by Michael V. Bourland
A Professional Corporation
City Center Tower II
(817) 877-1088
(817) 429-3945 (metro)
(817) 877-1636 (facsimile)
mbourland@bwwlaw.com (Email)
sguthrie@bwwlaw.com
(Email)
Presented to
Eleventh Annual Advanced
ALI-ABA Course of Study
ESTATE PLANNING FOR THE
FAMILY BUSINESS OWNER
Thursday – Saturday
©
100113/corrected 8/12
BIOGRAPHICAL INFORMATION
MICHAEL V. BOURLAND
EDUCATION
B.A.,
J.D.,
LL.M. in Taxation,
PROFESSIONAL ACTIVITIES
Founding Shareholder - Bourland, Wall &Wenzel, P.C.
Board Certified (Estate
Planning and Probate Law) –
Fellow,
Former Member, Real Estate,
Probate and Trust Law Council (State Bar of
ACADEMIC APPOINTMENT AND HONORS
Guest Lecturer in Estate Planning at
The Center for American and International Law
University of
SHANNON G. GUTHRIE
EDUCATION
B.S., Magna Cum Laude, University
of
J.D.,
PROFESSIONAL ACTIVITIES, ACADEMIC APPOINTMENTS AND HONORS
Associate Attorney - Bourland, Wall &Wenzel, P.C.
Adjunct Co-Instructor, Fall
2001 –
Adjunct
Instructor 1998-2001 –
GUEST LECTURER IN ESTATE PLANNING AT
State Bar of
State Bar of
State Bar
of
Halfmoon, LLC
TABLE OF CONTENTS
I. ATTRIBUTES
OF CHARITABLE LEAD TRUST (“CLT”).......................... 4
A. Payment
– Charitable Lead Interest.................................................... 4
1. ANNUITY
TRUST..................................................................... 4
2. UNITRUST................................................................................. 4
B. Distributions
in Satisfaction of Annuity or Unitrust Payment.................. 4
C. Term................................................................................................. 4
D. Remainder
Interest............................................................................. 5
E. Testamentary
and Inter Vivos CLTs.................................................... 5
F. No
Minimum Distribution.................................................................... 5
G. Private
Foundation Rules.................................................................... 6
II. BASIC DIFFERENCES BETWEEN
GRANTOR CHARITABLE LEAD TRUST AND NON-GRANTOR CHARITABLE LEAD TRUST.................................................................... 10
A. Non-Grantor
Charitable Lead Trust................................................... 10
B. Grantor
Charitable Lead Trust........................................................... 10
III. TAXATION OF NON-GRANTOR AND GRANTOR
CHARITABLE LEAD TRUSTS 10
A. Non-Grantor
CLT............................................................................. 10
1. INCOME
TAXATION OF TRUST............................................ 10
2. UNRELATED
BUSINESS TAXABLE INCOME (“UBTI”)....... 12
3. ALTERNATIVE
MINIMUM TAX (“AMT”)............................. 14
4. CAPITAL
GAINS TAX............................................................. 15
5. TIER
SYSTEM OF ALLOCATION........................................... 15
6. ESTATE/GIFT
TAX.................................................................. 15
7. GENERATION
SKIPPING TAX (“GST”)................................. 15
B. Grantor
CLT.................................................................................... 16
1. INCOME
TAXATION OF TRUST............................................ 16
2. ALTERNATIVE
MINIMUM TAX............................................ 17
3. CAPITAL
GAINS TAX............................................................. 17
4. TIER
SYSTEM OF ALLOCATION........................................... 17
5. ESTATE
TAXES....................................................................... 17
6. GIFT
TAX................................................................................. 18
7. GENERATION
SKIPPING TAX............................................... 18
8. UNRELATED
BUSINESS TAXABLE INCOME...................... 18
IV. SPECIAL CONSIDERATIONS................................................................... 18
A. Trustee............................................................................................ 18
1. INDEPENDENT
TRUSTEE OR QUALIFIED APPRAISER FOR VALUATION OF ASSETS.................................................................................... 18
2. INDEPENDENT
TRUSTEE AND GRANTOR TRUST RULES 20
3. RELATED
PARTY AS TRUSTEE............................................ 20
B. Disqualified
Person As General Partner Of Partnership/Avoidance Of Self-Dealing 22
C. Treatment
of CLT Payment Received By Private Foundation.............. 23
V. ADVANTAGES OF CHARITABLE LEAD
TRUST.................................... 24
Vi. DISADVANTAGES/LIMITATIONS OF
CHARITABLE LEAD TRUST..... 24
VIi. DRAFTING CONSIDERATIONS/FILING REQUIREMENTS.................... 25
Annual
(or more often) payments to charitable beneficiary for a number of years or for
a life or lives in being at the trust's creation. But see subparagraph C below regarding
proposed regulations limiting permissible term.
