In “Making Gifts Sooner Than Later … Accelerating Charitable
Bequests,” Trusts & Estates (March 2015), Robert F. Sharpe, Jr.
demonstrated how attractive the lifetime funding of bequest intentions are in
the current environment of unprecedented high exemptions from transfer taxes
and a low charitable midterm federal rate of interest. Here’s how the
acceleration of previously funded charitable remainder trusts (CRTs) can be
beneficial in both rising and declining financial markets.
Commutation of CRTs
The recipient of a unitrust or annuity trust amount can gift
the right to all or a portion of the payment to the charitable remainderman or
other charity. The donor will be entitled to an income tax deduction for the
present value of the estimated income to be foregone. So long as the recipient
of the trust payments relinquishes an undivided interest to the payments, an
income tax deduction is allowed. This relinquishment is called a
“commutation.” Commutation accelerates the charitable interest by terminating
the trust. The assets from the trust are then available for use by the
remaindermen for the charitable purpose originally determined by the donor
under the terms of the trust.
Responding to
Appreciating Markets
For many, the investment performance of the past years has
been better than could have been anticipated, especially in the aftermath
of the worst recession since World War II. Many donors have reaped the benefit
of higher than anticipated payments in the case of charitable remainder
unitrusts (CRUTs). Some of them may no longer need any payment from the trust.
Or, a donor’s personal portfolio has grown better than anticipated, while the
performance of the unitrust may not have been as impressive because of its
conservative asset allocations. After reviewing his entire portfolio, the donor
may now feel comfortable with existing resources generating adequate income to
maintain his lifestyle and meet likely financial needs. He’s ready to terminate
in full his rights to future unitrust amounts. Let’s determine the income
tax consequences of a full and partial commutation.
Full Commutation
Eight years ago, Jeff (now age 70) funded a CRUT with
$400,000 for the benefit of his alma mater, which also is serving as trustee.
In eight years, the CRUT has grown to $586,131. Jeff has seen his unitrust
payment of 5 percent increase from $20,000 to $29,307. Were Jeff to eliminate
his right to all future payments, the present value of foregone payments would
be $279,426. The income tax savings from the deduction would be $92,211—the
product of his marginal rate of 33 percent and the present value of the
foregone payments. The charity would have the full value of the trust to
fulfill Jeff’s charitable goals.
Partial Commutation
Jeff might decide he’d like to see the charity benefit now
from all of the growth of the trust. He’d like to gift the entire appreciation
of $186,131 to fund an immediate priority. Jeff waives his right to payment
from 31.7 percent of the trust. The charity will receive trust principal of
$186,131. Jeff will continue to receive the unitrust percentage of 5 percent on
$400,000, subject to the investment performance of the trust. He’ll also be
entitled to a charitable deduction of $88,734.The tax savings from the
deduction will be $29,282, representing almost an extra year of payments. Jeff
has received nine years of payments in eight years. He now feels especially
confident in his decision to make a partial commutation.
A Note of Excessive
Caution
For many years, the Internal Revenue Service issued private
letter rulings on the commutation of CRTs. One of the most cited is PLR
20025209 (Dec. 26, 2002), which offered guidance in the calculation of the
value of the commutation and identified the basis of the income interest as
zero.
Since the issuance of Revenue Procedure 2008-3, the IRS
won’t rule on the issue of whether the early termination of a CRT creates tax
hazards. Those hazards include loss of the tax-exempt status of the CRT and
whether the transaction should be taxed as a sale or exchange. Rev. Proc.
2013-3, 2013-1, IRB 113, Section 4 continues this no ruling policy absent
“unique and compelling reasons” to justify the issuance of a ruling.
While the commutations described above don’t have the same
potential for abuse as those involving a sale to a third party, which IRS
Notice 2008-99 labeled a “transaction of interest,” one must be willing to
complete a commutation without the protection of a PLR.
Responding to Down
Markets
There are times a donor can be caught in a down market. The
economic viability of the commutation should be examined not only when the
charitable assets have appreciated, but also when they’ve depreciated. The
donor has some options that might not initially be apparent.
The donor might salvage a CRUT income arrangement that
hasn’t performed well. The donor may be receptive to relinquishing payments
from the trust in exchange for a charitable gift annuity benefitting the
charity receiving the payment from the trust. The donor still desires to
benefit the original charity; thus, he funds a charitable gift annuity with
that charity.
Commutation and
Exchange
Seven years ago, Karen (then age 63) funded a CRUT with
$400,000. Her 5 percent unitrust payment has shrunk from $20,000 to $15,000.
Now, Karen would feel more comfortable with a fixed payment. After consulting
with her lawyer and CPA, she initiates a discussion with the charitable
remainderman. She’s willing to relinquish the right to all future payments in
exchange for a charitable gift annuity from the same charity. But, the payment
rate to her needs to be acceptable. Specifically, the amount received must be
at least equal to or closely approximate the amount of income surrendered. The
standard American Council on Gift Annuities (ACGA) rate can’t be assumed to be
adequate.
The commutation of a CRT (including a net income charitable
remainder unitrust and net income with makeup charitable remainder unitrust) in
exchange for a charitable gift annuity may be just the way to ensure good deeds
aren’t punished by poor markets!
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