Estate and Elder Law

Year-End Charitable Giving: More Attractive Than Ever In 2010

By Genevieve M. Moore, Esq.

As estate planners, we are familiar with advising clients about charitable gifts.  Gifts and bequests can yield valuable income, gift and estate tax deductions to donors, and of course provide significant philanthropic benefits.  This year's historically low federal discount rates have made certain types of gifts particularly attractive.  With these rates falling even lower in December, and with the fact that many donors consider making charitable gifts at year end, this month presents unusual opportunities for charitable giving, particularly when measured against the scheduled increases in gift and estate tax rates, and possible future escalations in income tax rates on retained property.

Simple charitable gifts.  Outright gifts of cash or other property are the simplest to make, and are not affected by changes in the federal discount rate.  Significant charitable gifts made this year could be advantageous by removing valuable property from a donor's estate that would otherwise be subject to estate tax in subsequent years (if not left to charity as part of the donor's estate plan).  As of this writing, the estate tax is scheduled to return in January 2011, with a maximum rate of 55% for estates in excess of $1 million, and an additional 5% surcharge on certain estates in excess of $10 million.  Estate tax rates and exemptions are always subject to change as a result of Congressional action; however, as long as there is an estate tax it is axiomatic that the more your client can comfortably give away during lifetime, the less will be subject to estate tax upon his or her death.  Also, making a lifetime gift to charity - as opposed to a testamentary gift - can yield valuable income tax deductions for your client.  Of course, if income tax rates go up next year, a charitable deduction might be more useful then, but this should be weighed against itemized deduction phaseouts that will apply next year.  Clients contemplating large charitable gifts should thoroughly review the possible income tax outcomes to determine the best timing for their gifts.

More complex charitable gifts.  It is in the area of more complex charitable gifts - "split-interest" gifts - that the greatest opportunities for tax savings exist.  Split-interest gifts are certain types of gifts, sanctioned by the Internal Revenue Code, in which individual and charitable beneficiaries receive successive interests in property.  The most common types of split-interest gifts are charitable remainder trusts, charitable lead trusts, gift annuities, and gifts of remainder interests in homes and farms.  Income and gift tax deductions for the present value of these gifts are determined using a federal discount rate (the "§7520 rate") that fluctuates every month.  The §7520 rates have reached record low levels this autumn, and will be even lower in December.  The lower the §7520 rate, the greater the charitable benefit for split-interest gifts in which the charity receives the upfront gift and the "remainder" passes to individuals.  That makes charitable lead trusts particularly attractive now. 

  • Charitable lead trust illustration:  A charitable lead trust can take two forms:  an charitable lead annuity trust (CLAT) or a charitable lead unitrust (CLUT).  The annuity (fixed) or unitrust (variable) amount is paid to one or more qualified charities for a specified period of years. The settlor receives an income tax deduction at the time of the gift equal to the present value of the annuity paid to charity, and pays gift tax only on the present value of the remainder passing to others.1  To illustrate the charitable benefit, suppose that in December 2010 your client transfers property worth $1 million to a CLAT in which his or her favorite charity will receive a 7.0% income interest for 10 years (i.e., $70,000 per year payable at the end of each of the 10 years), and his or her children will receive the remaining trust property after the 10-year term.  The taxable gift to the children is $364,589 ($1,000,000 less $635,411, which is the present value of the 10 payments of $70,000).  Any appreciation in the value of the transferred assets passes to the benefit of the children.  This suggests that if your client owns assets that are expected to appreciate, a charitable lead trust can be a great vehicle for transferring the appreciation to his or her children (or to others).2  Remember too that the gift tax generated by the gift to the children would be $127,606 in 2010 but rise to $164,065 in 2011, because of the scheduled increase in the gift tax rate from 35% to 45% on January 1 (assuming your client has fully utilized his or her $1,000,000 lifetime gift tax exemption).  This alone makes a December gift much more attractive.  Additional gift tax savings can be realized if the property contributed to the trust can be discounted, e.g., for lack of marketability.

Compare the hypothetical above to an identical CLAT established when the §7520 rate was 3.2%, as it was just one year ago.  Instead of a taxable gift of $364,589 to the children, in December 2009, the taxable gift would have been $408,934, and had the CLAT been funded in December 2007 when the §7520 rate was 5.0%, the taxable gift would have been $459,481.  This illustrates the effect of fluctuations in the §7520 rate.

