Monthly Archives: September 2013

The Charitable Remainder Trust and Wealth Replacement Planning: A Potent Combination

The Peconic Land Trust and I have worked together to assist families who wish to encompass donative intent in tax-wise Estate Planning.  The use of a Charitable Remainder Trust (CRT) coupled with a wealth replacement plan has proved very effective in enabling individuals to ensure the preservation of land, increase family income, achieve a charitable intent and replace the value of the amount of the charitable gift.  The purpose of this article is to explain how a CRT and wealth replacement planning work, and how they may benefit your family and you.


A CRT is a trust that annually pays the beneficiary either a fixed dollar amount, or fixed percentage of the value of the principal of the trust (which is valued annually).  Upon the death of the beneficiary or beneficiaries, the trust terminates and the remainder (the principal value of the trust at that time) is paid to a recognized charity or charities.


The procedure to establish the CRT is relatively straightforward.  The Trust Agreement is written and signed by the individual making the gift to the trust, the “Grantor,” and the person receiving the gift, the “Trustee.”  The trust must be irrevocable.  The Trustee holds the assets given to the trust for the benefit of the beneficiary, typically the Grantor and the Grantor’s spouse.  The charity has the remainder interest and is known as the remainderman.  The Grantor may be the Trustee.  The gift to the trust can create an income tax deduction for the charitable contribution that is the value of the remainder interest as of the date the trust is created.  Each year a payment from the trust is made to the beneficiary.  The payments can be made in monthly, quarterly, semi-annual or annual installments.


Typically, a CRT is used when a person has highly appreciated, low income producing assets such as stocks, that they desire to sell in order to invest in a higher income producing investment.  A CRT, thereby, enables the individual to make a charitable contribution and receive a higher income.  The sale of these assets would produce a significant capital gain between the sale price and the low-cost basis, resulting in an income tax on the gain. The payment of the tax will result in the loss of up to 30% of the sale proceeds (20% federal tax and up to 10% state tax).  This will reduce the amount available for reinvestment by up to 30%.  The value of the CRT is that, by giving the asset to the CRT and having the CRT, as owner, sell the asset, there is no capital gain tax due at the time of the sale because the CRT is tax-exempt.  Therefore 100% of the sale proceeds are available to generate the fixed income payment to the beneficiary.


For example, if “A” has land or stock worth $1,000,000 with a cost basis of $100,000 and “A” sold the property, the gain is $900,000 and the tax at 30% is $270,000.  Thus, a net of $730,000.  If invested in a safe haven investment such as bonds, the return will typically be approximately 5% or $36,500 per year ($730,000 x .05= $36,500).


On the other hand, if “A” has created a CRT, made the gift of the asset to the CRT and the CRT made the sale, the net is $1,000,000.  If the CRT provided that “A” (or “A” and “A’s” Spouse) receive an annual payment of 9% of the trust principal, the first year’s payment would be $90,000 or $53,500 more than in the previous example (subject to applicable income tax).  Typical percentage payment range between 5% and 12%, depending on the age of the Grantor and the Grantor’s spouse.  If, hopefully, the trust appreciated in value due to prudent investment in a combination of stocks and bonds, the annual payment can increase.


The drawback of the CRT is that the principal may not be invaded (except to the extent of the percentage payment) and that the principal is not available to the family at the death of the Grantor.  With respect to the first, it is usually the case that the Grantor would not be using the principal even if it were in his or her own name.


Here is where wealth replacement planning can replace the value of the remainder (the trust principal) that is given to the charity in order to make the family “whole.”  This is accomplished by the Grantor and the Grantor’s spouse  purchasing a Second to Die Life Insurance Policy (or Single Life Insurance Policy if there is no spouse) through an Irrevocable Life Insurance Trust which is the owner and beneficiary of the policy.  Because the policy is owned by the trust it is not subject to state tax in the estate of the Grantor or the Grantor’s spouse.  The $53,500 additional income provided by the CRT (refer to example) is the source of payment of a life insurance premium.


The combination of the CRT and wealth replacement strategies provides important planning tool and achieves a number of significant benefits.  A charitable deduction may be obtained, more income can be received and, through wealth replacement, the family is made whole or better via insurance trust.  Last, but far from least, a significant charitable contribution of lasting importance and value is made to the charity or charities.  You, your family and the charities, not the IRS, enjoy the benefit.  It is a question of whom you wish to benefit and the choice is yours.


