COMBINING CLTS AND CRTS TO BENEFIT DONORS

COMBINING CLTS AND CRTS TO BENEFIT DONORS AND CHARITIES Prepared By: Gregory W. Baker, J.D., ChFC, CFP, CAP Renaissance Ted R. Batson, Jr., J.D., MBA, CPA, CFP Renaissance Presented By: Gregory W. Baker, J.D., ChFC, CFP, CAP Renaissance 2003-2014 Renaissance

About Renaissance Founded in 1987, Renaissance is the nation s largest independent provider of charitable gift consulting and administration services. Renaissance supports financial advisors, estate planning attorneys, accountants, development officers and other professionals in designing and implementing charitable gifts to solve the financial and philanthropic goals of clients. With more than $4.7 billion in charitable assets and over 12,000 charitable gifts under administration, our expertise is second to none. Our advanced consulting services can help you address the challenge of dealing with complicated, unusual, or sophisticated assets. DISCLAIMER This publication is designed to provide accurate and authoritative information concerning the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting or other tax consulting services. If legal or other expert assistance is required, the services of a competent professional person should be sought. The information contained herein is merely an overview of an extremely complex area of tax and estate planning law and must not be construed as providing legal, tax or accounting advice. This material should not be relied upon for any particular situation without first consulting with an appropriate professional advisor. Renaissance and the authors hereby disclaim any and all responsibility or liability, which may be asserted or claimed arising from or claimed to have arisen from reliance upon the procedures and information or utilization by anyone of the forms, ideas or concepts set forth in this material. Circular 230 Notice - To ensure compliance with requirements imposed by the IRS, any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Copyright 2003-2014 Renaissance 6100 W. 96 th St., Ste. 100, Indianapolis, IN 46278 800-843-0050 info@reninc.com www.charitabletrust.com 2003-2014 Renaissance

COMBINING CLTS AND CRTs to BENEFIT DONORS AND CHARITIES I. Introductory Basics of CLTs A charitable lead trust (CLT) combines a donor s philanthropic values with his or her financial values. A CLT is an irrevocable agreement in which a donor transfers assets to a trust that creates a current income, or lead, interest payable to one or more charities. The trust s remainder interest either comes back to the donor or passes to some other non-charitable beneficiary typically the donor s heirs. The charitable interest can be designated for the benefit of one or more charitable beneficiaries, including public charities, donor-advised funds, supporting organizations, and private foundations. A. Types of Charitable Lead Trusts To qualify for the charitable deduction, a CLT must specify that the income interest will be paid as a fixed amount (a Charitable Lead Annuity Trust, or CLAT) or paid as a fixed percentage of the trust s assets revalued annually (a Charitable Lead Unitrust, or CLUT). Note that neither a net income nor a make-up option is allowed. See Appendix A for a summary of IRS statistics on CLTs. A second method of classifying charitable lead trusts is how they are taxed for income and transfer tax purposes. Unlike a CRT, a CLT is a taxable entity taxed under subchapter J. The type of CLT determines which party takes into account the CLT s items of income, deduction, and credit. Grantor CLT. In the grantor format CLT, the donor is treated as the owner of the trust by operation of one or more of the grantor trust rules (IRC 671-679). As a result, the donor can claim an income tax charitable deduction at inception for the present value of the charitable interest, but must include all items of income, deduction, and credit belonging to the trust in his or her personal income tax return (sometimes referred to as phantom income because the donor is not allowed to use the trust s assets to pay the tax liability created by the trust s income). No additional income tax deduction is allowed as the grantor CLT makes payments to the charitable income beneficiary. The most common method of ensuring a CLT is a grantor CLT is for the donor to retain a greater than 5% reversionary interest (IRC 673(a)). Non-Grantor CLT. In the non-grantor format CLT, the CLT s items of income, deduction, and credit are taken into account by the trust as they occur each year. Therefore the donor is not permitted an income tax deduction. However, the trust is permitted the unlimited income tax charitable deduction provided by IRC 642(c). 1 Because the remainder beneficiary is almost always someone other than the donor, a transfer tax deduction is allowed for the charitable interest. As a result, the non-grantor 1 The unlimited charitable deduction for CLTs is limited for each year in which the CLT has UBTI. See IRC 681. 2003-2014 Renaissance Page 1

CLT is commonly used to reduce or eliminate the transfer tax on a transfer to the donor s heirs. Super CLT. The third (less common) format of CLT, sometimes referred to as the Super CLT, or grantor defective CLT, combines elements of both the grantor and non-grantor CLT format. Like the grantor CLT, the Super CLT s items of income, deduction, and credit are included in the donor s gross income, and therefore the donor is allowed an income tax deduction for the charitable interest. Like the non-grantor CLT, the Super CLT s remainder beneficiary is typically the donor s heirs, therefore the donor is allowed a transfer tax deduction for the charitable interest. 2 Great care must be exercised in drafting and administering a Super CLT to ensure the donor realizes the expected tax benefits. B. Parties to a Charitable Lead Trust In its most basic form, a charitable lead trust consists of an arrangement between four parties: 1) a donor; 2) a trustee; 3) a charitable income beneficiary; and 4) a noncharitable remainder beneficiary. The donor enters into a trust agreement with the trustee to transfer certain assets to be managed and maintained by the trustee. In accepting the assets, the trustee agrees to pay an income stream to one or more charitable income beneficiaries for a specified period of time. At the expiration of the trust term, the trustee delivers the remaining trust assets to one or more non-charitable remainder beneficiaries. The Donor. Any individual, corporation, partnership, LLC, or trust can be a CLT donor; however, the donor is usually an individual because the most significant tax benefit obtained from creating and funding a CLT is a transfer tax charitable deduction. An individual donor can create a CLT during life or at death. Transfers to a CLT may qualify for one or more of the following charitable deductions: 1) income tax; 2) gift tax; 3) estate tax; and/or 4) generation-skipping transfer (GST) tax. The Trustee. The CLT trustee may be an individual or an institution such as a bank or charity. While the donor may serve as trustee of a grantor CLT, only in rare circumstances should the donor and/or the donor s spouse serve as trustee of a nongrantor or Super CLT. When an individual serves as trustee, it is possible to unbundle the traditional trustee services (fiduciary decision-making, investment management, and CLT administration), permitting the trustee to hire best-in-class service providers for investment management and CLT administration. Charities and banks can utilize this same outsourcing approach for investment management and CLT administration. The Charitable Income Beneficiary. The charitable lead interest in a CLT may benefit a public charity (e.g., one s alma mater, a religious institution, the United Way, etc.) or a privately-controlled charity (e.g., a private foundation). A third possibility is to 2 The Super CLT requires both expert drafting and a commitment to operate the trust in accordance with the governing instrument. To date the authority for a Super CLT is limited to private letter rulings that cannot be relied upon by anyone other than the taxpayer that requested the ruling. See for example PLR 9224029, PLR 9247024, PLR 9407014, PLR 9810019, PLR 199922007, PLR 199936031. 2003-2014 Renaissance Page 2

split the income interest among several charities such as "2/3 to my alma mater and 1/3 to my private foundation." The charitable income beneficiaries of many CLTs are named irrevocably. However, it is not uncommon in grantor CLTs for the donor to retain the power to change the charitable income beneficiaries. For non-grantor and Super CLTs, the donor should not have this power due to potential estate tax inclusion concerns. Nevertheless, granting the power to change the charitable income beneficiaries to the donor s children is often a feature of non-grantor and Super CLTs. Naming the initial charitable income beneficiaries and deciding whether to grant some party a power to change the charitable income beneficiaries should be guided by the donor's charitable goals. The Non-Charitable Remainder Beneficiary. At least one CLT remainder beneficiary must be an individual, corporation, partnership, LLC, or trust. As noted above, the remainder beneficiary of a grantor CLT is typically the donor and/or the donor's spouse. Note that if the donor dies during a grantor CLT s term, then the grantor CLT s assets will be included in the donor s estate and the donor may be required to recapture a portion of the income tax charitable deduction previously claimed. 3 In a non-grantor or Super CLT, the remainder beneficiaries are usually the donor s children and/or grandchildren. Non-grantor and Super CLTs are typically designed to remove all or a portion of the trust assets from the donor s taxable estate. Designing a non-grantor or Super CLT creates gift, estate, and/or GST tax ramifications that are discussed more fully below. The donor may elect to include one or more charities as the default remainder beneficiary. For example, if all of the other named remainder beneficiaries die before the end of the CLT term, a charity may be the back-up remainder beneficiary. It is important to remember that the remainder beneficiaries receive just that the remainder. It is possible that the combination of the charitable payments and the investment performance will exhaust the trust. In this situation, the remainder is zero, which means the remainder beneficiaries will receive nothing from the CLT. C. Benefits to Donors The charitable lead trust is a useful tool in the gift planner s toolbox. While less familiar than CRTs, CLTs are flexible enough to meet many charitable, financial, and non-financial goals for donors. For example, CLTs can: 3 See IRC 170(f)(2)(B) and Treas. Reg. 1.170A-6(c)(4). 2003-2014 Renaissance Page 3

Reduce income, gift, estate, and/or generation-skipping transfer taxes Transfer money, stock, and/or illiquid assets to heirs Maximize charitable giving Avoid the adjusted gross income limitations on the deductibility of charitable gifts Obtain an income tax charitable deduction for gifts to foreign charities Plan the donor s estate Preserve wealth for the family A CLT can empower donors to realize charitable goals that seem beyond their reach. For example, a CLT may enable a donor to commit to a multi-year pledge to the local hospital s capital campaign, while retaining ultimate use of the principal. D. Benefits to Charities The CLT creates immediate cash flow to the charity. The CLT also provides a great opportunity to steward multiple generations of a donor family and, thereby, enhance donor relations. CLTs offer a great talking point to engage donor support or the charity s programs. II. Introductory Basics of CRTs A charitable remainder trust (CRT) is an irrevocable agreement in which a donor transfers assets to a trust in exchange for an income interest 4. A qualified CRT is exempt from income tax, allows the donor to claim an income tax charitable deduction, permits the tax-free sale of appreciated assets and irrevocably designates the remainder for the benefit of one or more charitable beneficiaries, including public charities, donor-advised funds, and private foundations. A. Charitable Remainder Trust Formats There are a number of qualified CRT formats. The principal distinction among these formats is how the trust agreement defines the income interest. The trust must specify that the income interest will be paid as: (a) a fixed amount (a Charitable Remainder Annuity Trust, or CRAT) 5 or (b) a fixed percentage of the trust s assets revalued annually (a Charitable Remainder Unitrust, or CRUT). 6 The Code requires that these defined formats be used to receive the benefits of a qualified CRT. Within the CRUT format there are three varieties: Standard Charitable Remainder Unitrust (SCRUT). As described above, a SCRUT must pay a fixed percentage of the trust s assets revalued annually. 7 4 In some cases, the income interest may be designated to a person or persons other than the donor and the donor s spouse. See the section below titled Gift, Estate, and GST Tax Considerations for an overview of the gift tax implications of this choice. 5 IRC 664(d)(1)(A). 6 IRC 664(d)(2)(A). 7 Id. 2003-2014 Renaissance Page 4

Therefore, as the value of the trust s assets rises and/or falls on the annual valuation date, payments to the trust beneficiaries will rise and fall. Net-Income with Make-up Charitable Remainder Unitrust (NIMCRUT). 8 A NIMCRUT differs from a SCRUT in two key aspects. First, in determining the amount of the payments to the income beneficiaries, the trustee must compare the fixed percentage unitrust amount to the trust s accounting income 9 and pay the lesser of these two amounts to the income beneficiaries. 10 Second, for each year that the trust s accounting income is less than the unitrust amount, the difference (or deficiency) is accumulated as an amount that may be made up in the future 11 (i.e., the make-up amount ). Payments of the make-up amount must be made to the extent that the trust s accounting income in any year exceeds the fixed percentage unitrust amount. Flip Charitable Remainder Unitrust (Flip-CRUT). The life cycle of a Flip- CRUT is generally characterized by two phases. In the initial phase, a Flip- CRUT acts like a NIMCRUT and only distributes the trust s accounting income to the income beneficiaries. In the second phase, following the occurrence of a predetermined triggering event, the trust switches, or flips, to a SCRUT 12 and pays out a fixed percentage of the trust s annual fair market value. The trustee has only until the end of the tax year in which the triggering event occurs to make any payments pursuant to the make-up provision. 13 The change in the payout method commences on January 1 st of the year following the triggering event. Permissible triggering events 14 include: 1. The sale of an unmarketable asset; 2. A date certain; 3. The birth of any person; 4. The death of any person; 5. The marriage of any person; 6. The divorce of any person; or 7. An event outside the control of the trustees or any other persons. B. Parties to a Charitable Remainder Trust In its most basic form, a charitable remainder trust consists of an arrangement between four parties: 1) a donor; 2) a trustee; 3) an income beneficiary; and 4) a charitable remainder beneficiary. As discussed below, it is possible for the donor, 8 Technically another variation is the Net-Income Charitable Remainder Unitrust (NICRUT). Note that this version has no make-up provision. 9 To determine a trust s accounting income, IRC 643(b) specifies that the trustee look to state trust law. Most states have a Principal and Income statute that provides a set of default rules for determining whether a cash receipt or cash disbursement is allocated to trust income or trust principal. These rules often differ significantly from definitions of taxable income. 10 See IRC 664(d)(3) and Treas. Reg. 1.664-3(a)(1)(i)(b). 11 See IRC 664(d)(3) and Treas. Reg. 1.664-3(a)(1)(i)(b)(2). 12 See Treas. Reg. 1.664-3(a)(1)(i)(c). 13 Treas. Reg. 1.664-3(a)(1)(i)(c)(3). 14 See Treas. Reg. 1.664-3(a)(1)(i)(c)(1), (d). 2003-2014 Renaissance Page 5

