Split Interest Charitable Trusts,

Private Foundations andDonor Advised Funds

Fran M. DeMarisExecutive Vice President

Cannon Financial Institute, Inc.

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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

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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

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Example FMV Annuity Uni• Initial 2,000,000 100,000 100,000• Year 1 2,500,000 100,000 125,000• Year 2 3,000,000 100,000 150,000• Year 3 2,750,000 100,000 137,500

$2,000,000

5% Annual Payout

CorpusRemaining

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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

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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)

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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

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Annual Deduction Limits

Charity Type

Asset Type

Public Charity

Private Foundatio

n

Cash 50% of AGI 30% of AGI

Appreciated Assets

30% of AGI 20% of AGI

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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

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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

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The CRT Concept

Assets

Charity

Income

Assets are contributedTrust is irrevocableBasis transfers with assetsAssets are sold and generateno current gain since the remainder goes to charityCurrent tax deduction is generated

Income based on definedamount, not actual incomeearned by the assets

Character of income based onearnings of the trust

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CRTQualifiedCharity

$3MM ofReal 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

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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.

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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

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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

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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

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Heirs/Designees

Grantor contributes property

Fixed percentage payout to charityfor 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

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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

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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

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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

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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