Presentation at the Stanford & Silicon Valley Community Foundation Conference on Charitable Giving 2018 Kirsten Wolff Charitable Lead Trusts Demystified Sideman & Bancroft LLP

1. 1
May 10, 2018
Charitable Lead Trusts
Demystified
SPEAKER
Kirsten Wolff

2. 22
Session Overview
• Fundamentals of CLTs
• Planning Opportunities
• Case Studies

3. 33
Overview
• Fundamentals of CLTs
– What is a CLT?
– Legal framework
– Comparison with CRTs
– Basic types
– Key elements

4. 44
What is a CLT?
• Charitable lead trust
– Split interest trust
• Current beneficiary = charity
• Remainder beneficiary = an individual (non-charity)
– Inverse of a charitable remainder trust (CRT)

5. 55
Legal Framework
• General rule:
– Gifts to split interest trusts do not qualify for
charitable deductions from income tax, gift, or
estate tax
• Exceptions:
– CLTs that qualify under IRS requirements
– CRTs that qualify under IRS requirements

6. 66
Revenue Procedures:
A Roadmap to a Charitable Deduction
• Charitable Lead Annuity Trusts
– Revenue Procedures 2007-45 (intervivos) and
2007-46 (testamentary)
• Charitable Lead Unitrusts
– Revenue Procedures 2008-45 (intervivos) and
2008-46 (testamentary)
• Revenue Procedures specify requirements for each type of
CLT and provides form language
– If a CLT qualifies under the Revenue Procedure, the donor will be
entitled to charitable deductions from income tax, estate tax,
and/or gift tax, as applicable

7. 77
Comparison with CRTs
• CLT is the inverse of a CRT
• Many differences in requirements for
qualification

8. 88
CRTs v. CLTs

9. 99
CRTs v. CLTs

10. 1010
CRTs v. CLTs

11. 1111
CRTs v. CLTs
• Typical CRT plan:
– Contribute low-basis property to CRT.
– Trust sells property. No capital gains tax.
– Donor receives income for a term or life.
• Key: CRT is tax exempt

12. 1212
CRTs v. CLTs
• Typical CLT plan:
– Contribute income-producing property expected to
appreciate to CLT.
– Trust pays income to charity and takes a
charitable deduction.
– Property transfers to family members transfer tax
free at end of term.
• Key: CLT is taxable

13. 1313
Basic Types of CLTs
13

14. 1414
Basic Types of CLTs:
Intervivos or Testamentary
Q: When is CLT established?
• Intervivos:
– During donor’s life
– Gift trust or reversion to donor
• Testamentary:
– At donor’s death

15. 1515
Basic Types of CLTs:
Annuity or Unitrust
Q: What does the charity receive?
• Annuity
– Fixed percentage of initial value of trust (5%)
– Rate may increase over time (2%, increasing .25% per
year)
• Unitrust
– Fixed percentage of value of the trust as determined
each year (5%, determined annually)

16. 1616
Basic Types of CLTs:
Grantor or Nongrantor
Q: How is the CLT treated for income tax purposes?
• Grantor:
– CLT is taxed to donor.
– Donor pays the tax.
• Nongrantor:
– CLT is taxed as a complex trust under Subchapter J.
– Trust pays its own tax.

17. 1717
Key Elements of a CLT
• Trustee
• Beneficiaries
• Trust Property
• Flexible Features

18. 1818
Trustee
• Corporate or individual
• Trustee can have the power to change the
charitable beneficiaries
• Donor should generally not serve as trustee
– Donor can be trustee if the role is purely administrative
– Donor cannot hold the power to change beneficiaries
(causes estate tax inclusion)

19. 1919
Beneficiaries
• Charitable beneficiary
– One or more
– Need not be specified at time trust established
– Trustee may change beneficiaries or select new
beneficiaries
• Non-charitable remainder beneficiary
– Individual, estate, trust, partnership, corporation

20. 2020
Trust Property
• Income-producing property
– Non-income producing property may be sold
to cover annuity payments
• Trust instrument can allow borrowing funds
to cover annuity payments

21. 2121
Flexible Features
• Term of the trust:
– Term of years
– Life of one or two individuals
• Trustee may sprinkle the annuity payment
among a class of charities
– Donor-trustee should not hold this power to
avoid estate tax inclusion

22. 2222
Issues for Planning with
CLTs
• Economic outcome v. IRS projected outcome
• Income tax issues
• Gift tax issues
• Estate tax issues
• GST tax issues
• Private foundation rules
• Common planning opportunities