trustee, and income beneficiary to be the same person. The donor enters into a trust agreement with the trustee to transfer certain assets to be managed and maintained by the trustee. In accepting the assets, the trustee agrees to pay an income stream to one or more designated income beneficiaries for the rest of their lives or a designated period of time. At the expiration of the trust term, the trustee delivers the remaining trust assets to the charitable remainder beneficiary. A unique feature of the CRT is that it is generally exempt from tax. 15 The Donor. Any individual, corporation, partnership, limited liability company (LLC), or trust can be a donor. 16 An individual donor can create a CRT during life or at death. Transfers to a qualified CRT allow a donor to claim a charitable deduction for income, estate, gift, and generation-skipping transfer (GST) taxes. The Trustee. The CRT trustee may be an individual, including the donor, 17 or an institution such as a bank or charity. When the donor serves as trustee, the donor can hire best-in-class service providers for investment management and CRT administration. This arrangement unbundles traditional trustee services of fiduciary decision-making, investment management, and CRT administration. Charities and banks can utilize this same outsourcing approach for investment management and CRT administration. The Income Beneficiary. In most CRTs, the donor and the donor's spouse will be named for their joint lifetimes as the only income beneficiaries of a CRT. Nevertheless, the Code and regulations permit any person 18 to be named as a CRT s income beneficiary so long as at least one income beneficiary is not a charitable organization. 19 For example, the income beneficiary could be an individual, corporation, partnership, LLC or trust. However, if any non-natural person beneficiary could be an income beneficiary, the payout length of that person s CRT interest may not exceed 20 years. In addition, the donor may elect to include one or more charities as co-income beneficiaries. 20, 21 This may be desirable when the donor wishes to currently benefit the charity and/or purposefully reduce the amount paid to the non-charitable beneficiary. Occasionally, CRTs name an income beneficiary other than the donor and/or the donor s spouse. Designing such a CRT creates an array of complications in the 15 For an exception to the CRT s tax-exempt status, see IRC 664(c)(2) and the discussion below on unrelated business taxable income. 16 A sampling of PLRs that permit non-natural person entities to be a CRT donor includes: C-Corporation 9205031 and 8102093; S-Corporation 200644013 and 9340043; LLC 199952071; Partnership 9419021; and Trust 9821029. 17 See Revenue Ruling 77-285. 18 IRC 7701(a)(1) defines a person as an individual, trust, estate, association, company, corporation and partnership. 19 See IRC 664(d)(1)(A) and Treas. Reg. 1.664-2(a)(3)(1) for annuity trusts. See IRC 664(d)(2)(A) and Treas. Reg. 1.664-3(a)(3)(1) for unitrusts. 20 See PLRs 9323039 and 200108035 for a discussion of some of the issues surrounding naming a charity as a CRT income beneficiary. 21 If a charity is named as an income beneficiary, then the application of IRC 4943 (excess business holdings) and 4944 (jeopardizing investments) must be required by the trust s governing instrument. IRC 4947(b)(3). 2003-2014 Renaissance Page 6

design, drafting, investing, and administration of a CRT. These complications are discussed more fully below. The Charitable Remainder Beneficiary. The charitable remainder interest in a CRT may benefit a public charity (e.g., the donor s alma mater, a religious institution, the United Way, etc.) or a privately-controlled charity (e.g., a private foundation). A third possibility is to split the remainder interest among several charities such as "2/3 to my alma mater and 1/3 to my private foundation." In many CRTs, donors retain the power to change the charitable remainder beneficiaries. 22 The donor may choose to name a specific charitable remainder beneficiary immediately, defer the decision until later, name the charitable remainder beneficiary in their will, or grant that power to a child or friend. The donor s charitable goals should govern the selection and timing of naming the charitable remainder beneficiaries. The Heirs. Often the seemingly neglected fifth party to a CRT is the donor's heirs. Because most CRTs are created for the benefit of the donor and the donor's spouse, without additional planning heirs are left out of the equation. This omission is easily remedied by using life insurance held in an irrevocable life insurance trust to replace the assets transferred to the CRT. Another option is to name the children as additional income beneficiaries of the CRT. This creates additional complications as noted above. C. When Should Donors Consider a CRT There are three principal situations where a CRT may be appropriate: 1. A donor is contemplating a transaction which will generate a significant tax liability; 2. A donor needs income now or in the future; or 3. A donor has charitable goals and interests to support. These factors are not mutually exclusive and the greater degree to which each describes a donor, the more likely a CRT will be a satisfying solution. Much of the power behind the CRT is based on its tax-exempt status and irrevocable nature. CRTs can be funded with a variety of assets including stocks, bonds, mutual funds, restricted securities, exchange traded funds, real estate in various forms, partnership interests, LLCs, C-corporations, art and other tangible personal property. When combined with an ILIT, the CRT can solve many of your donor's noncharitable problems within a charitable context. A CRT can enable donors to realize charitable goals that seem beyond their reach. For example, making a current gift to endow a chair in the donors name at their alma mater may be infeasible, but by utilizing a CRT, this goal can be brought within the donors grasp. 22 See Revenue Rulings 76-7 and 76-8. 2003-2014 Renaissance Page 7

D. Benefits to Donors The charitable remainder trust has become a familiar tool in the gift planner s toolbox. CRTs are flexible enough to solve a myriad of donor charitable, financial, and non-financial problems. A best practice is to use a CRT to accomplish multiple donor goals. For example, CRTs can: Increase cash flow Avoid capital gain taxes Reduce income, gift, and/or estate taxes Plan the donor s estate Transfer money to heirs Maximize charitable giving Diversify concentrated stock or other illiquid assets Preserve wealth for the family Much of the power behind the CRT is based on its tax-exempt status and irrevocable nature. CRTs can be funded with a variety of assets including stocks, bonds, mutual funds, restricted securities, exchange traded funds, real estate in various forms, partnership interests, limited liability companies (LLCs), S-corporations, 23 C- corporations, and art and other tangible personal property. When combined with an irrevocable life insurance trust, the CRT can solve many of your donor's noncharitable goals within a charitable context. All donors like to be thanked and many like to be recognized. A CRT can enable donors to realize charitable goals that seem beyond their reach. For example, making a current gift to endow a chair in the donors name at their alma mater may not be feasible, but by utilizing a CRT, this goal can be brought within the donors grasp. Often the CRT concept can be used again and again to address a donor s charitable, financial, and non-financial goals. E. Benefits to Charities CRTs are a bread-and-butter part of any full-service planned giving program. The most obvious benefit is the charitable remainder. Other benefits include enhanced donor relations (with the prospect of other current gifts), possible income beneficiary opportunities, testimonials, creating opportunities to engage donors with new and exciting programs, etc. III. Advanced Design, Drafting, Investment and Operational Issues of CLTs A. Designing the CLT Select the Appropriate Payout Rate. When selecting the payout rate for a CLT, it is important to keep several key points in mind. First, CLTs have no minimum or maximum payout rate. Second, the payout rate is an integral part of the calculation of 23 Note that while S-corporation stock can be transferred to a CRT without disqualifying the CRT, doing so will immediately terminate the corporation s S-election. Therefore, this type of transfer should only be done where all other shareholders and any prospective purchaser of the corporation do not require that the S-election remain intact. 2003-2014 Renaissance Page 8

the actuarial present value of the charitable interest (APVCI). 24 Third, CLTs have no payout rate test that is comparable to the 10% tests applicable to CRTs and CGAs. Fourth, the higher the payout rate, the higher the APVCI. Fifth, the payout rate can be variable for CLATs so long as the annuity interest id determinable when the CLT is funded. The payout rate selected should coordinate with the donor s need for a charitable deduction, the charitable beneficiary s current and future cash flow requirements, and the hoped-for value of the noncharitable remainder interest. For CLATs, a payout rate greater than the actual investment return will reduce the remainder interest. For CLUTs, a payout rate greater than the actual investment return will reduce the remainder interest and reduce the payments to the charitable income beneficiary. If the payout rate is greater than the applicable federal rate (AFR) 25 and all other factors remain constant, the APVCI for a CLAT is greater than the APVCI for a CLUT. As noted earlier, the payout rate for a CLAT can vary from year to year so long as the variance is clearly defined and can be ascertained when the CLAT is created. 26 For example, a CLAT could have a payout structure that pays $10,000 to charity in the first year and increases that payment by 7% each subsequent year of the charitable term. By starting with a lower payout rate and increasing the payout rate in later years, there is a greater possibility of having a remainder amount to distribute at the end of the charitable term. Variable payouts in a CLAT add to its complexity during the design and operation stages. Match the CLT Format to the Donor s Goals. The donor to a Grantor or Super CLT is allowed an income tax charitable deduction. The donor to a non-grantor or Super CLT is allowed a transfer tax charitable deduction. The proper CLT format must be used to obtain the deduction the donor desires. Given the appropriate combination of charitable term, payout rate, and AFR, a CLAT can produce a 100% charitable deduction. The same result is only achievable for a CLUT with a lengthy charitable term and a double-digit payout rate. In the authors experience, a significant majority of CLTs use the non-grantor, CLAT format. Select the Appropriate Charitable Term. The term for a CLT may be for any fixed period of time without being limited to the 20-year rule applicable to CRTs. 27 Alternatively, the CLT term may continue for the life of one or more persons. Permissible measuring lives include the donor, the donor s spouse, a lineal ancestor of all of the noncharitable remainder beneficiaries, or the spouse of a lineal ancestor of all of the noncharitable remainder beneficiaries. 28 For example, the measuring life could be 24 The actuarial present value of the charitable interest is the amount that may be deducted for income tax purposes, transfer tax purposes, or both. It is discussed more fully below. 25 See IRC 7520. The AFR is published monthly by the IRS in a Revenue Procedure issued near the middle of each month. The historically low AFRs of past decade are one reason why CLTs are enjoying a renaissance in philanthropic planning. 26 See IRC 2055(e)(2)(B) & 2522(c)(2)(B) and Treas. Reg. 1.170A-6(c)(2)(i)(A), 20.2055-2(e)(2)(vi)(a) and 25.2522(c)-3(c)(2)(vi)(a). 27 Note that in some states the rule against perpetuities will limit the length of the trust term. 28 See Treas. Reg. 1.170A-6(c)(2)(i)(A) for CLATs and Treas. Reg. 1.170A-6(c)(2)(ii)(A) for CLUTs. There is a minor exception that permits persons who are not lineal descendants of the measuring life as remainder beneficiaries in a CLT if the probability that such non-lineal descendants will receive any CLT distributions does not exceed 15%. 2003-2014 Renaissance Page 9

the parent of the remainder beneficiaries. On the other hand, if the donor or donor s spouse is the measuring life, then the remainder beneficiaries do not have to be their lineal descendants. Note that where the CLT term measured solely by a fixed period of time, there is no relational limitation on the identity of the noncharitable remainder beneficiaries. Along with the payout rate and AFR, the CLT s charitable term is one of the most significant factors in determining the APVCI. The shorter the charitable term, the smaller the APVCI. Conversely, the longer the charitable term, the greater the APVCI. The amount of the APVCI is a primary CLT design consideration. Because the length of the term is one of the controllable inputs in the APVCI computation (along with the payout rate), the great majority of CLTs are designed to make the charitable payout for a term of years instead of for the lives of the donors (or another authorized measuring life). Table 3-1 below illustrates the impact of various payout rates and charitable terms assuming a 1.0% AFR. Table 3-1. Charitable Deduction for CLATs at 1.0% AFR. Level Payout Rate Length of Charitable Term 5 years 10 years 15 years 20 years 30 years 4.00% 19.49% 38.03% 55.67% 72.45% 100.00% 5.00% 24.36% 47.53% 69.58% 90.56% 100.00% 6.00% 29.23% 57.04% 83.50% 100.00% 100.00% 7.00% 34.10% 66.54% 97.41% 100.00% 100.00% 8.00% 38.97% 76.05% 100.00% 100.00% 100.00% Table 3-2 below depicts the impact of various payout rates and charitable terms assuming a 3.0% AFR. Table 3-2. Charitable Deduction for CLATs at 3.0% AFR. Level Payout Rate Length of Charitable Term 5 years 10 years 15 years 20 years 30 years 4.00% 18.52% 34.50% 48.29% 60.18% 79.28% 5.00% 23.15% 43.13% 60.36% 75.22% 99.10% 6.00% 27.79% 51.75% 72.43% 90.26% 100.00% 7.00% 32.42% 60.38% 84.50% 100.00% 100.00% 8.00% 37.05% 69.01% 96.57% 100.00% 100.00% Table 3-3 below depicts the impact of various payout rates and charitable terms assuming a 6.0% AFR. 2003-2014 Renaissance Page 10

