Saturday April 20, 2024
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6.7.5 Testamentary Charitable Remainder Unitrust
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The testamentary charitable remainder unitrust (CRUT) is beneficial in that it allows for an income stream to be paid to selected beneficiaries after the donor's death. This is often a nice planning tool because it spreads out the inheritance and ensures the beneficiary an income stream for life, lives, a selected term of up to 20 years or a combination of life or lives and a term of up to 20 years. Further, it entitles the estate to a charitable estate tax deduction thereby reducing the estate tax.
There are several options in establishing a testamentary unitrust. For instance, an individual retirement account (IRA) or pension plan can be used as the funding asset of the testamentary CRUT. Currently it is not possible for an IRA owner to transfer his or her IRA during life without paying ordinary income tax on the entire IRA. However, the IRA owner can transfer his or her IRA at death through the beneficiary designation form. If the transfer is to a testamentary CRUT, the CRUT does not have to pay any income taxes upon receiving the IRA because the CRUT is tax-exempt. The distribution of income is now based on the more friendly CRUT distribution rules rather than the not so friendly IRA distribution rules. For instance, a testamentary unitrust can be established with a net income plus makeup unitrust (NIMCRUT) type payout allowing for minimal distributions. If the surviving spouse is the beneficiary, then he or she can have more control over the amount distributed from the unitrust each year. If children are also beneficiaries, the spouse can take minimal distributions and allow the trust to grow for the benefit of the children who will receive distributions after the passing of the surviving spouse.
Another planning idea for individuals with large estates and large IRAs or pension plans is the bypass IRA unitrust. Instead of funding a standard bypass trust with the decedent's estate tax exemption, the decedent funds a testamentary unitrust for the life of the spouse plus either the lives of the children or a term of up to 20 years or a combination of life or lives and a term of up to 20 years. Again a NIMCRUT type payout can be selected, allowing the surviving spouse to take minimal distributions and thereby allowing the trust assets to be preserved for the children. The estate tax exemption plus the charitable estate tax deduction for establishing the CRUT are used to ensure that this trust is free from estate taxes. If a standard bypass trust was used instead, the IRA distribution rules would cause the income to be distributed much faster and thereby not leave much for the children.
Calculating the Charitable Income Tax Deduction
The regulations accompanying Sec. 664 outline the method for determining the charitable deduction for a testamentary CRUT. 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.
While Crescendo incorporates information from IRS Pub. 1458 in its software, it is helpful for gift planners to know how the deduction calculation would be performed if they have to look up all factors. To illustrate this, consider John Donor who has provided in his will for a testamentary CRUT. John dies on June 1, 2017 and his estate is valued at $3,000,000. The fair market value of the property transferred to the CRUT is $1,000,000. John's trust has a payout rate of 5.0%. The AFR for the month of June is 2.4%: however, the April rate of 2.6% is selected for a larger charitable deduction. John has selected quarterly payments. Using this information and IRS Pub. 1458, the charity's gift planner creates the following charitable deduction worksheet.
Unitrust–No Spouse Option
If the donor has no spouse or chooses not to leave anything to his or her spouse, the assets will be divided between the CRUT and the donor's family. If the estate is larger than the exemption equivalent, there may be estate taxes payable even after the charitable deduction is taken into account.
The charitable deduction worksheet provides John's personal data, information about the unitrust and the calculations used to compute his charitable deduction and the estate tax savings. The first box shows general information about John, including his name, the gift amount, gift date, payment frequency and gift amount. This information is used in calculating the charitable tax deduction.
The second box shows the steps taken to determine the charitable estate tax deduction for John's gift. The steps are identified in paragraphs (A) through (N) below.
(A) The unitrust payout percentage is shown here. John has chosen 5.0%, so 5.0% is shown here.
(B) The factor for the adjusted payout rate is found in Pub. 1458, Table F. The AFR for the current month or either of the two prior months may be used to determine the charitable deduction under Sec. 7520. For a unitrust, a higher AFR will produce a greater deduction, so John's gift planner selects April's 2.6% AFR. Locate the table corresponding to the 2.6% AFR selected. The left half of the table contains the number of months between the valuation and the first payout in the first full taxable year. Locate the proper period in this box (at least 3, but less than 4). The right side of the table corresponds to the selected payment frequency. Find the frequency selected (quarterly). The number that conforms to both the valuation and the frequency is the Table F factor (0.984111).
(C) The adjusted payout rate is calculated by multiplying the unitrust percentage shown in Line (A) by the adjusted payout rate factor shown in Line (B). For John's unitrust, multiply 5.00% by 0.984111 to produce 4.921%.
