University of Missouri - Kansas City

University of Missouri - Kansas City
Retirement Accounts *In First and Second Marriages: The Fun Begins * Maximizing Tax Savings With Charitable Gifts The Hutchinson Community Foundation Hutchinson, Kansas – September 6, 2018 CHRISTOPHER R. HOYT University of Missouri - Kansas City School of Law

Retirement Accounts. In First and Second Marriages: The Fun Begins
Retirement Accounts *In First and Second Marriages: The Fun Begins * Maximizing Tax Savings With Charitable Gifts * Estate Planning for Retirement Assets in Marriages * Washington Update – New Tax Rules for 2018 * Charitable Tax Planning with Retirement Assets - Lifetime Gifts: “Charitable IRA Rollover” - Charitable Bequests of Pre-tax Retirement $ * Drafting “Income-based Charitable Bequests”

Retirement Accounts Challenges with Second Marriages

TYPES OF QRPs Section 401(a) - Employer pension, profit sharing and stock bonus plans [incl. 401(k)] Section 408 – IRAs Section 403(b) - School and charity employers Section 457(b) plans - Government and tax-exempt employers

WHAT THE QRPs HAVE IN COMMON
1. Defer income taxation Traditional: back-end taxation Roth : front-end taxation ( tax-free after 59 ½ ) Roth IRA – Roth 401(k) – Roth 403(b) – Roth 457(b)

1. Defer income taxation 2. 10% penalty - on most taxable distributions received before age 59 1/2

1. Defer income taxation 2. 10% penalty - on most taxable distributions received before age 59 1/2 3. RMDs - 50% penalty for failure * Lifetime – beginning in the year attain age 70 ½ * After death – must begin to liquidate account

1. Defer income taxation 2. 10% penalty - on most taxable distributions received before age 59 1/2 3. RMDs - 50% penalty for failure 4. Taxation – ordinary income; no 3.8%

TAXATION OF DISTRIBUTIONS
General Rule – Ordinary income – 100% exempt from 3.8% NIIT Special Rules: -- Tax-free return of capital -- NUA for appreciated employer stock -- Roth distributions are tax-free -- Rollovers can defer taxation

DIFFERENCES AMONG THE RETIREMENT PLANS

Section 401(a) - Employer pension, profit sharing and stock bonus plans [incl. 401(k)] Your employer has your money Congress: you need protections from business failures; from creditors of your employer; from your own creditors ERISA

Section 408 – IRAs You select trustee / custodian of your IRA with a regulated financial institution There is no need to impose the many complicated ERISA laws to IRAs

Bottom Line: Your rights to your 401(k) account are governed almost exclusively by federal law Your rights to your IRA are governed primarily by your state’s law

Example: Your right to get money while employed

Example: Your right to get money while employed 401(k): Generally, no right to money until terminate employment.

Example: Your right to get money while employed 401(k): Generally, no right to money until terminate employment. Possible exceptions: 1. loan 2. hardship distribution 3. Age 59 1/2

Example: Your right to get money while employed 401(k): Generally, no right to money until terminate employment. Possible exceptions: 1. loan 2. hardship distribution 3. Age 59 1/2 IRA : No law restricts access to money. (if under 59 ½, may have to pay IRS 10% penalty)

THREE STAGES OF A RETIREMENT ACCOUNT
Accumulate Wealth Retirement Withdrawals Distributions After Death

Retirement Withdrawals
THREE STAGES Accumulate Wealth Retirement Withdrawals Distributions After Death

USUAL OBJECTIVE: Defer paying income taxes in order to get greater cash flow
Principal 10% Yield Pre-Tax Amount $ 100,000 $ 10,000 Income Tax on Distribution (40%) ,000 Amount Left to Invest $ 60,000 $ 6,000

REQUIRED MINIMUM DISTRIBUTION (“RMD”)
BACKGROUND: 50% penalty if not receive distribution from IRA, 401(k), etc: #1 – lifetime distributions from own IRA: beginning after age 70 ½ #2 – an inherited IRA, 401(k), etc –  beginning year after death

