Thursday March 28, 2024

3.1.6 Gifts from an Annuity Trust

Gifts from an Annuity Trust

Partial Interest Rules:   After the annuity trust has been funded, it is permissible to use the trust corpus to make a current gift.

Gift of an Income Interest:   Under state law, the donor has made an irrevocable gift of the remainder interest, but has retained the income interest.

Valuation of Annuity Income Interest:   Income and remainder interests are valued using the methods of Reg. 1.170A-7(a) and IRS Publication 1457.

Gift Tax Deduction:   The transfer of the income interest also will qualify for a gift tax deduction.

Gifts of Excess Principal:   It should be possible for donors to make occasional gifts from a charitable trust to a charity, so long as the amounts and timing of the gift are determined well after the trust is created.

Partial Interest Rules

After the annuity trust has been funded, it is permissible to use the trust corpus to make a current gift. However, the arrangement should not be created to avoid the application of the partial interest rules. Sec. 170(f)(3)(A). For example, it would not be appropriate to create a charitable remainder trust on Monday and then give the income interest to charity on Wednesday of the same week. If the gift of an income interest is contemplated, it should generally be made a year or more after creation of the trust.

Gift of an Income Interest

Under state law, the donor has made an irrevocable gift of the remainder interest, but has retained the income interest. If the donor then transfers part or all of an income interest to a vested remainder recipient, the charity owns the remainder and the income interest. Under the doctrine of merger, the charity then owns the entire interest in that portion and a distribution of principal may be made to the charity.

If a donor transfers part or all of his or her interest in the income to a charity, he or she has relinquished all rights with respect to that portion. There thus is a charitable deduction for a gift of his or her entire remaining interest in that portion of the trust. Reg. 1.170A-7(a)(2)(i).

Valuation of Annuity Income Interest


Income and remainder interests are valued using the methods of Reg. 1.170A-7(a) and IRS Publication 1457. Based upon the age or ages of the annuity recipients on the date of the income interest gift, the applicable federal rate, the frequency of payment and the annuity amount, the present value of the annuity may be determined. If the entire annuity is transferred to charity, then the amount calculated using the Treasury method is usually the deduction value.

However, there are two possible limitations on the deduction value. Under Sec. 170, all charitable deductions are limited to fair market value. If the annuity trust principal has declined in value to an amount less than the calculated Treasury annuity value, then the deduction will be limited to the lower fair market value of the annuity trust corpus on the date of the income interest gift.

The second limitation occurs if the payout amount, adjusted for payment period and calculated as a percentage of the trust fair market value, is higher than the applicable Sec. 7520 rate. If the adjusted payout rate is higher than the applicable federal rate and the annuity trust could exhaust before the youngest person reaches age 110, then a special factor is calculated. The value of the annuity interest is then the lower of the Pub. 1457 calculation, the Sec. 7520 special factor calculation or the trust fair market value. Reg. 25.7520-3(b)(2)(i).

Gift Tax Deduction

The transfer of the income interest also will qualify for a gift tax deduction. So long as the donor gives an undivided percentage of his or her entire interest, the charitable gift tax deduction will qualify. Reg. 25.2522(c)-3(c).

Gifts of Excess Principal

It should be possible for donors to make occasional gifts from a charitable trust to a charity, so long as the amounts and timing of the gift are determined well after the trust is created. In addition, with an annuity trust, it may be possible to give the excess growth to a charity. Since in this case there is no reduction of the annuity interest, there would be no charitable deduction, but it would be possible to achieve charitable objectives through gifts of excess growth of principal from the CRAT.

Example 3.1.6A Gift of 20% of Trust

A married couple had created a charitable remainder trust. The trust had grown substantially and the donors did not require income from the entire trust. They requested and received approval to give an undivided 20% of their income interest in the trust to the vested remainder charity. They received a charitable deduction for the value of the income interest. Since the trust was funded with an appreciated property asset, this gift was a transfer of appreciated property. As a capital gain-type gift, the deduction was limited to 30% of adjusted gross income, with a carry forward for five years. PLR 9550026.

