charitable planning charitable planning with iras and qualified plans
TRANSCRIPT
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Charitable Planning
Charitable Planning with IRAs and Qualified Plans
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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]
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Lifetime Charitable Lifetime Charitable PlanningPlanning
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IRA Charitable Rollover
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.
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IRA Charitable Rollover
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.
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IRA Charitable Rollover
Six Requirements:
1. Donor Must be 70½.
2. Only distributions from IRAs qualify.
3. Only direct distributions qualify.
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IRA Charitable Rollover
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.
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IRA Charitable Rollover
Six Requirements (continued):
5. Distribution must otherwise qualify for the income tax charitable deduction.
6. Only otherwise taxable distributions from the IRA qualify.
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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
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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).
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Remainder to Charity.
Estate Tax Savings.
Income Tax Deduction.
Tax Free Sale/Investment.
Trustee Controls Investments.
Charitable Remainder Trusts
RemainderTrust
Charity
Charitable Remainder Trust
Property
Income
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Charitable Remainder Trusts
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.
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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
Charitable Remainder Trusts
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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
Charitable Remainder Trusts
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Charitable Remainder Trusts
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:
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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.
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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)
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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).
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Taxation of the Rollout
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.
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Taxation of the Rollout
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
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The $600,000 ofThe $600,000 of NUANUAis Deferred Until the Stockis Deferred Until the Stock
is Sold!is Sold!
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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.
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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).
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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.
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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.
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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.
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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
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Testamentary Testamentary Charitable PlanningCharitable Planning
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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.
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Testamentary Planning - Example
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Testamentary Planning- Example
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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.
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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
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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.)
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Testamentary Charitable Remainder Trusts
Testamentary CRTs
• Requirements
- Obligation to pay begins with the date of death.
- Trustee may defer payment until the testamentary distribution is received.
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Testamentary Charitable Remainder Trusts
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.
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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
Testamentary Charitable Remainder Trusts
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Charitable Deduction = $299,237 (4.2% AFR).
IRA $800,000
5 % Unitrust$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
Testamentary Charitable Remainder Trusts
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Charitable Deduction = $100,392 (4.2% AFR).
IRA $800,000
5 % Unitrust$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
Testamentary Charitable Remainder Trusts
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Testamentary Charitable Remainder Trusts
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.
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Testamentary Charitable Remainder Trusts
Criticisms of IRAs to CRTs:
“There is little or no tax advantage to transferring . . .retirement plans to [CRTs] versus outright to children”
- Bianculli
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Testamentary Charitable Remainder Trusts
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.
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Testamentary Charitable Remainder Trusts
Criticisms of IRAs to CRTs:
“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
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Testamentary Charitable Remainder Trusts
Criticisms of IRAs to CRTs:
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.
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Testamentary Charitable Remainder Trusts
Criticisms of IRAs to CRTs:
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:
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IRA
0
Full Ordinary
Income Tax
Partly Tax Free
At Life Expectancy Payouts Terminate
Payments “Stretch Out”
For Life of Child
Testamentary Charitable Remainder Trusts
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Full Ordinary Income Tax
Life Expectancy Payouts End Age 86
Ordinary Income
691(c) Period
Partial DeductionTaxFree
Payouts Age 50
Testamentary Charitable Remainder Trusts
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UT
Charity
Long Term Capital Gain
Ordinary Income
Payments for Life
+ Tax Savings
Testamentary Charitable Remainder Trusts
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Ordinary Income
691(c) Period
Ordinary Income
Most or All
Capital GainCapital
Gain
Life Expectancy Payouts To Age 110+
Payouts Age 50
Testamentary Charitable Remainder Trusts
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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.
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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.
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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
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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.