REQUIRED MINIMUM DISTRIBUTIONS *LIFETIME DISTRIBUTIONS*
Age of Account Owner Required Payout 70 1/ % % % % % % %

Distributions After Death
THREE STAGES Accumulate Wealth Retirement Withdrawals Distributions After Death

Income taxation Mandatory ERISA distributions Estate taxation Asset Protection (Clark v. Ramaker) Collision of four legal worlds at death yet on I go

> Income taxation Mandatory ERISA distributions Estate taxation

INCOME IN RESPECT OF A DECEDENT - “IRD” – Sec. 691
No stepped up basis for retirement assets After death, payments are income in respect of a decedent (“IRD”) to the beneficiaries

> Income taxation > Mandatory ERISA distributions > Estate taxation

After death, must start liquidating the account Federal tax law provides that the maximum time period to liquidate an inherited account is either: Five years -- or -- Remaining life expectancy of the beneficiary

Company policy may require faster liquidation Employer might require account of deceased employee to liquidated in just one year No such problem with IRAs Beneficiary of employer plan account can compel transfer to an inherited IRA

Tax planning for inherited accounts: * DEFER distributions as long as possible – greater tax savings * Make payments over the beneficiary’s life expectancy - “Stretch IRA”

“ life expectancy“ Oversimplified: Half of population will die before that age, and half will die after

REQUIRED MINIMUM DISTRIBUTIONS *LIFE EXPECTANCY TABLE*
Age of Beneficiary Life Expectancy more years

REQUIRED MIN. DISTRIBUTIONS *LIFE EXPECTANCY TABLE* “STRETCH IRAS”
Age of Beneficiary Life Expectancy more years

REQUIRED MIN. DISTRIBUTIONS *LIFE EXPECTANCY TABLE* “STRETCH IRAS”
Age of Beneficiary Life Expectancy % more years % % % % % %

REQUIRED MINIMUM DISTRIBUTIONS * DEFINITIONS *
Required Beginning Date (“RBD”) April 1 in year after attain age 70 ½ Designated Beneficiary (“DB”) A human being. An estate or charity can be a beneficiary of an account, but not a DB. Determination Date September 30 in year after death.

HOW TO ELIMINATE BENEFICIARIES BEFORE DETERMINATION DATE
Disclaimers Full distribution of share Divide into separate accounts

REQUIRED DISTRIBUTIONS IF THERE IS EVEN JUST ONE NON-DESIGNATED BENEFICIARY
Death Before RBD Death After RBD Remaining life FIVE expectancy of YEARS someone who is decedent’s age at death

REQUIRED DISTRIBUTIONS IF ALL BENEFICIARIES ARE DESIGNATED BENEFICIARIES
Death Before RBD Death After RBD Maximum term is the life expectancy of the oldest beneficiary of the account.

Death Before RBD Death After RBD Maximum term is the life expectancy of the oldest beneficiary of the account. Exception if DB is older than decedent

Death Before RBD Death After RBD Maximum term is the life expectancy of the oldest beneficiary of the account. Exception if DB is older than decedent If establish separate account for each beneficiary, then each beneficiary can use own life expectancy.

MARRIED COUPLES: RETIREMENT ASSETS
Surviving spouse has an option that no other beneficiary has: a rollover of deceased spouse’s retirement assets to her or his own new IRA (creditor protection, too!) Other beneficiaries only option: an inherited IRA

REQUIRED DISTRIBUTIONS IF SOLE BENEFICIARY IS SURVIVING SPOUSE
Spouse can recalculate life expectancy IRAs only: Spouse can elect to treat IRA as her own Decedent die before 70½? Can wait for distribution

SENATE PROPOSAL: LIQUIDATE ALL INHERITED IRAs IN FIVE YEARS
2012 – Highway Bill – not enacted June, 2014 – Sen. Wyden adds to Highway Bill Sept 2016 – Senate finance committee action March 2018 – “Retirement Enhancement & Savings Act of 2018” EXCEPTIONS -- Spouse -- minor child -- disabled -- Person not more than ten years younger .

