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Sunday, May 5, 2024
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Case Studies |
Funding a Charitable Remainder Trust with a Commercial Annuity
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Case:
Judy Ross, age 55, recently attended a presentation by one of her favorite charities. In this presentation, she learned that she could transfer appreciated assets to a charitable remainder trust. By doing so, she could bypass capital gain, receive a charitable deduction and also receive an income stream for life. But Judy did not need any additional income at the present time. Thus, she was very interested when the presenter spoke about a net income with makeup charitable remainder trust. This type of charitable remainder trust would allow Judy to contribute the assets, receive an income tax deduction now, but delay the income payments from the trust for 10 years until her planned retirement date.
After returning from the presentation, Judy reviewed her assets to determine which of them would be appropriate for funding a charitable remainder trust. She decided that she would like to fund her charitable remainder trust with a commercial annuity she purchased two years ago. The commercial annuity had increased substantially in value. Judy thought it would be wonderful if she could bypass the gain by transferring it to a charitable remainder trust.
Judy set up an appointment with the planned giving officer, Jane Wilson, at her favorite charity. She wanted to discuss transfer of the annuity to a net income with makeup charitable remainder trust. At the meeting, she explained to Jane her plan to use the commercial annuity to fund a net income with makeup trust. Judy was particularly enthusiastic about the opportunity to bypass the gain.
With her best gift planning manners, Jane was diplomatic but honest. Under IRC Section 72 rules, an annuity may not be transferred to a unitrust without recognition of the gain. This transfer of a commercial annuity to a trust is treated as a surrender of the commercial annuity. Therefore, Judy will recognize ordinary income in the year she funds the charitable remainder trust for the difference between the surrender value of the commercial annuity and her basis in the annuity. While this was not the good news Judy had hoped to hear, Jane shared several reasons why Judy might still consider this plan.
Question:
Is it possible for Judy to fund a charitable remainder trust with this commercial annuity and benefit substantially, even with the ordinary income she will omit recognize when transferring the commercial annuity to the charitable remainder trust?
Solution:
Jane decided to run the numbers to see what Judy's charitable deduction would be if she funded a charitable remainder trust with the commercial annuity. Judy paid $100,000 for the commercial annuity and its current surrender value is $125,000. Thus, $25,000 will be reported as ordinary income. However, based on Judy's age of 55 and payout rate, her charitable deduction is approximately $34,000. Because the deduction is greater than the reportable ordinary income, using the commercial annuity to fund the charitable remainder trust will work nicely in this case. Judy will have to recognize the $25,000 of income, but she will receive an offsetting deduction of $34,000. Also, because Judy must recognize the income on the transfer of the commercial annuity, her deduction may be used up to 50% of adjusted gross income. As long as Judy has adjusted gross income of $68,000 for the year, she will be able to completely use the $34,000 deduction in the year she sets up the trust.
Judy is very happy to learn that she can use the commercial annuity to fund the charitable remainder trust. Plus, the trust may grow until she retires and then pay increased income at that time.
Planning Tip: In PLR 9825001, the Service allowed a unitrust to invest in a commercial annuity. If this is contemplated and the donor is trustee of the unitrust, there should be an Independent Special Trustee to make all decisions with respect to the commercial annuity. Please note that a PLR is helpful information, but is not a legal precedent.
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