Payment is a fixed dollar
amount or a fixed percentage of the initial net fair market value of the trust
assets. IRC §§ 2522(c)(2), 2055(e)(2)
and 170(c); Treas. Reg. §§ 25.2522(c)(3) and 1.170A-6(c).
Payment is a fixed
percentage of the net fair market value of the trust assets determined
annually. IRC §§ 2522(c)(2), 2055(e)(2)
and 170(c); Treas. Reg. §§ 25.2522(c)(3) and 1.170A-6(c).
The
Annuity Trust has traditionally been the preferred form of a CLT because remaindermen benefit from appreciation of the trust assets
without gift or estate taxation (but with potential generation-skipping
transfer taxation) and the assets do not need to be revalued each year for
determining the charitable payment.
However, the IRC now requires the Annuity Trust (but not the Unitrust)
to be valued at the end of the charitable term for Generation-Skipping Transfer
Tax (“GST”) purposes using the interest rate used for valuing the charitable
interest at the time of funding the trust and applying it to the value of the
remainder interest at the time of funding, compounded annually. IRC § 2642(e). (See
GST paragraph below.)
Formula
Clauses: The use of a formula clause has
been allowed by the Service as long as the gift is determinable at the time of
the transfer. Planning idea: make the
formula have one variable (either the term or the payment amount) calculated to
result in a certain gift amount.
The CLT instrument may provide for the payment of the annuity or unitrust interest to be made in cash or in kind. If the trust distributes appreciated property in satisfaction of the annuity trust or unitrust payment, the trust will realize capital gains on the assets distributed in kind to satisfy the annuity or unitrust payment. Rev. Rul. 83-75, 1983-1 C.B. 114. See also, P.L.R. 9201029 (Oct. 7, 1991) applying Rev. Rul. 83-75 to the income tax treatment of distributions of appreciated stock in satisfaction of a lead unitrust payment.
Planning
Payments
can continue for the life or lives of one or more individuals, all of whom must
be living when the trust is created or for a term of years (limited only by the
applicable rule against perpetuities).
Treas. Reg. §§ 1.170A-6(c)(2)(i)(A) and (ii)(A); Treas. Reg. §§ 20.2055-2(e)(2)(v)(a) and
(vi)(a); Treas. Reg. §§ 25.2522(c)-3(c)(2)(v)(a) and (vi)(a). However, the Service issued proposed
regulations on
The problem:
taxpayers
have been using an unrelated individual's measuring life as the term of the
charitable lead trust where that unrelated individual is seriously ill, but not
“terminally ill” as defined under I.R.C. § 7520 and the Regulations thereunder. (See,
for example, Treas. Regs. § 20.7520-3(b)(3)). The value of the charitable interest is
calculated under the applicable actuarial tables, which are based upon the
average life expectancies of individuals of the same age as the measuring
life. However, the life expectancy of
the measuring life involved is, in fact, much shorter than the life expectancy
of individuals set forth in the actuarial tables. If the individual dies prematurely (which is
expected), the charity's interest is terminated resulting in the remainder
beneficiaries receiving their interest sooner than anticipated by the tables at
a reduced gift or estate tax of that based upon the lives of those provided in
the tables. The measuring life
individual is paid a fee for allowing the trust creator to use such individual
as the measuring life. The Service
believes that this type of charitable lead trust is abusive and frustrates the
Congressional intent of allowing deductions for certain split-interest trusts
and further that the marketing of such is against public policy. The
Service's Solution: the final
regulations limit the permissible term for a guaranteed annuity interest and
unitrust interest to a specified term of years, or the life of certain
individuals living at the date of the transfer, such individuals being limited
to one or more of the donor, the donor's spouse, or a lineal ancestor or spouse
of a lineal ancestor of all of the remainder beneficiaries. Additionally, an interest payable for a
specified term of years will also qualify where the governing instrument
contains a “savings clause” that is intended to qualify with the rule against
perpetuities. A trust will satisfy the
requirement that all of the noncharitable remainder
beneficiaries are lineal descendants of the measuring life individual (or the
spouse of the measuring life individual), if there is less than a 15%
probability (computed based upon the current applicable Life Table under Treas.
