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Recent Commentary

Funding a Section 529 Plan

Thursday, January 14, 2021
Historical

By contributing low-yielding appreciated stock to a CRT, donors are able to fund their grandchildren's Section 529 plans, give to charity, avoid capital gains tax, and generate additional retirement income.

Visual Planned Giving - Chapter 12 - Charitable Remainder Trusts

Wednesday, January 23, 2019

In the twelfth chapter of Visual Planned Giving: An Introduction to the Law & Taxation of Charitable Gift Planning, author Russell James explores charitable remainder trusts (or "CRTs") and the rules governing each. CRTs offer both a wide range of benefits to correspond with a donor's goals and significant tax savings. They differ from CGAs because they are created by the donor, not the charity. The charitable remainder beneficiary of the CRT may not even know of its existence until it receives a check for the remaining assets after the death of the last income beneficiary. CRTs can last for one or more lives in being, or a term of years, not to exceed 20. To qualify as a CRT, the present value of the charitable remainder must be at least 10% at the creation of the trust.

There are two types of CRTs, the Charitable Remainder Annuity Trust (or "CRAT") and the Charitable Remainder Unitrust (or "CRUT"). Like a CGA, the CRAT pays a fixed sum to the annuitant each year. One difference is the annuity payments in the Charitable Remainder Annuity Trust are backed by the trust's assets, not the charity's assets. Thus, if the trust's assets are exhausted due to poor investments or the income beneficiaries' longevity, payments will cease. On the other hand, if a charity goes bankrupt, it won't be able to make the CGA payments.

Because the CRT is a tax-exempt entity, it can receive appreciated assets, sell them without incurring taxes, and make new investments. Income taxes will only be realized when the donor receives distributions. This leaves the CRT with more money to invest, which results in a higher income payout to the non-charitable beneficiary in the case of a CRUT or a longer stream of annuity payments in the case of a CRAT. Ultimately, the charity receives a larger sum upon the death of the last to die of the income beneficiaries due to the tax-exempt nature of the trust. CRTs offer flexibility not available with other forms of planned giving. Regardless of the complexity, one fundamental purpose is to swap a remainder interest for a charitable deduction and avoid taxes on the sale of the appreciated assets.

Some donors may be concerned with a premature death of all income beneficiaries, which would result in few income payments to the family unit. These donors typically consider using the income tax savings generated by the deduction to purchase life insurance to benefit heirs.

Income payments are taxed on a "worst in, first out" basis. Distributions are made first from ordinary income, second from capital gains (net short-term capital gain and then net long-term capital gain), third from tax-exempt income, and finally, fourth from a tax-free return of principal. If the CRT receives unrelated business income, it is subject to a 100% tax on this income.

In addition to the 10% remainder test, CRATs must pass a 5% probability of exhaustion test. Because income payments do not decrease when the trust asset value drops, as with a CRUT, there is a greater chance of the CRAT running out of funds. If the trust was exhausted, the donor would receive a charitable deduction, even though nothing passed to charity. Accordingly, a CRAT will be disqualified unless the chances of exhaustion of corpus are lower than 5%. With very low 7520 rates, CRATs will only qualify for the oldest donors. Fortunately, in 2016, IRS provided an alternative solution. A CRAT failing the 5% test will nonetheless qualify, if it requires termination, with all remaining assets passing to charity, whenever the assets fall to an amount less than 10% of the present value of the initial contribution.

Mr. James has created a set of 65 videos for his Complete Charitable Planning Training Series to help his readers understand Chapter 12 and the entire book.

Visual Planned Giving - Chapter 11 - Retained Life Estates (Remainder Interests) in Homes & Farmland

Wednesday, January 23, 2019

In the eleventh chapter of Visual Planned Giving: An Introduction to the Law & Taxation of Charitable Gift Planning, author Russell James gives an overview of retained life estates in homes and farmland. The charitable gift of a remainder interest in a home or farmland allows a donor to use the property for the rest of his or her life while at the same time allows a donor to enjoy an immediate tax deduction. As such, it is very attractive for a donor who intends to gift the property in his or her will since a donor does not obtain an income tax deduction if he or she makes a gift at death. However, unlike a gift through a will, which can be revoked if the donor changes his or her will, a gift of a remainder interest is irrevocable. Therefore, it differs from a bequest gift in another important way. Once the gift is made, the charity owns the remainder interest. The charity could wait until the donor's death to own the full home or could sell the remainder interest immediately to an investor. Coordinating the tax savings with payment of life insurance premiums through an Irrevocable Life Insurance Trust can allow for heirs to receive money in place of the property they would otherwise inherit. Combining these methods allows for both the charity and heirs to receive more, especially with taxable estates.

Any home owned will qualify for a remainder gift if the donor uses it as a residence. Even second homes, vacation homes, and boats qualify if they meet the residence test. The deduction for a gift of a residence is more complicated and will result in a smaller gift because IRS presumes the residence will depreciate over the donor's life. The Code does not define the useful life of the house over which it will be depreciated. The donor can get an opinion from an appraiser or an engineer. Alternatively, IRS examples use 45 years.

A charity may have concerns about accepting a gift of a remainder interest in a personal residence. If the donor fails to maintain the property, the remainder value may decline. Common law rules require the life tenant to pay for maintenance, insurance, and taxes on the property. Failure by the life tenant to do so gives the holder of the remainder interest the right to go to court and compel payment. Understandably, most charities prefer to avoid court, so they often require a donor to sign an agreement saying he or she will pay for these items. The donor could also make improvements to the residence, increasing its value. IRS letter rulings indicate these constitute additional charitable gifts.

Mr. James has created a set of 65 videos for his Complete Charitable Planning Training Series, to help his readers understand Chapter 11 and the entire book.

IRS Issues Revenue Procedures for 2021

Thursday, January 7, 2021
IRS Highlights

The Service issued six Revenue Procedures, updating the administrative and procedural mechanisms governing the issuance of letter rulings, determination and closing letters, and other advance guidance. These are gathered in Internal Revenue Bulletin 2021-1. Additional updates are expected in coming days.