Charitable Planning
Charitable Planning with IRAs and Qualified
Plans
Charitable Planning With IRAs and Qualified
Plans
For our Friends at WealthCounsel Advisors Forum
Teleconference Seminar
March 14, 2007 at 1 p.m. EST
Thomas J. Ray, Jr., Esq.
Ray Law Offices, P.C.
3520 Jeffco Boulevard. Ste 110
Arnold, MO 63010
raylawpc@aol.com
Lifetime Charitable
Planning
IRA Charitable Rollover
IRA Charitable Rollover
Passed as part of the Pension Protection
Act of 2006.
Effective only until December 31, 2007.
President Bush has proposed making the
bill permanent and a bill has been
introduced in Congress.
IRA Charitable Rollover
Effect:
A qualified taxpayer makes a tax-exempt
transfer of IRA assets to charity.
Limited to $100,000 per taxpayer.
Allows a client to meet his or her RMD for
the year of the transfer.
IRA Charitable Rollover
Six Requirements:
Donor Must be 70½.
Only distributions from IRAs qualify.
Only direct distributions qualify.
IRA Charitable Rollover
Six Requirements (continued):
Only Certain Section 170(b)(1)(A)
organizations qualify to receive
distributions.
a. Non-Operating PFs do not qualify.
b. Supporting Organizations and DAFs
cannot qualify under the new law.
IRA Charitable Rollover
Six Requirements (continued):
5. Distribution must otherwise qualify for
the income tax charitable deduction.
6. Only otherwise taxable distributions
from the IRA qualify.
NUA-CRT
A tax-efficient strategy involving the use of
a CRT funded with an lifetime transfer of
employer securities from a qualified plan.
PLR 199919039
Charitable Remainder Trusts
“. . . [A] charitable remainder trust is a trust
which provides for a specified distribution, at
least annually, to one or more beneficiaries, at
least one of which is not a charity, for life or a
term of years, with an irrevocable remainder
interest to be held for the benefit of, or paid
over to, charity.” Treas. Reg. § 1.6641(a)(1)(i).
Charitable Remainder Trusts
Charitable Remainder Trust
Property
Remainder
Trust
Charity
Income Tax
Deduction.
Tax Free
Sale/Investment.
Trustee Controls
Investments.
Income
Remainder to
Charity.
Estate Tax
Savings.
Charitable Remainder Trusts
A Charitable Remainder Trust:
Is tax-exempt (except to the extent it realizes
UBTI in a given year).
Not subject to the 2% Net Investment Income
Tax for Private Foundations.
Charitable Remainder Trusts
Types of Charitable Remainder Trusts
• 1 type of Charitable Remainder Annuity Trust
(CRAT).
• 4 types of Charitable Remainder Unitrusts
(CRUT).
- SCRUTs
- NICRUTs
- NIMCRUTs
- FLIP-CRUTs
Charitable Remainder Trusts
Income Control Uses of NIM-CRUT/FLIP-CRUTs
Capital Gains NIM-CRUTs
Conrad Tietell’s “FLEX-CRUT”
Spigot CRUTs
- Funded with Annuities
- Funded with Limited Partnership Interests
- Funded with Zero-Coupon Bonds
Charitable Remainder Trusts
How the Recipients are Taxed:
Step 2:
Step 6:
Step 1:
Step 3:
Step 4:
Step 5:
Current Accumulated Current Accumulated Current Accumulated
Income Capital Gain Capital Gain Tax-Exempt Tax-Exempt
Income
Income
Income
Ordinary
Income
Capital Gain
Income
Tax-Exempt
Income
Tier 1
Tier 2
Tier 3
Step 7:
Return of
Principal
Principal
Tier 4
Tax Planning Opportunities for
Employer Securities
IRC § 402(e)(4)(B)
• Generally, a Participant realizes ordinary
income on distributions from his or her
qualified plan in the year he or receive
receives the benefits.
• BUT an employee does not pay tax on “Net
Unrealized Appreciation” (NUA) distributed
from his or her plan in the form of a LSD.
Taking the LSD “Rollout”
Lump Sum Distribution under IRC §
402(d)(4)(D) qualifies for NUA if:
• On account of employee’s death
• After the employee attains age 59½
• On account of employee’s separation from
service
• After the employee has become disabled (within
the meaning of section 72(m)(7)
Taxation of the Rollout
• Ordinary income is recognized by the
Participant only on basis in the securities.
IRC § 402(e)(4)(B).
- Participant’s Basis is the FMV of the employer’s
securities when acquired by the plan
administrator. Treas. Reg. § 1.402(a)-1(b)(2)(i)
(with certain adjustments).
• Difference between Fair Market Value
(FMV) at rollout and basis is NUA. Treas.
Reg. § 1.402(a)-1(b)(2)(i).
Taxation of the Rollout
If the distribution does not qualify as
LSD, then the whole distribution is
taxed as ordinary income. Treas. Reg.
§ 1.402(a)-1(b)(1)(i).
Even if the distribution qualifies as LSD,
if Participant is under age 55, a 10%
excise tax penalty is imposed on the
basis of the securities.