Table 3-3. Charitable Deduction for CLATs at 6.0% AFR. Level Payout Rate Length of Charitable Term 5 years 10 years 15 years 20 years 30 years 4.00% 17.22% 30.09% 39.71% 46.90% 56.28% 5.00% 21.53% 37.62% 49.64% 58.62% 70.35% 6.00% 25.84% 45.14% 59.57% 70.35% 84.42% 7.00% 30.14% 52.66% 69.49% 82.07% 98.49% 8.00% 34.45% 60.19% 79.42% 93.80% 100.00% Note that a longer charitable term increases the likelihood the CLT trustee will need to invade principal to make the payments. Also, even if the APVCI exceeds 100% of the assets transferred to a CLT, the charitable deduction cannot be greater than the value of the assets given to the CLT. 29 Based on the numbers from Table 3-1 above, it is highly unlikely that a donor would create a 20-year CLAT with a payout rate higher than 6.00%. While the tables above illustrate deduction factors using payout rates expressed as whole numbers (i.e., with no values to the right of the decimal point) and depicted nonvariable payout rates for simplicity, the payout rate in a typical CLT document will be a percentage extended to 3 or 4 decimal places based on an extensive financial analysis of the financial aspects of the CLT plan. Match the CLT Format to the Charity s Needs. The CLT format, term, and payout rate selected may be important in complying with a charity s donor recognition or capital campaign recognition policies. For CLATs that irrevocably name one or more charitable income beneficiaries, such charities can count on the regular cash flow in planning their budgets and programs. In contrast, the CLUT s variable payments may mean the charity cannot be as certain in forecasting the available cash flow for its programs. Consider the Prohibition on Self-Dealing. IRC 4947(a)(2) prohibits CLTs from engaging in self-dealing transactions with disqualified persons. In general, a disqualified person includes the donor, the donor s family, the trustee, the trustee s family, any business entities or trusts in which these persons have a greater than 35% interest, and a person with a greater than 20% interest in any business entity or trust which is a substantial contributor. 30 Further, self-dealing transactions include purchases, sales, leases, loans, excess compensation, and use of trust property. 31 Several exceptions apply. 32 Some common examples of prohibited activities include: The donor continuing to reside in a home she has transferred to a CLT; The donor s child purchasing property from the CLT; and 29 See Treas. Reg. 1.170A-6(c)(3)(i) and (ii). 30 IRC 4946(a)(1). 31 IRC 4941(d)(1). 32 See IRC 4941(d)(2)(B)-(H). 2003-2014 Renaissance Page 11

The trustee making a loan from the CLT to a business enterprise he owns. Care should be exercised in the operation of a CLT because CLTs are not only associated with reducing or avoiding transfer taxes, but also with transferring specific assets to heirs. For example, if the donor s vacation home is transferred to a CLT (along with sufficient other assets to make the charitable payments), it is a prohibited act of self-dealing for the donor and/or the donor s heirs to use the home even if they pay fair market rent. Consider the Effect of Unrelated Business Taxable Income. Certain types of assets that produce UBTI may limit a non-grantor CLT s IRC 642(c) charitable deduction and therefore may be unsuitable for transfer to or investment by a nongrantor CLT. 33 Common examples of UBTI producing assets include: An interest in an active trade or business (regardless of whether it is classified as a sole proprietorship, a general partnership interest, a limited partnership interest, or a LLC interest); A working interest in an oil and gas well; and Unrelated debt-financed income from trading on margin or other borrowing. Because the grantor is taxed on all income generated by a grantor or Super CLT, there is no tax reason to avoid UBTI in these types of CLTs. B. Drafting the CLT Ensure the Document Drafted Supports the Plan Design. It is important to remember that a CLT is irrevocable. Therefore, it is critical to draft the document correctly the first time. An example of a good plan gone bad is when the plan requires a CLUT (perhaps for GST reasons) and the document is drafted as a CLAT. Another example is when the plan is to avoid estate tax inclusion but the non-grantor CLT governing instrument reserves to the donors the power to change the charities. 34 This is an even greater danger when the attorney engaged to draft the CLT governing instrument was not involved in the entire planning process. Application of IRC 4943 and 4944. If the APVCI exceeds 60% of the fair market value on the date of transfer, then the CLT s governing instrument must include the prohibitions against excess business holdings and jeopardizing investments found in IRC 4943 and 4944. 35 Beware of Using Generic Form Documents. Sample CLT documents are available from a variety of sources including the IRS. 36 Books containing sample trust forms may contain one or more sample CLT documents. Often, continuing legal education seminars will include a copy of the presenter s standard form. Alternatively, it is common to borrow from colleagues that have previously drafted CLTs. 33 See IRC 681(a). 34 See IRC 2036(a) and 2038(a). See PLR 200328030 for an application of this principle. 35 See IRC 4947(b)(3) and Treas. Reg. 1.170A-(6)(c)(i)(D), 20.2055-2(e)(2)(vi)(e), & 25.2522(c)-3(c)(2)(vi)(e). 36 Rev. Proc. 2007-45, 2007-29 I.R.B. 89 (providing forms for inter vivos charitable lead annuity trusts); Rev. Proc. 2007-46, 2007-29 I.R.B. 102 (providing forms for testamentary charitable lead annuity trusts); Rev. Proc. 2008-45, 2008-30 I.R.B. 224 (providing forms for inter vivos charitable lead unitrusts); Rev. Proc. 2008-46, 2008-30 I.R.B. 238 (providing forms for testamentary charitable lead unitrusts). 2003-2014 Renaissance Page 12

While it is tempting to use a document from one of the above sources and only change the names of the parties, the payout rate, and the term; the multitude of design variables (including trust format) makes this practice inadvisable. The authors have seen many CLTs that included conflicting provisions because the drafter failed to identify all of the edits necessary to convert a sample trust to one that conforms to the plan designed. Specific examples of errors include trust documents that: Refer to a different client and/or the wrong charitable income beneficiary; Permit the CLT to be amended as a charitable remainder trust; Define the payout in terms of both an annuity and unitrust amount; Include a net income provision; Include a makeup provision; Incorrectly specify multiple payout rates; Prohibit the trustee from accepting specific types of assets including the proposed funding asset; Prohibit excess business holdings (IRC 4943) when the charitable income interest is under 60% and the proposed funding asset is a large block of stock in a closely-held company; Directly authorize acts of self-dealing; Omit the power to change the charitable income beneficiary when the donor desires this power; Include the power to change the charitable income beneficiary when the donor does not desire this power, for example to qualify for donor recognition or gift matching; and Restrict the charitable income interest to public charities when the donor intended to create and fund a private family foundation. IRS Sample CLT Form Documents. In August 2007, the IRS issued sample inter vivos and testamentary CLAT forms via Revenue Procedures 2007-45 and 2007-46. The following year, the IRS released the complementary CLUT versions via Revenue Procedures 2008-45 and 2008-46. As a general rule, the IRS sample CLT form documents are well-drafted. Nevertheless, as noted above, the authors recommend caution when relying on another drafter s form document. Adequately Define Principal and Income. Unless the governing instrument is drafted to include capital gains as an item of gross income from which the annuity or unitrust amount may be paid, a 642(c) deduction will not be allowed for the portion allocable to capital gains. If the CLT administrator prefers a particular principal and income definition, include that definition. The power to deviate from the state law default provisions is explicitly authorized by 103(a)(3) of the Uniform Principal and Income Act of 1997 37 (as well as the 1931 and 1962 versions of the Model Act). Every state that has adopted any of the three versions of the Principal and Income Act has included a provision that defers to the governing instrument. 37 Uniform Principal and Income Act, 103(a)(3), available at http://www.law.upenn.edu/bll/archives/ulc /upaia/2000final.pdf. 2003-2014 Renaissance Page 13

A CLT s governing instrument may require that income in excess of the annuity or unitrust amount be paid to the charity. 38 Additional Contributions. A CLT s governing instrument must explicitly allow or disallow additional contributions. Almost all CLATs disallow additional contributions because, in a CLAT, no additional charitable deduction can be claimed. 39 This means the donor would owe transfer tax for the charitable interest as well as the remainder interest unless the additional contribution is treated as a separate trust. On the other hand, most CLUTs allow additional contributions in order to increase flexibility. Nevertheless, because the APVCI is likely to be less than at the inception of the trust, an otherwise permitted additional contribution to a CLUT may not produce the desired result. Therefore, a new CLUT may be a better option. Authority not to Diversify. It is not uncommon for a non-grantor CLT plan to contemplate that the contributed asset will remain in the CLT and be distributed to the remainder beneficiaries after the end of the payments to the charitable income beneficiaries. In such cases, it is important that the trust s governing instrument include language that authorizes or directs the CLT trustee not to diversify that asset. It is important to remember that the Prudent Investor rule is a default rule and 1(b) of the Uniform Prudent Investor Act permits the prudent investor rule to be expanded, restricted, eliminated, or otherwise altered by the provisions of a trust. 40 Extreme caution should be exercised if the trust instrument does not contain express authority to disregard the default duty to diversify since a New York court did surcharge a CLT trustee who failed to diversify the CLT s assets. 41 C. Computing and Claiming the Income, Estate, and Gift Tax Charitable Deduction The deduction allowed for a transfer to a CLT is equal to the APVCI. The APVCI is computed by multiplying a factor times the value of the asset transferred. Many inputs impact the computation of this factor. Among them are the expected term of the trust, the payout rate, the AFR, the trust format, and the frequency of the charitable payments. This computation is complex and generally performed using specialized software. Some websites do offer limited versions of calculation software on either a pay, free or trial basis. For income tax purposes, the Internal Revenue Code limits the amount of the charitable deduction that individuals and C-corporations 42 can claim in any year to a percentage of their adjusted gross income. A CLT interest is considered to be a gift for the use of 43 charity, which means the donor can claim any income tax charitable deduction against no more than 30% of his or her AGI. To the extent that percentage 38 See Treas. Reg. 1.170A-6(c)(2)(i)(C) and (ii)(c). 39 Treas. Reg. 1.170A-6(c)(2)(i); 20.2055-2(e)(2)(vi)(a); 25.2522(c)-3(c)(2)(vi)(a). 40 Uniform Prudent Investor Act, 1(b), available at http://www.law.upenn.edu/bll/ulc/fnact99/1990s/upia94.pdf. 41 See In re Estate of Rowe, 712 N.Y.S.2d 662 (Sup. Ct. 2000). 42 Gifts by other entities are beyond the scope of this handbook. 43 See Treas. Reg. 1.170A-8(a)(2). 2003-2014 Renaissance Page 14

limitations apply, any unused charitable deduction is carried forward for up to five years. The percentage limitations do not apply for gift, estate, or GST tax purposes. In order to claim a charitable deduction, strict substantiation requirements must be met. For gifts of unmarketable assets that result in claiming or reporting a deduction greater than $5,000, a qualified appraisal must be obtained. 44 Failure to obtain a qualified appraisal will generally result in the disallowance of the income tax charitable deduction and may result in the imposition of negligence and other penalties. D. Operation and Administration Making Proper Payments. Several potential traps exist regarding the proper amount to pay the income beneficiary. For example, a CLT must use the calendar year as its tax year. 45 As a result, it will normally have a short tax year in the first and last years of the trust. It is sometimes forgotten that, for any short year, it is necessary to prorate the annuity or unitrust payment. The proration is done on a daily basis. The proration factor has as its numerator the number of days in the short year, inclusive of the first day of the funding year and the last day of the final year. The denominator is 365, or 366 if February 29 is included in the numerator. Examples of other traps include: Assuming that this year s unitrust payment will be the same as last year s payment; Failing to make the payments to the charitable income beneficiary; and The charitable income beneficiary s failing to take possession of the payments (e.g., deposit the checks in the charity s account). One of the key elements used to compute the APVCI is the frequency with which charitable income beneficiary payments are to be made. While payments must be made at least annually, the trust s governing instrument may specify that payments are to occur more frequently than annually and that the payments occur at the beginning or end of the period. Making payments without regard to the timing specified in the CLT s governing instrument violates a key assumption used in computing the amount of the charitable deduction and may call into question the validity of the deduction. In addition, failure to observe and respect the provisions of the CLT s governing instrument may open the trustee to liability for breach of his or her fiduciary duty. It is therefore clearly advisable to make payments in accordance with the rules specified in the trust document. Tax Reporting by the Donor. There are a few forms that a donor may be required to file with respect to his or her transfer to a CLT. If the CLT is a grantor or Super CLT (for which the donor is claiming an income tax charitable deduction) and the trust is funded with most assets other than cash, then the donor may be required to attach a completed Form 8283 Noncash Charitable Contributions to the donor s Form 1040. 44 See Treas. Reg. 1.170A-13(c)(1)(i), 1.170A-13(c)(2) and (3). 45 See IRC 644. 2003-2014 Renaissance Page 15