(D) Pub. 1458, Table D lists the factors for the remainder interests in a unitrust for a term of years. The IRS publishes a factor in Table D only for every 0.2%. Accordingly, Table D does not list an adjusted payout rate of 4.921%. Therefore, the nearest table rate below 4.921% must be found. Locate the appropriate chart in Table D using the adjusted payout rate of 4.921%. The nearest rate below 4.921% is 4.8%. This number is found in the top row of the chart.
(E) Once the nearest rate below has been found (4.8%), locate the corresponding factor. Here, the corresponding factor under a 4.8% payout for a term of 20 years is 0.373886.
(F) Pub. 1458, Table D lists the factors for the remainder interests in a unitrust for a term of years. The IRS publishes a factor in Table D only for every 0.2%. Accordingly, Table D does not list an adjusted payout rate of 4.921%. Therefore, the nearest table rate above 4.921% must be found. Locate the appropriate chart in Table D using the adjusted payout rate of 4.921%. The nearest rate above 4.921% is 5.0%. This number is found in the top row of the chart.
(G) Once the nearest rate above has been found (5.0%), locate the corresponding factor. Here, the corresponding factor under a 5.0% payout for a term of 20 years is 0.358486.
Next, the interpolation between 4.8% and 5.0% must be determined. Lines (H) through (K) compute the interpolation for the 4.921% rate.
(H) The factor for the 5.0% rate (0.358486) is subtracted from the factor for the 4.8% rate (0.373886) to produce 0.01540. In short, Line (G) is subtracted from Line (E).
(I) Next, the 4.8% nearest below rate shown in Line (D) is subtracted from the 4.921% adjusted payout rate shown in Line (C) to give the range between the two rates of 0.121%.
(J) Because Table D shows rates only at 0.2% intervals, Line (I), or 0.121%, is divided by 0.2% to produce the factor differential percentage of 0.605.
(K) To find the interpolation result, Line (H) (0.01540) is multiplied by Line (J) (0.605). The result is 0.009317.
(L) Subtracting the interpolation result of 0.009317 shown in Line (K) from the factor from the nearest rate below shown in Line (E) produces an IRS deduction factor of 0.364569.
(M) The present value of the remainder interest can then be calculated by multiplying the IRS deduction factor of 0.364569 by the $1,000,000 gift amount. The resulting present value, or today's value of the remainder interest to charity based on the projected duration of the trust, is $364,569.
(N) Finally, the estate tax savings can be calculated by multiplying the $364,569 present value of the remainder interest by John's estate tax bracket (40%). Thus, John's estate will receive estate tax savings of $145,828.
Unitrust–For Spouse Only Option
Assuming the same information as above for John Donor and adding his wife Jane as the sole trust beneficiary, the calculation of John's estate tax charitable deduction is straightforward. Any gift from the estate of a deceased spouse to the surviving spouse qualifies for an unlimited marital deduction under Sec. 2056. Therefore, John's estate receives an unlimited marital deduction for the portion of the estate that passes to Jane outright. His estate also receives an unlimited marital deduction for the income interest from the unitrust. Also, the remainder of the unitrust qualifies for a charitable deduction. In essence, John's gross estate is first reduced by the unlimited marital deduction for the amounts passing to Jane and then by the charitable deduction, which produces a taxable estate of zero.
Unitrust–Spouse and Lives Option
A unitrust may also be created for a spouse and a life or lives. When the spouse passes away, the unitrust payments continue for the life or lives of the successor beneficiaries. While this ensures an income stream for the life or lives of the successor beneficiaries, the donor's estate receives a lesser charitable deduction because the unitrust continues after the spouse's life. In addition, the estate cannot utilize the unlimited marital deduction because the income stream will not pass solely to the surviving spouse.
Using the same donor information as above, the gift planner creates the following charitable deduction worksheet for John. While Crescendo incorporates information from IRS Pub. 1458 in its software, it is helpful for gift planners to know how the deduction calculation would be performed if they have to look up all factors.
The charitable deduction worksheet provides John's personal data, information about the unitrust and the calculations used to compute the charitable deduction and the estate tax savings. The first box shows general information about John, including his name; the gift amount; gift date; spouse's name, birth date and age; second beneficiary's name, birth date and age; and payment frequency. This information is used in calculating the charitable tax deduction.
John has chosen to fund the unitrust with $1,000,000.
The second box shows the steps taken to determine the charitable estate tax deduction for John's gift. The steps are identified in paragraphs (A) through (N) below.
(A) The unitrust payout percentage is shown here. John has chosen 5.0%, so 5.0% is shown.