Does the CRT and wealth replacement have a place in your planning?  Very likely.  Peconic Land Trust and I would be pleased to discuss your situation with you.

Charitable Planning Strategies for Qualified Plans and IRAs

The combination of estate and income taxes that apply to Qualified Plans and IRAs (hereafter referred to as “Plans”) can reduce the benefit to a non-spouse beneficiary by up to 70%.  Because the tax impact can so dramatically reduce the amount received by a non-spouse beneficiary, using the Plan assets for charitable giving can be a very cost efficient method to make desired charitable gifts.  If, during the Plan owner’s lifetime, distributions are used to replace the value of a charitable gift, the non-spouse beneficiary can also receive a benefit.  This strategy is particularly effective if the Plan owner does not require the Plan assets for funding his or her retirement needs.  Careful planning can avoid the double tax trap and enable the Plan assets to provide benefits for both family and charity.

The rules relating to Qualified Plans were primarily intended to provide an income tax deferral, but limited the time during which receipt of income could be postponed.  The primary reason for allowing deferral was to encourage savings for retirement.   Providing benefits to the Plan Owner’s beneficiaries was not a primary purpose of the rules.  Theses distribution rules have been simplified by the January 11, 2001 proposed regulations, but they still exist as to the required beginning date of distributions and the time limit of distributions.  The general rule is that distributions are required by begin by April 1st of the year following the year the owner attains age 70 ½ and continue annually over the distribution period.  The distribution rules also provide for a minimum required distribution (“MRD”).  This is determined on the required beginning date based on the table and the account balance as of December 31 of that year.  The table bases the distribution period on the life expectancy of the owner and of a designated beneficiary deemed to be ten years younger unless the designated beneficiary is a spouse who is more than ten years younger, in which case the actual joint life expectancy applies.

If the spouse is the beneficiary and the Plan owner dies first, the spouse can “roll over” the Plan and name a new designated beneficiary and start the clock again.  If the beneficiary is a non-spouse, upon the death of the Plan owner, the period of distribution becomes the life expectancy of the designated beneficiary.

There are strategies to extend the distribution period by naming children or grandchildren as designated beneficiaries.  This enables distributions to continue after the death of the owner for the life expectancy of the young beneficiaries.  For this strategy to be effective, however, the pro rated share of estate taxes due on the value of the Plan must be paid from non-Plan assets.  If the estate taxes are paid from the Plan assets, the spiral of income and estate taxation rears its ugly head.  Each dollar withdrawn from the Plan to pay estate tax incurs incomes tax.  The result is a combined income and estate tax of up to 70%.  This has a devastating effect on the amount passing to the beneficiary.  A plan valued at $2 million can be reduced to approximately $600,000.  The legacy you intended to leave is reduced dramatically by income and estate taxes.

Fortunately, there is an alternative that, if adopted, can provide substantial benefit to both family and charity.  The first part of the strategy involves naming a charity (or charities) as beneficiary of the Plan if the spouse does not survive or, if the spouse survives, he or she can roll over the Plan and name the charitable beneficiary.  By naming a charity, the estate receives a dollar-for-dollar charitable deduction and incurs no estate tax on the Plan assets comprising the charitable bequest.  Since the after-tax benefit to the non-spouse beneficiary would have been only approximately 30% of the value of the plan assets, naming a charity as the beneficiary has little impact on the non-spouse beneficiary, yet provides a very substantial gift to charity.

The second part of the strategy involves using the minimum required distribution (or a greater distribution if needed) during the owner’s life and the life of his or her spouse to pay the premium on a second-to-die life insurance policy owned by an Irrevocable Trust.  This is particularly efficient if the distributions are not required to provide retirement income.  If the income is required for retirement needs, an increased distribution may be taken to pay for the insurance.  However, careful planning is needed to chart the longevity of the Plan assets based on the distributions required.  The amount of the insurance could be the amount the non-spouse beneficiary would have received, but is often greater because the distribution from the Plan can support the required premium.

Upon the death of the second to die, the Irrevocable Trust will receive the death benefit free of income or estate taxes.  Additional planning can enable the Trust to 1) continue for the life of the non-spouse beneficiary, 2) have the use of the Trust assets and, 3) upon death, have the then Trust principal be paid estate tax-free to the next lower generation.  This can result in a substantial increase in the amount received by the next generation.