If the CLT is an inter vivos non-grantor or Super CLT, the donor must file Form 709 United States Gift (and Generation-Skipping Transfer) Tax Return to report the transfer of both the remainder interest to the non-charitable beneficiary (including GST tax if applicable) and the charitable interest for gift tax purposes. However, this is not without benefit because filing Form 709 starts the running of the statute of limitations on the valuation of the contributed asset for gift tax purposes (not for annuity or unitrust valuation purposes). If a CLT is funded testamentarily, then the executor or personal representative must file Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return to claim the estate tax charitable deduction. Income Ordering Distribution Requirements. On April 16, 2012, the Treasury published final regulations regarding trusts (including non-grantor CLTs) that distribute income to or for a charity. 46 Before these regulations, many non-grantor CLT documents were drafted to require the charitable distribution to first come from ordinary income, then from short-term capital gains, then from long-term capital gains, then from unrelated business taxable income, then from tax-exempt interest and finally from trust corpus. This income ordering provision distributed higher tax rate income to the taxexempt charitable beneficiary before distributing items with a lower tax rate, which meant the non-grantor CLT would pay less tax on its remaining income. The regulations disregard such income ordering provisions unless they have economic effect independent of the income tax consequences. 47 Tax Reporting by the CLT. Revenue Procedure 83-32 lists the filing requirements for CLTs. In general, all CLTs must annually file Form 5227 Split-Interest Trust Information Return. A copy of the trust document accompanied by a certification of its conformity to the original must be submitted with the initial Form 5227. All IRS Forms 5227 are subject to public inspection. Any person may submit IRS Form 4506-A Request for Public Inspection or Copy of Exempt or Political Organization IRS Form to the IRS to receive the public portion of a copy of a CLT s IRS Form 5227 that was filed for a particular year. Further, the IRS publishes the name, EIN, value and trustee s name and address as part of its IRS Business Master File. 48 For this reason, clients who are concerned about privacy no longer use their name as part of their CLT s name. Grantor and Super CLTs must also follow the filing requirements peculiar to grantor trusts for reporting the trust s items of income, deduction, and credit to the donor. Where the trust is funded with joint property, the trust s items of income, deduction, and credit should be allocated between the grantors in proportion to their ownership interest in the property gifted to the CLT. Many practitioners prepare a Form 1041 U.S. Income Tax Return for Estates and Trusts with the name and address of the trust and trustee; attach a statement of income, deductions and credits; and superimpose a stamp on the face of the return stating this is a grantor trust and that all income is taxable to the grantor under that grantor trust section of the Code. Because Form 5227 requires a taxpayer identification number (which is different from a social 46 See Treas. Reg. 1.642(c)-3(b)(2). 47 See Treas. Reg. 1.642(c)-3(b)(2) Example 1. 48 During July 2013, the IRS suspended its practice of including CLT information in the IRS Business Master File. 2003-2014 Renaissance Page 16

security number), grantor trust reporting methods that utilize the grantor s social security number are not available to grantor CLTs. A non-grantor CLT must file Form 1041 U.S. Income Tax Return for Estates and Trusts. Other potential filing requirements in conjunction with the funding or operation of a CLT include: Form 8283 Noncash Charitable Contributions. If the donor intends to claim an income tax charitable deduction, then a CLT trustee should sign the donee acknowledgement section of Form 8283. Form 8282 Donee Information Return. 49 If Form 8283 was prepared for a contribution to the CLT and the contributed asset is sold within 3 years of the date of gift, then the CLT trustee must file Form 8282 to report the sale price of the asset. The return must be filed within 125 days of the disposition of the contributed property. Note that this provides a way for the IRS to compare the value used to claim the deduction with the amount realized by the CLT. Form 4720 Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code. As previously noted, a CLT is subject to the private foundation rules regarding self-dealing. If a CLT has engaged in an act of self-dealing with a disqualified person, then Form 4720 is used to disclose the act, describe the corrective action taken, and compute the excise taxes on the foundation manager (i.e., the trustee) and the disqualified person. Form 1041-ES Estimated Income Tax for Estates and Trusts. For nongrantor CLTs, the Form 1041-ES is used to make estimated payments of the tax liability due for the year. Valuation. Unmarketable assets provide the greatest challenge in valuing a trust s assets. A CLT trustee will need to know the value of the trust s assets in a number of situations. For example: Valuing the initial contribution to the trust; Determining the annual valuation of the trust s assets and liabilities required to compute the unitrust amount; Valuing additional contributions for the incremental change in the unitrust amount; and Computing how much of an asset to transfer to make an in-kind distribution. For CLTs, this is an area with limited authoritative guidance. Many administrators refer to the charitable remainder trust rules at Treas. Reg. 1.664-1(a)(7). Compliance. In order to ensure the continued qualification of a CLT, it is important for the trustee, the investment manager, the administrator, the attorney (and any other professional advisor) to be familiar with the laws and regulations governing CLTs and the terms of the governing instrument. All of the parties to a CLT must 49 See Treas. Reg. 1.6050L-1. 2003-2014 Renaissance Page 17

continually monitor the activity of the trust for compliance. Among the specific areas of concern are trustee powers, prohibited investments, self-dealing transactions, and (for non-grantor CLTs) transactions that could produce UBTI. Annual Reporting. In some states, the trustee is required to provide a periodic statement or accounting to the income beneficiaries, remainder beneficiaries, and/or a court. Charities that prepare financial statements in accordance with generally accepted accounting principles (GAAP) are required to include certain information about charitable lead trusts if the charity knows the CLTs name the organization. The type of information to be included depends on whether the charity serves as trustee (or not) and whether the charity s interest is revocable or irrevocable. E. Investments Prudent Investor Standard. In structuring a CLT s investment portfolio, the trustee must be aware of the standard under which his or her decisions may be evaluated. Since its promulgation in 1994, many states have enacted a version of the Uniform Prudent Investor Act. This act permits a trustee to invest for total return based on Modern Portfolio Theory. A trustee is therefore evaluated on the performance of a portfolio considered as a whole, rather than the performance of each individual asset. Ensure the Investment Philosophy (i.e., the Risk Profile) is that of the CLT not Just the Charitable Income Beneficiary and not Just the Remainder Beneficiary. By definition, a CLT is a split-interest trust. As such, the trustee has a duty to impartially balance the interests of the income and remainder beneficiaries. This duty extends to the identification of a risk profile that blends the relative risk profiles of the income and remainder beneficiaries. In identifying the CLT s risk profile, the trustee should consider such factors as the remaining term of the trust, the sophistication of the income and remainder beneficiaries, prevailing economic conditions, inflation, the required trust payout, the trust format and liquidity needs, tax efficiency (as described below), and restrictions in the governing instrument. The bottom line is that when an investment manager invests the assets for more than one CLT, they should not necessarily be invested the same way. Tax Efficiency and Grantor and Super CLTs. In selecting investments for grantor and Super CLTs, it is necessary for the trustee to be aware of the impact that income produced by the trust will have on the donor. For example, tax loss harvesting by the CLT can be used to offset other gains realized by the donor (and vice versa). For Non-Grantor CLTs, Be a Slave to the 642(c) Deduction. For non-grantor CLTs, it is important to carefully monitor the production of taxable income and net realized capital gains compared with the IRC 642(c) charitable deduction for a particular tax year. It is highly desirable to match the realized investment return to the payout rate. Generate too little realized income and some of the charitable deduction will be wasted. Generate too much realized income and the trust will owe income tax. For example, if a non-grantor CLT needs to make a $70,000 charitable distribution this year, but the trust has realized only $64,000 of taxable income and net capital gains, the investment manager should seek prudent methods of generating additional income or realizing gains (even short-term gains). 2003-2014 Renaissance Page 18

Make Sure the Person Picking the Investments Knows the Rules. It is important that the person selecting the CLT investment portfolio is aware of the rules peculiar to CLTs. For example, assets that produce UBTI should be avoided in nongrantor CLTs. It is important to avoid transactions that are subject to the IRC 4941 excise taxes on self-dealing. If the initial charitable interest is greater than 60%, then the trust must avoid excess business holdings (IRC 4943) and jeopardizing investments (IRC 4944). F. Gift, Estate, and GST Tax Considerations General Comments. A charitable lead trust should not pay the estate tax or gift tax of the donor because it is a prohibited act of self-dealing. The best practice is for a CLT s governing instrument to prohibit the payment of gift or estate taxes during the charitable term. Although Revenue Ruling 82-128 does not specifically address CLTs, most practitioners believe that the inclusion of this provision helps the charitable income interest to qualify as a guaranteed annuity or unitrust interest. Gift Tax. If the donor or the donor s spouse is not a recipient of the remainder interest (e.g., the donor s children are the named recipients in a non-grantor or Super CLT) and the APVCI is less than 100%, then the donor has made a taxable gift. The amount of the gift is the value of the property transferred less the APVCI. Because it is a gift of a future interest, this gift will not qualify for the annual gift tax exclusion. As a result, either the donor s lifetime gift tax applicable exclusion amount will be reduced or gift tax will be due. Many CLTs are designed so that no gift tax will be due for the gift of the charitable interest. Estate Tax. If the donor dies during the charitable term of a grantor CLT and the donor retained control over the CLT such as the power to modify the identity or purpose of the charitable payments, the CLT s fair market value will be included in the donor s gross estate. The donors estate will receive a charitable deduction for the remaining APVCI calculated as of the donor s date of death. If the donor dies during the charitable term of a grantor CLT and the donor did not retain sufficient control over the trust to bring the entire trust back into the donor s estate, then only the present value of the donor s retained interest in the CLT will be included in the donor s gross estate. In either case, for most estates, the only estate tax impact of a grantor CLT is that the present value of the donor s remainder interest is included in the donor s estate. One of the chief purposes of an inter vivos non-grantor or Super CLT is to remove the CLT s assets from the donor s estate. To achieve this result, provisions such as the following are typically avoided: Donor or donor s spouse serves as Trustee; Donor or donor s spouse being named as a beneficiary; Donor or donor s spouse directly or indirectly retaining control over the CLT s assets (e.g., retaining the power to vote shares contributed to the CLT; retaining the power to direct the CLT s investments; or retaining the power to control the CLT s distributions paid to a private foundation controlled by the donor or spouse); 2003-2014 Renaissance Page 19

Donor or donor s spouse retaining the power to change the charitable income beneficiary; and Donor or donor s spouse retaining the power to change the remainder beneficiary. As a reminder, any one of these items by itself is sufficient to cause possible estate tax inclusion. When included in an inter vivos non-grantor or Super CLT, the assets will be in the donor s gross estate if the donor dies during the charitable term or within three years of relinquishing such power. As with all estate tax computations, if the gross estate (including the CLT assets and other lifetime gifts) is valued at less than the estate tax applicable exclusion amount, the inclusion of the CLT assets will not create an estate tax liability. For estates whose value exceeds the estate tax applicable exclusion amount, a testamentary CLT is a viable strategy for reducing the value of the estate below the limit, while providing a benefit to the donor s spouse, heirs, and charity. Note that the fact that the gross estate, net of the estate tax charitable deduction from funding a CLT, is less than the estate tax applicable exclusion amount does not eliminate the requirement to file Form 706. Generation-Skipping Transfer Tax. Planning for allocation of a donor s GST exemption is an important design consideration for CLTs that may benefit grandchildren or other skip-persons. 50 When a CLT includes a generation-skipping transfer, it is possible for the donor to allocate all, or a portion, of his or her GST exemption. If any portion of the donor s GST exemption 51 is to be allocated to the CLT, then care should be exercised in selecting the trust format (i.e., annuity format versus unitrust format). While the GST inclusion ratio for CLUTs is ascertainable as of the funding date, the GST inclusion ratio for CLATs cannot be ascertained until the lead interest terminates. 52 This uncertainty causes most planners to recommend CLUTs when skip-persons are potential remainder beneficiaries of a CLT. As a final comment on GST and CLTs, the GST tax will not apply to a skipperson s portion of the remainder interest if the intervening generation predeceases funding of the CLT. 53 As a consequence, for testamentary CLTs the executor should be granted discretion to create separate CLTs for skip-persons and non-skip persons and allocate the GST exemption accordingly. G. Post-Mortem Planning with CLTs As noted above, the AFR is an essential component in determining the APVCI of a CLT. Unfortunately, the AFR for testamentary CLTs is almost always a variable that cannot be known until the donor s death. Some donors find comfort in learning that it is possible to give the executor a direct instruction to create a CLT while still granting the executor enough discretion to choose the appropriate payout rate and charitable term. It is important to keep the discretion sufficiently limited so that the charitable deduction is 50 See IRC 2613 for the definition of a skip person. 51 The lifetime GST exemption is now indexed for inflation. It was $5,000,000 for 2011, $5,120,000 for 2012, $5,250,000 for 2013 and $5,340,000 for 2014. See IRC 2623(c). 52 See IRC 2642(e). 53 See IRC 2651(e). Note this exception does not help if the intervening generation dies after the CLT is funded. 2003-2014 Renaissance Page 20

not lost. A best practice for testamentary CLT planning is to use a formula clause so that the charitable interest can be determined with certainty as of the donor s death. 54 H. Disclaimer Planning with CLTs Opportunities exist for donors to use disclaimer planning to create alternative scenarios in their estate plan. For example, a donor s will could provide that $4 million be transferred outright to her spouse, however if the spouse disclaims the interest, 55 then the $4 million would be transferred to a CLT for the benefit of a named charity and their children. IV. Advanced Design, Drafting, Investment and Operational Issues of CRTs A. Designing the CRT Select the Appropriate Payout Rate. When selecting the payout rate for a CRT, it is important to keep several key points in mind. First, the annual payout rate of all CRTs must be between 5% and 50%. 56 Second, the payout rate is an integral part of the calculation of the actuarial present value of the remainder interest (APVRI). 57 For CRTs funded after July 29, 1997, the APVRI for qualified transfers to a CRT must be 10% or greater of the amount transferred. 58 This requirement also applies to additional contributions to all unitrusts. 59 Third, the payout rate selected should take into account the income beneficiary s current and future cash flow requirements. A payout rate greater than the actual investment return will cause unitrust payments to decrease with time. Fourth, the higher the payout rate, the lower the income tax deduction. Note that for the same payout rate, the deduction allowed for a SCRUT is equal to the deduction allowed for a NIMCRUT or Flip-CRUT. This is true despite the fact that the actual charitable remainder of a SCRUT is likely to be less than the actual charitable remainder of a NIMCRUT. This is discussed further below. Match the CRT Format to the Income Beneficiary s Needs. The range of payout rates that satisfies all the requirements for qualification is only the jumping off point in designing the CRT. The CRT format selected has a significant impact on the amount and regularity of the income beneficiary payments. For example, if the SCRUT format is selected, the annual payments will vary in amount as the trust value fluctuates, but must be made regardless of trust s income. If the NIMCRUT format is selected, the annual payments will vary in amount and may cease altogether if the trust does not receive income. If the CRAT format is selected, payments of the same amount will occur like clockwork. For older income beneficiaries, this level payment stream is attractive, but 54 See Treas. Reg. 20.2055-2(e)(2)(vi)(a). 55 See IRC 2518. 56 See IRC 664(d)(1)(A), 664(d)(2)(A). 57 The payout rate is a key factor in determining if a CRAT will pass the 5% probability test of Revenue Ruling 77-374. 58 See IRC 664(d)(1)(D) and 664(d)(2)(D). 59 CRUTs may be drafted to permit additional contributions, but CRATS may not. 2003-2014 Renaissance Page 21

