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Monday, May 6, 2024
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Case Studies |
So Many Charities, Not Enough Choices
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Case:
Anne Clarke Johnson, age 58, is a very successful real estate agent who deals primarily in the high-end commercial real estate market. Over the years, she has acquired a number of exclusive properties including an office complex which is valued at $3.5 million and is not encumbered. This property is fully leased and is returning 10% on a net-net-net basis. Anne currently has an estate of approximately $10 million and is interested in transferring the office complex to her only son, Thomas, when he turns 50. Thomas is now 35 years of age and his real estate management company is managing the property for his mother. Anne feels she does not need the income from the property as her other stock and real estate investments are producing more than enough income to support her livelihood.
She is well acquainted with the estate tax burden on a $10 million estate and would like to begin planning the disposition of her estate. Even though Anne is very healthy, her close friend of many years, who had an estate of similar size, was recently killed in a tragic auto accident. She witnessed the friend's estate, which consisted primarily of real estate holdings, being depleted by over 75% because of estate taxes and forced liquidation of the real estate to pay those taxes. She certainly does not want that to happen to her estate.
Anne is known throughout her community as a very generous philanthropist. When her husband passed away of prostate cancer in 1995, she gave $500,000 to the local community hospital which cared for her husband throughout those difficult days. Other charities that have benefited from her generosity include children's homes, her alma mater, the local symphony, Salvation Army, Boy Scouts and Girl Scouts, disaster relief organizations and her church. It seems that whenever a need arises, Anne is the first in line not only to give, but also to volunteer.
Question:
Anne would like to transfer the office complex to Thomas in 15 years, but she does not want to pay gift tax on the $3.5 million transfer. She would also like to be able to give the income from the property to selected charities during that period of time. What is the best course of action available to accomplish her objectives?
Solution:
In conversations with the Major Gifts Officer at the local community foundation, Anne learns that the best course of action to transfer the office complex to Thomas would be to utilize a charitable lead trust. The property would be transferred to the lead trust which would pay income for 15 years to charity. At the end of the term, the trust would terminate and the office complex would then be transferred to her son. There are two primary advantages in utilizing a lead trust - (1) The gift to her son will result in a substantially reduced transfer for gift tax purposes; and (2) Payments will be made to charity during the lead trust term as Anne desires.
Anne has one concern with this arrangement. She is informed by the Major Gifts Officer that she would probably need to choose up front the charities that will receive the income from the lead trust. In other words, the selected charities would be drafted into the lead trust agreement and thereby "set in stone" in the chosen amounts. Anne would like to have the ability to change the charities should she so desire. However, she was informed that if she keeps the power to change charities, there is a good probability that the lead trust assets would be included in her estate should she pass away during the trust term. She certainly does not want this to occur, so she wonders if there are any solutions to this dilemma.
The Major Gifts Officer stated that there is a creative solution that should work very well. In the lead trust document, the community foundation will be listed as the charity which receives the trust distributions. More specifically, a Donor Advised Fund (DAF) on behalf of Anne would be the trust recipient. With a DAF, Anne would then have the opportunity to make requests of the community foundation to make distributions to her desired charities.
Anne is very pleased with the concept of coupling a lead trust with a DAF. Therefore, she decides to fund a 15 year charitable lead annuity trust with the office complex and chooses a 9% distribution percentage. This will result in a charitable gift tax deduction of $2,874,275 million and, thus, a taxable gift to her son of only $625,725. Since she has her entire lifetime exemption still in place, she will not pay any gift taxes upon this transfer. The trust will distribute $315,000 of income annually to the DAF. From this fund, distributions can be made to Anne's desired charities at her request.
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