rarely asked, yet vitally important, not just for the intellectual pursuit but for a civil society.

What do you want your degree to mean?

A six-figure salary and a place in TV punditry. Just kidding. I hope it means that I’ve been trained to conduct cutting-edge research in my field, that I have areas of expertise beyond what anyone else has done before, and that I am adding to the world’s knowledge through my work.

Q & A by Elisabeth McKetta, September 2007


New team member: Michelle Rosenblatt

Associate Director Michelle Rosenblatt joined the Gift Planning team in May 2008. She previously worked as a tax and estate-planning attorney for a boutique law firm in Los Angeles and for Crescendo Interactive, Inc., a national provider of gift-planning consulting, software, and education. She earned a bachelor’s degree in psychology from UT Austin, a law degree from Pepperdine University School of Law, and is admitted to practice law in California and Texas. She is also a member of the National Committee on Planned Giving and the Estate Planning Council of Central Texas.