Reg. § 20.2031-7 at the time the property is transferred to the trust, taking
into account interest of all primary and contingent remainder beneficiaries
living at that time) that individuals who are not lineal descendants will
receive any trust corpus. Treas. Dec.
8923.
If a transfer is made to a trust on or after
Although comments to the proposed regulations pointed out that the
limitations on the measuring lives, although not a bad thing, were too narrow
and precluded many situations where the beneficiaries are not related to the
creators of the charitable lead trust, the Service did not adopt any of such suggestions,
except as they further broadened the class of the measuring lives as described
above.
The
remainder interest, after payment of the charitable lead amount, is distributed
to the noncharitable beneficiary or beneficiaries,
which may include (but is not limited to) the donor, donor's estate, children,
grandchildren or other trust or trusts for children or grandchildren.
The
charitable lead trust may be established as an inter vivos
trust (during life) or as a testamentary trust (at death).
Unlike a Charitable Remainder Trust and a Private Foundation, there is no minimum percentage or amount that must be distributed annually and, therefore, the Charitable Lead Trust (“CLT”) is not subject to the Annual Minimum Distribution Amount, which is 5% of the initial fair market value of the trust assets (with a charitable remainder annuity trust) and 5% of the annual fair market value of the trust assets (with a charitable remainder unitrust), or 5% of the annual fair market value of the assets of the private foundation. Compare IRC §§ 664(d)(1)(A) and 664(d)(2)(A).
CLT is a split-interest trust under IRC § 4947(a)(2). As such, it is subject to the following private foundation rules:
1. Self-Dealing: Trust must not be involved in self-dealing
whether direct or indirect with disqualified persons as precluded by IRC §
4941(d). Includes any direct or
indirect: a) sale or exchange or leasing of property between trust and a
disqualified person; b) lending of money or extension of credit between a trust
and a disqualified person; c) furnishing of goods, services, or facilities
between a trust and a disqualified person, unless such goods, services or
facilities are made available to the general public on at least as favorable a
basis as they are made to the disqualified person, Treas. Reg. §
53.4941(d)(3)(b)(1); d) payment of compensation (or payment or reimbursement of
expenses) by a trust to a disqualified person, unless it is for personal
services and such compensation is reasonable and necessary to carry out the
exempt purpose and is not excessive, Treas. Reg. § 53.4941(d)(3)(c)(1); e)
transfer to, or use by or for the benefit of, a disqualified person of the
income or assets of a private foundation; and, f) agreement by a private
foundation to make any payment of money or other property to a government
official [as defined in § 4946(c)] other than an agreement to employ such
individual for any period after the termination of his government service if
such individual is terminating his government service within a 90 day
period. IRC § 4941(d).