the longer the trust term, the more the purchasing power of each payment is eroded by inflation. If the SCRUT format is selected, then it is possible for payments to increase each year thereby keeping pace with inflation. 60 If the NIMCRUT or Flip-CRUT format is selected, then it is possible to create an accumulation phase followed by a distribution phase. This scenario might benefit a younger beneficiary who wishes to postpone income until retirement. Match the CRT Term to the Income Beneficiary s Needs. The trust term may be for a fixed period of time up to 20 years or, where the income beneficiaries are individuals, the term may continue for their lives so long as all are living at the time of funding. A trust for a fixed period of time is often selected for younger beneficiaries, when the donor wishes to benefit a class of beneficiaries (e.g., my grandchildren ) all of whom may not be yet living, when the income stream is expected to be used by the beneficiary for a specific purpose (e.g., pay college expenses or underwrite a mortgage payment), or an entity is the income beneficiary. A third (less common) variation is to combine a life interest with a term interest. 61 Match the CRT Format to the Contemplated Contribution Asset. The CRAT and SCRUT formats require sufficient liquidity to make immediate income beneficiary payments. Therefore, if the funding asset is an illiquid, unmarketable asset that produces insufficient cash flow to make the income beneficiary payments, then the NIMCRUT or Flip-CRUT format is preferable. Match the CRT Format to the Charity s Needs. Because CRATs and SCRUTs must make their income beneficiary payments regardless of the amount of trust accounting income, there is a greater probability that the charity s interest will be reduced to make those payments. CRAT payout rates that exceed the actual investment return will not only result in a reduced remainder to the charity, but also create the potential that the trust will run out of money. CRUT payout rates that exceed the actual investment return will result in declining income payments to the income beneficiaries as well as a reduced remainder to the charity. Extended bear markets combined with a high payout rate also reduce the future value to charity. In the authors experience, the highest donor and charity satisfaction seems to come from CRTs with payout ranges between 5 and 7 percent. Conversely, because NIMCRUT income beneficiary payments are limited to trust accounting income, there is a greater probability that the charity s interest will not be reduced even with a higher payout rate. The same can be said for a Flip-CRUT before the trigger occurs. Consider the Prohibition on Self-Dealing. IRC 4947(a)(2) prohibits CRTs from engaging in self-dealing transactions with disqualified persons. In general, a disqualified person includes the donor, the donor s family, the trustee, the trustee s family, any business entities or trusts in which these individuals have a greater than 35% interest and an individual with a greater than 20% interest in any business entity or trust which is a substantial contributor. 62 Further, self-dealing transactions include 60 For this to occur, the spread between the payout rate and the net investment return must exceed the inflation rate. 61 See Treas. Reg. 1.664-2(a)(5) and 1.664-3(a)(5) for further discussion on combination terms. 62 IRC 4946(a)(1). 2003-2014 Renaissance Page 22

purchases, sales, leases, loans, excess compensation and use of trust property. 63 Several exceptions apply. 64 Some common examples of prohibited activities include: The donor continuing to reside in a home she has transferred to a CRT; The donor s child purchasing property from the CRT; and The trustee making a loan from the CRT to a business enterprise he owns and operates. Consider the Danger of Unrelated Business Taxable Income (UBTI). In general, a CRT is exempt from Federal income taxation. However, for years in which a CRT has unrelated business taxable income (UBTI), the CRT will pay an excise tax of 100% on the UBTI received. 65 Certain types of assets produce UBTI and are, therefore, unsuitable for transfer to (or investment by) a CRT. Common examples of UBTIproducing assets or activities include: An interest in an active trade or business (regardless of whether it is classified as a sole proprietorship, a general partnership interest, a limited partnership interest, or a limited liability company (LLC) interest); A working interest in an oil and gas well; and Unrelated debt-financed income from trading on margin or other borrowing. Consider the Grantor Trust Rules. While a CRT is generally exempt from the grantor trust rules, 66 the improper operation of a CRT can result in the application of one or more of the grantor trust rules. For example, using the income of the trust for the grantor s benefit such as making the donor s mortgage payments will convert the trust into a grantor trust which disqualifies the CRT. Another example is using the CRT s income to pay life insurance premiums on a policy on the life of the donor or donor s spouse. 67 B. Drafting the CRT Document Ensure the CRT Trust Document Supports the Plan Design. It is important to remember that a CRT is irrevocable. Therefore, it is critical to draft the document correctly the first time. An example is when the donor wants a SCRUT and the document is drafted as a CRAT. Or, the donor desires the flexibility to request that the trustee make accelerated distributions of trust principal to the charitable remainder beneficiary and the provision is omitted. This is an even greater danger when the attorney engaged to draft the CRT governing instrument was not involved in the entire planning process. Beware of Using Generic Form Documents. Numerous sample CRT documents are available from a variety of sources. For example, the IRS issued a series of sample CRT 63 IRC 4941(d)(1). 64 See IRC 4941(d)(2)(B)-(H). 65 See IRC 664(c)(2). Treas. Reg. 1.664-1(c)(2) example 2 illustrates the use of the $1,000 specific deduction described at IRC 512(b)(12) in computing a CRT s UBTI. This effectively allows for a de minimis amount of UBTI from partnerships, unrelated debt-financed income, and income received from securities acquired on margin. 66 See IRC 664(a) and Treas. Reg. 1.664-1(a)(4). 67 See IRC 677(a)(3). 2003-2014 Renaissance Page 23

documents in 1989, 68 1990 69, 2003, 70 and 2005. 71 Most books of trust forms have one or more samples many based on the IRS sample documents. Often continuing legal education seminars will include a copy of the presenter s standard form. Alternatively, it is common to borrow from colleagues that have previously drafted CRTs. While it is tempting to use a document from one of the above sources and only change the names of the parties, the payout rate, and the term; the multitude of design variables (including trust format) makes this practice inadvisable. The authors have seen many CRTs that include conflicting provisions (such as a SCRUT agreement that referenced the make-up amount) because the drafter failed to identify all of the edits necessary to convert a sample trust to one that conforms to the plan design. Other examples of errors include trust documents that: Reference a different client and/or the wrong charitable remainder beneficiary; Incorrectly specify multiple payout rates; Fail to properly address the gift tax ramifications of naming someone other than the donor or the donor s spouse as an income beneficiary; Prohibit the trustee from accepting specific types of assets including the asset actually contributed to the CRT; Directly authorize acts of self-dealing; Omit the power to change the charitable remainder beneficiary when the donor desires this power; Include the power to change the charitable remainder beneficiary when the donor doesn t desire this power, for example to qualify for donor recognition or gift matching; Restrict the charitable remainder interest to public charities when the donor intends to create a private family foundation; and Permit the charitable remainder interest to be paid to a private foundation, thereby limiting the donor s income tax charitable deduction to basis. Adequately Define Principal and Income. Many charitable plans call for the use of a NIMCRUT or Flip-CRUT. These CRT formats must pay out the lesser of the trust s accounting income and the unitrust amount (note that for Flip-CRUTs we are referring to the pre-flip period). The definition of trust accounting income is a function of the language of the trust s governing instrument and the principal and income statute of the applicable state. Where one or more provisions of the trust s governing instrument are in conflict with the principal and income statute, the trust s governing instrument takes precedence. It is sometimes the case that the trustee will select investment assets that do not produce income under the default provisions of the applicable principal and income statute. For example, realized capital gains are generally not considered income (but rather are treated as principal) under most state statutes. Therefore, it is desirable in the course of designing and 68 See Revenue Procedures 89-20 (sample charitable remainder unitrust) and 89-21 (sample charitable remainder annuity trust). The revenue procedures were superseded by revenue procedures issued in 2003 and 2005. 69 Revenue Procedures 90-30 and 90-31 (sample charitable remainder unitrust forms), and 90-32 (sample charitable remainder annuity trust forms). The revenue procedures were superseded by revenue procedures issued in 2003 and 2005. 70 See Revenue Procedures 2003-53, 2003-54, 2003-55, 2003-56, 2003-57, 2003-58, 2003-59, and 2003-60 for sample charitable remainder annuity trust forms. 71 See Revenue Procedures 2005-52, 2005-53, 2005-54, 2005-55, 2005-56, 2005-57, 2005-58, and 2005-59 for sample charitable remainder unitrust forms. 2003-2014 Renaissance Page 24

drafting the trust s governing instrument to consider provisions that will match the anticipated investment practice with a definition of income that meets the plan design. Consider Desirable Optional Provisions. A number of desirable optional provisions exist that can increase the utility and flexibility of a CRT. For example, the donor may retain the power to change the charitable remainder beneficiary. The donor may provide the trustee with the ability to accelerate the distribution of principal to the charitable remainder beneficiary. The trust might have a spendthrift clause designed to restrict the income beneficiary s ability to alienate his or her interest, while still giving the income beneficiary the flexibility to make a charitable gift of his or her income interest. C. Computing and Claiming the Income Tax Deduction The deduction allowed for a transfer to a CRT is equal to the actuarial present value of the remainder interest (APVRI). The APVRI is computed by multiplying a remainder factor times the value of the asset transferred. 72 Many inputs impact the computation of the remainder factor. Among them are the expected term of the trust, the payout rate, the prescribed federal rate, and the frequency of the income payments. The bottom line is that the longer the charity must wait and the greater the income payments to the income beneficiaries, the lower the amount of the charitable deduction. This computation is complex and is generally performed using specialized software. Some websites and smartphone apps do offer limited versions of calculation software on either a pay, free or trial basis. For income tax purposes, the Internal Revenue Code limits the amount of the charitable deduction that individuals and C-corporations 73 can claim in any year to a percentage of their adjusted gross income. The type of asset transferred and type of charity named as a remainder beneficiary determine the specific percentage limitations that apply. To the extent that percentage limitations apply, any unused charitable deduction is carried forward for up to five years. The percentage limitations do not apply for gift, estate, or GST tax purposes. The type of asset transferred and type of charity named as a remainder beneficiary may also invoke a separate set of rules that may reduce the income tax deduction. For example, if a private foundation is permitted to receive a portion of the remainder interest, then the donor s income tax deduction is limited to smaller of the donor s basis in the asset or the asset s fair market value. The primary exception to this rule is for gifts of unrestricted publicly traded stock. For this reason, if the CRT will be funded with assets other than unrestricted publicly traded stock, the charitable remainder interest is usually limited to a public charity. A public charity alternative to a private foundation is a donor-advised fund. Because of the percentage limitations and reduction rules described above, it is a best practice for a CRT s governing instrument to either affirmatively permit or affirmatively disallow a private foundation as a potential remainder beneficiary. To affirmatively disallow a private foundation, the instrument should specify that permissible remainder beneficiaries must be described by IRC 170(b)(1)(A). This requirement is in addition to references to the relevant income ( 170(c)), gift ( 2522(a)) and estate ( 2055(a)) tax provisions. In order to claim an income tax charitable deduction, strict substantiation requirements must be met. For gifts of most unmarketable assets that result in claiming or reporting a 72 In general, the present value factor is applied to the fair market value of the contributed asset. However, the present value factor is applied to the donor s basis for certain gifts. See IRC 170(e)(1), 170(b)(1)(C)(iii). 73 Gifts by other entities are beyond the scope of this outline. 2003-2014 Renaissance Page 25

deduction greater than $5,000, 74 a qualified appraisal must be obtained. 75 Failure to obtain a qualified appraisal will generally result in the disallowance of the income tax charitable deduction and may result in the application of negligence and other penalties. Selecting the Appropriate AFR. Among the various inputs used in computing the actuarial present value of a CRT s remainder interest (APVRI) is the applicable federal rate, or AFR, described at IRC 7520. When an income, estate, or gift tax charitable contribution deduction is allowable as the result of a transfer of property, IRC 7520(a) provides that a taxpayer may choose the AFR for the month of the gift or the two previous months. This choice is important because selecting the highest available AFR for a CRT will increase the APVRI. Changes in the AFR have a significantly greater impact on the APVRI for CRATs than for CRUTs. D. Income Taxation of CRTs The Trust. In general, a CRT is exempt from Federal income taxation. However, for years in which a CRT has unrelated business taxable income (UBTI), the CRT will pay an excise tax of 100% on the UBTI received. 76 Taxation by the states is unique to each state. Some states (such as Pennsylvania and New Jersey) do not exempt the CRT from taxation. Other states (such as Indiana) exempt CRTs from taxation, but require that a copy of the IRS Form 5227 be filed with the state taxing authority. Income Beneficiaries. CRT distributions to income beneficiaries are taxed under a unique system commonly called "4-tier accounting." This system employs a "worst-in-first-out" method for characterizing income distributions in the hands of the income beneficiaries. Each item of income earned by the trust must be separately tracked according to type (e.g. interest, dividends, capital gains, tax-exempt interest, etc.). Then each type of income is "used up" starting with items taxed at the highest rate and moving to items that are taxed at the next lower rate. The end result is that ordinary income items, such as interest and dividends, are passed out first, followed by short-term capital gains, then long-term capital gains, tax-exempt interest, and finally trust principal. Any CRT earnings in excess of the income beneficiary distributions are retained in the trust in a tax-free environment and combined with future transactions for characterizing future income beneficiary distributions. Note that while the CRT avoids taxation on capital gains realized from the sale of appreciated assets, such gains may be used to characterize future income beneficiary distributions. E. Operation and Administration Making Proper Payments. Several potential traps exist regarding the proper amount to pay the income beneficiary. For example, like most other trusts, a CRT must use the calendar year as its tax year. 77 As a result, it will have a short tax year in the first and last year of the trust. It is sometimes forgotten that, for any short year, it is necessary to prorate the annuity or unitrust payment. The proration is done on a daily basis. The proration factor has as its numerator the number of days in the short year, inclusive of the first and last days of the year 74 For gifts of nonpublicly traded stock, the dollar threshold increases from $5,000 to $10,000. See Treas. Reg. 1.170A-13(c)(2)(ii)(B)(1). 75 See Treas. Reg. 1.170A-13(c)(1)(i), 1.170A-13(c)(2) and (3). 76 See IRC 664(c)(2). 77 See IRC 644. 2003-2014 Renaissance Page 26

