1. Split Interest Charitable Trusts, Private Foundations and Donor Advised Funds Fran M. DeMaris Executive Vice President Cannon Financial Institute, Inc.

2. 2 Irrevocable Trusts Any trust without the power to revoke is an irrevocable trust The purpose and operation of the trust is defined by the document Many irrevocable trusts have different current and future beneficiaries Certain of these trusts follow a very specific pattern whose valuation is defined in the IRC

3. 3 Annuity Trust vs. Unitrust Most split-interest trusts call for annual percentage payments to the beneficiary rather than “income” payments. These payouts are set as a percentage of the principal of the trust. Annuity - percentage is calculated against the original value of trust corpus or stated as a fixed dollar amount Unitrust - payout is recalculated annually against current value of trust corpus

4. 4 Example FMV AnnuityUni Initial 2,000,000 100,000 100,000 Year 12,500,000 100,000 125,000 Year 23,000,000 100,000 150,000 Year 32,750,000 100,000 137,500 $2,000,000 5% Annual Payout Corpus Remaining

5. 5 Tax Issues Involving Split Interests To determine the present value of a payment stream, you need to know three other factors: –Payment Amount –Payment Term & Frequency –The Discount Rate

6. 6 Present Value Split Interests The payment amount is determined by the grantor in the trust agreement The payment term & frequency is determined by the grantor in the trust agreement The discount rate is determined by the federal government, adjusted monthly –§7520 denotes the discount rate as 120% of the Mid-Term Applicable Federal Rate (AFR)

7. 7 Charitable Transfers Clients benefit greatly in making transfers to or for charities –Fulfill philanthropic desires –Derive tax benefits Contributions to charity are deductible yet subject to: –Percentage of AGI limitations –5 year carry-forward period for unused deduction

8. 8 Annual Deduction Limits Charity Type Asset Type Public Charity Private Foundation Cash 50% of AGI30% of AGI Appreciated Assets 30% of AGI20% of AGI

9. 9 Charitable Trusts Split Interest Arrangements –One beneficiary receives a payment stream for a determined period of time –One beneficiary receives the “remainder” of trust assets once the payment stream period ends Charitable Remainder Trust –Charity receives “remainder” of trust corpus at end of payment period Charitable Lead Trust –Charity is the “lead” beneficiary, thus receiving the up- front stream of payments

10. 10 Charitable Remainder Trust Transfer assets to an irrevocable trust which pays a stream of income to the current beneficiary(ies) and the remainder to charity Qualify for the gift tax marital deduction for spousal interests and charitable deduction for charitable interests Usually results in no gift tax effect and a substantial, current charitable deduction

11. 11 The CRT Concept Assets Charity Income Assets are contributed Trust is irrevocable Basis transfers with assets Assets are sold and generate no current gain since the remainder goes to charity Current tax deduction is generated Income based on defined amount, not actual income earned by the assets Character of income based on earnings of the trust

12. 12 CRT Qualified Charity $3MM of Real Estate Trustee sells R/E w/o Capital Gain Tax Liability Trust terms call for a 6% payout for 20 years Annual Payment is 6% of $3MM = $180,000 Trust agreement may specify a family foundation or donor advised fund as remainder … The Charitable Remainder Trust

13. 13 Payout Limitations 10% Remainder Rule –Present value of charitable interest much equal 10% of funding value Maximum payout –Payout may not be more than 50% of the value of trust property Minimum payout –Payout must equal at least 5% of the value of trust property Exhaustion Test –If there is greater than a 5% probability that the trust will be exhausted, no gift or estate tax deduction is available.

14. 14 Income Tax Treatment of Payments Special DNI allocation rule for CRTs (IRC 664) –First, ordinary income Ordinary Qualified dividends –Second, capital gains Short term Long term –Third, other income (including tax-exempt) –Fourth, return of principal

15. 15 Charitable Lead Trust Profile Client has made or intends to make a commitment to a series of payments for the benefit of a qualified charity The client has assets that will not only produce the “cash flow” to fulfill the charitable commitment, but should grow in value as well The client would like to see the assets eventually go to heirs or specific designees

16. 16 The Charitable Lead Trust Assets Income Charity Assets are contributed Trust is irrevocable Basis transfers with assets Annual income stream is paid to charity Current tax deduction is generated, if a Grantor Trust Income based on defined amount, not actual income earned by the assets Charity receives an annuity or unitrust payout from the trust Beneficiaries

17. 17 Heirs/Designees Grantor contributes property Fixed percentage payout to charity for designated period CLT Charitable Lead Trust Charity’s payout interest can be set for: –Term of years –Life or lives of individual(s) living at trust’s creation –Combination of the above At the end of the payout term, the property is distributed or held in trust as the grantor defined

18. 18 Charitable Lead Trusts The charitable beneficiaries can be specified in the trust or left to the trustee’s discretion. Grantor should not retain any powers over CLTs that have payment streams based on their lifetime. At funding grantor makes: –a gift to charity of the present interest of the annuity stream –a taxable gift or bequest of the remainder interest to the remainderpersons Calculations are determined per IRC sec. 7520

19. 19 Taxation Issues with Charitable Lead Trusts Taxation of the trust’s income will be allocated to: –The trust if the CLT is not a grantor trust No charitable deduction to grantor on funding Trust receives unlimited income tax charitable deduction –The grantor if the CLT is a grantor trust Full charitable deduction on funding for present value of payment stream to charity Grantor’s payment of taxes allocable to CLT is not a gift

20. 20 Private Foundation Privately funded organization –Makes grants to charities –Donor receives immediate deduction –Property may be invested and later distributed –Must distribute 5% of assets annually Annual excise tax of 1 – 2% on net investment income and on-going administrative costs Files a 990-PF tax return Can employ and appropriately compensate family members

21. 21 Donor Advised Fund Similar to private foundation yet: –Fund is a commingling of many clients’ assets A “mutual fund” of charitable assets –Donor advisor “advises” sponsor on distributions –Meets definition of a public charity –No excise tax –Administration handled by sponsor