The idea of asking donors to make a "blended gift" is an emerging trend in the world of philanthropy. A blended gift is the combination of a current gift, or a commitment to make a series of current gifts, together with a planned gift, such as a bequest, charitable trust or charitable gift annuity. The current gift portion of the blended gift will provide the donor and charity with benefits today while the planned gift portion typically provides both current and future benefits. With a blended gift, a donor can make his or her giving go further.
Over the past decade, the focus of charitable capital campaigns has shifted so that many campaigns now include goals with respect to planned gifts. Campaigns now target 30% to 40% of the overall goal toward the receipt of planned gifts. Individuals who have made regular gifts in the past, who strongly support a charity or who have the capacity to make a large gift, may be asked to consider making a blended gift.
As the likelihood of a blended gift request grows, professional advisorsattorneys, CPAs, financial advisors and insurance agentswho work with potential donors will increasingly be asked to help their clients assess the feasibility, benefits and best structure for their clients to make these gifts. This article series explains twelve of the most common blended gifts arrangements and the potential donor benefits for each.
Part IV of this series focuses on two types of blended gifts a gift combination of a non-grantor lead trust and bequest as well as a gift combination of an outright gift and testamentary lead trust. This article will discuss some of the unique aspects of these gifts, the motivating factors and the benefits for the donor and the donor's family. It will also provide examples to illustrate how these gift strategies can help a donor meet his or her estate and tax planning goals.
LEAD TRUST AND BEQUEST
As the previous articles in this series have explained, a blended gift is often an effective means of achieving each donor's objectives. For donors who desire to make a charitable impact today, transfer wealth to family in a tax-efficient manner and create a charitable legacy, a lead trust combined with a bequest could be the right giving strategy.
A charitable lead trust is often described as the inverse of a charitable remainder trust (see Part III for a discussion of blended gifts using charitable remainder unitrusts). A lead trust operates by making annual gifts to charity for a period of time and then, after the trust term is completed, the trust assets will pass to family (non-grantor lead trust) or back to the donor (grantor lead trust). When the trust is established, the donor may be entitled to either a gift, estate or income tax deduction depending on the type of lead trust created. The deduction will be equal to the present value of the income stream to charity. Reg. 25.2522(c)-3(c)(2).
There are two basic types of lead truststhe non-grantor lead trust (or "family lead trust") and the grantor lead trust. Within the grantor lead trust category is another type of lead trust often referred to as a "super lead trust."
The most common type of trust (and the type that this article will focus on for purposes of funding a blended gift) is the family lead trust. The family lead trust will produce a gift tax deduction when created and will distribute the remaining trust assets to family at the end of the trust term. Thus, the major benefit of this type of lead trust is the donor's ability to pass on assets to family members at a reduced gift or estate tax cost. The trust can be funded during the life of the grantor or at death as a testamentary lead trust. Note that, unlike tax-exempt charitable remainder trusts, lead trust income is taxable. If the trust is structured as a family lead trust, the income earned by the trust is taxable to the trust.
The second type of lead trust is the grantor lead trust. With this trust, the remaining trust assets will revert back to the grantor at the end of the trust term. The grantor lead trust provides the donor with a charitable income tax deduction in the year the trust is funded. Sec. 170(f)(2). However, if the trust is structured as a grantor lead trust, then the income earned by the trust is taxable to the donor on his or her personal tax return. As such, the trust investment strategy for a grantor lead trust will be designed to minimize recognition of income during the term of the trust.
The third type of lead trust is sometimes referred to as a "super lead trust." It is technically a grantor lead trust that will pass assets to family at the end of the trust term rather than reverting back to the grantor. Through careful drafting, the super lead trust will be classified as a grantor lead trust, enabling the donor to qualify for a charitable income tax deduction in the year the trust is funded. The trust also will contain a Sec. 675(4) power that enables a non-adverse party to acquire trust assets. By including this power in the trust document, the trust will be held outside the donor's estate for tax purposes (so long as the donor does not retain a reversion or control over the distribution of income). Sec. 2036(a).
All three types of lead trust payouts can have fixed or variable payments to charity. If the trust is structured as a lead annuity trust, then the trust will make fixed payments to charity each year regardless of trust earnings. The other option is to structure the trust as a lead unitrust, which will pay out a percentage of trust assets each year. Therefore, with a lead unitrust, the amount going to charity could go up or down depending on the trust's value. Lead trusts will most commonly be structured as annuity trusts because, since the payment is fixed, the trust principal is able to compound and grow over time. For example, if an annuity trust pays 5% and earns 7%, there is significant growth potential over a term of 10, 12, 15 years or longer. Even though the annuity payment is fixed and will not change, the 7% earnings will continue to be based on a larger compounding corpus. Thus, some annuity lead trusts have grown to three, four or even five times the initial trust value. In contrast, a lead trust that is structured with the variable unitrust payouts will end up paying out some of the trust's growth to charity rather than passing it on to family at the end of the trust term. As such, unitrust payouts are less frequently used than annuity payouts for lead trusts.
