Wednesday April 24, 2024

6.2.1 Annuity Trust for a Life or Lives

Annuity Trust for a Life or Lives

Calculating the Charitable Income Tax Deduction:  The regulations in Sec. 664 outline the method for determining the charitable deduction for a CRAT.

Greater of Life or a Term of Years Annuity Trust:  A one- or two-life CRAT may include a provision that guarantees payments for a set number of years.

Calculating the Charitable Income Tax Deduction:  The regulations in Sec. 664 outline the method for determining the charitable deduction for a CRAT.
A charitable remainder annuity trust (CRAT) pays a fixed annuity for a life or lives. Generally, a one-life annuity trust benefits a donor and a two-life annuity trust benefits a donor and the donor's spouse. However, other combinations are possible, such as a CRAT for a donor and a nephew or niece. The duration of a CRAT may be shortened by a qualified contingency, such as a marriage, divorce or a similar defined event. Sec. 664(f). A CRAT must pay one or more persons at least annually a minimum of 5%, but not more than 50% of the initial net fair market value of all property placed in the trust. Sec. 664(d)(1). In addition, a CRAT must produce a charitable deduction equal to 10% or more of the initial fair market value of the trust corpus. Sec. 664(d)(1). In Rev. Rul. 77-374, the IRS created an additional requirement for CRATs payable for one or more lives. If there is a 5% or greater probability that the donor(s) will live long enough to exhaust the trust, the charitable deduction will be denied.

Calculating the Charitable Income Tax Deduction
The regulations in Sec. 664 outline the method for determining the charitable deduction for a CRAT. The fair market value of the contributed property, the corresponding trust payout rate, the applicable federal rate (AFR), the beneficiary's age and the payment frequency are all needed to perform the deduction calculation.

To illustrate how the deduction is calculated, consider John Donor who creates a charitable remainder annuity trust on June 1, 2017 with his favorite charity. John is 72 years old. The fair market value of the property transferred to the CRAT is $100,000. John's trust has a payout rate of 5.0%. The AFR for the month of June is 2.4% and John has selected quarterly payments. Using this information and IRS Pub. 1457, the charity's gift planner creates the following charitable deduction worksheet.

           
Remainder Annuity Trust for One Life
Election: Sec. 7520(a) election made using April 2.6% AFR
  Donor: John Donor Gift Amount: $100,000 Gift Date: 06/01/2017
  1st Person: John Donor Birth Date: 06/01/1945 Age*: 72
  Payment Frequency:   Quarterly              (Payments at End of Selected Period)
  Age* - Year changes at six months from birth date.
 
 Annuity Trust Initial Percentage: 5.0%  
 (A) Annuity Trust Payout: $5,000 (A) 
       AFR:   2.6%    
 (B) Factor: 10.3859 (B) 
       Age:   72    
       Reg. Sec. 25.7520-3(b) exhaustion calcuation    
 (C) Adjustment for Time of Payment: 1.0097 (C) 
      (IRS Pub. 1457, Table K)    
End of Period
1 Annual 1.0000 
2 Semi-Annual 1.0065 
3 Quarterly 1.0197 
4 Monthly 1.0119 
 (D) Adjusted Factor: 10.4866 (D) 
       Line(B) x Line(C)    
 (E) Present Value of Annuity: $52,433.22 (E) 
       Line(D) x Line(A)    
 (F) Amount Transferred to Trust: $100,000 (F) 
 (G) Present Value Remainder: Charitable Deduction $47,566.78 (G) 
       Line(F) Less Line(E)    
 (H) Tax Percent & Savings:      24% $11,416.03 (H) 
(Rev. Rul. 77-374 5% Probability Test Value is 1.95%)


The charitable deduction worksheet provides John's personal data, information about his annuity and the calculations used to compute his charitable deduction and tax savings. The first box delineates general information about John, including his name, age, the gift amount, gift date and payment frequency. This information is used in calculating the charitable tax deduction.

The second box provides the steps taken to determine the charitable tax deduction for John's gift. The steps are identified in Lines (A) through (H).

(A) To find the amount the annuity trust will pay John, the annuity trust payout percentage is multiplied by the fair market value of the property transferred to the trust. The annuity trust payout of 5% is multiplied by the $100,000 gift, which produces an annuity trust payout of $5,000. In other words, John will receive $5,000 annually, regardless of the value of the trust in any given year. Because John has selected quarterly payments, he will receive four payments of $1,250 each year. The AFR for the month of the gift or either of the two prior months may be used to determine the charitable deduction under Sec. 7520. For an annuity trust, a higher AFR will produce a greater deduction, so John's gift planner selects April's 2.6% AFR.