In summary, Qualified Plans and IRAs are subject to both estate and income taxes, thereby having a devastating effect on the amount the non-spouse beneficiary receives.  The strategy of having a charitable beneficiary coordinating withdrawals from the Plan with the purchase of insurance owned by an Irrevocable Trust, significant charitable and family benefits can be achieved.

In the last issue of the Peconic Land Trust’s Newsletter, I discussed a similar wealth replacement plan involving Charitable Remainder Trusts.  This method of charitable giving and wealth replacements with the assets being ultimately given to charity has application in many areas.  If there is a downside, it is for the IRS.  The upside is for you, your charities and your family.  It is a fine legacy to leave.

New Estate and Gift Tax Law Highlights (2013)

On January 1, 2013, Congress passed new law known as the American Taxpayer Relief Act of 2012, or “ATRA.”  ATRA makes many important changes to the Internal Revenue Code. The following are some notable highlights:


Estate, Gift & Generation-Skipping Tax Transfers  

The exemptions for federal estate, gift and generation-skipping tax (“GST”) transfers are set at $5,000,000, indexed for inflation. For 2013, the exemption is $5,250,000 (or $10,500,000 per couple), reduced by any portion of the exemption used in prior years. Taxable transfers beyond the available exemption will be subject to a 40% tax rate. This law sets so-called permanent exemptions because, unlike the prior law, the exemptions and rates do not automatically adjust or sunset. However permanent, the law is still subject to future legislation.


New York still does not have a gift tax, which means lifetime gifts continue to be particularly advantageous for New York residents.



ATRA makes portability permanent. Portability allows a surviving spouse to inherit the unused federal (not state) exemption amount of the deceased spouse, if the executor files an estate tax return for the deceased spouse and makes an affirmative election. The unused GST exemption of a predeceased spouse is still not portable to the surviving spouse.


Income Taxes 

ATRA increased the top Federal income tax bracket from 35% to 39.6%, effective for this year.  In addition, there is a new 3.8% Medicare Tax that applies to most dividends, interest, rents, royalties, certain annuities and capital gain.  Although the 39.6% and 3.8% tax rates apply only to individuals with relatively high levels of income, these rates of tax apply to trusts with about $12,000 of income. One immediate reaction is that the use of trusts should be curtailed.  However, I believe a flexible trust will continue, in most cases, to be beneficial for asset protection and generational wealth preservation.


Annual Exclusion 

ATRA does not change the annual exclusion from the federal gift tax. The annual exclusion was already indexed for inflation, and, for 2013, the exclusion has increased from $13,000 to $14,000 per donee (or $28,000 per donee for a couple).


Not Included in ATRA

It is important to note that ATRA did not include many proposals to limit certain estate planning techniques that, if enacted, would have dramatically effected estate planning. These include the restriction the of the term for Grantor Retained Annuity Trusts, disallowing minority discounts for many family owned entities, consistent valuation requirements for estate tax and basis for capital gains, limiting the duration of generation-skipping trusts, and providing consistent treatment of grantor trusts with respect to income, estate and gift tax.  These techniques are still effective, however, subject to future legislation.


Estate and Gift Tax Law Highlights (2012)

Startlingly, Congress passed a very favorable gift and estate tax law which not only applies in 2011 and 2012 but can be retroactive for estates of decedents who died before December 17, 2010.  A brief summary follows:

Beginning January 1, 2011, individuals can give up to $5 million (or $10 million per couple) free of gift tax, reduced by any portion of the exemption used in prior years.  Gifts over $5 million will be subject to a 35% tax rate.  New York still does not have a gift tax.

Beginning January 1, 2010, the estate tax is reinstated with a 35% rate, a $5 million exemption and stepped-up basis for all assets included in the estate for estate tax purposes.  However, for the estates of decedents who in 2010, before the date of enactment, the Executor can elect out of estate tax in favor of the carryover basis rules, with an allocation of $1.3 million of basis step-up and an additional $3 million for assets passing to a surviving spouse.

This is new and is currently applicable only to decedents dying after January 1, 2011 and before December 31, 2012. If an estate tax return is filed for a decedent and an election is made, the surviving spouse can use the unused estate tax exemption amount of the deceased spouse.  Unless the law is extended, both spouses must die within the two year period (2011 and 2012) for this provision to apply.  Also, note that any unused GST exemption of a predeceased spouse is not portable to the surviving spouse.