Lead trust donors are given wide latitude when selecting both the amount of the payout and the trust duration. Unlike charitable remainder trusts, which must pay out a minimum of 5% and a maximum of 50%, lead trusts do not have payout restrictions. Similarly, the donor has flexibility in selecting the duration of the trust. A lead trust can make payments to charity for the life of the donor, for a term of years or even for the lesser of a life or a term of years. In contrast with a term of years charitable remainder trust, which is limited under Sec. 664 to a maximum term of 20 years, lead trusts do not have the same term of years limit. For example, a donor could choose to create a lead trust for 30 years, with the remainder passing to family upon the expiration of that term.
The trustee also has flexibility in determining trust investments. However, he or she will need to carefully select trust investments in order to avoid tax on trust income. Recall that, if the trust is structured as a family lead trust, the income earned by the trust is taxable to the trust. Fortunately, the trust can claim an unlimited income tax deduction for the amount distributed to charity. Sec. 642(c). However, earnings above the amount distributed to charity will be subject to tax. As such, most family lead trusts will invest in growth stocks, earn ordinary income from bonds and receive dividends from stocks. These trusts will also avoid selling appreciated assets within the trust and funding the trust with income producing assets. The trustee will want to manage the trust so that the income earned by the trust matches the amount of the distribution to charity in order to minimize tax liability. Also note that if a lead trust has unrelated business income (defined in Sec. 512-514), then the trust will only be able to deduct 50% of the income transferred to charity. Sec. 681.
As mentioned above, combining a family lead trust with a bequest may be a great solution for those donors who wish to contribute to the immediate needs of their favorite charities today, transfer wealth to family members at a reduced gift and estate tax cost and also leave a lasting legacy to charity.
For individuals who desire flexibility in their financial planning, a lead trust and a bequest will satisfy this need. With a lead trust, the donor can use the trust to meet personal objectives by deciding what assets to use to fund the trust, the duration of the trust, what percentage of trust assets will be paid to charity each year, which charities will benefit from the trust and who will receive the trust assets after the trust term. Likewise, a bequest provides the donor with the flexibility to continue to use assets during life and to structure the bequest in a way that best suits the donor's objectives (e.g., the donor could make a bequest of a specific asset, a percentage of the donor's estate or a bequest of the residue of the estate).
By coupling a family lead trust with a bequest, a donor will benefit from two different types of deductions. The family lead trust will provide the donor with a charitable gift tax deduction while the bequest will produce a charitable estate tax deduction, which could be extremely beneficial for those individuals who desire to reduce or completely eliminate estate taxes. In addition, by creating a living family lead trust, a donor who is concerned about estate tax consequences will be able to move substantial assets through to family and avoid inclusion of those assets' appreciation in the donor's estate at death.
Oliver is a successful business owner and father. He would like to start funding an inheritance plan for his two daughters and pass some assets to them during life in order to decrease the size of his taxable estate. Oliver has also been very involved as a donor and volunteer at his favorite charity. The charity is in the early stages of a large construction project and approached Oliver to see if he would be willing to provide funding. Oliver is interested in doing so, but he also wants to make sure that he provides for the charity after he passes away through a bequest gift and hopes to receive an estate tax deduction for the gift as well.
Oliver talks to his financial advisors and decides to transfer a building valued at $2,000,000 along with $500,000 cash to a charitable lead annuity trust. At Oliver's request, his advisor structures the trust so that it will make a 5% fixed payment to Oliver's favorite charity each year for 12 years. After the 12-year term, the appreciated principal will pass to his daughters. The lead trust will produce a gift tax deduction of $1,120,274. Between the deduction and the trust's estimated remainder value of $3,141,500, Oliver is able to able to meet his goal of transferring valuable assets to his daughters outside of his estate. In addition, Oliver receives personal satisfaction knowing that the annual $125,000 gifts from the lead trust will enable his favorite charity to move forward with its construction project.
Oliver also asks his advisor to include a $1,000,000 gift to the charity in his estate plan. This will reduce his estate taxes by producing a charitable estate tax deduction. This bequest will enable him to make a large impact by providing for his favorite charity's future needs.
GIFT AND TESTAMENTARY LEAD TRUST
Another type of blended gift that utilizes a lead trust is the combination of an outright gift and a testamentary lead trust. This blended gift will enable a donor to help a charity meet its pressing needs today while also providing an inheritance for family and a legacy gift to charity. From a tax-savings standpoint, the immediate gift will help the donor reduce his or her tax bill this year and the testamentary lead trust will provide a charitable estate tax deduction, which can reduce estate taxes for donors with taxable estates.
