I CAN T GET NO CLATISFACTION. By Dan Rice INDEX. 1. Presentation Synopsis...Pages 2 5

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1 I CAN T GET NO CLATISFACTION By Dan Rice INDEX 1. Presentation Synopsis......Pages Charitable Lead Annuity Trusts Planning Strategies Part 1... Pages Charitable Lead Annuity Trust Planning Strategies Part 2. Pages Citations Of Authority... Pages

2 1. Presentation Synopsis Not since Charitable Lead Trusts came into existence in the Tax Reform Act of 1969, have we experienced this historical confluence of: 1. Low-priced, high value stocks; 2. applicable federal rates at a 20 year low; and, 3. the largest, ongoing intergenerational wealth transfer ever witnessed. This confluence has created the perfect combination of circumstances to consider Charitable Lead Trusts for select clients, particularly, the Charitable Lead Annuity Trust (CLAT). A. Charitable Lead Trusts General Description Of Qualified Lead Trusts This presentation is primarily for planners who are already familiar with Charitable Lead Trusts. Charitable Lead Annuity Trust Charitable Lead Unitrust Grantor or Non-Grantor; Reversionary or Non-Reversionary No minimum or maximum Trust payout rate Trust Duration (number of years or lifetime(s)) Trust Taxation and Tax Benefits (income, gift and estate tax benefits) Permissible Charitable Beneficiaries B. The Grantor Reversionary Charitable Lead Annuity Trust You could nickname this CLAT the Conundrum CLAT" because this plan enigmatically uses a GRANTOR REVERSIONARY Charitable Lead Annuity Trust (CLAT). It sounds counterintuitive to suggest a reversionary CLAT for family wealth transfers? Let's go through an overview of the plan. Afterwards, we will look at an example. Overview 1. The Donor creates a Grantor Reversionary CLAT, funding it with a treasure chest of assets, which have significant appreciation potential (i.e., real estate, partnership units, LLC interests, closely-held stock (C stock or S stock), etc.). The CLAT trustee must be independent; however, the Donor can remove/replace the independent trustee. 2. The CLAT makes annual (or more frequent) annuity payments to charity for a term of years. 3. The G-CLAT is designed so that the Grantor s reversionary interest is less than 5% of the fair market value of G-CLAT assets under IRC 7520(a). The G-CLAT is also designed so that the Grantor is treated as the owner 2

3 for income tax purposes. In such a situation, the Grantor will receive an income tax charitable deduction, but the Grantor will also personally report the G-CLAT s income during the G-CLAT term. 4. Contemporaneous with the Donor's transfer of assets to the CLAT, the Donor sells the reversionary interest to their child, for its fair market value. There is no gift tax or related issues because the reversionary interest is sold. 5. After the CLAT term, the CLAT assets are transferred to the child who owns the CLAT reversionary interest. The child's cost basis in these assets is what the child paid for the reversionary interest. Example 1. Parent creates a Grantor Reversionary CLAT and funds the CLAT with $5 million of S corporation stock. The CLAT will make annual payments of $437,500 (8.75% of $5 million) to charity for 12 years. 2. The reversionary interest (using the March 2012 rate of 1.4%) is $198,087 (approximately 4% of $5 million). 3. Parent sells the reversionary interest to child for the fair market value of $147, After the CLAT terminates and the CLAT assets transfer to the child, the child will receive these assets tax-free, since the child previously purchased the reversionary interest for $147,800. Comment Be careful when establishing the CLAT term and payout percentage. If the assets do not produce enough income to meet the required payments to charity, then the actual assets must be distributed to the charity to make up any shortfall. Prior to creating the CLAT, valuation adjustment devices can help make certain that enough income will be produced. Planning Opportunities The Grantor Reversionary CLAT might be especially attractive for whalesized family wealth transfers, where the parents have rapidly appreciating assets and when they have previously used up their Federal gift tax credits on prior gifts. Another application involves transfers of stock in closely-held businesses. When a non-reversionary CLAT is funded with closely-held stock, the excess business holdings rules of IRC 4943 present special challenges. The Code provides that a charitable lead trust is not subject to the rules unless the present value of the charitable income interest exceeds 60% of the fair 3

