Bills / Cases / IRS

QUESTION: Can charitable deductions within the lead trust offset capital gains from sale of property within the lead trust? In other words, if you sell property to pay the charity, does the trust still have zero income tax?

ANSWER: Yes, this would be the case. The trust will pay no tax on the gain because of the offsetting charitable income tax deduction. For example, a 7% payout lead trust is funded with $1,000,000 of closely-held stock yielding no dividends. Let's assume the worst case - the basis of the grantor's stock is $0. If the trust is required to make a distribution to charity of $70,000 per year, then the trust must first sell the stock to generate the $70,000 for the required distribution. However, by selling the stock, a capital gain of $70,000 is incurred by the trust. When the distribution is made to charity, the trust can take a charitable income tax deduction of $70,000 on its income tax return (Form 1041). Therefore, even though gain of $70,000 is incurred, that gain is offset in entirety by the charitable tax deduction.


QUESTION: Regarding tax deductions generated by remainder and lead trusts, are these tax preference items for alternative minimum tax (AMT)?

ANSWER: Under prior tax law enacted in 1986, a gift of appreciated long-term capital gain property deductible at fair market value for regular tax purposes received onerous treatment under the AMT. In general, for AMT purposes, any unrealized appreciation represented an exclusion preference that effectively limited the AMT charitable deduction for such gifts to the donor's tax basis in the gift property.

To reverse this financial strain on charities, The Omnibus Reconciliation Act of 1993 effectively eliminates from the list of AMT preferences the unrealized appreciation in gifts of all tangible and intangible property for gifts after 1992. The change was retroactive to July 1, 1992 for gifts of tangible personal property such as art.

Please note the preference has been eliminated for Federal tax purposes. However, for state income purposes, the preference may still exist. This is, in fact, the case in the State of California. Check your state income tax law for possible applicability in your state.


QUESTION: Are there any excess business holding concerns with having a mall or "C" Corporation stock in a charitable lead trust?

ANSWER: The prohibition against excess business holdings precludes a lead trust from owning more than a prescribed percentage of certain interests in a business. Generally, the interest in the business cannot be greater than 20% (See Code Section 4943(c)). This rule can make it difficult for a donor to use an interest in a closely-held business to fund a charitable lead trust. However, the excess business holdings provisions would not apply to a lead trust funded by a mall or publicly-traded "C" corporation stock.


QUESTION: What is the difference between the family and grantor lead trusts?

ANSWER: The trust with remainder to family produces a gift or estate tax deduction. On the other hand, a lead trust with a grantor receiving the property back is usually going to hold municipal bonds and produces an income tax deduction up front for the present value of the income stream to charity during the term of the trust.


QUESTION: How do we maximize the charitable estate tax deductions using a layered lead trust approach?

ANSWER: If a 3 or 4 layer lead trust is selected, the shorter duration trusts will produce less tax deductions. Therefore, it is typical to place larger amounts in the trusts that last for a longer period of time. In addition, it may be desirable to pay a slightly higher percentage from those longer term trusts. In this way, the family benefits from distributions from the early trusts, but the estate tax is still significantly reduced.


QUESTION: I know that the maximum term of years on a charitable remainder trust is 20 years. Is there a maximum term that is allowed for a lead trust? How should the term be determined using the layered lead trust?

ANSWER: If a 3 or 4 layer lead trust is selected, then quite commonly the first layer will be 4 or 5 years. However, the middle or latter layers can be 10, 15, 20, 25 or even 30 years. Unlike the charitable remainder trust, the lead trust is not limited to 20 years and may extend out 25, 30 or 35 years into the future. Particularly with the "layered" lead trust, it is feasible to consider longer duration lead trusts.


QUESTION: What are the factors used in determining the lead trust payout percent and why?

ANSWER: The lead trust payout percent will quite often be reasonably close to the expected trust return. This will maximize the charitable deduction, while allowing a small rate of growth for the benefit of family members.


QUESTION: In your "Tandem Trust" plan, should an IRA or pension plan be used as the funding vehicle for the charitable remainder trust (CRT)? Are there any GSTT consequences if the CRT is created for grandchildren?

ANSWER: An IRA or pension plan into is an excellent funding vehicle for a testamentary CRT. Since the trust is tax-exempt, the income tax on the IRA (income in respect of a decedent) is avoided. A number of favorable private letter rulings have now been issued by the IRS on this subject. If the CRT will make income payments to grandchildren, it may be desirable to allocate a portion of the $1,010,000 generation-skipping tax exemption to the trust so that there are no generation-skipping taxes payable.