(B) The annuity factor must be determined to calculate the deduction. The annuity factor for a single life is provided in IRS Pub. 1457, Table S. Based on John's age of 72 and the AFR, the table shows an annuity factor of 10.3859. Pub. 1457, Table R(2) contains annuity factors for a two life CRAT. Under Table R(2), the beneficiary's age and the AFR are used to arrive at an initial factor. For two lives, the factor derived from Table R(2) is subtracted from 1 and the result is divided by the selected AFR. However, there is a potential limitation on deduction value. The deduction may be adjusted if the payout amount, adjusted for payment period and calculated as a percentage of current 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 the trust may cease payments during the life of the annuity recipient. In this case a special factor to reflect this risk of trust exhaustion is calculated. See Reg. 25.7520-3(b)(2)(i).

(C) An adjustment must be made based on the payment frequency selected. The time adjustment factor is found in Pub. 1457, Table K by locating the appropriate AFR (2.6%) along the left side of the table and using the corresponding payment frequency (quarterly).

(D) The time adjustment factor is multiplied by the annuity factor to calculate the adjusted annuity factor. In the worksheet above, Line (B) is multiplied by Line (C). The annuity factor of 10.3859 is multiplied by John's adjustment factor of 1.0097 to arrive at an adjusted annuity factor of 10.4866.

(E) Once the adjusted annuity factor is calculated, the present value of the annuity must be determined. The fair market value of the property transferred to the annuity trust is multiplied by the adjusted annuity factor. Line (D) is multiplied by Line (A). The adjusted annuity factor of 10.4866 is multiplied by the $5,000 annuity payout to produce a present value of $52,433.22.

(F) The amount transferred to the trust is the amount of cash or the fair market value of the property contributed. The funding amount of John's CRAT is $100,000 cash.

(G) Finally, the present value of the annuity is subtracted from the fair market value of the annuity trust property. Line (E) is subtracted from Line (F). The resulting number equals the charitable deduction. The $100,000 funding amount less the $52,433.22 present value of the annuity produces a charitable deduction of $47,566.78.

(H) To determine the tax savings, John's tax rate of 24% is multiplied by the $47,566.78 charitable deduction to produce a tax savings of $11,416.03. The tax savings provides a dollar-for-dollar offset on John's tax bill.

All of this information can be found in the charitable deduction worksheet accompanying the CRAT proposal in Crescendo Software Program 47. An explanation of each item can be found in the professional advisor text.

Greater of Life or a Term of Years Annuity Trust
A one- or two-life CRAT may include a provision that guarantees payments for a set number of years. If a guaranteed number of years is chosen and the income beneficiary or beneficiaries die early, a successor beneficiary or beneficiaries will receive the income stream for the balance of the selected term. Reg. 1.664-2(a)(5)(ii)(b). Although this ensures an income stream for a set number of years, the donor receives a lesser charitable deduction because the trust may continue after the income beneficiary's life. Accordingly, as the number of guaranteed years increases, the deduction decreases. In addition, a two-life annuity trust that includes a guaranteed term of years precludes the marital deduction under Sec. 2056(b)(8) if one spouse passes away prior to the expiration of the specified term of years.

Calculating the Charitable Income Tax Deduction
The regulations in Sec. 664 outline the method for determining the charitable deduction for a CRAT. The fair market value of the contributed property, the corresponding trust payout rate, the AFR, the beneficiary's age and the payment frequency are all needed to calculate the deduction.

To illustrate the deduction, consider John Donor who creates a charitable remainder annuity trust on June 1, 2017 with his favorite charity. John is 72 years old. The fair market value of the property transferred to the CRAT is $100,000. John's trust has a payout rate of 5.0%. The AFR for the month of June is 2.4% and John has selected quarterly payments. Using this information and IRS Pub. 1457, the charity's gift planner produces the following charitable deduction worksheet.

           
Remainder Annuity Trust for One Life
Election: Sec. 7520(a) election made using April 2.6% AFR
10 Years Guaranteed
  Donor: John Donor Gift Amount: $100,000 Gift Date: 06/01/2017
  1st Person: John Donor Birth Date: 06/01/1945 Age*: 72
  Payment Frequency:   Quarterly              (Payments at End of Selected Period)
  Age* - Year changes at six months from birth date.
 
 Annuity Trust Initial Percentage: 5.0%  
 (A) Annuity Trust Payout: $5,000 (A) 
       AFR:   2.6%    
 (B) Factor: 11.8311 (B) 
       Age:   72    
 (C) Adjustment for Time of Payment: 1.0097 (C) 
      (IRS Pub. 1457, Table K)    
End of Period
1 Annual 1.0000 
2 Semi-Annual 1.0065 
3 Quarterly 1.0097 
4 Monthly 1.0119 
 (D) Adjusted Factor: 11.9459 (D) 
       Line(B) x Line(C)    
 (E) Present Value of Annuity: $59,729.31 (E) 
       Line(D) x Line(A)    
 (F) Amount Transferred to Trust: $100,000 (F) 
 (G) Present Value Remainder: Charitable Deduction $40,270.69 (G) 
       Line(F) Less Line(E)    
 (H) Tax Percent & Savings:      24% $9,664.97 (H) 
(Rev. Rul. 77-374 5% Probability Test Value is 1.95%)


The charitable deduction worksheet provides John's personal data, information about the annuity he has selected and the calculations used to arrive at his charitable deduction and tax savings. The first box delineates general information about John, including his name, age, the gift amount, gift date and payment frequency. This information is used in calculating the charitable tax deduction.