Age of Beneficiary Life Expectancy 40 2.3% 43.6 50 2.9% 34.2
REQUIRED MINIMUM DISTRIBUTIONS Example: Death at age 80? CURRENT LAW: *Life Expectancy Table* Age of Beneficiary Life Expectancy % more years % % % % % % * [10.2 yrs]

Age of Beneficiary Life Expectancy 40 5 50 5 60 5 70 5.9% 17.0
REQUIRED MINIMUM DISTRIBUTIONS Example: Death at age 80? PROPOSED: FIVE YEARS if >10 yrs younger Age of Beneficiary Life Expectancy years % % % * [10.2 yrs]

IMPLICATIONS FOR CHARITIES Donors more likely to consider Outright bequests Retirement assets to tax-exempt CRT Child: income more than 5 years; then charity Spouse & children (no estate tax marital deduction)

MARRIED COUPLES: PLANNING WITH RETIREMENT ASSETS

Tax Planning: -- Rollovers ? -- Funding Trusts ? -- Second Marriages ? Legal Rights -- 401(k) plans: federal law -- IRAs: state laws

Surviving spouse has an option that no other beneficiary has: a rollover of deceased spouse’s retirement assets to her or his own new IRA (creditor protection, too!) Other beneficiaries only option: an inherited IRA over remaining life expectancy

Should the estate plan provide: -- a rollover of deceased spouse’s retirement assets to a new IRA? -- or -- -- the deceased spouse’s retirement assets are payable to a trust for the surviving spouse?

Exception: “Look-through” trust if four conditions
FUNDING TRUSTS General Rule: Trust is not DB Exception: “Look-through” trust if four conditions Types:-- “accumulation trusts” -- “conduit trusts”

MULTIPLE BENEFICIARIES OF A SINGLE IRA?
Must liquidate over life expectancy of oldest beneficiary Payable to a trust? Use life expectancy of oldest trust beneficiary

FUNDING TRUSTS WITH RETIREMENT ASSETS
Challenges when there are multiple beneficiaries with a big age spread (Mom and children)

MEDIAN AGE AT DEATH ON FEDERAL ESTATE TAX RETURNS:
Age 80 – Men Age 84 - Women

AGE AT DEATH Percentage of Federal Estate Tax Returns

AGE AT DEATH

MEDIAN AGE AT DEATH ON FEDERAL ESTATE TAX RETURNS:
Age 80 – Men Age 84 - Women

REQUIRED MINIMUM DISTRIBUTIONS *LIFE EXPECTANCY TABLE*
Age of Beneficiary Life Expectancy more years more years more years

USUAL OBJECTIVE: Defer paying income taxes in order to get greater cash flow
Principal 10% Yield Pre-Tax Amount $ 100,000 $ 10,000 Income Tax on Distribution (40%) ,000 Amount Left to Invest $ 60,000 $ 6,000

MANDATORY DISTRIBUTIONS [Assume inherit IRA at age 80 and die at 92]
ROLL - Accumulation Conduit AGE OVER Trust Trust . % % % % % % % % % % empty % % empty %

IRS PLRs: Surviving Spouse Rollover
12+ IRS Private Letter Rulings – Surviving spouse can rollover deceased spouse’s IRA, even when the account is payable to: Trust for the spouse The estate, with estate pour-over into a trust for the spouse The estate, where the spouse is the sole or residuary beneficiary of the estate

IS A PLR NECESSARY? IRS user fee for PLR now $28,300 (2015) – PLR on IRA issues now $10,000 (2016) ACTEC: “public needs a Revenue Ruling” Some trustees willing to do rollover without a PLR, if facts fit the PLRs Kirkland

IRS user fee for PLR now $28,300 (2015)
IS A PLR NECESSARY? IRS user fee for PLR now $28,300 (2015) – PLR on IRA issues now $10,000 (2016)

IS A PLR NECESSARY? IRS user fee for PLR now $28,300 (2015) – PLR on IRA issues now $10,000 (2016) Most common request: waiver for failure to complete rollover within 60 days

IS A PLR NECESSARY? IRS user fee for PLR now $28,300 (2015) – PLR on IRA issues now $10,000 (2016) Most common request: waiver for failure to complete rollover within 60 days IRS: No need for ruling in 11 situations; taxpayer can “self-certify” (August 2016)