Treas. Reg. §
53.4941(d)-1(b)(3) provides an exception to the prohibitions against
self-dealing in a transaction involving the administration of an estate or
revocable trust if the administrator or executor or trustee either possesses a
power of sale with regard to the property, has the power to reallocate the
property to another beneficiary, or is required to sell the property under the
terms of a preexisting option, such transaction is approved by the probate
court having jurisdiction over the estate, the transaction occurs before the
estate is considered terminated under Treas. Reg. Sec. 1.641(b)-3(a), the
estate or trust receives an amount which equals or exceeds the fair market
value of the foundation's (CLT's) interest or
expectancy in the property at the time of the transaction taking into account
the terms of any options subject to which the property was acquired by the
estate and (with respect to transactions occurring after 4/16/73) the
transaction either resulted in the foundation receiving an interest or
expectancy at least as liquid as the one it gave up, resulted in the foundation
(CLT) receiving an asset related to the activity carrying out its exempt
purposes or is required under the terms of any option which is binding on the
estate or revocable trust.
A “disqualified person” is a substantial
contributor to the CLT (an individual, trust, estate, corporation or
partnership who or which contributes an aggregate amount in excess of $5,000 to
the CLT, if his or her total contributions are more than 2% of the total
contributions received), or a family member of a substantial contributor
(spouse, descendants and spouses of descendants), or persons owning more than
20% of an entity which is a substantial contributor to the CLT (includes an
entity in which a disqualified person [considering the attribution rules of
I.R.C. § 4946(a)(4)] owns more than 35%.]
Reimbursement for Expenses: Reimbursement to disqualified persons for
travel expenses cause the CLT and the disqualified person's spouse to be
potentially liable for penalty taxes for self-dealing, for making
non-charitable expenditures, or possibly both.
Such reimbursement of expenses will not be taxed if the expenses are
reasonable and necessary to carrying out the exempt purposes of the CLT and are
not excessive. I.R.C. § 4941(d)(2). The Code does not explain what is “reasonable
and necessary.” Treas. Reg. §
53.3941(d)-3(c)(1). Generally, business
expense deductions under Treas. Reg. § 1.162-2(1) include travel fares, meals
and lodging and expenses incident to travel.
Travel expenses are not included if the trip is primarily personal in
nature. Treas. Reg. § 1.162-2(a). The Code does cross-reference Treas. Reg. §
1.162-7 to determine what is “excessive.”
Under Treas. Reg. § 1.162-7, an amount spent on director's services will
not be deemed “excessive” if it is only such as would be paid “for like
services by like enterprises under like circumstances.” Treas. Reg. § 1.162-7 (i.e. As the
organization would pay to someone independent of the CLT).
A grant by one private foundation (a CLT in this case) to another private foundation does not constitute self-dealing within the meaning of I.R.C. § 4941 even when one entity serves as Trustee of both foundations. Rev. Rul. 82-136 (1982-2 C.B. 300). See also Treas. Regs. Examples 53.4941(d)-2(f)(2).
Excise
Tax on Acts of Self-Dealing: Any
disqualified person who engages in an act of self-dealing is assessed an excise
tax of 5% of that amount involved in the transaction for each year that the
transaction is uncorrected.
Additionally, a foundation manager who knows the act is prohibited but
approves it may also be subject to a tax of 2.5% of the amount involved (up to
$10,000 for each such act) for each year that the transaction is
uncorrected. If the transaction is not
timely corrected and the 5% was initially assessed, the disqualified person is
subject to being assessed an additional tax of 200% of the amount
involved. Any foundation manager who
does not correct the transaction may also be subject to an additional
assessment of 50% of the amount involved (up to $10,000 for each such act.)
2. Excess Business
Holdings: Trust must not retain
excess business holdings as restricted by IRC § 4943(c). To apply, the entity in which an interest is
held must be engaged in a business enterprise.
IRC § 4943(a)(1). A business
enterprise includes the active conduct of a trade or business and also includes
any activity which is regularly carried on for the production of income from
the sale of goods or the performance of services and that constitutes an
unrelated trade or business. Treas. Reg.
§ 53.4943-10(a)(1). Production of a
profit is not required.