23. 2323
Economic Outcome
• Value of lead and remainder interest will vary
based on the 7520 rate
– Divides the value between the lead interest and
the remainder interest
• Generally, lower 7520 rates produce more
favorable results

24. 2424
CLAT Example:
7520 Rate 2.8%

25. 2525
CLAT Example:
7520 Rate 2.8%

26. 2626
CLAT Example:
7520 Rate 5.6%

27. 2727
CLAT Example:
7520 Rate 5.6%

28. 2828
Economic Outcome
• Asset performance > Annuity payment = Success!
– Additional value passes to beneficiaries
tax-free

29. 2929
Economic Outcome

30. 3030
Economic Outcome

31. 3131
CLAT v. CLUT –
Sensitivity to 7520 Rates

32. 3232
Income tax treatment
Grantor or non-grantor?

33. 3333
Grantor CLTs
• Initial contribution to trust => Donor receives deduction
– Amount of deduction limited by the usual factors (size, type
of property, type of charitable recipient)
– No further deductions are available for annuity payments
• Trust income => Reported on Donor’s return
– Donor effectively recaptures the deduction over the term
– If donor dies before the end of the term (or grantor trust
status is lost), a portion of the charitable deduction must be
recaptured

34. 3434
Grantor CLTs
• Grantor trust status triggered if:
– Grantor or spouse holds the remainder
interest
– Trust provides that the grantor holds powers
that trigger grantor trust status
• Power to swap out trust assets for assets of
equivalent value

35. 3535
Nongrantor CLTs
• Initial contribution to trust => No deduction!
• Trust income => Reported on separate trust return
– Trust receives charitable deductions from income for
payments made to charity during the term
– Character of income distributed is determined by
terms of trust, local law, or pro-rata share of all types
of income
– Files annual trust return (Form 1041) and also
information return (Form 5227)

36. 3636
Gift tax treatment
• Split interests:
– Lead interest to charity = Charitable deduction
– Remainder interest = Taxable gift
• Gift tax return must be filed to claim charitable deduction, and
possibly to report taxable remainder gift
• Value lead and remainder interest based on IRS methodology
and 7520 rate
– “Zeroed-out” CLT has a remainder interest with a value of zero

37. 3737
Example: Zeroed-Out Gift

38. 3838
Example: Zeroed-Out Gift

39. 3939
Estate tax issues:
Lifetime CLT
• CLT may be included in donor’s estate if:
– Donor retains reversionary interest of 5% or
more
– Donor retains certain powers, including to
determine charitable beneficiaries
• Assets transferred take carry-over basis

40. 4040
Estate tax issues:
Testamentary CLT
• CLT is included in donor’s gross estate
• Assets receive new basis
– Any capital gain on sale by CLT is minimized

41. 4141
GST tax issues
• CLUTs
– Usual GST rules apply
– May allocate GST exemption equal to value of the
remainder interest
• CLATs
– Special allocation rules apply
– Do not use CLATs for GST planning
• Remainder should go to children (not issue of child)

42. 4242
Private Foundation Issues
• CLTs are subject to the private foundation rules:
– Prohibitions on self-dealing
• Disqualified persons (donor, relatives, entities)
– Taxable expenditures
– Jeopardy investments
– Excess business holdings

43. 4343
Private Foundation Issues
• Exception to the rules on excess business
holdings and jeopardy investments
IF
– All of the income and none of the remainder
goes to charity
– The lead interest is not valued at more than
60% of the trust
• This does not work for zeroed-out CLATs

44. 4444
Common Planning
Opportunities
• Lifetime CLTs
– Estate freeze for estate tax planning
• Use in larger estates
• Good for appreciating assets
• Good for income-producing assets
– Income tax planning
• Grantor CLT => donor takes income tax deduction at
formation
• Nongrantor CLT => trust takes income tax deduction
when annuity is paid

45. 4545
Common Planning
Opportunities
• Testamentary CLTs
– Reduce or eliminate estate tax
• Donor retains assets for life
– Income tax benefit
• Basis step-up at death

46. 4646
Impact of 2017 Tax Bill
• Higher exemption amount
– A CLT may be a good way to “spend” some of
the extra lifetime exemption amount
• Increased limit on cash contributions
– Up to 60% of AGI (previously 50%)
– May make CLTs less relevant for income tax
planning

47. 4747
Case Studies
Techie Tycoon
No-Taxes Tanya
Philanthropist Pete

48. 4848
Techie Tycoon: Base Case
45-year old tech entrepreneur
expects unusually large
income this year due to the
successful IPO of his company
Believes his investment team
can beat the 7520 rate
Philanthropically inclined