Impact if self-certify?
IRS: “OK to self-certify certain 60 day rollover mistakes” Rev. Proc Impact if self-certify? IRA or plan administrator can rely on taxpayer’s certification (unless actual knowledge that it is false). Treat as an eligible 60 day rollover Taxpayer: may treat as eligible rollover, unless IRS informs otherwise

Eligibility to self-certify?
IRS: “OK to self-certify certain 60 day rollover mistakes” Rev. Proc Eligibility to self-certify? Any one of 11 reasons caused delay: (1) an error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates; (2) the distribution, having been made in the form of a check, was misplaced and never cashed; (3) the distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an eligible retirement plan;

IRS: “OK to self-certify certain 60 day rollover mistakes” Rev. Proc Eligibility to self-certify? Any one of 11 reasons caused delay: (4) the taxpayer’s principal residence was severely damaged; (5) a member of the taxpayer’s family died; (6) the taxpayer or taxpayer’s family member was seriously ill; (7) postal error; (8) the taxpayer was incarcerated; (9-11) foreign country restrictions; IRS levy; info was withheld

IRS: “OK to self-certify certain 60 day rollover mistakes” Rev. Proc Eligibility to self-certify? Taxpayer has duty to promptly correct the mistake soon after learning of it (preferably within 30 days) Rev Proc contains model document that taxpayers can use to self-certify IRA administrator should report to IRS that the rollover took more than 60 days

IS A PLR NECESSARY? Rev Proc probably applies to a traditional rollover by a surviving spouse who misses the 60 day deadline

IS A PLR NECESSARY? Rev Proc probably applies to a traditional rollover by a surviving spouse who misses the 60 day deadline Does not offer relief when IRA was payable to a trust or estate for spouse --Still need ruling or a cooperative trustee

IRAs in SECOND MARRIAGES

Own Accumulation Conduit AGE IRA Trust Trust . % % % % % % % % % % empty % % empty %

SURVIVING SPOUSE ROLLOVER? The surviving spouse sets up a new IRA in her/his own name Then the surviving spouse selects the beneficiaries upon death

SURVIVING SPOUSE ROLLOVER? The surviving spouse sets up a new IRA in her/his own name Then the surviving spouse selects the beneficiaries upon death What assurance that a child from the deceased spouse’s prior marriage will be named as a beneficiary?

All IRAs to spouse? Buy some life insurance for children?

All IRAs to spouse? Buy some life insurance for children? Divide IRAs? Some to spouse; some to children from prior marriage

All IRAs to spouse? Buy some life insurance for children? Divide IRAs? Some to spouse; some to children from prior marriage -- caution: 401(k) & ERISA plans: 100% to spouse, unless executes waiver

Tax Planning: -- Rollovers ? -- Funding Trusts ? -- Second Marriages ? Legal Rights -- 401(k) plans: federal law -- IRAs: state laws

MARRIED COUPLES: 401(a) RETIREMENT ASSETS
Legal Rights: Regardless of who a plan participant named as a beneficiary of a 401(a) account, the surviving spouse is entitled to 100% of the assets in the account unless that spouse executed a waiver. By comparison, IRAs are generally subject to state laws, including general divorce and community property laws.

A Waiver: A spouse may waive the privilege to receive the entire account balance by executing a qualified waiver. Such a waiver is also required for other transactions that might reduce a surviving spouse’s benefit at death, such as a rollover from a QRP to an IRA.

A Waiver: Prenuptial agreements usually ineffective

A Waiver: Prenuptial agreements usually ineffective The waiver must be signed while married; must acknowledge the effect of the waiver; and must be witnessed by a plan representative or by a notary public

IRAs in SECOND MARRIAGES -- 401(k) versus IRA --

Divorce? Then die? And the will or a life insurance policy never changed (still names former spouse as beneficiary)?

Divorce? Then die? And the will or a life insurance policy never changed (still names former spouse as beneficiary)? State law in most states: Then the former spouse will not receive under the will, unless the decedent reaffirmed intent that the former spouse should inherit.