As §7520 rates rise, gifts by which individuals receive the income interest and a charity receives the "remainder" become more attractive, because the value of the deductible remainder rises with the §7520 rate.  With this month's historic low §7520 rate and a record low 35% gift tax rate, not to mention depressed asset values, charitable lead trusts are more appealing, but in the right situation a charitable remainder trust also could be attractive.

  • Charitable remainder trust illustration:  A charitable remainder trust is more or less the reverse of a charitable lead trust.  The annuity or unitrust amount is paid to one or more individuals for their lifetime(s) or for a specified period of years. The settlor receives an income tax deduction at the time of the gift for the present value of the remainder, and pays gift tax only on the present value of the income interest only if it passes to others.  To illustrate, suppose that in December 2010 your client transfers property worth $1 million to a CRAT in which his child will receive a 5% annuity interest for 10 years (i.e., $50,000 per year payable at the end of each of the 10 years), and his or her favorite charity will receive the remaining trust property after the 10-year term.  The taxable gift to the child is $453,865 (the present value of the 10 payments of $50,000 per year) and the value of the charitable gift is $546,135.  The charitable gift also gives your client a valuable income tax deduction this year.  A taxable gift of this size to the child this year - even at the relatively low 35% gift tax rate - would generate significant gift tax liability (or use a large portion of your client's lifetime gift tax exemption).  In this situation your client might prefer to name himself or herself (or his or her spouse) as the income beneficiary(ies) of the charitable remainder trust, which would avoid any gift tax liability this year.

Caution:  Today's low §7520 rates make it easier to run afoul of certain IRS requirements that the charitable gift be no less than 10% of the value of the assets transferred, and that there be no greater than a 5% probability that the trust assets will be exhausted during the trust term.  For particularly old or young annuitants, this problem can be solved by choosing a term of years instead of a lifetime interest for the annuitant. 

Other possibilities:  If a charitable trust is not a good fit for your client, he or she might want to consider establishing a charitable gift annuity (if offered by the charity of choice), or giving a remainder interest in a personal residence or farm/ranch property to a charity.  The latter option works particularly well if your client already plans to leave such property to a charity upon his or her death.  Giving a remainder interest to the charity during his or her lifetime allows your client to retain a life estate in the property and obtain a significant income tax deduction. 

Naturally these structures are complicated and require careful valuation and tax advice, and strict adherence to the requirements set forth for split-interest gifts.  They also may require the input of the charitable donee.  But the advantages of making such gifts this year may make the extra cost and effort well worth the tax savings.

 

For two decades Genevieve Moore has represented individual clients in the areas of estate planning and estate and trust administration.

With respect to estate planning, Ms. Moore assists clients with their wills and revocable "living" trusts, and advises clients on a broad range of estate planning issues. These include personal matters involving guardianships, health care arrangements and powers of attorney, and tax advice with respect to gift tax, estate tax, and generation-skipping transfer tax planning. Her work often focuses on the most tax-efficient ways to transfer family wealth to successive generations, through the use of family partnerships, limited liability companies, and S corporations, and also the formation of sophisticated trust arrangements (e.g., grantor-retained annuity trusts, and qualified personal residence trusts). She also advises clients on techniques to transfer real property, and on structures for carrying out their philanthropic goals, often through the formation of charitable trusts and private foundations. She also has expertise in educational planning.

With respect to estate and trust administration, Ms. Moore advises executors and trustees on all aspects of the administration of a decedent's estate and trust. This includes advice and representation in state probate court, as well as the review of decedents' estate tax returns. She also represents individual and institutional trustees in trust litigation matters.

Ms. Moore received her law degree from the University of California, Hastings College of the Law, in 1989, where she served as Senior Managing Editor of the Hastings Constitutional Law Quarterly .

 

Morrison & Foerster's Trusts and Estates group provides sophisticated planning and administration services to a broad variety of clients.  If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or PMcCabe@mofo.com.

© Copyright 2010 Morrison & Foerster LLP.  This article is published with permission of Morrison & Foerster LLP.  Further duplication without the permission of Morrison & Foerster LLP is prohibited.  All rights reserved.  The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Morrison & Foerster LLP or any of its clients.  The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.


[1]  These trusts can also be established for the grantor's benefit, or as grantor trusts, but those options are not discussed here.

[2] Your client can receive an income tax deduction as well this year for the charitable gift, but only if the CLAT is a grantor trust.

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