Taxation of the Rollout
Taxation of the Net Unrealized Appreciation
Fair Market Value (FMV) of stock
$ 750,000
Employer basis
$ 150,000
Net Unrealized Appreciation (NUA)
$ 600,000
Amount taxable if stock is rolled out $ 150,000
The $600,000 of NUA
is Deferred Until the Stock
is Sold!
Taxation of the Stock Sale
Post-Distributions Taxation:
• The Participant pays taxes on the NUA as long-term
capital gain only when he or she sells the securities,
and regardless of how long the securities were held
before sale. Treas. Reg. § 1.402(a)-1(b)(1)(i). IRS
Notice 98-24, 1988-1 C.B. 929.
• At sale, the Participant may also pay tax as LTCG
or STCG on that part of the gain not attributable to
NUA. Treas. Reg. § 1.402(a)-1(b)(1)(i).
- The characterization depends on the Participants holding
period.
Taxation of the Stock Sale
Holding Periods:
• 1 year or less -- Short-term Capital Gain –
taxed as ordinary income. IRC § 1221(a)(3).
• Greater than 1 year -- Long-term Capital
Gain – Taxed with Favorable Rates. IRC §
1222(3).
NUA Treatment at Participant’s
Death
• NUA is IRD. Rev. Rul. 69-297, 1969-1 C.B.
131.
• In our example, the $600,000 of rollout gain
does not receive a step-up in basis at the
Participant’s death.
• But post-distributions gain (above $600,000)
should receive a step-up in basis.
The NUA-CRT
• If the participant chooses to take employer
securities from his plan as a lump-sum
distribution, he may find a CRT useful.
• This option allows the participant to
diversify his securities in a tax-exempt
environment.
The NUA-CRT
Example:
Chester, 65,
401(k) with $600,000 in employer
securities.
Securities have a cost basis of $100,000 to
the plan.
The NUA CRT
Chester, Age 65
401(k) stock
$600,000
7% Unitrust
$600,000
Income Tax
Deduction of
$218,256 (4.6 AFR)
(Offsets Tax on
Basis)
Avoid Tax on
LTCGs.
One
Charity
$800,000
Life
Trust Income of 5%
paid first year =
$42,000. Estimated
Total = $882,000
At death:
No Probate
No Estate
Taxes
Testamentary
Charitable Planning
Testamentary Charitable Planning
From a tax standpoint, retirement plan
assets may be the ideal asset to fund
testamentary charitable gifts:
1. The gift qualifies for the estate tax
unlimited charitable deduction.
2. Because the charity is a tax-exempt
entity, it pays no income tax on receipt
of the distribution.
Testamentary Planning - Example
Testamentary Planning- Example
Problems with Charitable Planning
Problems arise if the client wants charities and
non-charitable beneficiaries to share
retirement assets at the client’s death:
1.
If the client names a charity in the beneficiary
designation, he may spoil DB status for the noncharitable beneficiaries.
2. If the client names a trust with individuals and
charities as beneficiary of the plan, the client
may spoil DB status for the trust.
Solving the Dilemma
Solutions:
• Split IRA into separate IRAs during participant’s
lifetime with one IRA having only charitable
beneficiaries and one IRA with only DBs.
• Cash out the charity by September 30 of the year
following the participant’s death, thus leaving only
individuals as beneficiaries on the determination date.
• Create separate accounts by December 31 of the year
following the participant’s death.
• If the spouse is named as a primary beneficiary with a
charity, the spouse can do a roll-over of his or her share
into his or her own IRA.
Testamentary Charitable Remainder
Trusts
Testamentary Remainder Transfer
• Uses – Because of the IRD Element for IRAs and
Qualified Plans, Testamentary CRTs make great
recipients for these assets! Both charity and noncharitable beneficiaries share in the benefits.
• Under current law, it is poor planning to make an
inter vivos transfer to a CRT
- No rollover – treated as a withdrawal from the plan.
- If under participant under 59½, transfer subject to 10%
penalty.
- BUT inter vivos transfer of employer securities from
qualified plan may be viable. (More about that later.)
Testamentary Charitable Remainder
Trusts
Testamentary CRTs
• Requirements
- Obligation to pay begins with the date of
death.
- Trustee may defer payment until the
testamentary distribution is received.
Testamentary Charitable Remainder
Trusts
A CRT to hold retirement assets typically
take one of three forms:
- CRT for IRA participant’s spouse.
- “Term of Years” CRT for participant’s
children. (the “Give-It-Twice” trust.)
- “S t r e t c h” CRT for children.
Testamentary Charitable Remainder
Trusts
Retirement Plans to CRT for Spouse, 56
IRA
$800,000
5 % Unitrust
$800,000
One
Marital Deduction
and Charitable
Deduction result in
zero taxes.
Life
Trust Income of 5%
paid first year =
$40,000. Estimated
Total = $1,148,000
Charity
$800,000
At spouse’s
death, trust
assets to
charity.
