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Sunday, April 28, 2024
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Case Studies |
Impatient CLAT Beneficiary Wants Inheritance Now
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Case:
Sandy Collins, 45, is a corporate attorney for a mid-sized law firm in downtown Cityville. Sandy comes from a very wealthy and charitable family. In fact, her late father, Dennis Collins, Jr., was a Gold Circle member of the local hospital, university and museum. At his death, Dennis created a 20-year charitable lead annuity trust, which he funded with $3 million of stocks. The CLAT had an annual 5% payout of $150,000. The $150,000 was distributed among the three charities for the 20-year term. Upon the CLAT termination, Sandy was the sole remainder beneficiary.
Ten years of the twenty-year term have now passed and the trust has grown to $4.5 million. However, Sandy has grown impatient and does not want to wait another ten years for her inheritance. She has a very large mortgage, three children in private school and could really use her inheritance now.
During a discussion with a tax attorney within the same firm, Sandy learned that a charitable remainder unitrust beneficiary successfully "cashed out" his or her share prior to the termination of the trust (See PLR 200208039). Excitedly, Sandy wonders, based on the PLR reasoning, if she too could cash out her share now instead of waiting another ten years.
Question:
Can Sandy elect to terminate her father's CLAT early and, therefore, receive her share of the trust principal immediately? If so, what is the amount that Sandy will receive? How is that amount calculated?
Solution:
Generally, under state law, it is permissible to terminate a trust if all of the vested beneficiaries consent, a local court approves of the termination and in the case of charitable trusts, the attorney general is made a party to the proceeding. However, charitable lead trusts and charitable remainder trusts are created to be in compliance with the tax code and regulations. Therefore, any attempt to alter, reform or revoke a charitable trust should be done based upon legal authority or with approval from the Service.
In Rev. Rul. 88-27, a donor created a CLAT and included a trust provision which gave the trustee discretion to "commute and prepay" the charitable interest prior to trust termination. The trust provision further stated that the prepayment amount would be computed using the applicable federal rate and the methodology used to determine present value of annuity payments under the Code and Regulations. (The Service in the PLR referenced above approved this computation method.) The Service ruled the discretion to "commute and prepay" failed to qualify the income interest as a guaranteed annuity. Therefore, the trust failed to qualify as a charitable lead annuity trust. Accordingly, no charitable deduction was permitted. The rationale of Rev. Rul. 88-27 may likewise apply to CLUTs.
Nevertheless, following this ruling, charitable lead annuity trusts drafted today will not contain prepayment provisions. Therefore, present day trusts will qualify under the Code. The question then is whether the Service would approve "cashing out" a remainder beneficiary's interest in a qualified charitable lead trust.
In PLR 199952093, the Service did approve a lump sum distribution to charity from a charitable lead annuity trust. The lump sum distribution to charity was computed by merely adding up the remaining annuity payments that was required to be paid out by the trust. It is crucial to note that the prepayment to charity was determined without discounting the remaining annuity payments. After charity received its entire undiscounted distribution, the lead trust was terminated and the trust assets were distributed to family.
In this instance, the CLAT has a ten-year remaining term. Each year the trust pays $150,000 to the hospital. Under PLR 199952093, the hospital may receive $1,500,000 in the current year (10 x $150,000). This prepayment distribution would fully satisfy the trust's obligation to the hospital and the trust could be terminated. Therefore, Sandy could receive the remaining trust assets of $3 million ($4.5 million - $1.5 million).
Editor's Note: It is important to note that the grantor, the trustee, the remainder beneficiaries and the charity consented to this prepayment. Further, the prepayment would be approved by court order and the state attorney general would be made part of the proceedings. In conclusion, it is possible to "cash out" a remainder beneficiary's lead trust interest in accordance with this letter ruling. However, because letter rulings are not a precedent, one should consider first seeking an independent private letter ruling before implementing a lead trust prepayment to charity.
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