under consideration. The denominator is 365, or 366 if February 29 is included in the numerator. 78 Examples of other traps include: Assuming that the current year s unitrust payment will be the same as the prior year s unitrust payment, and Paying the income beneficiary of a NIMCRUT or a Flip-CRUT (pre-flip) the full fixed percentage amount without regard to the trust s accounting income. Importance of Making Payments. It is important that the trustee of a CRT actually make the payments to the income beneficiary. Similarly, it is important for the income beneficiary to demonstrate that he or she took possession of the payments (e.g., deposited the checks in a personal account). In Estate of Melvine B. Atkinson v. Commissioner, 79 the 11 th Circuit Court of Appeals affirmed the Tax Court s ruling that the failure of the trustee to make the annuity payments of a CRAT caused it to fail to qualify for treatment as a CRT on operational grounds. Tracking the Make-up Amount. Where a CRT is a NIMCRUT or a Flip-CRUT (pre-flip), then it is necessary to properly track the make-up amount. Note that additions to this amount occur each year that the trust accounting income is less than the unitrust amount. Deductions from this amount occur each year in which trust accounting income exceeds the unitrust amount. Payments of the excess of trust accounting income over the unitrust amount are mandatory to the extent of the make-up amount. Respecting the Payment Frequency. One of the elements used to compute the APVRI is the frequency with which income beneficiary payments are to be made. While payments must be made each tax year, the trust s governing instrument may specify that payments are to occur more frequently than annually. Making payments more frequently than specified in the trust s governing instrument violates a key assumption used in computing the amount of the income tax charitable deduction and may call into question the validity of the deduction. In addition, failure to observe and respect the provisions of the trust s governing instrument may open the trustee to liability for breach of his or her fiduciary duty. It is therefore clearly advisable to not make payments on a greater frequency than that specified in the trust agreement. CRTs That Run Out of Money. It is possible for a CRT (particularly a CRAT) to exhaust. When a CRT created for the benefit of a key donor exhausts, it is tempting for a charity serving as trustee to continue to make payments to the donor from its general fund much in the same manner as a charitable gift annuity. However, this is a path to a bigger problem. Such payments constitute private inurement and may subject the charity to the Intermediate Sanctions of IRC 4958. Tax Reporting by the Donor. In general, the donor may be required to prepare two forms with respect to his or her transfer to a CRT. Form 8283 Noncash Charitable Contributions is attached to the donor s Form 1040 to report the income tax charitable deduction claimed by the donor for a gift to a CRT of non-cash property valued in excess of $5,000. Additionally, if the donor claims a charitable deduction for a non-cash gift that exceeds $500,000, then the donor must attach a copy of the qualified appraisal to the tax return claiming the deduction. Form 709 United States Gift (and Generation-Skipping Transfer) Tax Return is used to report the charitable gift for gift tax purposes. The same form is also used to report taxable gifts to the spouse and/or other income recipients. However, this is not without benefit because filing 78 See Treas. Reg. 1.664-2(a)(1)(iv)(a) and (b) and Treas. Reg. 1.664-3(a)(1)(v)(a) and (b). 79 Atkinson v. Commissioner, 309 F.3d 1290; 90 A.F.T.R.2d 2002-6845; 2002-2 U.S.T.C. 60449 (11th Cir. 2002). 2003-2014 Renaissance Page 27

Form 709 starts the running of the statute of limitations on the valuation of the contributed asset for gift tax purposes. Funding a testamentary CRT, however, requires filing Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return to claim the estate tax charitable deduction. Tax Reporting by the Income Beneficiary. In general, an income beneficiary that receives distributions from a CRT is required to include the amounts reported on the CRT s Schedule K-1 on the income beneficiary s federal tax returns. Where applicable, such amounts are also required to be included on state returns. Subject to the income thresholds of the 3.8% surtax on Net Investment Income, a CRT s income beneficiary may also need to file Form 8960 Net Investment Income Tax -- Individuals, Estates, and Trusts to report how much of the year s distribution is treated as Net Investment Income and how much is exempt from treatment as Net Investment Income. Tax Reporting by the CRT Proper 4-Tier Classification. The key to accurate tax reporting by the CRT is the proper classification of all trust activity according to the 4-tier classification scheme unique to CRTs. 80 The scheme requires the tracking of trust activity according to income type (i.e., non-qualified dividends, interest, royalties, rents, annuity income, qualified dividends) and tax rate (i.e., shortterm capital gains, 28% rate gains, 25% unrecaptured 1250 gains, 20%/15% long-term capital gains, etc.). In effect, these refined classifications act as sub-tiers within the more broadly defined 4-tiers (ordinary income, capital gains, tax-free income, and corpus). As described above, income beneficiary payments result in relieving each sub-tier of the same tax rate within a tier on a pro-rata basis beginning with the ordinary income tier until it is exhausted, continuing through the capital gain tier until it is exhausted, and so on. For tax years after 2012, CRT distributions paid to income beneficiaries will likely include amounts subject to the 3.8% surtax on Net Investment Income. 81 CRT trustees must track and report this information to income beneficiaries annually on Schedule K-1 for potential inclusion on each income beneficiary s person tax returns. Filing the Proper Form. Revenue Procedure 83-32 lists the filing requirements for CRTs. In general, a CRT only needs to annually file Form 5227 Split-Interest Trust Information Return. A copy of the trust instrument accompanied by a certification of its conformity to the original must be submitted with the initial Form 5227. All IRS Forms 5227 are subject to public inspection. Any person may submit IRS Form 4506-A Request for Public Inspection or Copy of Exempt or Political Organization IRS Form to the IRS to receive the public portion of a copy of a CRT s IRS Form 5227 that was filed for a particular year. Further, the IRS publishes the name, EIN, value and trustee s name and address as part of its IRS Business Master File. For this reason, clients who are concerned about privacy no longer use their name as part of their CRT s name. Other potential filing requirements in conjunction with the funding or operation of a CRT include: Form 8283 Noncash Charitable Contributions. The CRT trustee should sign the donee acknowledgement section of Form 8283. Form 8282 Donee Information Return. If Form 8283 was prepared for the contribution to the CRT and the contributed asset is sold within 3 years of the gift date, then the CRT trustee must file Form 8282 to report the sale price of the asset. 80 See IRC 664(b) and Treas. Reg. 1.664-1(d). 81 See IRC 1411 and Prop. Treas. Reg. 1.1411-3(c)(2)(iii). 2003-2014 Renaissance Page 28

The return must be filed within 125 days of the disposition of the contributed property. Note that this provides a way for the IRS to compare the value used to claim the deduction with the amount realized by the CRT. Form 8960 Net Investment Income Tax -- Individuals, Estates, and Trusts. CRTs use Form 8960 to report to income beneficiaries how much of the year s distribution is treated as Net Investment Income and how much is exempt from treatment as Net Investment Income. Form 4720 Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code. As previously noted, a CRT is subject to the private foundation rules regarding self-dealing. If a CRT has engaged in an act of self-dealing with a disqualified person, then Form 4720 is used to disclose the act, describe the corrective action taken, and compute the excise taxes on the foundation manager (i.e., the trustee) and the disqualified person. A CRT also must file Form 4720 for each year in which it has UBTI. State Registration Requirements. Some states (for example Illinois and Oregon) require that CRTs register as charitable trusts with the state Attorney General. This requirement complements the Federal information return requirements and any state income tax reporting requirements. Valuation. Unmarketable assets provide the greatest challenge in valuing a trust s assets. A CRT trustee will need to know the value of the trust s assets in a number of situations. For example: Valuing the initial contribution to the trust; Determining the annual valuation of the trust s assets and liabilities required to compute the unitrust amount; Valuing additional contributions for the incremental change in the unitrust amount; and Computing how much of an asset to transfer to make an in-kind distribution. Treas. Reg. 1.664-1(a)(7) provides the trustee with two alternative methods for securing the value of a CRT s unmarketable assets. First, the valuation can be performed exclusively by an independent trustee. Second, the value can be determined by a current qualified appraisal. Compliance. In order to ensure the continued qualification of a CRT, it is important for the trustee, the investment manager, the administrator, the attorney (and any other professional advisor) to be familiar with the laws and regulations governing CRTs and the terms of the governing instrument. All of the parties to a CRT must continually monitor the activity of the trust for compliance. Among the specific areas of concern are trustee powers, principal and income allocations, prohibited investments, self-dealing transactions, and transactions that could produce UBTI. Annual Reporting. In some states, the trustee is required to make a periodic statement or accounting to the income beneficiaries, remainder beneficiaries, and/or a court. Charities that prepare financial statements in accordance with generally accepted accounting principles (GAAP) are required to include certain information about charitable remainder trusts. The type of information to be included depends on whether the charity serves as trustee (or not) and whether the charity s interest is revocable or irrevocable. 2003-2014 Renaissance Page 29

F. Investments Prudent Investor Standard. In selecting a CRT s investment portfolio, the trustee must be aware of the standard under which his or her investment decisions may be evaluated. Since its promulgation in 1994, many states have enacted a version of the Uniform Prudent Investor Act. This act permits a trustee to invest for total return based on Modern Portfolio Theory. A trustee is therefore evaluated on the performance of a portfolio considered as a whole, rather than the performance of each individual asset. Warning: Total Return Unitrust (TRU) 82 provisions alter the definition of trust accounting income. In regulations, the IRS has specifically ruled that a NIMCRUT may not make use of a TRU definition of income even if permitted by state law. 83 Don t Be a Slave to the Payout Rate. It is not necessary, and may be undesirable, to match the investment return to the payout rate. For example, if a CRT uses a 12% payout rate, it would not be necessary to invest speculatively to achieve a 12% or greater investment return. Similarly, if the payout rate were 5%, it is not necessarily correct (or prudent) to only purchase a fixed income portfolio returning 5%. Rather, a CRT trustee should invest for total return while keeping in mind all of the relevant factors (e.g., the risk/reward profile, the trust format, liquidity requirements, etc.). Make Sure the Investment Philosophy (i.e., the Risk Profile) is that of the CRT not Just the Income Beneficiary and not Just the Charity. By definition, a CRT is a splitinterest trust. As such, the trustee has a duty to impartially balance the interests of the income and remainder beneficiaries. This duty extends to the identification of a risk profile that blends the relative risk profiles of the income and remainder beneficiaries. In identifying the CRT s risk profile, the trustee should consider such factors as the remaining term of the trust, the sophistication of the income and remainder beneficiaries, prevailing economic conditions, anticipated inflation, the required trust payout, the trust format and liquidity needs, tax efficiency as it relates to the expected income beneficiary distributions, and restrictions in the governing instrument. Because these factors may differ from CRT to CRT, it follows that not all CRTs should be invested in the same way. Make Sure the Person Picking the Investments Knows the Rules. The person selecting a CRT s investment portfolio must be aware of certain rules peculiar to CRTs. For example, the trustee should avoid: purchasing assets that produce UBTI; purchasing securities on margin or otherwise borrowing funds to avoid unrelated debt-financed income (a form of UBTI); and entering into transactions that are subject to the IRC 4941 excise taxes on selfdealing. If there is a charitable income interest, then the trust must avoid excess business holdings (IRC 4943) and jeopardizing investments (IRC 4944). 84 Because a CRT s distributions to the income beneficiaries are taxed under the quasipassthrough 4-tier system, 85 it is important for the trustee to understand how the investment portfolio selected interacts with the 4 tiers. For example, the tiers segregate earnings by income class and the tax rate imposed on the beneficiary. If the investments selected produce income that populates lower tax rate tiers, then it is possible for income beneficiary distributions to be taxed at a lower rate. However, the carryover nature of the tiers means that carryovers within a 82 As applied to non-crt trusts, the Total Return Unitrust concept creates an environment that permits trustees of those trusts to invest for total return without the necessity for computing an income beneficiary s payment on traditional definitions of trust accounting income. 83 See Treas. Reg. 1.664-3(a)(1)(i)(b)(3). 84 However, the trust must be subject to 4943 and 4944 beginning at the end of the CRT term if by it s the trust continues as a private foundation. 85 See IRC 664(b) and Treas. Reg. 1.664-1(d). 2003-2014 Renaissance Page 30

higher tax rate tier will override current year income that is otherwise taxed at a lower rate. The classic example of this phenomenon is that a large capital gain carryover (typically from the sale of a contributed asset in a prior year) overrides the current production of tax-free municipal bond interest in determining the tax character of income beneficiary distributions. G. Gift, Estate, and GST Tax Considerations General Comments. A charitable remainder trust should not pay the estate tax or gift tax of the donor. In addition to creating potential self-dealing issues, this is expressly prohibited by Revenue Ruling 82-128. The best practice is for all CRT governing instruments to echo this express prohibition. Gift Tax. The creation of an income interest for a person other than the donor creates a gift equal to the value of the property transferred less the APVRI. If the donor s spouse is the only person other than the donor to receive an income interest, then the gift tax marital deduction (IRC 2523(g)) eliminates most gift tax concerns. If the CRT is properly designed, no tax will be due for the gift of the charitable interest. If the donor or the donor s spouse is not a recipient of any income interest (e.g., the donor s children are the named recipients), then the donor has made a taxable gift to the income beneficiary. This gift may qualify for the gift tax annual exclusion to the extent it is an immediate interest valued at $14,000 or less. 86 To the extent that the gift of an immediate interest to any person is greater than $14,000, then the donor s lifetime gift tax applicable exclusion amount will be reduced or gift tax will be due. 87 Of course, the donor s lifetime gift tax applicable exclusion amount will also be reduced by the amount of any gift to such a CRT that does not otherwise qualify for either the charitable deduction or the gift tax annual exclusion. A third variation is to create an income interest for the donor succeeded by his or her spouse succeeded by one or more children. While this can be a powerful planning technique, it does produce a challenging gift tax result. The inclusion of a non-spousal recipient nullifies any gift tax marital deduction for the spouse s interest. 88 This means that both the children and the spouse s interests are presently subject to gift tax. By retaining a testamentary right to revoke all income interests (but his or her own), a donor can eliminate the gift tax. 89 However, at the donor s death, the donor will only receive an estate tax charitable deduction for the remainder interest there will not be a marital deduction for the spouse s interest. With the Gift Tax Exemption at an all-time high, the loss of the marital deduction will be irrelevant to most donors. Estate Tax. It is common for the assets of a CRT to be included in the donor s gross estate. This can occur for a variety of reasons including: 86 The gift tax annual exclusion under IRC 2503(b)(1) is indexed for inflation under IRC 2503(b)(2). For gifts made from 2002 through 2005, the gift tax annual exclusion for a present interest gift was $11,000. The gift tax annual exclusion increased to $12,000 for gifts made from 2006 through 2008. It increased to $13,000 for gifts from 2009 through 2012. It increased to $14,000 for gifts made during or after 2013. 87 Retention of a testamentary right to revoke an income interest complicates determining the gift tax. See PLR 8637084 in which the IRS ruled that each year s unitrust payments to the child would separately qualify as annual exclusion gifts when the CRT included a testamentary right to revoke the child s interest. 88 IRC 2523(g). 89 See Treas. Reg. 1.664-2(a)(4) for annuity trusts and Treas. Reg. 1.664-3(a)(4) for unitrusts. Both regulations permit this power to be exercised only at death and only by will. 2003-2014 Renaissance Page 31

