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October 25, 2007 GiftLaw Teleconference Q & A Answer: With an annuity trust, the exemption from transfer tax is applied at the inception of the trust. Because the value of the trust grows after creation, the augmented exemption is compared with the value of the trust at termination to determine the generation skipping transfer tax (GSTT). It is nearly always better to create a lead unitrust because the donor can allocate exemption equal to the taxable transfer; then upon termination of the lead unitrust, the proceeds pass free of GSTT. Question: What are the consequences of having unrelated business income (UBI) in a charitable remainder trust? Answer: The old rules would disqualify the CRT, but the new rules apply a 100% excise tax on the amount of the unrelated income. This may be acceptable, but many donors prefer that there is no UBI. A fixed lease usually insulates the trust from UBI. So long as the lease is real property with less than 10% personalty, the trust under Sec. 512(b) (3) should avoid UBI. Therefore, assets of an active business may be leased to a third party to create passive income and bypass any possible UBI. Question: Why cannot Subchapter S stock be transferred to a CRT? Answer: If Sub S stock is transferred to a CRT or other non-grantor trust, the Sub S election is terminated and the corporation becomes a Subchapter C corporation. Sub S corporations are taxed only at the shareholder level while Sub C corporations have two layers of taxation: the corporate level and again at the shareholder level. Question: Why can a supporting organization sell stock back to donors but a CRT cannot? Answer: A supporting organization is a public charity while a CRT is treated as a private foundation. Self-dealing rules prevent donors from purchasing assets back from their own trust. A supporting organization is allowed to sell stock back at fair market value to donors under a self-dealing exception that applies to supporting organizations but not to CRTs. Question: Can donors create a charitable remainder trust that will only pay income and not principal to their children as beneficiaries? Answer: With an estate subject to substantial estate tax, it is generally not advisable to fund a CRT because in addition to paying estate tax, the children would also have to pay income tax on proceeds from the CRT. In a private letter ruling (PLR), the IRS said the Sec. 691(c) deduction does not flow through a CRT to the children. If parents desire to pay only income and no principal to the children, a combination lead trust and remainder unitrust is preferred. Create a 5% CRUT for the lives of the children funded with a reasonable amount and set up a layered lead trust of 3, 6, 9 and 12 years. The lead trusts should be funded with the majority of the estate assets using either the $1 million gift tax exemption or the $2 million estate tax exemption ($3.5 million by 2009). As each layer of the lead trusts terminates, the proceeds are then poured into the CRT. The CRT can sell the assets tax-free, re-invest and begin to pay income to the children. This plan helps zero out the estate tax and pay income to the children with zero transfer tax. Question: What is the benefit of funding a CRUT with equipment from a business if the deduction is based only on cost basis and not the equipment's fair market value? Answer: The benefit is the bypass of ordinary income. If the equipment were sold outside of the CRT, donors would have to recognize ordinary income because recapture of depreciation on equipment produces ordinary income. Selling the equipment inside the CRT allows the donors to avoid paying tax as high as 35% on the sale of the asset. Question: Is there an exception that allows a donor to transfer debt encumbered property to a CRT without the adverse UBTI rules applying? Answer: Yes, a narrow exception applies if the donor has owned the property for five or more years, the debt on the property is five or more years old and the debt is nonrecourse. This exception is called the 5 and 5 rule. If the donor's property falls within this narrow exception, the property may be placed in the CRT and the trustee then would have 10 years to sell the property and pay the debt before the trust would incur any UBI. Question: What is the deduction for transferring closely held stock to a supporting organization, how is the deduction determined and what is the adjusted gross income (AGI) limitation for this deduction? Answer: Gifts of long-term capital gain property (including stock) to charity are deductible at full fair market value. An appraisal is required for gifts of closely held stock for which the donors are claiming a deduction in excess of $10,000. Because a supporting organization is a public charity and the donation is of appreciated property, the donors may take a deduction up to 30% of their AGI with a carryforward of any excess deduction up to an additional 5 years. Question: Will the gift by the S Corp flow through and reduce ordinary income of the shareholders? Answer: Yes, provided that the shareholders have sufficient outside basis. For example, Sub S Corp owns a lot with basis of $10,000 and value of $50,000. It gives the lot to a public charity. The $50,000 deduction flows through to donors and they reduce their outside basis in their Sub S stock shares by the $10,000 basis to the Sub S Corp of the lot. The $50,000 deduction is a 30%-type appreciated deduction for the shareholders and reduces their taxable income by that amount. Question: Sub S Shareholders are very senior and desire to help charity. May they set up the 20 year unitrust and give the UT corpus to charity if they die before the end of the 20 years? Answer: It should be possible, assuming that this has always been a Sub S corporation. Sec. 664(f) permits a unitrust to be shortened if the named contingency occurs. If the 20 year term trust created by the Sub S Corp includes a provision that the UT terminates if both Mother and Father die before 20 years, the plan will benefit the donors for the lesser of 20 years or their two lives. Of course, before they die, they also have the option of giving part or all of the UT to the remainder charity and receiving an additional deduction for the present value of the gifted income interest. |