4 market value of the trust's assets on the date of creation. However, the cost of avoiding these rules requires subjecting at least 40% of the trust assets to gift or estate tax. C. The Testamentary Charitable Lead Annuity Trust Implementation Steps Imagine children as expectant heirs. Next, think of the children's disappointment when they discover that their parent's estate will be transferred to a Testamentary Charitable Lead Annuity Trust (CLAT), whose term will last a decade before the children finally get the assets. Is there a way to turn their delayed CLATification into instant gratification? Consider the following steps: Step 1. Create a Testamentary CLAT now. Upon the death of the surviving parent, when the CLAT is funded, the Trustee can then decide the CLAT term and payout rate to the Charity (public charity, donor advised fund, foundation, etc.). Depending upon the CLAT Trust term and payout rate, estate taxes can be significantly reduced or eliminated. After the CLAT term, the trust assets pass to the children. Step 2. The parents grant an option for, say, $2,500 to each child. Each child now owns an option to purchase an equal share of the selected assets (option assets) from the surviving parent's estate. The options are exercisable for nine months from the date of the death (the option period). The option can be exercised during the option period to purchase an option asset at its fair market value. In certain situations, there is no need to sell options to the children because they will have similar arrangements under customary business succession plans (i.e., pursuant to buy/sale agreements for closelyheld businesses, partnerships and limited liability companies). Step 3. Each child may exercise their option and purchase option assets with cash (perhaps from insurance proceeds), or an installment note (a balloon payment type), or a combination of the two. Notes used to purchase option assets must bear interest at the "applicable federal rate" for such notes and should be secured by an amount acceptable to the seller. Step 4. The CLAT term will end before the Promissory Note balloon payment is due. The Promissory Note will pass to the children and no balloon payment will have to be made. 4

5 Planning Opportunities There are many creative uses for this type of testamentary CLAT, and remember, it's child-friendly with its instant gratification characteristics. Let's take a life insurance example, since life insurance is a common asset in many estates. Suppose your client previously bought life insurance years ago to cover future estate taxes, however, since the insurance purchase, the client's estate is much larger today and the insurance coverage needed now is unavailable because it's too expensive or the client is uninsurable. The client's estate can sell the children all of the assets, which will have a step up in basis, in exchange for an interest only promissory note. The children can pay the interest payments to the CLAT using the insurance proceeds and/or the investments earned on the insurance proceeds, rather than using the insurance to pay estate taxes. Another life insurance option would be to buy enough life insurance to cover the promissory note interest payments, rather than to buy enough life insurance to pay higher estate taxes. 5

6 2. Charitable Lead Annuity Trusts Planning Strategies Part 1 Charitable Lead Trusts in a Nutshell The Charitable Lead Trust (CLT) is often referred to as the reverse of the Charitable Remainder Trust. In a CLT, the charity leads off by receiving an income interest for a certain period of time, and then the noncharitable beneficiaries receive the remaining trust principal. A qualified CLT will meet the various IRC requirements for deductibility of the lead interest for federal estate, gift and income tax purposes. The charity may receive an annuity payment, through the Charitable Lead Annuity Trust, or a unitrust payment through the Charitable Lead Unitrust. An annuity payment is the right to receive a specified amount from the trust each year that does not change. A unitrust payment is the right to receive a specified percentage of the trust assets each year that will vary from year to year. A CLT is not exempt from federal income tax. A grantor CLT treats the donor as the owner for federal income tax purposes and the donor is taxed on all of the income of a grantor CLT. A non-grantor CLT is taxed as a complex trust for income tax purposes. However, a non-grantor CLT receives an unlimited charitable income tax deduction for the annuity or unitrust payments made to charity each year. Citations of authority for Charitable Lead Trusts begin on page 16 of this outline. A. Planning Strategy Using The Reversionary Grantor Charitable Lead Annuity Trust At first glance, you might justifiably wonder why anyone would recommend using this type of Charitable Lead Trust to implement a family wealth transfer plan. So, let s nickname this strategy the Conundrum CLAT because it enigmatically anchors itself to a REVERSIONARY GRANTOR Charitable Lead Annuity Trust (G-CLAT). Admittedly, it s counterintuitive to suggest using a reversionary trust as a family wealth transfer device. Overview 1. Donor (Grantor) creates a Reversionary G-CLAT and funds the G-CLAT with assets which have significant appreciation potential (i.e., real estate, partnership units, LLC interests, closely-held stock (C stock or S stock), etc.). The G-CLAT Trustee must be an independent Trustee. Neither the Grantor, nor related or subordinate persons may serve as Trustee. The Grantor may remove/replace the independent Trustee (Revenue Ruling 95-58). 2. The G-CLAT makes an annual payment to charity equal to a certain percentage of the initial fair market value of the G-CLAT assets for a term of years. 6