Retaining an Income Interest. IRC 2036 requires estate inclusion of trust assets created by the donor if the donor retained a lifetime income interest. Retaining a Right to Revoke a Surviving Income Recipient. IRC 2036 and 2038 require estate inclusion of trust assets for trusts created by the donor if the donor retained a power to designate a beneficiary. The power to revoke a surviving income recipient fits this category. Retaining a Right to Change the Charitable Beneficiary. IRC 2036 and 2038 require estate inclusion of trust assets for trusts created by the donor if the donor retained a power to designate a beneficiary. The power to change the charitable beneficiary fits this category. As a reminder, any one of these items by itself is sufficient to cause the assets to be included in the donor s gross estate. However, this does not mean that there is a tax due for single-life or spousal CRTs. Between the estate tax charitable deduction and (for spousal CRTs) the estate tax marital deduction, the value of the CRT assets included in the donor s estate is effectively eliminated. 90 However, the fact that the gross estate net of the available deductions is less than the estate tax applicable exclusion amount does not eliminate the requirement to file Form 706. As with all estate tax computations, if the gross estate (including the CRT assets and other lifetime gifts) is valued at less than the estate tax applicable exclusion amount, the inclusion of the CRT assets will not create an estate tax liability. For estates whose value exceeds the estate tax applicable exclusion amount, a testamentary CRT may be a strategy for reducing the value of the estate below the limit, while providing a benefit to the donor s spouse, heirs, and charity. Table 4-1 below lists the estate, gift, and generation skipping transfer tax rates and applicable exclusion amounts. The Gift, Estate, and GST tax rates and Exclusion Amounts will continue to be indexed for inflation each year. Table 4-1. Gift, Estate, and GST Tax Rates and Exclusion Amounts Year Highest Estate and GST Tax Rates Estate Tax Applicable Exclusion Amount GST Exemption Amount Gift Tax Applicable Exclusion Amount Highest Gift Tax Rate 2011 35% $5,000,000 $5,000,000 35% $5,000,000 2012 35% $5,120,000 $5,120,000 35% $5,120,000 2013 40% $5,250,000 $5,250,000 40% $5,250,000 2014 40% $5,340,000 $5,340,000 40% $5,340,000 Generation-Skipping Transfer Tax (GSTT). The enactment of the 10% remainder test in 1997 significantly reduced the danger that a CRT will cause generation skipping transfer tax (GSTT) concerns. Nevertheless, any CRT that names a skip person 91 as a possible income beneficiary must address the GSTT. Some 90 For a limited number of estates, inclusion of the value of the CRT s assets in the donor s gross estate may limit the estate s eligibility to claim a special use valuation, IRC 6166 deferral of tax, or IRC 303 redemption. 91 See IRC 2613 for the definition of a skip person. 2003-2014 Renaissance Page 32

examples of CRTs that have a higher probability of GSTT complications include term of years CRTs, CRTs that combine lives and terms, CRTs that benefit non-direct descendants (e.g. nieces, nephews, non-spousal May-December relationships) where the donor is more than 37½ years older than the CRT beneficiary. Note that GSTT concerns exist whenever a skip person is named, even if there is an intervening nonskip beneficiary. Allocation of GST Exemption. Even though a transfer to a CRT may be a generation-skipping transfer, it is possible for the donor to allocate all or a portion of his or her GST exemption to the transfer. H. Post-Mortem Planning with CRTs The actuarial present value of a CRT s remainder interest must be at least 10% of the value of the contributed assets. The combined life expectancies of all measuring lives are a key factor in computing the remainder interest. Unfortunately, when designing a donor s estate plan it is impossible to know what the combined life expectancies of the donor s children will be at the donor s death. Therefore, it is advisable to determine the degree of discretion the donor is willing to grant the executor in altering the CRT terms to pass the 10% test. For example, some donors find comfort in knowing that a 20-year term-certain CRUT with a payout rate of 10% or less will always pass the 10% test. Alternatively, because fewer measuring lives increases the probability that a trust will pass the 10% test, the donor can grant the executor discretion to create separate CRTs for the life of each child. Three primary options are available for CRTs that fail the 10% test. All three options are available both when the CRT is initially funded as well as for each additional contribution to a CRUT. First, the CRT (or the additional contribution) can be declared null and void ab initio. 92 A second, more common solution is to reduce the CRT s payout rate until the 10% test is met. 93 The third solution is to reduce the payout period. 94 The third solution could include removing one or more noncharitable income beneficiaries, changing the payout term from lives to a term of years or reducing the term of years. I. Disclaimer Planning with CRTs. Opportunities exist for donors to use disclaimer planning to create alternative scenarios in their estate plan. For example, a donor s will could provide that $4 million be transferred outright to her spouse, however if her spouse disclaims his interest, 95 then the $4 million would be transferred to a CRT for the benefit of their children and a named charity. 92 See IRC 2055(e)(3)(J)(i). See also PLR 201040021 in which the CRT was declared null and void multiple years after the purported CRT was initially funded. 93 See IRC 2055(e)(3)(J)(ii). 94 See IRC 2055(e)(3)(J)(ii). 95 See IRC 2518. 2003-2014 Renaissance Page 33

V. Case Study #1: CLT Endgame A. The Worst Thing to do during the Last Few Days of a CLT As noted above, grantor and Super CLTs are typically invested to produce taxefficient results to reduce the phantom income that must be reported by the grantor. Similarly, the trustees of most non-grantor CLTs monitor the investment portfolio and recognize income and capital gains each year in an amount tied to the IRC 642(c) charitable deduction. The net result is low portfolio turnover and higher unrealized appreciation in the remaining assets. As the end of the term approaches, it is tempting to liquidate idate the trust s assets to facilitate distributing the trust remainder to the remainder beneficiaries. This makes it easy to divide the remainder interest among several beneficiaries. However, liquidating these assets will produce a significant tax liability for either the grantor or the CLT. This tax liability can be avoided if the remaining assets are distributed in-kind rather than liquidated. B. Advising Remainder Beneficiaries of a CLT As noted above, at the conclusion of a CLT s charitable interest, the remainder beneficiaries will probably receive an in-kind distribution of the trust s remaining highly- appreciated assets. The receipt of such assets presents a dilemma for most CLT remainder beneficiaries. While they are grateful to the donor for being named a beneficiary, they struggle with the inherent capital gain tax liability associated with converting their highly-appreciated interest to cash. This is the classic case for using a CRT. For example, when Jack Simpson died in the Spring of 1995, his will directed his executor to create a 20-year testamentary CLT for the benefit of charities determined by Jack s daughter, Kay. Kay is also the sole remainder beneficiary of the CLT. The trustee has invested the trust portfolio for low turnover. When the charitable interest terminates (in Spring 2015), Kay will receive a highly-appreciated portfolio. The CLT is currently worth $4,250,000 with one more $250,000 charitable distribution due to the charities in March. After the charitable distribution, the CLT will be worth $4,000,000 and its assets will have a cost basis of $600,000. After discussing the situation with her financial adviser, Kay (age 50) decides to use half of the CLT remainder to create a 6% CRUT for the lives of herself and her husband, Joe (also age 50). Kay and Joe will avoid capital gain tax of $388,620 on the half they contribute to the CRUT and claim an income tax charitable deduction of 2003-2014 Renaissance Page 34

$255,460. Kay and Joe use the income tax deduction to offset the capital gain tax when they diversify a portion of the remaining appreciated assets. Additionally, Kay and Joe create a life insurance trust that will buy a second-to-die life insurance policy with their children as Crummey beneficiaries. C. Helping the Charity Replace the Income Stream from a Terminating CLT During the term of a CLT, the charity and the CLT remainder beneficiaries share a common interest in the affairs of the trust. If the charity is concerned about replacing the income stream it has been receiving, the CLT remainder beneficiaries represent a ready audience for a discussion of charitable alternatives. In the example above, the charity laid the groundwork for discussing additional charitable planning well before the expiration of the trust term. As a result, Kay was ready, willing and able to include the charity in her plans. Among the other charitable opportunities Kay could have selected are: Making an outright charitable gift from her windfall; Naming the charity as a co-income beneficiary of her CRT; Creating a new CLT; and Funding a private foundation or donor-advised fund. VI. Case Study #2: Using a CRT to Provide an Interim Cash Flow to the Heirs until the CLT is Ready to Terminate It is common for a donor to impose a complex set of requirements when soliciting estate planning assistance. Perhaps his or her heirs are financially unsophisticated. Perhaps his or her heirs require protection from the claims of creditors or the heirs own financial ineptitude. Perhaps the donor wishes to dictate the final disposition of his or her estate from beyond the grave. Whatever the reasons, in addressing these donor concerns, estate planners often design plans that include trusts that specify staggered (or laddered) distributions of trust principal to the heirs. For example, the trust instrument might read the trustee shall distribute 1/4 of the trust principal on John s 30th birthday, 1/3 of the remaining principal balance on John s 40th birthday, and the balance of the trust principal on John s 50th birthday. The possibilities are only limited by the creativity of the trust s drafter and the desires of the client. Consider the estate plan of Cynthia Smith, John s mother. Cynthia has already devised a traditional estate plan that includes a trust with the aforementioned laddered principal distribution schedule for John s benefit. As an individual who has already engaged in this type of planning, she may be a candidate for a strategy that includes instructions to: Make an immediate bequest of $1,500,000 to John at her death. Establish a 6%, 20-year testamentary CRUT funded with 50% of her residual estate (i.e., her estate after John s outright bequest, estate 2003-2014 Renaissance Page 35

administration expenses, and estate taxes) naming John as the income beneficiary. Establish three testamentary, term-certain, non-grantor CLATs with laddered terms designed to mature in 7, 14, and 20 years funded with the remaining 50% of her residual estate. The payout rate of each CLAT is to be set by the executor. This will permit the executor some flexibility in targeting the amount of the estate tax charitable deductions arising from funding the CLATs and therefore the amount of any estate tax to be paid. Direct all charitable interests, in equal proportions, to Cynthia s alma mater, the local art museum, and the local hospital. Assuming Cynthia has a taxable estate of $15 million and dies in 2014 when the applicable exclusion amount is $5,340,000 and the maximum federal estate tax rate is 40%, then, after paying estate administration expenses of $150,000, Cynthia's final estate tax liability is $1,298,897. Therefore, after funding the outright bequest of $1,500,000, the residual estate is $12,051,103. Tables 6-1 and 6-2 below summarize the results of this plan. Table 6-1 Summary of Charitable Plan Results Outright Bequest CRUT CLAT 1 CLAT 2 CLAT 3 Total Funding Amount 1,500,000 6,025,552 2,008,517 2,008,517 2,008,518 12,051,104 Trust Term 20 years 7 years 14 years 20 years Payout Percent 6.00% 7.25% 7.00% 6.23% Charitable Interest Factor 29.51% 46.56% 83.56% 99.90% Estate Tax Deduction 1,778,140 935,228 1,678,381 2,006,510 6,398,259 John Smith Receives: Sum of After-Tax Cash Flows (not adjusted for inflation) 1,500,000 5,634,910 1,965,063 2,008,517 2,644,099 13,752,589 Sum of After-Tax Cash Flows (inflation adjusted) 1,500,000 4,151,012 1,597,776 1,327,866 1,463,974 10,040,628 Charitable Organizations Receive: Sum of Charitable Cash Flows (not adjusted for inflation) 7,352,318 1,019,322 1,968,347 2,501,851 12,841,838 Sum of Charitable Cash Flows (inflation adjusted) 4,070,800 907,238 1,588,185 1,861,061 8,427,284 Assumptions: State Death Taxes are ignored. Marginal Federal and state income tax rate = 46.23%. Marginal Federal and state capital gains tax rate = 27.61%. Total Return = 7% (Ordinary income rate of return = 2%, Realized capital gain =3%, Unrealized capital appreciation = 2%). AFR for CRUT = 2.2%, AFR for all CLATs = 2.2%. CRUT payments occur quarterly, CLAT payments annually. Estate 2003-2014 Renaissance Page 36

administration expenses are assumed to be 1% of the gross estate, or $150,000. Inflation rate used to discount cash flows = 3%. Table 6-2 Comparison of Estate Tax Burden Using a Charitable Plan Without a Charitable Plan Gross Estate $ 15,000,000 $ 15,000,000 Estate Administration Expenses (150,000) (150,000) Charitable Estate Tax Deduction (6,398,258) 0 Taxable Estate $ 8,451,742 $ 14,850,000 Estate Tax $ 1,298,897 $,4,867,000 Inflation adjusted amounts passing to John $ 10,040,628 $ 9,983,000 This plan did not eliminate estate taxes; however, had no charitable planning been done, the inflation adjusted net estate proceeds passing to John Smith after expenses and estate tax would have been $9,983,000. By comparison, the present value of all cash flows passing to John under Cynthia s charitable plan totals $10,040,628, which is slightly more than in the old plan. John s influence in his community is substantially enhanced by the $8,427,284 in gifts to Cynthia s favorite charities. In addition, the third CLT provides a steady cash flow to the charities until the CRT term expires. Traditional life insurance planning can be used to create liquidity to pay the reduced estate tax liability. In a plan of this complexity, any number of variables could be altered to create slightly different or vastly different results. VII. Case Study #3: Planning for Children and Grandchildren A third estate planning scenario involves parents with taxable estates who want to ensure some monies go to both their children and grandchildren. One solution to meet their objectives is to create a testamentary CRUT for the children and a testamentary CLUT for the grandchildren. Jane Starkey was widowed 13 years ago and her estate today is valued at $12,000,000. She wants to provide for her children, grandchildren, her church, and the Humane Society where she has volunteered since her husband s death. After careful consideration of other options, Jane s estate planning team creates the plan shown in the diagram: 2003-2014 Renaissance Page 37