Testamentary Charitable Remainder
Trusts
IRA
$800,000
“Give It Twice” Trust
Retirement Plans to CRT for
Children
5 % Unitrust
$800,000
Term of
Charitable
Deduction =
$299,237 (4.2%
AFR).
20 Years
Trust Income of 5%
paid first year =
$40,000. Estimated
Total = $800,000
Charity
$800,000
At end of term,
trust assets to
charity.
Testamentary Charitable Remainder
Trusts
IRA
$800,000
“S t r e t c h Unitrust”
Retirement Plans to CRT for
Lives of Children, Ages 47, 45, 43
5 % Unitrust
$800,000
Three
Charitable
Deduction =
$100,392 (4.2%
AFR).
Lives
Trust Income of 5%
paid first year =
$40,000. Estimated
Total = $1,932,000
Charity
$800,000
Death of last
child, trust
assets to
charity.
Testamentary Charitable Remainder
Trusts
Mechanics
1. Prepare and Submit a Beneficiary
Designation Naming CRT as Beneficiary.
2. Name a
•
Preexisting CRUT (Cannot Name a Pre-existing
CRAT).
•
Testamentary CRT.
3. Upon death, IRA transferred to CRT.
Testamentary Charitable Remainder
Trusts
Criticisms of IRAs to CRTs:
“There is little or no tax advantage to
transferring . . .retirement plans to [CRTs]
versus outright to children”
- Bianculli
Testamentary Charitable Remainder
Trusts
Criticisms of IRAs to CRTs
Our Response:
•
The Stretch IRA is fully subject to estate tax; the CRT is not.
•
Many Stretch IRAs fail to achieve the parent’s objectives.
-
Stretch not available.
-
No income control.
•
Hard to accomplish charitable planning with a Stretch IRA.
•
It is possible to outlive a Stretch IRA; it is impossible to
outlive a Stretch CRT.
•
Potiental for better investment performance.
Testamentary Charitable Remainder
Trusts
Criticisms of IRAs to CRTs:
“The beneficiaries will never realize the benefit of
the deduction for estate taxes paid.”
Bianculli
“The deduction for practical purposes disappears –
nobody gets to use it.”
- Choate
Testamentary Charitable Remainder
Trusts
Criticisms of IRAs to CRTs:
What are they talking about?
•
Section 691(c) allows the IRD recipient to take an
income tax deduction for federal estate taxes paid
on IRD.
•
PLR 199901023 – the 691(c) deduction does not
flow through a CRT to the trust recipients; it does
offset Tier One Ordinary Income.
Testamentary Charitable Remainder
Trusts
Criticisms of IRAs to CRTs:
Our Response:
•
With estate tax reform, many taxpayers can’t use the 691(c)
deduction anyway.
•
PLR 199901023 permits the trustee to push ordinary
income out of the trust more rapidly.
•
Through proper investment, the beneficiaries may receive
capital gains income/dividend income taxed at 15% rather
than ordinary income.
Illustrated Thusly:
Testamentary Charitable Remainder
Trusts
IRA
Partly
Tax Free
Full
Ordinary
Income
Payments
“Stretch Out”
For Life of Child
Tax
0
At Life Expectancy
Payouts Terminate
Testamentary Charitable Remainder
Trusts
Payouts Age 50
Tax
Free
Ordinary
Income
Life Expectancy
Payouts End Age 86
691(c) Period
Partial Deduction
Full Ordinary
Income Tax
Testamentary Charitable Remainder
Trusts
UT
+
Tax
Savings
Ordinary Income
Long Term
Capital Gain
Charity
Payments
for Life
Testamentary Charitable Remainder
Trusts
Payouts Age 50
Ordinary
Income
Capital
Gain
Life Expectancy
Payouts To Age 110+
691(c) Period
Ordinary Income
Most or All
Capital Gain
CST-CRT
A CRT as a CST for Retirement Plans
The Idea: Use a CRT in lieu of a traditional credit shelter
trust to hold IRAs and Qualified Plan benefits.
Estate Profile:
• Estate $1,000,000 to $8,000,000.
• IRA/Qualified Plan is 60% to 80% of the estate.
• Non-IRA Assets < Exemption.
• Particularly Important as Exemption grows: $1,500,000,
$2,000,000, $3,500,000.
CST-CRT
Case profile:
Dr. Benjamin Rush - $4,000,000 Estate –
- $200,000 in cash equivalents.
- $3,800,000 in IRA.
Mrs. Rush - $1,500,000 Estate –
- $800,000 personal residence.
- $500,000 in IRA.
- $200,000 in cash equivalents.
CST-CRT
2005
QTIP
$2.3M
Ben’s
Estate
$4M
IRA
5%UT
$1.7M
Three
Lives
Mary and Children
$7.8M Income
Charity
$6M
(No Income
Tax Paid by
Charity)
CST-CRT
Drafting/Planning Ideas:
•
Create the CST/CRT as a Spigot Trust.
•
Create the CST/CRT as a Capital Gains Unitrust.
•
Create the CST/CRT as a FLIP-CRUT
-
•
With death of Spouse as Trigger.
Create the CST/CRT as a FLEX-CRUT.