Friday March 29, 2024

3.6.1 Double Discount Lead Trust

Double Discount Lead Trust

Family Limited Partnership:   The double discount lead trust concept involves both a family limited partnership and a charitable annuity lead trust.

Charitable Lead Trust:   Charitable lead trusts are usually funded with a portfolio of securities.

Planning Considerations:   Clearly, the double discount lead trust has enormous tax advantages.

Lead trusts provide wonderful leveraged gifts. The gift and estate tax deduction, of course, is equal to the present value of the income to charity. When the Applicable Federal Rate approaches 6% or lower, a lead trust paying 8% will provide a very significant gift or estate tax deduction. Depending on the trust term, the deduction can range from 60% to 100% of the lead annuity trust value.

But can a donor double his or her benefit? Is it possible through creative planning to receive a double discount? If the plan is structured correctly, it may be possible to obtain a double discount and move assets through to children in a few short years with zero gift or estate taxation.

Family Limited Partnership


The double discount lead trust concept involves both a family limited partnership (FLP) and a charitable annuity lead trust. The family limited partnership is created with 99% limited partnership interests and 1% or less general partnership interests. Under IRS guidelines, there must be a business purpose for the limited partnership.

A limited partnership interest is typically not easily sold. The family member with the general partnership interest controls the operation and liquidation of the partnership. Thus, the limited partner might wait for many years with very minimal benefits. Under this circumstance, the willing buyer/willing seller test results in a significant discount from fair market value.

While there have been cases with higher discounts, the discount levels for FLPs with liquid securities are typically 15% to 20% and for those that hold real estate are approximately 30% to 40%. These discounts reflect both the lack of marketability and the lack of liquidity of the FLP interests.

Charitable Lead Trust


Charitable lead trusts are usually funded with a portfolio of securities. While other assets are permissible, securities are relatively easy to manage and thus are favored by trustees. However, in some circumstances it may be possible to fund a charitable lead trust with limited partnership interests. There are three primary requirements for this arrangement. First, there should not be debt in the partnership. Second, there should not be an active business in the partnership that would cause the charitable trust to recognize unrelated business taxable income (UBTI). Third, there must be a friendly general partner who will not violate rule one or rule two during the term of the trust.

Several tax rules require these conditions. If there were debt in the partnership, then under Sec. 512 and Sec. 514, the presence of debt could give rise to unrelated business income. Similarly, if the business is not engaged solely in producing passive income, but is involved in an active business, there also could be UBTI. The problem with a charitable lead trust that has UBTI is that under Sec. 681, the trust no longer receives a full deduction for all distributions to charity. While lead trusts normally are able to earn and deduct 100% of income under Sec. 642(c) when the income is transferred to charity, lead trusts with UBTI are subject to the 60% cash limits of Sec. 170. Thus, it is essential to avoid the creation of UBTI in a lead trust.

Planning Considerations


Clearly, the double discount lead trust has enormous tax advantages. It is possible in family business planning to move a multimillion-dollar block of C corporate stock from one shareholder to another in just under five years with minimal taxation. Alternatively, families might use the plan to transfer a major inheritance value to children within a relatively short period of time.

However, the combination FLP and lead trust does require a fairly knowledgeable attorney and an experienced appraiser. The valuation of the discount on the FLP must be very well supported, or it may be subject to attack by the IRS.

Other planning factors include considering the possibility of sale of assets during the term of the lead trust. Since a lead trust is a taxable trust, there would be very significantly negative consequences with a sale of trust assets and payment of capital gains tax out of the lead trust. Indeed it is possible that a major portion of the lead trust principal could then be required to make the distributions to charity, thus reducing the inheritance for family.

In some circumstances, the limited partnership will make distributions to the lead trust and those distributions may then be transferred to the charity. However, it may in other circumstances be necessary or appropriate to transfer limited partnership interests to the charity. At a future time, a plan would necessarily contemplate repurchase of those interests by the family from the charity. Fortunately, a public charity is not subject to the Sec. 4941 self-dealing rules. Therefore, the children or an entity owned by the children would be permitted to repurchase limited partnership shares at fair market value.

The FLP/lead trust plan provides a very effective means for wealth transfer. Assets may be transferred to family members in a relatively short period of time with little or no gift taxation. Truly, the double discount lead trust is a double benefit to all concerned.

Example 3.6.1A Living Lead Trust

Harold Wilson has a very substantial estate and desires to move significant assets through to family members. However, he would like to leverage his exemption by a factor of at least seven. That is, for each dollar of exemption used, he would like to move at least seven dollars through to family members.

Harold transfers assets valued at $1 million to a family limited partnership. He selects a mix of liquid property and real estate with a fixed-payment lease. Under appropriate Treasury and Tax Court guidelines, the appraiser determines a 35% discount for lack of marketability and lack of control. Harold then transfers the limited partnership interests with their discounted value of $650,000 into a lead trust. Based upon an assumed $80,000 payout on the $1 million in value, the lead trust is written to pay out 12.31% of the $650,000 value, or $80,015 per year for a term of eight years. The charitable interest is valued at $517,153. Harold's CPA files a Form 709 gift tax return and shows a transfer of $650,000 with a charitable gift deduction of $517,153, reducing the taxable gift to $132,847.