7 3. The G-CLAT is designed so that the Grantor s reversionary interest is less than 5% of the fair market value of G-CLAT assets under IRC 7520(a). The G-CLAT is also designed so that the Grantor is treated as the owner for income tax purposes. In such a situation, the Grantor will receive an income tax charitable deduction, but the Grantor will also personally report the G- CLAT s income during the G-CLAT term. (See, e.g., IRC 674(a) regarding a power of a independent third party to allocate income and/or principal among charitable beneficiaries, which would cause the Grantor to be taxed on the income of a G-CLAT, but would not cause the corpus of the G-CLAT to be included in the Grantor s gross estate; see also, e.g., IRC 675(4), which would have the same effect.) 4. Contemporaneous with the Grantor s transfer of assets to the G-CLAT, the Grantor will sell to his or her child his entire reversionary interest in the G- CLAT, for fair market value. There is no gift tax or related 3 year rule issues involved because the reversionary interest is sold to the child. 5. After the G-CLAT term of years expires, the G-CLAT assets are transferred to the child who owns the G-CLAT reversionary interest. The child s cost basis in these assets is what he or she paid the Grantor for the reversionary interest (IRC (c)). See Private Letter Ruling Example 1. Grantor creates a Reversionary G-CLAT and funds the G-CLAT with $5 million of S stock. The G-CLAT will make annual payments of $437,500 (8.75% of $5 million) to a charity for 12 years. 2. The reversionary interest (based on the March 2012 Discount Rate of 1.4% under IRC 7520(a)) is $198,087 (or approximately 4% of $5 million). 3. Grantor sells the $198,087 reversionary interest to his or her child. 4. After 12 years, the G-CLAT will terminate and the G-CLAT assets will transfer to the child. Assuming the G-CLAT assets have grown to $15 million during the 12 year period, the child will receive these assets tax free, since he or she previously purchased the reversionary interest for $198,087. Comments Care should be taken when establishing the G-CLAT term of years and payout percentage to the charity. If the G-CLAT assets do not produce enough income to meet the required annual payments to the charity, then the G-CLAT assets must be distributed to the charity to make up any annual shortfall. Prior to creating the G-CLAT, asset valuation adjustment planning may be accomplished to make certain that enough income will be produced. 7