GST Taxes
The GST tax is reinstated effective January 2010, with a $5 million exemption.  However, the tax rate is 0% for 2010 transfers.  The rate increases to 35% effective January 1, 2011.  The historically low rate is an opportunity if you are interested in GST planning, specifically direct gifts or gifts in trust for grandchildren.

A Good Time for Charitable Lead Trusts

Many estate planning techniques involve split interest gifts, gifts which have two components, (1) the current interest and (2) the remainder interest. A Charitable Lead Trust (“CLT”) is such a gift. The use of the CLT is particularly effective at this time because the Applicable Federal Rate (“AFR”) is particularly low. The AFR, which is an interest rate equal to 120% of the Federal midterm rate in effect for the month in which the gift is made, is used in the computation to determine the respective current interest and remainder interest of split interest gifts. A low AFR will reduce the value of the future interest, thus lowering the taxable gift.

The Charitable Lead Trust is one of the more valuable planning devices available for wealthy persons who wish to make gifts to charity and also want to ensure the continued affluence of family members. It is most appropriate when the Donor and Donor’s family do not require the income from the assets to be given to the CLT, or are willing to forego current income for the potential of realizing long-term capital appreciation for themselves or other family members at low gift or estate tax cost. Using a CLT lowers the amount of the taxable gift and transfers all appreciation to the beneficiary at no further gift tax cost at the termination of the CLT.

It is possible, by selecting an appropriate payout rate and trust term, to greatly reduce or even eliminate almost entirely the gift or estate taxes due upon the transfer to the CLT. Because of this, the lead trust is a significant means by which a donor may pass on assets to the next generation of family members at little or no tax cost. The CLT is a particularly advantageous means to transfer wealth when the AFR is low, as it has been in the last few months, because the lower the AFR, the smaller the remainder interest is deemed to be when the value of the remainder interest is computed upon creation and funding of the CLT. The effect is that the Donor will be deemed to be making a smaller taxable gift when the AFR is low.

For example, Donor owns a parcel of real estate worth $1,000,000 that he wishes to give to his children. If he gives it to them outright, the taxable gift is $1,000,000 and the tax is $345,000. There is no charitable gift component in this case.

If he gives the property to a CLT for a 20-year term with an annual gift to charity of $50,000, the taxable value of the gift when the AFR is 8% is $469,822 and the tax is $145,539. Under the same facts, if the AFR is 6.01%, as in the month of August, the taxable gift is reduced to $392,095 and the tax is reduced to $119,112.

If the Donor wishes to further reduce the taxable gift, an increase in the charitable gift component will have that result. For instance, an increase in the annual gift to the charity to $60,000 will reduce the taxable portion of the gift to only $270,514 and the tax is only $77,775.

The use of the CLT not only reduces tax, but also provides a charitable component to the transaction. Upon termination of the CLT, all the appreciation passes without further taxes to the children. If the appreciation is consideration, a significant tax savings would be realized.

The current low AFR makes the use of the Charitable Lead Trust an efficient vehicle to make larger charitable gifts with no adverse effect to the Donor or his family while allowing the family to enjoy the future appreciated value of the gifted property.

Section 3 of the Defense of Marriage Act (DOMA) is unconstitutional

On June 26, 2013, the United States Supreme Court, in U.S. v. Windsor, ruled that Section 3 of the Defense of Marriage Act (DOMA) is unconstitutional under the Due Process Clause of the Fifth Amendment.

Under DOMA, the federal government had defined “marriage” as between one man and one woman. As a result, same-sex marriages that were legally recognized in many states did not enjoy full rights and responsibilities under federal law. The Windsor case marks a monumental shift: the federal government will recognize “marriage” as defined by each state.

As a result, same-sex couples legally married under state law will now have many federal income and estate planning opportunities that were previously unavailable to same-sex couples. Some such benefits include the option to file federal income taxes jointly or individually, eligibility for the marital deduction for lifetime and testamentary transfers whether made outright or in a marital trust, the option to elect to split gifts on federal tax returns, the ability to elect portability of a deceased spouse’s unused applicable exclusion amount, spousal IRA rollovers, entitlement to Social Security benefits or other spousal survivorship benefits available under many federal programs, and immigration protections.

The Windsor case did not challenge Section 2 of DOMA. Section 2 affords all states and territories the right to deny recognition of the marriage of same-sex couples that originated in states where they are legally recognized. This will continue to cause complexity for same-sex couples that reside in or move to a state that does not recognize same-same marriage. The Marriage Equality Act has been in effect in New York since 2011.