The second box provides the steps taken to determine the charitable tax deduction for John's gift. The steps are identified in Lines (A) through (H).

(A) To calculate the amount the annuity trust will pay John, the annuity trust payout percentage is multiplied by the fair market value of the property transferred to the trust. The annuity trust payout of 5% is multiplied by the $100,000 gift, which produces an annuity trust payout of $5,000. This means that John will receive $5,000 annually, regardless of the value of the trust in any given year. Because John has chosen quarterly payments, he will receive four payments of $1,250 each year. The AFR for the month of the gift or either of the two prior months may be used to determine the charitable deduction under Sec. 7520. For an annuity trust, a higher AFR will produce a greater deduction, so John's gift planner selects April's 2.6% AFR.

(B) An annuity factor must be selected to further calculate the deduction. The annuity factor for a single life by age is provided in IRS Pub. 1457. Based on John's age of 72, the guaranteed 10-year term and the AFR, a factor of 11.8311 is calculated. This factor is larger than the Pub. 1457 factor for John's age because the payout will last for a minimum of 10 years, even if John passes away during that time.

(C) The next step is to determine the time adjustment factor. An adjustment must be made based on the payment frequency selected. Because John selected quarterly payments, the time adjustment factor is found in Pub. 1457, Table K. Locate the appropriate AFR along the left side of the table and use the corresponding payment frequency (quarterly) to find the adjustment factor of 1.0097.

(D) The time adjustment factor is multiplied by the annuity factor to calculate the adjusted annuity factor. Line (B) is multiplied by Line (C). The annuity factor of 11.8311 is multiplied by John's adjustment factor of 1.0097 to arrive at an adjusted annuity factor of 11.9459.

(E) Once the adjusted annuity factor is known, the present value of the annuity must be determined. The fair market value of the property transferred to the annuity trust is multiplied by the adjusted annuity factor. Line (D) is multiplied by Line (A). Here the adjusted annuity factor of 11.9459 is multiplied by the $5,000 annuity trust payout to produce a present value of $59,729.31.

(F) The amount transferred to the trust is the amount of cash or, if property is used, the fair market value of the property contributed. The funding amount of John's CRAT is $100,000 in appreciated property.

(G) Finally, the present value of the annuity is subtracted from the fair market value of the annuity trust property. Line (E) is subtracted from Line (F). The resulting number equals the charitable deduction. The $100,000 funding amount less the $59,729.31 present value produces a charitable deduction of $40,270.69.

(H) To determine the tax savings, John's tax rate of 24% is multiplied by the charitable deduction of $40,270.69. John's tax savings is $9,664.97. The tax savings provides a dollar-for-dollar offset on John's tax bill.

All of this information can be found in the charitable deduction worksheet accompanying the CRAT proposal in Crescendo Software Program 47. An explanation of each item is in of the professional advisor text.

Private Letter Rulings

PLR 199903001 Charitable Remainder Annuity Trust and Special-Needs Trust:   The parent of a disabled child desired to leave one-half interest in a home outright to charity, with a life estate in the other one-half interest to a special-needs trust for the life of the child and the remainder interest from this trust to charity. Other assets are to go to a charitable remainder annuity trust that pays to a special-needs trust.

PLR 8637084 Current Income Annual Gift Exclusion:   The donor created a charitable remainder trust for a term of 13 years. Beneficiaries S and T will each receive one-half of the income for the lesser of the first four years or their respective lifetimes. Beneficiaries U, V and W will each receive one-third of the income for the lesser of the succeeding nine years or their respective lifetimes.

Related Topics on Annuity Trust for a Life or Lives

1.1.3  Deduction Limits - 60%, 50%, 30%, 20%:    There are several limits on deducting charitable gifts. Generally, cash gifts and appreciated gifts to public charities are deducted first. Then, cash and appreciated gifts to private foundations are deducted. If there are carry-forwards in either category, those are deducted next if the current gifts have not reached the applicable deduction limits.

3.1.10  Income, Gift, Estate and GSTT:    The donor to a charitable remainder annuity trust will receive an income tax deduction equal to the present value of the remainder interest. It is calculated using the applicable federal rate for the current month or one of the prior two months, as permitted under Sec. 7520.

3.1.3  Annuity Trust Payouts:    A charitable remainder annuity trust must pay a minimum of 5% of the initial net fair market value of the trust at least annually to one or more persons. Sec. 664(d)(1). In addition, the annuity trust may not pay more than 50% of the initial fair market value annually. Reg. 1.664-2(a)(1).

3.1.4  5% Probability Test/10% Termination Test:    In Rev. Rul. 77-374, the Service specified an additional test for charitable remainder annuity trusts payable for one or more lives. In addition to passing the 5% minimum payout, 50% maximum payout and 10% minimum deduction interest tests, an annuity trust must pass a 5% probability test.

      Quiz-Basic



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