8 The child may work for the S corporation or otherwise manage the G-CLAT assets during the G-CLAT term and be compensated. Planning Opportunities The Grantor Reversionary CLAT might be especially attractive for significant wealth transfers, in cases where the parents own rapidly appreciating assets and are facing substantial gift taxes and have previously used up their Federal gift tax credits on prior gifts. Another practical application is for situations involving transfers of closely-held stock or other interests in privately owned businesses. When a non-reversionary CLAT is funded with closely-held stock, the excess business holdings rules of IRC 4943 can present special challenges. The Code provides that a charitable lead trust is not subject to the excess business holdings rules unless the present value of the charitable income interest exceeds 60% of the aggregate fair market value of all trust assets on the date of creation. For non-grantor lead trusts, the cost of avoiding the excess business holdings rules requires subjecting at least 40% of the trust assets to gift or estate tax. However see Private Letter Ruling for an interesting solution to this problem. Planning Considerations for Reversionary G-CLAT funded with S stock Will the Grantor status of the G-CLAT change to a Non-Grantor status if the reversionary interest is less than 5%, because of IRC 673(a)? Also, will the S-corporation's S-election be lost if its shares are transferred to a G- CLAT in which the grantor has less than a 5% reversionary interest? There are numerous ways for a CLAT to qualify as a grantor trust, and the grantor's retention of a greater than 5% reversionary interest is only one of them. Assuming one or all of the following methods are used to qualify the CLAT as a grantor trust, the fact that the grantor's reversionary interest is less than 5% should not make a difference: 1 - Power of independent Trustee to add charity as a beneficiary; 2 - Power to substitute assets in a non-fiduciary capacity; and 3 - Requiring consent by non-trustee for distributions. Power #3 can be problematic and depends on the wishes of the Grantor, which is why powers #1 and #2 are relied upon more often. Power # 2 is questionable, since it is always a facts and circumstances test, and the IRS will not rule. Power #1 is considered the most reliable. Some attorneys recommend adding a fourth power, allowing the CLAT to buy life insurance (even cheap joint and survivor term) on the life of the Grantor and/or his or her spouse. Private Letter Ruling directly addressed the issue concerning whether a G-CLAT qualified for the grantor trust provision in the S-corporation 8

9 rules, that conditionally permitted grantor trusts to be qualified S-corporation shareholders. In this ruling, the IRS held that if the grantor is considered the sole beneficial owner of the G-CLAT under the grantor trust rules, than the G-CLAT can hold the S-stock without terminating the S-election. The IRS refused to rule directly on whether the G-CLAT does in fact qualify as the sole beneficial owner for purposes of the grantor trust provision in the S-corporation shareholder eligibility rules. This leaves open the possibility that the charitable lead beneficiary might also be deemed to have a beneficial interest in the trust, causing it to have more than one beneficial owner for grantor trust purposes. A literal reading of the S- corporation provision permitting grantor trusts to be qualified shareholders indicates that there can be only one beneficial owner who must be a U.S. citizen, so this issue remains open. However see Private Letter Ruling Planning Considerations for Term of Years Reversionary G-CLAT funded with S Corporation Stock What happens if the G-CLAT is designed to run for a term of years, instead of for the grantor s life, and the grantor dies before the term of years expire? Will the Grantor status of the G-CLAT change to a Non-Grantor status and will the S-corporation's S-election be lost because the CLAT is no longer a qualifying S stock owner? The grantor trust status expires after a 2 year grace period following the Grantor s death, during which the CLAT can still own the S stock (IRC 1361(c)(2)(A)(ii)). Incorporating an Electing Small Business Trust (ESBT) provision, to be eligible to elect ESBT status, may be an effective defensive measure. See Private Letter Ruling and

10 3. Charitable Lead Annuity Trusts Planning Strategies Part 2 Briefly, this philanthropic estate planning strategy is a testamentary method for transferring specific assets to children tax free, while supporting charitable organizations or funding a family foundation (or Donor Advised Fund), through a testamentary Non-Grantor Charitable Lead Annuity Trust (CLAT). Typically, the plan operates upon the death of the surviving spouse. Not surprisingly, children are often adversaries of the testamentary CLAT. Imagine children as expectant heirs and think of their disappointment when they discover that their parent s estate will be placed in a testamentary CLAT for a decade before the children finally get the trust assets. Is there a way to turn delayed CLATification into instant gratification and to allow the children to become advocates of their parents using the testamentary CLAT? A. Planning Strategy Using The Testamentary Charitable Lead Annuity Trust Implementation Steps 1. Step 1. Create a Testamentary CLAT now. After the donor s life, the Trust is funded. The Trustee can decide the Trust term and payout rate to the charitable organizations. Depending upon the Trust term and payout rate, estate taxes can be significantly reduced or eliminated. After the Trust term, the trust assets pass to the children. If the Trust income went to a Donor Advised Fund or Family Foundation to be used as Trust principal and additions to principal, the charity may continue to operate, using the CLAT annuity income it received. 2. Step 2. The parents grant an option for $2,500 to each child. Each child now owns an option to purchase an equal share of the selected assets (option assets) from the surviving parent s estate. The options are usually exercisable for 9 months from the date of the death (the option period). The option can be exercised during the option period to purchase an option asset at its fair market value (see Private Letter Rulings , , , , , and ). In certain situations, there is no need to sell options to the children because they will have similar arrangements under customary business succession plans (i.e., pursuant to buy/sale agreements for closely-held businesses, partnerships and limited liability companies. See Private Letter Rulings and ). 10

