Estate Planning with Charitable Lead Trusts (CLTs) and Family Foundations

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1 Estate Planning with Charitable Lead Trusts (CLTs) and Family Foundations Authors Michael V. Bourland Jeffrey N. Myers Darren B. Moore John W. Conner Bourland, Wall & Wenzel, P.C. Attorneys and Counselors 301 Commerce Street, Suite 1500 Fort Worth, Texas (817) (817) (facsimile) E mail: mbourland@bwwlaw.com Bourland, Wall & Wenzel, P.C. 1 Charitable Lead Trusts (CLTs) An irrevocable trust that distributes a guaranteed annuity (CLAT) or unitrust amount (CLUT) to a qualified charity or charities for a term of years or the lifetime of living individual(s) Annuity (See II.A.1) Unitrust (See II.A.2) Remainder interest paid to non charitable beneficiary CLT can be inter vivos or testamentary, grantor or non grantor Grantor CLT (See III.A) Non Grantor CLT (See III.B) Other Requirements Completed Gift (See II.B) Qualified Beneficiary (See II.C) No Required Minimum Distributions (See II.G) 2 1

2 Charitable Lead Trusts Non Grantor CLT (See IV.A) Income Tax: Taxed to the Trust; 642(c) Unrelated Business Taxable Income (UBTI) Estate & Gift Tax: Grantor will pay tax only on value of remainder interest GST Tax: Depends on the status of the remainder beneficiaries and type of CLT 3 Grantor CLT (See IV.B) Income Tax: Charitable Lead Trusts Taxed to Grantor; Grantor receives income tax deduction upon creation/funding; no income tax deduction over lead trust term Estate & Gift Tax: Inter vivos transfer subject to gift tax but not estate tax, unless Grantor or Grantor s Spouse retains powers required to make trust a grantor trust GST Tax: Depends on the status of the remainder beneficiaries and type of CLT 4 2

3 Charitable Lead Trusts Private Foundation Rules (See II.H) CLT subject to certain private foundation rules Self Dealing (See II.H.1) Reimbursement of Expenses (See II.H.1a) Jeopardizing Investment (II.H.3) Taxable Expenditures (II.H.4) Unrelated Business Taxable Income (UBTI) (See II.H.2, IV.A.2 & IV.B.8) Arises when the CLT has income from an unrelated trade or business or when CLT has income incurred with respect to debt financed property Only applies to non grantor CLT Independent Trustee v. Related Party as Trustee (See VI.A) Treatment of CLT Payment Received by Private Foundation (See VI.C) Sale of CLAT Remainder Interest (See VI.D) 5 Private Foundations Per 509(a): Organization described in 501(c)(3) other than the following public charities: (See II.C & D) Traditional public charities Publicly supported charities Supporting organizations Public safety testing organizations (i.e. 501(c)(3) is a private foundation if it fails to qualify as a public charity) 6 3

4 Private Foundations Non Operating (most common) (See II.E.1) Funding usually comes from a single or limited number of source(s) (i.e. an individual) Must generally distribute annually at least 5% of its Asset Base (i.e. cash, stocks, bonds, etc.) in Qualifying Distributions (See IV. A & B) Qualifying Distribution is a grant to a charity or to a noncharity for charitable purposes See IV.A & IV.B More limited charitable income tax deductions Operating (See II.E.2 & V) Directly carries on charitable activities More liberal public charity income tax deductibility limits Must meet income test and one of the other tests ( assets test; endowment test; and support test ) 7 Private Foundations Tax Treatment for Donors (see II.F): Non Operating Private Foundation Income Tax Deduction Limits Gift of Cash/Nonappreciated Property: 30% of AGI Gift of Appreciated Property: 20% of AGI Basis limitation if not Qualified Appreciated Stock Operating Private Foundation Income Tax Deduction Limits Gift of Cash/Nonappreciated Property: 50% of AGI Gift of Appreciated Property: 30% of AGI Operating Foundations not subject to tax on undistributed income (see V.B.4) Whether Non Operating or Operating Private Foundation, gift, estate and GST tax, deductions are 100% of value of transferred asset Subject to Excise Taxes on: Self Dealing; Excess Business Holdings; Jeopardizing Investments; and Taxable Expenditures See IV 8 4

