charitable planning charitable planning with iras and qualified plans

Charitable Planning

Charitable Planning with IRAs and Qualified Plans

Charitable Planning With IRAs and Qualified Plans

For our Friends at WealthCounsel Advisors ForumTeleconference Seminar

March 14, 2007 at 1 p.m. EST

Thomas J. Ray, Jr., Esq.Ray Law Offices, P.C.

3520 Jeffco Boulevard. Ste 110Arnold, MO [email protected]

Lifetime Charitable Lifetime Charitable PlanningPlanning

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.


Effect:

1. A qualified taxpayer makes a tax-exempt transfer of IRA assets to charity.

2. Limited to $100,000 per taxpayer.

3. Allows a client to meet his or her RMD for the year of the transfer.


Six Requirements:

1. Donor Must be 70½.

2. Only distributions from IRAs qualify.

3. Only direct distributions qualify.


Six Requirements (continued):

4. 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.


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. § 1.664-1(a)(1)(i).

Remainder to Charity.

Estate Tax Savings.

Income Tax Deduction.

Tax Free Sale/Investment.

Trustee Controls Investments.


RemainderTrust

Charity

Charitable Remainder Trust

Property

Income


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.

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


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



OrdinaryIncome

Capital GainIncome

Tax-ExemptIncome Principal

Step 1:CurrentIncome

Step 2:Accumulated

Income

Step 3:Current

Capital Gain

Step 4:AccumulatedCapital Gain

Step 5:Current

Tax-ExemptIncome

Step 6:AccumulatedTax-Exempt

Income

Step 7:Return ofPrincipal

Tier 1 Tier 2 Tier 3 Tier 4

How the Recipients are Taxed:

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).


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 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 ofThe $600,000 of NUANUAis Deferred Until the Stockis Deferred Until the Stock

is Sold!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.

Income Tax Deduction of $218,256 (4.6 AFR) (Offsets Tax on Basis)Avoid Tax on LTCGs.

401(k) stock $600,000

7% Unitrust$600,000

One Life

Trust Income of 5% paid first year = $42,000. Estimated Total = $882,000

Charity$800,000

At death: No Probate No Estate Taxes

The NUA CRTChester, Age 65

Testamentary Testamentary Charitable PlanningCharitable 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 non-charitable 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.

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.

Solving the Dilemma

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 non-charitable 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 CRTs

• Requirements

- Obligation to pay begins with the date of death.

- Trustee may defer payment until the testamentary distribution is received.


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.

Marital Deduction and Charitable Deduction result in zero taxes.

IRA $800,000

5 % Unitrust$800,000

One 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.

Retirement Plans to CRT for Spouse, 56


Charitable Deduction = $299,237 (4.2% AFR).

IRA $800,000


Term of 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.

“Give It Twice” TrustRetirement Plans to CRT for

Children


Charitable Deduction = $100,392 (4.2% AFR).

IRA $800,000


Three 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.

“S t r e t c h Unitrust”Retirement Plans to CRT for

Lives of Children, Ages 47, 45, 43



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.


Criticisms of IRAs to CRTs:

“There is little or no tax advantage to transferring . . .retirement plans to [CRTs] versus outright to children”

- Bianculli


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.



“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



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.



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:

IRA

0

Full Ordinary

Income Tax

Partly Tax Free

At Life Expectancy Payouts Terminate

Payments “Stretch Out”

For Life of Child


Full Ordinary Income Tax

Life Expectancy Payouts End Age 86

Ordinary Income

691(c) Period

Partial DeductionTaxFree

Payouts Age 50


UT

Charity

Long Term Capital Gain

Ordinary Income

Payments for Life

+ Tax Savings


Ordinary Income

691(c) Period

Ordinary Income

Most or All

Capital GainCapital

Gain

Life Expectancy Payouts To Age 110+

Payouts Age 50


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.

Ben’sEstate$4M Charity

$6M

(No Income Tax Paid by Charity)Mary and Children

$7.8M Income

Three Lives

QTIP $2.3M

5%UT $1.7M

IRA

2005

CST-CRT

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.

charitable planning charitable planning with iras and qualified plans

Documents

ira charitable rollover

irrevocable remainder

income tax deduction

tax planning opportunities

net investment income

qualified plans

income control

qualified taxpayer