The lead trust pays $640,120 to Harold's favorite charity over the next eight years. At the end of eight years, the family limited partnership is transferred to family members. The assets have a discounted value of $781,734, but the underlying value is $1,202,668.

Has Harold leveraged his exemption? For the use of $132,847 of gift exemption, Harold has transferred in just eight years over eight times as much value to family. This leverage factor of eight achieves Harold's leveraged transfer goal.

Example 3.6.1B Testamentary Lead Trust

Clara Williams has a $5 million estate. She is recovering from cancer, and the treatment two years ago was apparently successful. She is concerned that her estate will grow and be taxable in the future. Therefore, Clara seeks opportunities to protect her estate from estate taxation.

Her attorney observes that a substantial proportion of her estate could be transferred to a family limited partnership. If she were to pass away, the FLP could be distributed to a lead trust. She would receive a discount first for the FLP and then for the lead trust.

Clara followed her attorney's advice and created a FLP with $3 million in assets. Her attorney drafted a lead trust to receive the limited partnership interests when she passes away. Unfortunately, she did have a recurrence of the cancer and passed away quite suddenly in 2012.

At that time the $3 million lead trust was discounted by 25%, since the majority of the trust was composed of liquid assets. The discounted value of $2.25 million was used when setting the 9.33% payout of the lead trust annuity. For 15 years, the trust will pay an annuity of $209,925 to charity. At the end of this time, the trust will be distributed to family. It will have grown to $3,839,677 of discounted value. However, the underlying assets will then be valued at $5,119,569. Best of all, after both the FLP and the lead trust discounts, the plan produced a trust that changed the taxable transfer from $3 million to the modest sum of $71,041. With almost no estate taxation, Clara will have transferred over $5 million in value to family.

Case Studies on Double Discount Lead Trust

The FLP/CLT Bailout:   James Kestrel was in the process of transferring ownership in his stake of Printing Shop, Inc. After weighing his options, he decided that the Charitable Bailout Plan was an excellent way for him to transfer a third of his shares to his cousin, Ruby, while still providing his wife and charity with substantial benefits. James now had to determine the best way to transfer his remaining shares in Printing Shop, Inc., to his children. The value of James' remaining shares was approximately $1.2 million. Unfortunately, James had used his entire exemption equivalent six years ago when he made very large gifts to his four children. Therefore, he needs a plan that will allow him to transfer his shares to his children, and eliminate or greatly reduce the tax burden associated with such a transfer.

Double Discounting Through a Lead Trust and LLC:   Barry and Tracy Fletcher, both age 55, own farmland inherited from Tracy's grandfather five years ago. At that time, the farmland was valued at $1.5 million and, therefore, this is their cost basis in the property. The current fair market value of the land is $2.5 million.

Double Your Discount, Leverage Your Gift:   Ralph and Virginia Thompson, both age 65, own a number of business assets which they would like to transfer to their three children. One of the business assets is stock in a closely held "C" corporation that the Thompsons started 15 years ago on a shoestring and now is worth $2.5 million. The three children all work for the corporation and are minority shareholders. Ralph and Virginia have been utilizing their gift exclusions to transfer shares to the children over the past seven to eight years and have been able to transfer $500,000 of value to them. However, they desire the complete ownership of the company to be transferred to the children within the next few years.

Facilitating a Lead Trust Through a Corporate Recapitalization:   Timothy and Molly Armstrong own 90% of the outstanding stock in a manufacturing company, and the other 10% is owned by another family. The stock is divided into four classes of common stock, which are non-voting Class B and voting Classes C, D and E. The corporation had redeemed a number of Class B shares over the past three years, but there has never been any intent to change the proportionate interests of the shareholders by such redemptions. The corporation's charter provides that dividends can be paid only on the Class B shares. If dividends were to be paid on the other classes, the charter provides that those classes must participate equally in the dividends. All classes are to share equally in any liquidating distributions.

Private Letter Rulings

PLR 200018062 Lead Trust May Hold Limited Partnership Units:   A charitable lead unitrust was created in the husband's estate in 1989. In the wife's 1996 estate, a substantial addition was made to the lead unitrust. The lead unitrust pays charity 8.15% for a term of nine years, with the remainder to children and grandchildren.

PLR 200207028 No Self-Dealing Where Disqualified Person Purchases LLC Interests From Charitable Lead Trusts:   H and W created a trust during their lifetimes. Upon H's death, the trust was divided into a survivor's trust and a decedent's trust. The decedent's trust was primarily to benefit W's children and grandchildren. However, the survivor's trust was to benefit an individual during W's lifetime, but at W's death would fund a charitable lead unitrust (CLUT) and a charitable lead annuity trust (CLAT). Both charitable lead trusts (CLTs) were designed to benefit W's private foundation, with the eventual remainder to W's family.

PLR 201807010 IRA Distribution Rollover Requirement Waived:   Taxpayer received a distribution from IRA Annuity. Taxpayer's financial advisor invested IRA Annuity funds in bonds, mutual funds and certificates of deposit.

PLR 201831004 Service Rules on Spousal IRA Rollover:   Decedent and Taxpayer established Trust, a revocable trust. Decedent subsequently passed away, leaving Taxpayer as the sole trustee of Trust. Trust was the beneficiary of Decedent's IRA. Under the terms of Trust, the IRA was allocated to Survivor's Trust.


      Quiz-Basic



© Copyright 1999-2024 Crescendo Interactive, Inc.