Because the CLUT can be structured to significantly reduce the estate tax for the CLUT transfer, a larger portion of Jane s applicable exclusion amount ($5,340,000 in 2014) can be focused on the CRUT or other gifts to the children. In this scenario, the CRUT for Jane s children can be used either instead of or in conjunction with a credit shelter trust. The children will be the only noncharitable beneficiaries of the CRUT and the CLAT. The grandchildren will be the only noncharitable beneficiaries of the CLUT. The church and Humane Society will share equally in the charitable portion of the CRUT and the CLUT. Jane s church alone will benefit from the charitable portion of the CLAT. Another addition to this plan is the inclusion of a life insurance trust for the benefit of the children, which will hold a life insurance policy on Jane s life. A similar trust for the benefit of the grandchildren will hold a life insurance policy on the lives of Jane s children. These trusts are created and funded by Jane while she is alive. The trusts will provide a lump sum guaranteed payout for the children and grandchildren regardless of the CRUT and CLTs investment results. (For many donors, it is possible that the life insurance trusts will already be in place. If so, a key planning strategy is to Charities Remainder Interest Lead Interest Lead Interest Estate Tax Deduction Estate Tax Deduction CRUT CLAT Jane CLUT Assets Assets Annual Cash Flow Remainder Interest Premiums Premiums Remainder Interest Children Life Insurance at Donors Death Wealth Replacement Trust Wealth Replacement Trust Life Insurance at Children s Death Grandchildren confirm whether the original reason for creating the life insurance trusts is still valid and whether the existing life insurance policies need to be changed based on changes to her goals and the new plan). At Jane s death, her will bequeaths $2,500,000 directly to her children and creates a 20-year term-certain CRUT for her children as depicted in the diagram. Jane could use the minimum allowed CRT payout rate of 5% to maximize her estate s charitable deduction for the CRT; however, after reviewing several cash flow illustrations, Jane decides to increase the CRT s payout to 7% because she believes it will provide the cash flow for her children that matches her desired gifts to them. Based on an AFR of 2.2%, this produces a 23.904% charitable remainder factor. The CRUT is funded with $3,121,840 from Jane s estate, which leaves $464,411 of her estate tax exclusion to be applied to the CLUT. The CLUT will provide a 7% unitrust amount for the church and Humane Society for 30 years. Based on the prior numbers, the CLUT will be funded with $3,902,301. The CLUT format is chosen to eliminate all GST tax considerations. Additionally, the executor is instructed to place the residue of the estate ($2,355,859) in a zero-estate tax CLAT for the church with the children as the remainder beneficiaries. The end result for Jane is an estate plan free of estate and GST taxes, and the assurance that children, grandchildren, the church and the Humane Society will all benefit. 2003-2014 Renaissance Page 38

In arriving at the amounts to fund the CLUT and CRUT, Jane decided to put more in the CLUT than the CRUT because her children were receiving a substantial amount outright at her death as well as the remainder interest in a large CLAT. VIII. Case Study #4: CRT Pays to Charity Now and Later Nick and Betty Harless (both 50) love the time they ve spent watching their children and grandchildren play in Hometown s Junior Football League. For the past 20 years, Nick has been a volunteer coach and the Betty has been team mom organizing the weekly snack rotation. Nick and Betty want to make a significant cash gift, but they simply cannot afford to give up all the cash flow from their mutual funds. When Nick and Betty mentioned their desire with Pat Brown, a fellow board member, Pat described how they could transfer some of their mutual funds to a brokerage stock, keep a lifetime cash flow and give some of the cash flow to the League. Pat said that so long as Nick and Betty committed irrevocably to the plan, they could claim a current income tax deduction, receive tax-advantaged cash flow from the account and commit all of the future value to the League. Pat said the technical name for this account is a Charitable Remainder Trust (CRT). Nick and Betty work with their attorney and the League to create a CRT designed to pay a total unitrust amount of 6% with 5% of that paid to Nick and Betty and the other 1% to the League. All of the remainder interest will also go to the League. Additional Comments: Note that for purposes of the gift and estate tax deduction, Nick and Betty s deduction is the combination of the remainder interest and the extra 1%. However, their income tax deduction will be limited to the present value of the remainder interest. Under these calculations, their income tax charitable deduction would DECREASE from $175,300 (5% CRT) to $125,640 (6% CRT) even though the donors are simply being MORE charitable. Nick and Betty created a $1,000,000 CRT with the 6% unitrust amount split as described above. They also considered a $950,000 CRT that paid 5% to them and giving the other $50,000 outright to the League. In this alternative, they could deduct the $50,000 since it would be an outright gift. The $50,000 could be structured so that the Junior Football League could only use a measured amount each year to simulate the unitrust payout. Because most local charities cannot handle endowment funds, a Donor- Advised Fund or Designated Fund at a local community foundation could handle the Fund. A third alternative to consider is to create the $1M CRT at 6% with the CRT paying the entire unitrust amount payment to the donors. Nick and Betty could then write an annual check to the League. In the final analysis, Nick and Betty wanted to ensure that the League received a future benefit from the CRT as well as a current cash flow so they named the League as the recipient of 1/6 of the unitrust amount. 2003-2014 Renaissance Page 39

Treasury Regulations 1.664-2(d) and 1.664-3(d) contemplate that a charity could be named as a current beneficiary of a CRT. The IRS also approved CRTs that paid the unitrust amount partly to a charity and partly to an individual in PLRs 2008108035, 200813023, 200813006 and 200831002. One ruling even included a sprinkle power that allowed the trustee to sprinkle the unitrust amount among the CRT s various beneficiaries. 96 Side Note on Sprinkle Power: A CRT trustee may be given the power to sprinkle the annuity or unitrust amount among named income recipients (or a class of living recipients) provided the trust does not thereby become a grantor trust. 97 Grantor trust status can be avoided if the only fiduciary who can exercise the income sprinkling power is a trustee that is "independent" of the donors. It is imperative that neither the donor nor a person acting under the donor s control be given this power (if) when serving as trustee. 98 At this stage of analysis, some gift planners recognize that the charity is a corporation and remember that if a CRT can make payments to a non-natural entity (such as a corporation, LLC, trust or partnership), then the CRT term cannot last any longer than twenty (20) years. However, Nick and Betty expressly wanted the Junior Football League to receive cash flow for the rest of their lives. While the 20-year limit does apply if the Unitrust Amount is paid to a taxable entity (e.g., partnership, trust, corporation, LLC), the 20-year limit does not apply to charities. See the highlighted sentence below from Treasury Regulation 1.664-3(1)(5), which permits a charity to receive the Unitrust Amount for life: Treasury Regulation 1.664-3(a)(5)(i) General rules. The period for which an amount described in subparagraph (1) of this paragraph is payable begins with the first year of the charitable remainder trust and continues either for the life or lives of a named individual or individuals or for a term of years not to exceed 20 years. Only an individual or an organization described in section 170(c) may receive an amount for the life of an individual. If an individual receives an amount for life, it must be solely for his life. 96 Of course, a sprinkle power is a grantor trust power to allocate as described in IRC 674(d), which could disqualify the trust as a CRT if held by a non-independent trustee. The power could also disqualify the CRT if a non-independent trustee could hold the power in the future. For example, if the donor retains the power to remove an independent trustee and appoint herself as the trustee, the trust would not qualify as a CRT. 97 See Code 674(c); Treas. Regs. 1.664-2(a)(3)(ii) and 1.664-2(a)(3)(ii); Rev. Rul. 72-395, 1972-2, C.B. 340, 5.03 and 7.03; Rev. Rul. 77-73, 1977-1, C.B. 175; and Priv. Ltr. Ruls. 9511029, 9423020, 9052038 (sprinkling power in a testamentary CRT), 8003047 (right to sprinkle unitrust amount among named successor income recipients only), 7926029 and 7938127. 98 Rev. Rul. 77-285, 1977-2 C.B. 213. 2003-2014 Renaissance Page 40

Appendix A IRS Charitable Lead Trust Statistics 99 Each year, the Statistics of Income division of the IRS publishes tables and a paper based on a statistical study of IRS Forms 5227, which were filed for the stated tax year. 100 The tables below present a compilation of selected statistics from the last several tax years of data published by the IRS. Tax Year Number of CLTs CLT Book Value 2000 4,571 $10,810,272,000 2001 5,292 $15,075,433,000 2002 5,481 $12,781,399,000 2003 5,658 $12,318,893,000 2004 6,168 $15,500,073,000 2005 6,298 $16,485,658,000 2006 6,377 $18,093,904,000 2007 6,521 $19,648,472,000 2008 6,626 $18,274,043,000 2009 6,609 $19,338,914,000 2010 6,617 $20,945,036,000 2011 6,498 $23,705,416,000 99 Source: IRS Statistics of Income Report Tables www.irs.gov/uac/soi-tax-stats-split-interest-trust-statistics. 100 Because the study covers IRS Form 5227, the annual study also addresses some data about Charitable Remainder Trusts and Pooled Income Funds. 2003-2014 Renaissance Appendix A Page 1

Appendix B IRS Charitable Remainder Trust Statistics 101 Each year, the Statistics of Income division of the IRS publishes tables and a paper based on a statistical study of IRS Forms 5227, which were filed for a tax year. 102 The tables below present a compilation of selected statistics from the last eight tax years of data published by the IRS. The data indicates that the 80/20 rule applies to the breakdown of CRUTs vs. CRATs, with CRUTs comprising 86.19% of all CRTs. However, when reviewing the Book Value of all CRTs, CRUTs comprise 92.97% of the Book Value of CRT Assets. Note that the CRUT values include both Book Values and Market Values while the CRAT statistics include only Book Values because CRUTs report additional information to the IRS. During tax year 2010, most CRUTs (85.0%) had a unitrust amount between 5% and 10%. Further, 79.1% of CRUTs were SCRUTs, another 16.7% were NIMCRUTs and the remaining 4.2% were NICRUTs. IRS CRT Statistics (for Tax Years 2008 through 2011) Money amounts are in thousands of dollars 2011 2010 2009 2008 Number of CRUTs (all types) 91,250 93,829 93,825 95,928 Market Value of CRUTs $92,712,995 $98,256,070 $97,349,477 $92,165,720 Book Value of CRUTs $85,240,003 $86,901,148 $91,582,144 $96,060,677 Percentage of Total Number 86.19% 85.54% 84.71% 83.78% Number of CRATs 14,616 15,862 16,937 18,572 Book Value of CRATs $6,447,093 $7,136,591 $7,494,666 $8,139,773 Percentage of Total Number 13.81% 14.46% 15.29% 16.22% TOTAL NUMBER OF CRTs 105,866 109,691 110,762 114,500 Total Book Value of CRTs $91,687,096 $94,037,739 $99,076,810 $104,200,450 101 Source: Internal Revenue Service, www.irs.gov/uac/soi-tax-stats-split-interest-trust-statistics. 102 Because the study covers IRS Form 5227, the annual study also addresses some data about Charitable Lead Trusts and Pooled Income Funds. 2003-2014 Renaissance Appendix B Page 1

IRS CRT Statistics (for Tax Years 2004 through 2007) Money amounts are in thousands of dollars 2007 2006 2005 2004 Number of CRUTs (all types) 96,248 95,567 94,767 94,779 Market Value of CRUTs $119,198,640 $106,425,220 $96,835,553 $95,053,618 Book Value of CRUTs $98,042,480 $86,741,306 $81,121,949 $79,845,710 Percentage of Total Number 83.34% 82.56% 81.65% 81.39% Number of CRATs 19,241 20,187 21,296 21,667 Book Value of CRATs $8,931,574 $9,080,252 $9,041,175 $9,540,935 Percentage of Total Number 16.66% 17.44% 18.35% 18.61% TOTAL NUMBER OF CRTs 115,489 115,754 116,063 116,446 Total Book Value of CRTs $106,974,054 $95,821,558 $90,163,124 $89,386,645 2003-2014 Renaissance Appendix B Page 2