11 3. Step 3. Each child may exercise their option and purchase option assets with cash (perhaps from insurance proceeds), or an installment note (a balloon payment type), or a combination of the two. Notes used to purchase option assets must bear interest at the applicable federal rate for such notes, determined under IRC 1274(d), and should be secured by the option asset purchased or an amount acceptable to the seller (see Private Letter Rulings , , , , , , , , and ). Comment. The options would bind the current and successor executors and trustees of the surviving parent s estate, and if the option assets are distributed to the CLAT, the options will apply to the option assets of, and will bind the trustees of, the CLAT. 4. Step 4. The CLAT term will end before the Promissory Note balloon payment is due. The Note will pass to the children and no balloon payment will have to be made. Self-Dealing Rules and Exceptions Like Private Foundations, the CLT is governed by the self-dealing rules under IRC Certain exceptions to the general rules can be found under Section (d)-1(b)(3) of the Foundation and Similar Excise Taxes Regulations. This Section excepts certain transactions carried out during the administration of an estate ("the Estate Administration Exception") from the definition of self-dealing. Specifically, Section (d)1(b)(3) provides that the term "indirect self-dealing" shall not include a transaction with respect to a private foundation's interest or expectancy in property (whether or not encumbered) held by an estate or revocable trust (including a trust which has become irrevocable on a grantor's death), regardless of when title to the property vests under local law, if: (i) The administrator or executor of an estate, or trustee of a revocable trust either -- (a) Possesses a power of sale with respect to the property, (b) Has the power to reallocate the property to another beneficiary, or (c) Is required to sell the property under the terms of any option subject to which the property was acquired by the estate (or revocable trust); (ii) Such transaction is approved by the probate court having 11

12 jurisdiction over the estate (or by another court having jurisdiction over the estate (or trust), or over the private foundation); (iii) Such transaction occurs before the estate is considered terminated for Federal income tax purposes pursuant to paragraph (a) of section 1.641(b)-3 of the regulations (or in the case of a revocable trust, before it is considered subject to section 4947 of the Code); (iv) The estate (or trust) receives an amount which equals or exceeds the fair market value of the foundation's interest or expectancy in such property at the time of the transaction, taking into account the terms of any option subject to which the property was acquired by the estate (or trust); and (v) With respect to transactions occurring after April 16, 1973, the transaction either -- (a) Results in the foundation receiving an interest or expectancy at least as liquid as the one it gave up, (b) Results in the foundation receiving an asset related to the active carrying out of its exempt purposes, or (c) Is required under the terms of any option which is binding on the estate (or trust). Planning Opportunities Life Insurance Typically, life insurance is a common component in many estate plans. Suppose your client previously bought life insurance years ago to pay future estate taxes. However, since the life insurance purchase, the client s estate is much larger today and the insurance coverage now needed is unavailable because it s too expensive or the client is uninsurable. The client s estate can sell the children all of the assets, which will have a step up in basis, in exchange for an interest only promissory note. The children can pay the interest payments to the CLAT using the insurance proceeds and/or the investments earned on the insurance proceeds, rather than using the insurance to pay estate taxes. Another life insurance option would be to buy only enough life insurance to cover the promissory note interest payments, rather than to buy enough life insurance to pay higher estate taxes. 12

