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Two Attractive Gift Vehicles While IRS Discount Rates Are Low

Posted July 2010

The IRS has just released its discount rate for July 2010, and it is 2.8% (the lowest since June of last year). The discount rate is one of the three factors that determine the charitable deduction for so-called split-interest charitable arrangements; charitable remainder annuity and unitrusts; charitable gift annuities; charitable lead trusts; pooled income funds; and gifts of a remainder interest in a person's residence or farm. The other two factors are the size of the gift and the number of noncharitable beneficiaries.

Generally speaking, the lower the interest rate, the lower the value of the charitable deduction. But there are major exceptions.

1. Charitable Lead Trust (CLT)

You transfer assets into a CLT that will make payments to a designated charity for a period of time (or life) after which the assets in the trust are returned either to you (with a grantor lead trust) or to your beneficiaries—typically children and/or grandchildren (with a nongrantor lead trust). The latter is the far more popular of the two types.

The reason a CLT is more attractive right now is that the income- or gift-tax deduction increases as the discount rate goes down, thereby increasing the leverage the gift provides: Now you can either pass more to beneficiaries at significantly reduced transfer-tax costs with a nongrantor lead trust or generate a higher income-tax deduction with a grantor lead trust.

Example: Jim B establishes a $1,000,000 charitable lead annuity trust that will pay your institution $65,000 a year for 20 years. After the trust term ends, the trust assets will pass to Jim’s children.

Applying the July IRS discount rate of 2.8%, the present value of our right to receive $1,300,000 over 20 years (20 x $65,000) is $985,160. This means the gift-tax value of the children’s right to receive the trust assets after 20 years is only $14,840. Jim can use a small portion of his lifetime gift-tax exemption of $1,000,000 to offset the gift to the children.

 Assuming the trust grows at:
  The children will receive after 20 years:
 4.5%  $372,572
 6.5%  $1,000,000
 7.5%  $1,433,047
   

All amounts that eventually pass to the children will be free of any transfer tax (even though the federal estate tax is in temporary hiatus, that will probably change this year and for sure as of 1/1/11).

2. Gift of Remainder Interest in a Personal Residence or Farm

Under this arrangement, the donor makes a gift of a residence or farm and retains the right to occupy the property for life or until such time he or she wishes to move for whatever reason.

Result: A substantial tax deduction and tax savings that free up tax dollars into spendable income without causing any disruption in the donor’s lifestyle. In addition, the donor will escape capital-gain tax consequences, if any.

Moreover, the term "personal residence" is broadly defined in the tax regulations to include any property used by the owner as a personal residence (e.g., a condominium, a vacation home, and even a boat).

Example: Alice, who is 70, has lived in her home for almost 30 years and has no current plans to move. She and her deceased husband paid $80,000 for their home, which is currently valued at $500,000. In discussions about her estate plan with her attorney, she mentions that she would like to bequeath the home to our organization, a favorite charity of hers and her husband’s.

The lawyer suggests that she consider giving a gift of a remainder interest in her home to us now and retain the right to continue to live in it. If she decides to do so, the lawyer says that she will be entitled to an income-tax deduction of $296,278 using the July 2010 discount rate of 2.8%. If Alice is able to use the entire deduction—she has six years—she will be able to save up to $103,697 in income tax in her 35% bracket.

Note: In 2007 when the discount rate was as high as 6.2%, Alice’s deduction could have been $212,078 and her tax savings $74,227.

If the time comes when Alice feels the need to relocate, the following options would be available to her: make another gift—a gift of her life estate (her right to live in her home) to us; or we could jointly sell the home and share the proceeds, based on the value of our respective interests at the time.

Please let us know if either of the above gift plans would be of interest to you.



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