Case Studies on Gifts from an Annuity Trust

Low AFR Generates 107% Deduction:   Jack Shaw was a highly decorated colonel in the service. He graduated from a military academy at age 22 and went on to serve his country for the next 20 years. After a successful business career, Jack finally decided to retire at age 65 to spend more time with his children (his wife passed away several years prior). In addition to his family pursuits, Jack was an active supporter of his alma mater, which was undergoing a multi-year capital campaign. In fact, in the year he retired, Jack created a Charitable Remainder Annuity Trust for the academy. He liked the tax benefits of such a trust, but more importantly he liked the fixed payments each year. Jack's 7% CRAT was funded in April of 1995 with $500,000. At that time, the AFR (Applicable Federal Rate, a.k.a. Rate of the Month) was very high, and thus the CRAT computation used the February AFR of 9.6%. As a result, Jack was entitled to a charitable income tax deduction of approximately $235,000 (47% of the original gift). For the next five years, Jack happily received his $35,000 a year from this CRAT. In addition to this CRAT payment, Jack had another $100,000 each year from his other investments. However, turning 70½ in 2000 caused Jack consternation because he had to begin taking Minimum Required Distributions (MRDs) from his IRA. His IRA had $2 million, and therefore his MRD was be about $85,000 that year. Jack is a simple man, and did not need or want all that extra income - or the extra tax liability! He has already provided for his children financially with bequests from his estate, so he wanted to investigate other uses of his excess income.

Marketing Ideas During Soft Markets and Dropping Interest Rates, Part 7 - Relinquishing your CRAT:   After attending a planned giving presentation, Bill Braun created a charitable remainder annuity trust (CRAT). He liked the tax benefits of such a trust, but more importantly he liked the fixed payments each year. Bill's 7% CRAT was funded in April of 1995 with $500,000.

Private Letter Rulings

PLR 199929033 Annuity Trust Principal to Charity Each Year:   Donors created a remainder annuity trust and, as is true with many annuity trusts, the principal grew substantially. Since the donors desired to transfer a portion of the growth each year to charity, the Service allowed a distribution of a certain amount as long as a given principal amount remained in the trust. Presumably, the principal amount balance will be sufficient to fund the annuity for the two lifetimes.

PLR 200052035 Testamentary CRAT and Personal Foundation:   In the decedent's estate, a 5% charitable remainder annuity trust (CRAT) was created for the life of beneficiary A. After the demise of beneficiary A the trustees will distribute the principal from the annuity trust to qualified exempt charities.

PLR 200617026 Proposed Trust Modification Won't Affect CRAT Status:   A established a two-life charitable remainder annuity trust (CRAT), authorizing the trustee to pay an annuity to A for his life and then to his son B, for his life.

PLR 9550026 Gift of Portion of Unitrust Income Interest:   In PLR 9550026 the donors had previously created a charitable remainder unitrust. Since the trust had grown substantially, they thought that their desire to make a $1,000,000 gift to a university could be accomplished by giving 20% of their interest in the trust. The Service allowed them to give an undivided 20% of their income interest and receive a tax deduction for that value, based on a factor calculated using their ages and 20% of trust fair market value on the date of the gift. Since the university was the remainder recipient and now held both the income and remainder interests in the 20% of the trust that equaled $1,000,000, that amount could be severed from the trust and used to fund the new building.

PLR 9721014 Gift of Unitrust Income Interest:   When a unitrust is created, the donors retain the rights to an income interest and the charity receives irrevocably the remainder interest. This income interest retained by donors is a property right under state law and thus should be transferable like any other property rights. The Service allowed the donors to transfer their income interest to the remainder recipient. When the income interest is transferred, since it is their only interest in the trust, there will be a charitable deduction under Sec. 170 of the Code for the value of the income interest gifted. To calculate that interest, run the unitrust again with the value on the date of the gift of income interest. The deduction is the income value. For example, if the trust was originally $400,000, but has grown to $500,000, run the deduction with the $500,000 value, the current date and the current Rate of the Month. If the remainder value is $200,000, their deduction is $300,000. The $500,000 total value less the $200,000 remainder value equals the $300,000 gift deduction. This is of course an appreciated-type gift deductible to 30% of AGI. Since the charity now owns both the income and the remainder interest, under the doctrine of merger, the trust no longer exists and the charity may use the trust principal for appropriate charitable purposes.


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