13 Promissory Note from Intentionally Defective Irrevocable Trust If the intentionally defective irrevocable trust (IDIT) promissory note drops into a testamentary CLAT, you still have to go to court to reissue the notes to avoid self-dealing problems longer term. Under the self-dealing rules, a note with a disqualified person that drops into a CLAT (or private foundation, or any trust governed by the private foundation rules), even though the note preexisted the CLAT, creates a self dealing problem unless you go to court to swap the note out for a new, identical note. Is a CLAT funded with a promissory note of any real benefit over simply using a private foundation? If the children purchase the estate assets from a private foundation with a promissory note, the interest payable on the note will be the applicable federal rate (AFR) under IRC 1274(d) rate. However, the CLAT interest rate is the IRC 7520 rate, which is 120% of midterm AFR and is almost always higher than even the long-term AFR. The CLAT would be designed to only earn the AFR from the note, but the interest rate applicable to the charitable payout would be the IRC 7520 rate, which is higher. So most CLATs funded with such notes would actually run out of money before the end of the term. Therefore, in many cases, a testamentary private foundation (or an outright gift to a public charity) has the same economics for the family. There is the possibility of discounting the note values, by comparing the IRC 7520 rate at time of death versus at the time the IDIT note was issued, etc., so the analysis is very much case-by-case. B. The Shark Fin Lead Annuity Trust The so-called Shark Fin Lead Trust relies on the tax law governing charitable lead trusts that requires that the payment amounts of a charitable lead annuity trust must be known at the time that the trust is created, but they do not have to all be the same. It is possible to include as part of the trust document a schedule of future payments that calls for the amounts to change over the term of the trust. (Treas. Reg (e)(2)(vi) and (c)- 3(c)(2)(vi).) A charitable lead annuity trust includes the schedule of small payments for all years of the trust except the last, with a large balloon amount being paid in the final year. A graph of this payment pattern causes the final payment to look like a shark fin above the waterline. By having the payments from the trust remain low until its final year, investors can manage the effects of any poor investment returns in the early years. If better investment results are expected over the long term, there should be sufficient funds accumulated in the trust by the final year both to make the balloon payment that year and leave significant assets to the donor's heirs. 13

14 Example The following scenario will help clarify the risks and rewards of the Shark Fin Lead Trust strategy. Mr. Thomas has significant assets, but due to the current investment climate, many of these assets have lost a lot of their value. Despite his losses, Mr. Thomas is confident that these investments will recover and appreciate considerably in future years. He funds a non-grantor charitable lead annuity trust with $6,000,000 in assets for a term of 10 years. In years 1 through 9 the trust pays just $1,000 per year to charity. In year 10, however, the trust makes a balloon payment of $8,053,035, the amount necessary for the trust to earn a 100% gift tax deduction using January 2010's IRS discount rate of 3%. 14

15 Investment Returns and Timing How can the trust afford the balloon in year 10? Given the small payments in years 1 through 9, the trust is able to grow rapidly during these years if it has consistent investment returns of 8%, or even 6%. Since the trust's deduction is based on an IRS discount rate of 3%, any average investment return above 3% will allow enough growth to cover the balloon payment. The greater the excess over 3%, the more there will be left over for the heirs. In the chart below, we compare the results for the Shark Fin trust described above under 3 different investment returns: a consistent 8% return (6% appreciation, 2% income), a consistent 6% return (4% appreciation, 2% income), and a bad timing case where the investment return is -10% in year one followed by a consistent 6% in years two through ten. Charitable Lead Annuity Trust Charitable Lead Annuity Trust Charitable Lead Annuity Trust Gross Principal $6,000,000 $6,000,000 $6,000,000 Annuity to Charity years 1 to 9 Annuity to Charity in year 10 Gift Tax Deduction Gift Tax (Paid 2010 by donor) Investment Return, Year 1 Investment Return, Years 2 to 9 Total Income Tax Paid Principal after 10 Years $1,000 $1,000 $1,000 $8,053,035 $8,053,035 $8,053,035 $6,000,000 $6,000,000 $6,000, % 6% -10% 8% 6% 6% $497,144 $456,623 $391,760 $4,169,080 $2,074,460 $391,760 15