If a CLT holds
business holdings, it must be determined whether the business holdings are
excess business holdings, meaning that they are in excess of permitted
holdings. I.R.C. § 4943(c)(1). Three rules apply as to permitted holdings:
1) General Rule as to
Permitted Holdings: the CLT's holdings in a
corporation's voting stock is 20% of the voting stock reduced by the percentage
of the voting stock actually or constructively owned by all disqualified
persons, I.R.C. § 4943(c)(2)(A);
2) The 35% Rule:
Where the CLT and all disqualified persons together do not own more than 35% of
the voting stock of a corporation and it is established to the satisfaction of
the Secretary that effective control is in one or more persons who are not
disqualified persons with respect to the CLT, then the 20% General Rule becomes
a 35% rule, I.R.C. § 4943(c)(2)(B)-l; and,
3) 2% De Minimus Rule: The CLT is not treated as having excess
business holdings in any corporation in which it, together with all other
private foundations, owns not more than 2% of the voting stock and not more
than 2% in value of all outstanding shares of all classes of stock, I.R.C. §
4943(c)(2)(C).
Exception For Gratuitous Transfer: If the CLT is determined to have excess business holdings and the receipt of the assets constituting excess business holdings is by gratuitous transfer, then the assets received are treated as being held by a disqualified person for 5 years after the gratuitous acquisition. I.R.C. § 4943(c)(6). The CLT must dispose of the excess business holdings within the 5 year period. An additional 5 year extension may be granted to the CLT in order to provide additional time for the CLT to dispose of the excess business holding received by gratuitous transfer. The discretion is given to the Secretary to extend the period of disposition in the case of unusually large gifts or bequests of diverse holdings with complex corporate structures. I.R.C. § 4943(c)(7). The extension may be given provided that the following requirements are met:
1) the CLT establishes that it has made diligent efforts to dispose of the excess business holdings within the initial 5 year period;
2) disposition of the excess business holdings within the initial 5 year period has not been possible (except at a price substantially below fair market value) by reason of such size and complexity or diversity of the excess business holdings;
3) before the end of the initial 5 year period, the CLT a) submits to the Secretary a plan for disposing of all of the excess business holdings involved; b) the CLT submits such plan to the Attorney General (or other appropriate State official) having administrative or supervisory authority or responsibility with respect to the CLT's disposition of the excess business holdings and submits to the Secretary any response received by the CLT from the Attorney General (or other appropriate State official) to the plan within the 5 year period; and,
4) the Secretary determines that such plan can reasonably be expected to be carried out before the close of the extension period.
Corporate Redemption: One way to dispose of the excess business holding is to have the corporation redeem the excess business holding of the CLT. This includes holdings of a partnership in a corporation since the CLT is attributed with owning the shares of the corporation. However, in redeeming the stock, care must be taken not to violate the rules against self-dealing. (See generally, the discussion above regarding self-dealing.) In the case of a corporate redemption, the involved act of self-dealing is the direct or indirect sale or exchange of property between a disqualified person and a private foundation. I.R.C. § 4941(d)(1)(A). The CLT is treated as a private foundation for these purposes. However, as to acts which would be an act of self-dealing, an exception is provided where liquidation or redemption of stock held in a private foundation (or CLT) is to a disqualified person which is the corporation if:
1) the corporation makes a bona fide offer of liquidation or redemption on a uniform basis to the private foundation (or CLT) and to every other person who holds stock in the corporation; and,
2) the liquidation terms provide for the liquidation at a price which is no less than fair market value. Further, the corporation cannot use a note to redeem its stock from the private foundation (or CLT). Treas. Reg. § 53.4941(d)-2(c)(1); Treas. Reg. § 53.4941(d)-3(d). The exception for redemption on a uniform basis exception has been applied to partnerships in P.L.R. 9237032.
Excise Tax on Excess Business Holdings: the CLT is taxed on its excess business holdings in the amount of 5% of the value of the excess business holding. A penalty of 200% is imposed on the CLT if the initial penalty is assessed and the excess business holding is not timely corrected. I.R.C. § 4943(b). Although the CLT has a 5 year time period to dispose of the excess business holding, the disposition of such holding is subject to the restrictions against acts of self-dealing.