Facts: Man dies with ex-spouse still named as beneficiary of retirement account and company group-term life insurance. There are children from a prior marriage.

Facts: Man dies with ex-spouse still named as beneficiary of retirement account and company group-term life insurance. There are children from a prior marriage. U.S. Supreme Court: ERISA pre-empts state law. Ex-spouse gets 100% since she is named as beneficiary Egglehoff v. Eggelhoff

Facts: Man dies with ex-spouse still named as beneficiary of retirement account and company group-term life insurance. There are children from a prior marriage. U.S. Supreme Court: ERISA pre-empts state law. Ex-spouse gets 100% since she is named as beneficiary Egglehoff v. Eggelhoff This is extremely covfefe ! Donald J Trump

Facts: Man dies with ex-spouse still named as beneficiary of retirement account and company group-term life insurance. There are children from a prior marriage. U.S. Supreme Court: ERISA pre-empts state law. Ex-spouse gets 100% since she is named as beneficiary Egglehoff v. Eggelhoff Solution? Company drafts plan to match state law policies

Facts: Man dies with ex-spouse still named as beneficiary of retirement account and company group-term life insurance. There are children from a prior marriage. U.S. Supreme Court: ERISA pre-empts state law. Ex-spouse gets 100% since she is named as beneficiary Egglehoff v. Eggelhoff IRAs? Probably follow state laws

All IRAs to spouse? Buy some life insurance for children?

All IRAs to spouse? Buy some life insurance for children? Divide IRAs? Some to spouse; some to children from prior marriage

All IRAs to spouse? Buy some life insurance for children? Divide IRAs? Some to spouse; some to children from prior marriage IRAs to a 2-generation charitable remainder trust ?

CHARITABLE REMAINDER TRUST
Payment to non-charitable beneficiary (ies) for life *or* for a term of years (maximum 20 years) Remainder interest distributed to charity Exempt from income tax

2-GENERATION CHARITABLE REMAINDER TRUST
Typically pays 5% to elderly surviving spouse for life, then 5% to children for life, then liquidates to charity Like an IRA, a CRT is exempt from income tax Can be like a credit-shelter trust for IRD assets [no estate tax marital deduction]

Can be a solution for second marriages when estate is top-heavy with retirement assets. Example: -- Half of IRA to surviving spouse -- Other half of IRA to a CRT for 2nd spouse and children from 1st marriage

TECHNICAL REQUIREMENTS Minimum 10% charitable deduction -- all children should be over age 30 CRUT – minimum 5% annual distrib Not eligible for marital deduction Charitable intent !

Own Accumulation Conduit AGE IRA Trust Trust . % % % % % % % % % % empty % % empty %

Own Accumulation Conduit AGE IRA Trust Trust C R T . % % % % % % % % % % % % % empty % % % empty % %

All IRAs to spouse? Buy some life insurance for children? Divide IRAs? Some to spouse; some to children IRAs to a 2-generation charitable remainder trust ? .

All IRAs to spouse? Buy some life insurance for children? Divide IRAs? Some to spouse; some to children IRAs to a 2-generation charitable remainder trust ? What about the grandchildren? (Trust assets go to charity upon death of last child)

All IRAs to spouse? Buy some life insurance for children? Divide IRAs? Some to spouse; some to children IRAs to a 2-generation charitable remainder trust ? What about the grandchildren? (Trust assets go to charity upon death of last child) Solution: Life insurance on lives of the children, to benefit grandchildren

Retirement assets to tax-exempt CRT Child: income more than 5 years; then charity Spouse & children (no estate tax marital deduction)

Retirement assets to tax-exempt CRT Child: income more than 5 years; then charity Spouse & children (no estate tax marital deduction) What about the grandchildren? (Trust assets go to charity upon death of last child)

Retirement assets to tax-exempt CRT Child: income more than 5 years; then charity Spouse & children (no estate tax marital deduction) What about the grandchildren? (Trust assets go to charity upon death of last child) Solution: Life insurance on lives of the children, to benefit grandchildren

charitable planning with retirement accounts: strategies, traps and solutions

LIFETIME GIFTS “Charitable IRA Rollover”

