The CPA Journal

Private Foundation, Charitable Remainder Trust, or Both?

By Mark Stone, CFP, CPA, Margolin, Winer & Evens, LLP

The charitable remainder trust (CRT) and the private foundation both offer financial, tax, and philanthropic benefits that make them popular charitable giving vehicles. Combining the CRT and the private foundation into one comprehensive charitable gifting plan can capture the benefits of both.

Advantages

A CRT is a tax-exempt trust that is split into two interests. The income interest permits an annuity payment for a fixed term of years or for the length of the non-charitable beneficiary’s life. This annuity payment can either be based on a percentage (at least 5%, but cannot exceed 50%) of the initial contribution (charitable remainder annuity trust, CRAT) or a percentage of the fair market value of the trust assets each year (charitable remainder unitrust, CRUT). The income beneficiary of the annuity is usually the donor. If the beneficiary is someone else, then there may be a taxable gift. If the spouse is the only other noncharitable beneficiary, then IRC section 2523(g) permits a gift tax marital deduction. The timing of this gift should be considered in light of the repeal of the estate tax and the increase in the unified credit.

The second component is the remainder interest, which eventually passes to a designated charity at the end of the CRT period. As the annuity percentage increases, the size of the remainder interest passing to the charitable beneficiary will decrease. Under IRC section 664(d)(1)(D), the actuarial present value of the property that passes to the charity at the end of the trust term must equal at least 10% of the initial fair market value of the property transferred to the trust. The designated charity can be a 501(c)(3) private foundation. When the trust is funded, the donor receives an income tax charitable deduction (as well as a gift or estate tax charitable deduction). A CRT is most advantageous when the donor would like to make a gift to a charity but also wants an income stream from the contributed property.

A private foundation is a tax-exempt organization, contributions to which qualify for a current income tax deduction. The foundation will generally invest contributions and pay out the proceeds (and income) to charitable organizations over a long span of time. Aside from the income tax benefit, a foundation has several other advantages: It serves as a family memorial, allows the taxpayer to meet long-term charitable giving goals, provides future generations with philanthropic opportunities, and allows future generations to receive compensation for services provided to the foundation.

Example

An affluent, charitable-minded elderly couple (ages 70 and 69) intends to eventually bequeath part of their estate to charity. They want to help secure the financial future of their two children (ages 39 and 36), as well as impart their philanthropic ideals to them. Because of the recent bull market, they now own substantially appreciated, growth-oriented stocks that pay very little in dividends. The couple is willing to part with jointly owned stock valued at $5 million. They also want a lifetime annuity to supplement their annual cash consumption needs.

Analysis. The two potential planning solutions would be to use the stock to fund either a private foundation or a CRT. A private foundation would result in a full charitable deduction based on the value of the stock, whereas a CRT would result in a partial charitable deduction plus a lifetime annuity. Could both vehicles be combined?

Solution. To meet all the stated objectives, the taxpayers should combine both vehicles. A CRT can be created over the taxpayers’ and their children’s joint life expectancies. In exchange for $5 million of substantially appreciated securities, they will receive a 5% lifetime annuity, close to the 5.28% maximum annuity available under the 10% test of IRC section 664(d)(1)(D). This annuity will supplement their cash consumption needs over their lifetimes and, upon their deaths, secure the financial future of their children. The value of the income interest according to IRS mortality tables (based on a section 7520 rate of 7%) is $4,436,500. The portion of this income interest attributable to other noncharitable beneficiaries creates a taxable gift of $2,145,575.

Under this plan, the taxpayers avoid paying capital gains tax on the appreciation of the stock and receive a tax deduction for the present value of the remainder interest of $563,500. As an added benefit, the stock will escape future estate taxes (at 55%) and paying the gift tax will further reduce their taxable estates. The taxpayers could also fund a life insurance trust with the tax benefit of the charitable deduction and a portion of the yearly annuity if the annuity is greater than their cash consumption needs. The overall income tax, gift tax, and estate tax cost or savings can only be determined by running projections, which should take care to avoid the alternative minimum tax (AMT) trap possible with large charitable deductions.

At the conclusion of the CRT payments, the remainder interest will go to a 501(c)(3) private foundation. This will serve as a family memorial for generations to come while extending the taxpayers’ philanthropic ethos to future generations.

To implement this plan, it is important to receive a fair market value deduction for the remainder interest of the stock going into the CRT. To determine the charitable deduction allowed, the taxpayers must determine whether the deduction would be allowed if the CRT were not involved. In this case, a fair market value deduction will be allowed for the contribution directly to the foundation and therefore the taxpayer will receive a deduction for the remainder interest to the CRT (see Revenue Ruling 79-368 and PLR 9452026).

If the private foundation is not in existence when the CRT is funded, then the CRT document should not specify a charity, but instead stipulate that the remainder beneficiary be a charitable organization described in IRC sections 170(c), 2055(a), and 2522(a). In addition, the CRT should provide the income beneficiary (the children) with a testamentary power or a lifetime power of appointment to designate the charitable remainder beneficiary (see Revenue Rulings 76-7 and 76-8 and PLR 9452026). With these powers, the children can choose the designated charitable remainder beneficiary during their lives or in their wills. Listing an alternative charitable beneficiary would also be prudent. If these conditions are met, the taxpayers will be allowed the tax benefit of a current deduction.

Editors:
Lawrence M. Lipoff, CPA
Deloitte & Touche LLP

Susan R. Schoenfeld, JD, LLM, CPA
Bessemer Trust Company, N.A.

Contributing Editors:
Jerome Landau, CPA

Debra M. Simon, MST, CPA
The Videre Group, LLP

Richard H. Sonet, JD, CPA
Marks Paneth & Shron LLP

Peter Brizard, CPA

Ellen G. Gordon, CPA
Margolin Winer & Evens LLP

Jeffrey S. Gold, CPA
Joseph R. Beyda & Company P.C.

Harriet B. Salupsky, CPA
Weinick Sanders Leventhal & Company LLP

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