3. Jeopardizing Investments: Trust must not make investments which would
jeopardize the carrying out of the exempt purpose as prohibited by IRC §
4944. (See Exception subsequent to #6 below.) Although no investment is a per se violation, this rule requires
close scrutiny of the standard of care in investment of the assets of the CLT
when the trustees have invested in speculative investments such as working
interests in oil and gas, trading on margin, trading in commodity futures,
purchase of “puts” and “calls” and “straddles”, warrants and selling
short. This restriction addresses
actions of investing and does not cover assets received by a CLT by gift or
bequest.
Excise Tax on Jeopardizing Investments: The CLT is not allowed to invest its funds in
investments which could jeopardize the CLT's ability
to carry on its exempt purpose. If it
does, it is taxed 5% of the amount of the improperly invested assets. Additionally, each trustee who willfully
participated in the making of the investment knowing that it jeopardized the
carrying out of the CLT's exempt purposes may be
subject to being assessed a tax of 5% of the amount of the improperly invested
assets. If the investment is not
disposed of within 90 days after imposition of the initial tax, the CLT is liable
for an additional tax of 25% of the amount improperly invested and each trustee
who willfully participated in the making of the investment knowing that it
jeopardized the carrying out of the exempt purposes may be subject to being
assessed an additional tax of 5% of the amount of the improperly invested
assets.
4. Taxable
Expenditures: Trust must not
make taxable expenditures as governed by IRC § 4945(d). This covers amounts paid for propaganda or to
attempt to influence legislation or the outcome of a public election, amounts
paid to carry on any voter registration drive, or amounts paid as certain
grants. IRC § 4945(d).
5. Termination Tax: Trust is subject to “termination of private
foundation status” of IRC § 507. The tax
is the lower of the aggregate tax benefit resulting from status as a private
foundation or the fair market value of its net assets. IRC § 507(c).
6. Governing
Instrument Requirements: Trust
must meet “governing instrument language” of IRC 508(e). This includes provisions, the effects of
which are to require income to be distributed so as to not subject the
foundation to tax under IRC § 4942 and to prohibit foundation from engaging in
self-dealing, retaining any excess business holdings, making jeopardizing
investments and making taxable expenditures.
Exception:
Under IRC § 4947(b)(3)(A), the excess business holdings and jeopardy investment restrictions are not applicable if the charitable interest of the CLT at inception does not exceed 60% of the aggregate fair market value of the trust assets at inception and the CLT income interest (and none of the remainder interest) is devoted to specified charitable purposes. This exception allows the qualified CLT to hold closely-held stock if the value of the charitable interest does not exceed 60% of the value of the trust assets at inception of the trust.
Planning
By using a testamentary CLT that satisfies the exception described above, a decedent may retain control of a family corporation while reducing the estate tax on transfer of the stock to children or other beneficiaries and receive an income tax basis adjustment on the family corporation stock at death.
1. Grantor (donor) will not receive an income tax
charitable deduction upon contribution to the trust. IRC § 170(f).
2. Grantor (donor) will
receive a gift tax charitable deduction upon contribution to the trust based
upon the present value of the stream of payments to be made to the charity.
3. Income of the trust is not
taxed to grantor. IRC § 641.
4. This trust is most
often used as transfer tax reduction technique.
5. The trust receives an
unlimited income tax charitable deduction for payments to charitable
organizations from gross income. IRC §
642(c). Excess income is taxed at
compressed trust income tax rate.
1. Grantor (donor) receives an income tax and gift tax
charitable deduction upon contribution to the trust. IRC § 170(f)(2)(B). The income tax deduction is the present value
of the charitable interest in the charitable lead trust. Treas. Reg. § 1.170A-6(c)(3). The income tax charitable deduction is
subject to the limitations on charitable deductions made by individuals under
IRC § 170(b).
2. Grantor (