LIFETIME GIFTS “Charitable IRA Rollover” CHARITABLE BEQUESTS Taxable and Non-Taxable Estates: Planning a Charitable Bequest of IRD

LIFETIME GIFTS “Charitable IRA Rollover” CHARITABLE BEQUESTS Taxable and Non-Taxable Estates: Planning a Charitable Bequest of IRD Non-Taxable Estates: Income-Based Charitable Bequest

Washington Update Tax Cut and Jobs Act of 2017 – H.R. 1
Reduced tax rates for individuals

Individual Income Tax Rates
MARRIED – (FILING JOINTLY) 2017 2018 Rate Income bracket 10% $ –$ 19,050 15% $19,050 – $ 77,400 12% 25% $77,400 – $156,150 22% $77,400 – $165,000 28% $156,150– $237,950 24% $165,000– $315,000 33% $237,950– $424,950 32% $315,000– $400,000 35% $424,950– $480,050 $400,000– $600,000 39.60% $480,050 and up 37% $600,000 and up

Reduced tax rates for individuals Reduce maximum corporate tax rate from 35% to 21% (flat tax) 20% tax deduction on business income earned by pass-through S corps & LLCs and self-employed (Attorneys, etc. are eligible if income is less than $157,500 single ($315,000 if married-filing jointly)).

Reduced tax rates for individuals Reduce maximum corporate tax rate from 35% to 21% (flat tax) 20% tax deduction on business income earned by pass-through S corps & LLCs and self-employed (Attorneys, etc. are eligible). Raise threshold for alternative minimum tax Raise maximum charitable deduction to 60% AGI (from 50% AGI) Raise estate tax threshold to $11.2 million per person Double the standard deduction, but eliminate deductions for personal exemptions and dependents Eliminate most itemized deductions except (1) home mortgage interest [max debt: $750,000], (2) charitable gifts, and (3) up to $10,000 of state & local income taxes and property taxes

Increased Standard Deduction
Single Married couple – two children AGI $ S-AGI M-AGI * Standard deduction 6,350 12,700 * Personal exemption 4, ,200 . =Taxable Income $ S-TI $ M-TI

Increased Standard Deduction
Single Married couple – two children AGI $ S-AGI $ S-AGI $ M-AGI $ M-AGI * Standard deduction , , , ,000 * Personal exemption , , =Taxable Income $ S-TI $ S-TI $ M-TI $ M-TI

Increased Standard Deduction Example: $20,000 SALT; $5,000 mtg & charit
Single Married couple – two children AGI $ S-AGI $ M-AGI * Itemized deduction , ,000 * Personal exemption , ,200 =Taxable Income $ S-TI $ M-TI

Tax Cut and Jobs Act of 2017 – H.R. 1 Double the standard deduction, but eliminate deductions for personal exemptions and dependents Eliminate most itemized deductions except: (1) home mortgage interest [max debt: $750,000], (2) charitable gifts, and (3) up to $10,000 of state & local income taxes and property taxes

Single Married couple – two children AGI $ S-AGI $ S-AGI $ M-AGI $ M-AGI * Itemized deduction , ,000 * Personal exemption , , =Taxable Income $ S-TI $ S-TI $ M-TI $ M-TI

Single Married couple – two children AGI $ S-AGI $ S-AGI $ M-AGI $ M-AGI * Itemized deduction , , ,000 * Personal exemption , , =Taxable Income $ S-TI $ S-TI $ M-TI $ M-TI

Single Married couple – two children AGI $ S-AGI $ S-AGI $ M-AGI $ M-AGI * Itemized deduction , , , ,000 * Personal [std dedn] exemption , , =Taxable Income $ S-TI $ S-TI $ M-TI $ M-TI

Who Gets Tax Benefits from Charitable Gifts?
Donors who itemize tax deductions (who don’t take the “standard deduction”)

Donors who itemize tax deductions (who don’t take the “standard deduction”) Impact of 2017 tax changes * Number of returns that itemize is projected to fall from 47 million tax returns to just 19 million * Number of taxpayers who deduct charitable gifts is projected to fall from 36 million to 16 million.