49. 4949
Techie Tycoon: Base Case
• Need: Generate a large income tax
deduction this year
• Plan: 20-year CLAT
– Remainder either to Techie or to third party

50. 5050
Techie Tycoon: Base Case

51. 5151
Techie Tycoon: Base Case

52. 5252
Techie Tycoon: Base Case

53. 5353
Techie Tycoon: Base Case
• Techie takes the full charitable deduction for
income tax purposes when the CLAT is established
• Techie owns the CLAT assets for income tax
purposes
• Techie pays tax on the trust income and is not
entitled to further deductions

54. 5454
Techie Tycoon: Base Case
• Either Techie gets his investment back at age 65
• Or it is transferred to the non-charitable
beneficiary
– Future value depends on investment performance
• Lower 7520 rates make this structure more
attractive

55. 5555
Techie Tycoon: Base Case

56. 5656
Techie Tycoon: Variation 1
• Facts:
– Techie is now 65
– Would like to help secure the retirement of his
three children and get them involved in
philanthropy
• Plan:
– CLAT to make increasing payments to three DAFs
– Zero value remainder gift
– Children to receive remainder at end of term, near
their own retirement

57. 5757
Techie Tycoon: Variation 1
CLAT structure

58. 5858
Techie Tycoon: Variation 1
Annuity payments

59. 5959
Techie Tycoon: Variation 1
Remainder interest

60. 6060
Techie Tycoon: Variation 1
CLAT compared with alternatives

61. 6161
Techie Tycoon: Variation 2
• Facts:
– Techie would like to provide for his four
grandchildren
• Plan:
– CLUT at 5% (or 3% or 1%)
– Use exemption to cover gift of remainder
interest

62. 6262
Techie Tycoon: Variation 2
CLUT structure

63. 6363
Techie Tycoon: Variation 2
Increasing annuity payments

64. 6464
Techie Tycoon: Variation 2
CLUT compared with alternatives

65. 6565
Techie Tycoon: Variation 2
CLUT compared with alternatives

66. 6666
Techie Tycoon: Variation 2
CLUT compared with alternatives

67. 6767
No Taxes Tanya
65-year old high net worth
woman is motivated to avoid
taxes at all costs
Philanthropically inclined;
believes family members have
been adequately provided for
Single or does not want to
leave her wealth to her spouse

68. 6868
No Taxes Tanya
• Need: Eliminate estate tax on death
• Plan: Transfer remainder of Tanya’s
estate to a 20-year testamentary CLAT with
remainder to her children
– Formula clause eliminates estate tax

69. 6969
No Taxes Tanya:
CLAT structure

70. 7070
No Taxes Tanya
• Estate taxation:
– Estate receives charitable deduction for the full
amount transferred to the trust (if zero remainder
interest)
– If estate tax is due, cannot be paid from the CLT
• Income taxation:
– Nongrantor, so trust pays tax and receives
charitable deduction from income tax

71. 7171
No Taxes Tanya
• If the trust investments perform well, the
transfer to the remainder beneficiary could be
large
• Value of remainder interest is impacted by
– 7520 rate applicable at the time of death
– Investment performance of trust after death
– Both are unpredictable

72. 7272
No Taxes Tanya:
Economic Results

73. 7373
No Taxes Tanya:
Sensitivity to Investment Performance

74. 7474
Valueofremainderinterest
Growth rate of trust assets
No Taxes Tanya:
Sensitivity to Investment Performance

75. 7575
No Taxes Tanya:
Sensitivity to Interest Rates

76. 7676
Philanthropist Pete
70-year old philanthropist has
far exceeded the permissible
income tax deduction
limitations and has large
charitable deduction
carryforwards
Would like to donate additional
amounts and receive a
charitable deduction against
income

77. 7777
Philanthropist Pete
• Need:
– Make additional charitable contributions
eligible for income tax deduction outside of
limitations on individual charitable deductions
• Plan:
– 20-year nongrantor CLAT with remainder to
children or third party

78. 7878
Philanthropist Pete
• Gift taxation:
– Remainder interest may have value
– Use exemption to cover

79. 7979
Philanthropist Pete:
CLAT Structure

80. 8080
Philanthropist Pete
• Income taxation:
– Non-grantor
– No deduction for Pete at initial contribution
– Trust receives charitable deduction against
income earned when annuity is paid

81. 8181
Philanthropist Pete:
CLAT compared with direct gifts

82. 8282
Philanthropist Pete
• Outcome for remainder beneficiary depends on
performance of trust assets

83. 8383
SIDEMAN & BANCROFT LLP
(415) 392-1960
Kirsten Wolff
kwolff@sideman.com