5 Individual creates a Charitable Lead Annuity Trust (CLAT) under Individual s Will or Revocable Trust Testamentary Non Grantor Charitable Lead Annuity Trust CLAT will be funded with property from Decedent s estate or revocable trust Preferably, the property will be in the form of an illiquid interest in a pass through discount vehicle; i.e. a limited partnership interest, etc. CLAT will pay a specific annuity amount to the charitable beneficiary for a specified number of years In this case study, charitable beneficiary will be the Decedent s Family Foundation Non charitable remainder beneficiary will be a Non GST Trust Use the Non GST Trust, as opposed to individuals, to provide for creditor protection, asset management control, asset consumption control, family law issues 9 After being funded, CLAT will sell Decedent s discount vehicle interests to a GST Trust under the estate administration exception to the private foundation excise tax rules for self dealing. The following requirements apply and administrator or executor of the Decedent s estate or trustee of Decedent s revocable trust to qualify for the estate administration exception: (See II H I. TR I(d) (I)(b)(3)) 1. Possesses a power of sale with respect to the property, or Has the power to reallocate the property to another beneficiary, or Is required to sell the property under the terms of pre existing option subject to which the property was received by the estate or revocable trust. 2. Such transaction is approved by the probate court having jurisdiction over the estate (or by another court having jurisdiction over the estate, trust (CLAT) or foundation) 3. Transaction occurs before the estate is terminated 4. Estate or Trust (CLAT) receives amount equal to/exceeds FMV of CLAT s interest in property 5. Estate or Trust (CLAT) receives asset at least as liquid as the asset it sold. 10 5

6 As part of the sale, the CLAT will receive a note from the GST Trust Note length will track the length of the charitable lead term Interest rate for the note will be the applicable AFR or such rate, when combined with note principal payments, will be sufficient to allow CLAT to make its annuity payments to Family Foundation CLAT will receive note payments from the GST Trust and will use the payments in order to make the annuity payments to the Family Foundation 11 Remainder beneficiary (Non GST Trust) will sell its remainder interest to the GST Trust for a note Will allow the CLAT to avoid the date of CLAT termination rule for determining value the denominator of the fraction in a generation skipping transfer Adjustment to CLAT spendthrift clause will be required At the end of the charitable lead term the remaining trust assets (i.e. primarily the note) are distributed to the GST Trust (which has purchased the remainder interest from the Non GST Trust) 12 6

7 Tax Results: Non Grantor CLAT is taxed as a separate entity Estate Tax value of the remainder interest is significantly less than value of CLAT assets at time of funding the CLAT Post death appreciation of assets in CLAT pass to remainder non charitable beneficiaries (GST Trust) and to the CLAT asset purchaser (GST Trust) without estate tax ramifications Decedent s estate receives an estate tax charitable deduction for value of private foundation s interest in CLAT Value of assets transferred to CLAT are subject to reduced estate tax or estate tax is eliminated (i.e. zeroed out CLAT ) 13 The information set forth in this outline should not be considered legal advice, because every fact pattern is unique. The information set forth herein is solely for purposes of discussion and to guide practitioners in their thinking regarding the issues addressed herein. Non lawyers are advised to consult an attorney before undertaking any issues addressed herein. Unless otherwise stated herein, pursuant to requirements prescribed by the Internal Revenue Service under Circular 230 for tax practitioners, Bourland, Wall & Wenzel P.C. must inform you that any U.S. federal tax advice or opinions contained in this paper are not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction or matter addressed in this communication. 14 7