16 Benefit to Family $4,169,080 $2,074,460 $536,291 Total Distributed to Charity $8,062,035 $8,062,035 $8,062,035 In each case, the charity receives the same $8,062,035, almost all of which is distributed in the trust's final year. The benefit to the family, on the other hand, changes dramatically with the investment results of the trust. The share distributed to family members ranges from $4.1 million when the trust earns 8% every year, to $2.0 million when it earns 6% every year, to $536,000 when the trust suffers a 10% decline in its first year. Taxation of the Shark Fin CLAT The shark fin CLAT will pay greater income taxes during its term than a standard CLAT will. This is because a lead trust is fully taxable on earned income and realized capital gain that exceed its distributions to charity. Since Mr. Thomas shark fin trust is making smaller payments to charity in years 1 through 9, there is very little offsetting deduction to reduce the 2% income we assume the trust will earn each year. The result is $400,000 to $500,000 of income taxes paid by the trust over its 10 years. Conclusion The shark fin lead trust tends to preserve more assets for its remainder beneficiaries, typically family members, than a standard charitable lead annuity trust. In today's financial climate, where many assets have lost significant value over the past few years and the near term financial outlook is uncertain, the shark fin lead trust can be an attractive planning tool for a donor who is interested in passing assets to heirs and making a substantial charitable gift. 16

17 4. Citations of Authority Income tax charitable deduction Only allowed if all the income earned by the trust, including the income paid to the charity is taxable to the donor; and, the charity s interest is a guaranteed annuity or unitrust interest. IRC 170(f)(2)(B); Reg A-6(c)(2). The charitable deduction substantiation rules do not apply to charitable lead trusts. Reg A-13(f)(13). Ceiling on deduction 30% of adjusted gross income, with a 5-year carryover for any excess. IRC 170(b)(1)(B). Different rules may apply when the lead interest beneficiary is a non-operating private foundation. IRC 170(b)(1)(D). If the donor ceases to be treated as the owner before the trust terminates, the deduction is recaptured. IRC 170(f)(2)(B). Capital gain: Reversionary interest Donor is taxed on the gain in year realized by the trust. Non-reversionary interest Trust is taxed on the gain in year realized by the trust. Gift and estate tax To avoid gift and estate tax on the charity s income interest, the interest should be a guaranteed annuity or unitrust interest. IRC 2522(c)(2)(B) and 2055(e)(2)(B); Reg (c)-3(c)(2) and (e)(2); Rev. Rul , CB 352. Also, some commentators state that Rev. Rul , CB 71, dealing with charitable remainder trusts, could also apply to charitable lead trusts. Generation-skipping tax There is no generation-skipping tax on the remainder to a grandchild whose parents are not living on the trust s creation; nor for the remainder to a grandnephew or grandniece if the parents are not alive at the trust s creation and the trust grantor has no lineal descendents. IRC 2651(e). Treasury table citations for computing value of charity s lead interests: Unitrusts Reg (d) and -4; IRS Pub Annuity Trusts Reg (c) and ; IRS Pub Federal midterm rates IRC 7520; Reg , -3. When Treasury-issued actuarial tables are disregarded Reg (b); (b) and (b). 17

18 IRS Sample Forms for Inter Vivos CLAT: Rev. Proc Issued: Friday, June 22, 2007 IRS Sample Forms for Testamentary CLAT: Rev. Proc Issued: Friday, June 22, 2007 IRS Sample Forms for Inter Vivos CLUT: Rev. Proc Issued: Friday, July 28, 2008 IRS Sample Forms for Testamentary CLUT: Rev. Proc Issued: Friday, July 28,