A testamentary lead trust is essentially an application of the family lead trust discussed above. However, instead of the donor funding the trust during life, the lead trust is funded upon the death of the donor through the donor's estate. The trust will make income payments to selected charities for a number of years and then the remainder will pass to designated family members or other beneficiaries. As such, it will produce a charitable estate tax deduction equal to the present value of the income payments to charity rather than a gift tax deduction. The difference between the value of the assets transferred to the lead trust and the estate tax deduction will be a taxable transfer. However, the unified estate and gift tax lifetime exclusion may reduce or completely zero out taxes due on the transfer to family. Therefore, one significant benefit of the testamentary lead trust is the ability to move a substantial amount of assets to family with little or no taxation.
A testamentary lead trust will be funded with property from the estate. Therefore, appreciated property within the lead trust will receive a step-up in basis at the time of funding. As such, testamentary lead trust assets are often sold and the proceeds invested in a diversified portfolio of stocks and bonds. Like living lead trusts, testamentary lead trusts are not tax-exempt. Therefore, the trust should be carefully managed in order to ensure that the income generated within the trust matches the income distributed to charity because the trust is permitted to deduct the entire amount transferred to charity on the trust income tax return (so long as the income is not UBTI).
Whether to use a living lead trust or a testamentary lead trust often depends on timing considerations and the goals of the donor. These considerations include: the age of the lead trust beneficiaries, whether the donor wants to use current assets or assets in the estate to fund the trust and the age of the donor. A testamentary lead trust is sometimes preferable to a living lead trust for more senior donors.
While a testamentary lead trust can be an excellent planning tool by itself, coupling it with an outright gift enables the donor to benefit from tax savings in the year of the gift and make an immediate impact by helping favorite charities meet their needs today. Combining these two gifts will provide the donor with an income tax deduction for the full amount of the outright gift and enable the donor's estate to claim a charitable estate tax deduction equal to the present value of the lead trust payments to charity after the donor passes away. Additionally, if the donor has an appreciated asset and he or she plans to minimize taxation on the gain, then a gift of that appreciated asset would allow the donor to bypass the gain completely. Thus, from a tax savings-standpoint, blending these two gifts will allow individuals to realize multiple forms of tax savings and thereby achieve several goals at once.
For charitably minded individuals, this plan enables donors to provide lasting support to their favorite charities. The outright gift could help the selected charity achieve its short-term goals today (e.g., meeting a current campaign fundraising goal, constructing a new building, growing the charity's endowment or creating a new scholarship program). In addition, the lead trust will enable the donor to create a legacy long after he or she passes away thanks to the lead trust payments to the selected charities. Thus, philanthropic donors will experience a sense of satisfaction knowing that their charitable support will continue to impact the organizations near and dear to their hearts well into the future.
Annie is 87 years old and lost her husband a few years ago. She has a very large estate and makes substantial gifts to her favorite charities every year. Last year, she revised her estate plan to include a testamentary charitable remainder unitrust. When Annie passes away, the remainder trust will make payments to her children for a term of 10 years, after which the trust balance will be distributed to the charity named in the trust agreement. (See last month's article for a discussion on testamentary unitrusts.)
Annie would like to find a strategy that allows her to continue making charitable gifts. She also wants to transfer a large inheritance to her children beyond the income that will be paid from the unitrust. In addition, she would like to reduce her tax bill this year and perhaps avoid gain on the sale of appreciated stock that she bought many years ago.
After meeting with her advisor, Annie decides to first make an outright gift of $100,000 of her appreciated stock to her favorite charity's current campaign. Annie will receive a deduction this year and will be able to bypass all of the capital gain on the stock. Note that because the stock is an appreciated property gift, her deduction will be limited to 30% of her AGI this year, but she will be able to carry forward the remaining deduction for up to an additional five years.
Second, Annie's attorney helps her draft a testamentary lead trust, which will be funded with $15,000,000 in assets from her estate. The unitrust and lead trust will work in tandem. The lead trust will make annual annuity payments of $750,000 to charity for a term of 10 years while the unitrust will make payments to Annie's children for 10 years. After 10 years, the unitrust assets will be distributed to charity and the lead trust remainder will be distributed to Annie's children. Her estate will also receive a $6,666,975 estate tax deduction based on the establishment of the lead trust. Annie is thrilled because she will be able to provide continued support to her favorite charities and to her children when she passes away. By combining the testamentary lead trust with the outright gift of appreciated stock, Annie is able to save on taxes today, reduce her estate costs and provide more wealth for her family and charity in the future.
A blended gift is a great way for donors to contribute to a charity's capital campaign while maintaining assets for use later in life. Donors are able to make an immediate impact on their favorite charities and also establish planned gifts that will continue to benefit those charities for years to come. In addition to the satisfaction of knowing that they are furthering charitable purposes, blended gifts donors who combine gifts or bequests with lead trusts will see substantial tax benefits from their gifts and be confident that income will be available for personal or family needs in the future. Not only do blended gifts accomplish donors' personal and financial goals, they enable donors to support the causes that matter most to them and leave a lasting legacy.