Home Estate Planners Corner

Estate Tax Repeal and the Philanthropic Client

The current estate planning chaos – created by failure of Congress to fix the federal estate tax and generation-skipping tax mess before one-year repeal took effect January 1 – extends well beyond clients who have transfer tax exposure.  The presence in 2010 of “modified carryover basis,” for example, could cost many estates and heirs dearly. (The step-up in basis for 2010 deaths is limited to only $1.3 million of gain, plus $3 million of additional step-up for assets left to spouses.)

Congress may or may not take quick action to reinstate all transfer taxes for 2010.  The federal gift tax remains in effect for 2010, of course, but with the top tax rate reduced from 45% to 35% and a $1 million lifetime gift tax exemption.  No one can predict what Congress will do, when they will do it, or if proposals such as restoring federal estate and GST taxes retroactively will hold up in court.  Flexibility, obviously, is the key to drafting estate planning documents in 2010.

Estate plans of philanthropic clients with formula clauses for benefiting charity could be thrown into confusion if they die in 2010.  Clients may have wills or revocable living trusts with charitable distribution clauses that reference the federal estate tax credit shelter ($3.5 million in 2009 and $1 million in 2011).  Such clauses could be difficult or impossible to interpret if estate taxes – and estate tax credits – have been repealed at their deaths in 2010.  Other donors may have made charitable bequests that are limited to a maximum (or minimum) percentage of their “adjusted taxable estate,” as computed for federal estate tax purposes.  The meaning of such clauses may be murky if the estate tax is nonexistent.

Clearly, all formula clauses need to be reviewed and revised quickly, even though the review process may be required all over again, depending on what Congress does.  Philanthropic clients also might consider bequeathing low-basis capital assets to charity, in case modified carryover basis is in effect at their deaths.  Risk-tolerant estate owners who want to use the current “window of opportunity” aggressively to make taxable gifts at the reduced 35% tax rate, might consider applying further leverage with charitable lead annuity trusts.  Such strategies could blow up, of course, if Congress changes the law retroactively. 

Adding Flexibility to CRT Beneficiary Arrangements

Priscilla has established a unitrust that will pay her income for life, then continue payments to her three children, limited to a maximum of 20 years following her death.  The payments would be made equally to each child, but Priscilla worries that the children may have widely varying income needs at the time of her death.  Under Code §664, donors can’t keep the right to alter the division of trust payments among beneficiaries. (Such power would cause the trust to be treated as a grantor trust, which cannot qualify as a charitable remainder trust.)  Priscilla could name an independent trustee, who would have sprinkling powers to decide who gets what from the trust, but she wants to be able to make these decisions herself before her death.

One solution is for Priscilla to keep the right, exercisable only by will, to revoke the income interest of any beneficiary.  Thus, if one of her children develops special needs before Priscilla’s death and requires larger trust payments, or if one of them wins the lottery and won’t need anything, Priscilla can make a change in her will that revokes a child’s income interest.  The revoked payments would redound to the benefit of the remaining beneficiaries.  Partial revocations do not seem to be prohibited under the Code, so Priscilla might be able to fine tune the relative income interests of her children. 

Accelerating Benefits to Charity from CRTs

A recent private letter ruling (PLR 200950032) permitted the beneficiary of a charitable remainder annuity trust to reform the trust to allow limited annual distributions of principal to the remainder beneficiary, assuming that annual trust values exceeded a certain amount.  The IRS stated that the proposed modification would not disqualify the trust under Code §664.  (See also, PLR 200617026.)  Early benefits to charity are not necessarily limited to distributions of principal, however:

• Sharing the Unitrust or Annuity Amount with Charity.  A charitable remainder trust must provide that the annuity or unitrust amount be paid to or for the use of one or more persons, at least one of which is not a Code §170(c) organization [Code §664(d)].  The clear implication is that a charity, in addition to being a remainder beneficiary, can be named as one of the income beneficiaries and receive some of the annual unitrust or annuity trust payment.  So in a 7% CRT, charity might receive 2% and the donor 5%.   No additional income tax charitable deduction is available from this arrangement, but the payments to charity won't be included in the recipients' taxable income.  Sharing CRT payments with charity is a commendable plan for younger donors who wish to establish unitrusts that pay them lifetime income (example: a 45-year-old entrepreneur or professional who sets up a CRT primarily to minimize capital gains taxes). 

• Sprinkling Income on Charity.  A private letter ruling approved a payout arrangement in which the donor and the charitable remainderman were co-income beneficiaries of a CRAT, with an independent trustee holding the power to sprinkle the trust's annuity amount.  At least 20% was required to be paid to the donor (PLR 9052038).  The trust would be disqualified unless an independent trustee wielded the sprinkling power.  Presumably, the independent trustee would consult with all the income beneficiaries and inquire as to their income needs.  The grantor of the trust might have some leverage over the charity's response to trustee inquiries if the charity named as income beneficiary were also the revocable remainder beneficiary.  (See also, PLR 200813006.) 

• Excess Trust Income Designated for Charity.  The trust instrument may direct, or give the trustee discretion to make, payments of trust corpus to charity [Reg. §1.664-2(a)(4), 1.664-3(a)(4)].  The trust also may give the trustee discretion to pay trust income in excess of amounts needed to satisfy unitrust or annuity payouts to charity (PLR 8034056).  In another case, a trust provided that any trust income in excess of the annuity amount was to be paid to charity.  Because charity had received only nominal distributions over the years, the donors wished to amend the trust to give the trustee the power to distribute up to a certain amount after required annuity payments. The IRS said the reformation would not disqualify the trust (PLR 199929033).

Liquidation of Corporations by Charity

Owners of C corporations – particularly those with personal holding companies – may propose contributing their businesses to charitable remainder trusts, or perhaps outright to a charity, with the expectation that the trust or charity will liquidate the corporation. Two levels of taxation ordinarily occur upon liquidation: The owner incurs capital gains tax on redemption of his stock in the corporation, and the corporation is taxed when it sells or distributes its assets in a complete liquidation of the company.

IRS regulations require recognition of gain by a C corporation in most cases where a tax-exempt organization acquires all or substantially all of the corporation’s assets [Reg. §1.337(d)-4]. Under the 1986 Tax Reform Act, corporations must recognize gain or loss when appreciated or depreciated property is distributed or sold in a complete liquidation (Code §§336, 337). The regulations foreclose attempts to get around corporate tax through transferring corporation assets to tax-exempt entities. No tax is imposed as to transferred assets used by the tax-exempt organization in an activity subject to the unrelated business income tax [Code §511(a)]. The regulations also impose tax where a taxable corporation switches status and becomes a tax-exempt entity.

Business owners can still transfer all their shares in a corporation to charity or a charitable trust and receive a deduction based on the fair market value of their stock, without having to pay capital gains taxes. So one layer of tax is avoided. But when the charity or trust liquidates the corporation, the corporation will be taxed, which will reduce the amount remaining for the charity or charitable trust.

<back
Copyright © R&R Newkirk. All rights reserved.