(B) The factor for the adjusted payout rate is found in Pub. 1458, Table F. The AFR for the current month or either of the two prior months may be used to determine the charitable deduction under Sec. 7520. For a unitrust, a higher AFR will produce a greater deduction, so John's gift planner selects April's 2.6% AFR. Locate the table corresponding to the 2.6% AFR selected. The left half of the table contains the number of months between the valuation and the first payout in the first full taxable year. Locate the proper period in this box (at least 3, but less than 4). The right side of the table corresponds to the selected payment frequency. Find the frequency selected (quarterly). The number that conforms to both the valuation and the frequency is the Table F factor (0.984111).
(C) The adjusted payout rate is calculated by multiplying the unitrust percentage shown in Line (A) by the adjusted payout rate factor shown in Line (B). For John's unitrust, multiply 5.00% by 0.984111 to produce 4.921%.
(D) Pub. 1458, Table U(2) lists the factors for the remainder interests in a unitrust based on two or more lives. The IRS publishes a factor in Table U(2) only for every 0.2%. Accordingly, Table U(2) does not list an adjusted payout rate of 4.921%. Therefore, the nearest table rate below 4.921% must be found. Locate the appropriate chart in Table U(2) using the adjusted payout rate of 4.921%. The nearest rate below 4.921% is 4.8%. This number is found in the top row of the chart as the adjusted payout rate.
(E) Once the nearest rate below has been found (4.8%), locate the oldest person's age (69) in the age column along the left side of the chart and then find the corresponding entry for the youngest person (49). Here, the corresponding factor under a 4.8% payout for a 69-year old and a 49-year old is 0.237.
(F) Pub. 1458, Table U(2) lists the factors for the remainder interests in a unitrust based on two or more lives. The IRS publishes a factor in Table U(2) only for every 0.2%. Accordingly, Table U(2) does not list an adjusted payout rate of 4.921%. Therefore, the nearest table rate above 4.921% must be found. Locate the appropriate chart in Table U(2) using the adjusted payout rate of 4.921%. The nearest rate above 4.921% is 5.0%. This number is found in the top row of the chart as the adjusted payout rate.
(G) Once the nearest rate above has been found (5.0%), locate the oldest person's age (69) in the age column along the left side of the chart and then find the corresponding entry for the youngest person (49). Here, the corresponding factor under a 5.0% payout for a 69-year old and a 49-year old is 0.224130.
Next, the interpolation between 4.8% and 5.0% must be determined. Lines (H) through (K) compute the interpolation for the 4.921% rate.
(H) The factor for the 5.0% rate (0.224130) is subtracted from the factor for the 4.8% rate (0.2370) to produce 0.01297. In short, Line (G) is subtracted from Line (E).
(I) Next, the 4.8% nearest below rate shown in Line (D) is subtracted from the 4.921% adjusted payout rate shown in Line (C) to give the range between the two rates of 0.121%.
(J) Because Table U(2) shows rates only at 0.2% intervals, Line (I), or 0.121%, is divided by 0.2% to produce the factor differential percentage of 0.605.
(K) To find the interpolation result, Line (H) (0.012870) is multiplied by Line (J) (0.605). The result is 0.007790.
(L) Subtracting the interpolation result of 0.007790 shown in Line (K) from the factor from the nearest rate below shown in Line (E) produces an IRS deduction factor of 0.229210.
(M) The present value of the remainder interest can then be calculated by multiplying the IRS deduction factor of 0.229210 by the $1,000,000 gift amount. The resulting present value, or today's value, of the remainder interest to charity based on the projected duration of the trust is $229,210.
(N) Finally, the tax savings can be calculated by multiplying the $229,210 present value of the remainder interest by John's estate tax bracket (40%). Thus, John's estate will receive tax savings of $91,684 for establishing the unitrust.
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Private Letter Rulings
PLR
199901023 IRA or Pension Plan to Unitrust, No Sec. 691(c) Income Tax Deduction:
When a qualified retirement plan is transferred at death to a unitrust, there is a charitable estate tax deduction. If the unitrust does not have unrelated business taxable income (UBTI), the transfer is not subject to income tax for the estate or the unitrust. When payments are received, there is Sec. 664 tier one ordinary income to recipients but no Sec. 691(c) income tax deduction for the estate tax attributable to the income interest.
PLR
9244013 QDOT and Unitrust:
Taxpayer desired to create a charitable remainder unitrust (CRUT) for himself and his spouse. However, his spouse was not a U.S. citizen and therefore did not qualify for the Sec. 2056(b)(8) marital deduction. Taxpayer planned to fund the CRUT with separate property and retain a testamentary right of revocation. The CRUT included the required provisions for a qualified domestic trust (QDOT) under Sec. 2056A(a).
PLR
9634019 IRD to Testamentary Unitrust:
One of the most attractive planning devices is the transfer of an IRA, pension plan or other income in respect of a decedent (IRD) asset to a testamentary charitable remainder trust.
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