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 Forum Teleconference Seminar

March 14, 2007 at 1 p.m. EST

Thomas J. Ray, Jr., Esq. Ray Law Offices, P.C. 3520 Jeffco Boulevard. Ste 110

Arnold, MO 63010 [email protected]

Lifetime Charitable

Lifetime Charitable

Planning

Planning

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.

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.

IRA Charitable Rollover

Six Requirements:

1. Donor Must be 70½.

2. Only distributions from IRAs qualify.

3. Only direct distributions qualify.

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.

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.

NUA-CRT

A tax-efficient strategy involving the use of

a CRT funded with an lifetime transfer of

employer securities from a qualified plan.

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).

Charitable Remainder Trusts

Remainder Trust

Charity

Charitable Remainder Trust

Property

Income

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.

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

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

Charitable Remainder Trusts

Ordinary Income

Capital Gain

Income Tax-Exempt_Income Principal

Step 1: Current Income Step 2: Accumulated Income Step 3: Current Capital Gain Step 4: Accumulated Capital Gain Step 5: Current Tax-Exempt Income Step 6: Accumulated Tax-Exempt Income Step 7: Return of Principal

Tier 1 Tier 2 Tier 3 Tier 4

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).

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.

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

The $600,000 of

The $600,000 of

NUA

NUA

is Deferred Until the Stock

is Deferred Until the Stock

is Sold!

Taxation of the Stock Sale

• 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.

The NUA CRT

Testamentary

Testamentary

Charitable Planning

Charitable 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

Problems with Charitable Planning

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.

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 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.

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.

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

Children

Testamentary Charitable Remainder

Trusts

Testamentary Charitable Remainder

Trusts

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.

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

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.

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

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.

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.

IRA

0

Partly Tax Free

At Life Expectancy Payouts Terminate

Payments “Stretch Out” For Life of Child

Testamentary Charitable Remainder

Trusts

Full Ordinary Income Tax

Life Expectancy Payouts End Age 86

Ordinary

Income

Testamentary Charitable Remainder

Trusts

UT

Charity

+

Testamentary Charitable Remainder

Trusts

Ordinary Income 691(c) Period Ordinary Income Most or All Capital Gain

Capital

Gain

Testamentary Charitable Remainder

Trusts

CST-CRT

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

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’s

Estate

$4M

_Charity

$6M

Mary and Children $7.8M Income Three Lives

QTIP

$2.3M

5%UT

$1.7M

CST-CRT

CST-CRT

• 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.