Donors who itemize tax deductions (who don’t take the “standard deduction”) Impact of 2017 tax changes * Number of returns that itemize is projected to fall from 47 million tax returns to just 19 million * Number of taxpayers who deduct charitable gifts is projected to fall from 36 million to 16 million. * Will the 20 million change their giving amounts?

WHAT TO DO ? Most donors give because they believe in the mission of the organization >> tell your story

WHAT TO DO ? Tax Saving Strategies for Charitable Gifts
Don’t forget the 11% who itemize their tax deductions

Don’t forget the 11% who itemize their tax deductions “Bunching” charitable gifts every few years -- donor advised funds will become more popular

Don’t forget the 11% who itemize their tax deductions “Bunching” charitable gifts every few years -- donor advised funds will become more popular Most donors over age 70 ½ should make ALL of their charitable gifts from their IRAs: “Charitable IRA Rollover”

Charitable IRA Rollover -- Lifetime Gifts from IRAs –
Law Permanent! 2015 PATH Act Dec Eligible Donors: -- Won’t report charitable gifts from IRAs as taxable income -- Not entitled to charitable income tax deduction

Charitable IRA Rollover -- Lifetime Gifts from IRAs --
IRA owner must be over age 70 ½ Maximum: $100,000 per year Yes! Charitable gift satisfies required minimum distribution requirement from IRA!

Donors who do not itemize tax deductions (“standard deduction”)
WHO WINS? Donors who do not itemize tax deductions (“standard deduction”)

Donors who do not itemize tax deductions (“standard deduction”)
WHO WINS? Donors who do not itemize tax deductions (“standard deduction”) Donors who live in states where the state income tax laws do not permit deductions for charitable contributions (Ohio, Indiana, etc)

WHO WINS ? Donors who incur taxes as their income increases -- social security benefits taxable -- Medicare “B” premiums -- 3.8% health tax if AGI>$200,000

LEGAL REQUIREMENTS Over age 70 ½ IRA (only) – not 403(b), 401(k), etc.
“Directly” from the IRA to charity -- “IRA checkbooks” are OK

LEGAL REQUIREMENTS ELIGIBLE CHARITY – Public charity or private operating foundation -- however, a PF, donor advised fund or supporting org is not eligible Must qualify for full charitable deduction – no dinners; no CGAs

LEGAL REQUIREMENTS -- tax-free distributions protected
Taxable part of IRA distributions (only) -- tax-free distributions protected Donor must have letter from charity that donor received no goods or services in exchange for the gift

TECHNICAL ISSUES Yes! Charitable IRA gifts can satisfy legally binding pledges! Joint return? Up to $200,000 No withholding taxes Beneficiary of an inherited IRA who is over age 70 ½ can make charitable gifts of required distributions

LIFETIME GIFTS “Charitable IRA Rollover” CHARITABLE BEQUESTS Taxable and Non-Taxable Estates: Planning a Charitable Bequest of IRD Non-Taxable Estates: Income-Based Charitable Bequest

Charitable bequests: having the conversation

Three Guiding Tax Principles
#1 - Lifetime charitable gifts usually produce more tax benefits than charitable bequests

#1 - Lifetime charitable gifts usually produce more tax benefits than charitable bequests #2 - If charitable bequest, make it with assets that generate IRD

#1 - Lifetime charitable gifts usually produce more tax benefits than charitable bequests #2 - If charitable bequest, make it with assets that generate IRD #3 - Non-taxable estate? Make income-based charitable bequests

income tax deductions for charitable bequeSTS OF I.r.d.
The basics : Charitable tax deductions IRD – What is it? Can a single charitable payment generate tax deductions on two separate tax returns? Does there have to be an “economic effect”? Pecuniary amounts trigger gain? Solution? Planning the charitable bequest Solutions when no instructions in governing inst

Charitable Tax Deductions
Will: “I leave $100,000 to The College; All income of estate: pay to my child”

Will: “I leave $100,000 to The College; All income of estate: pay to my child” Form Charitable estate tax deduction

Will: “I leave $100,000 to The College; All income of estate: pay to my child” Form Charitable estate tax deduction Form No charitable income tax dedn

Will: “I leave $100,000 to The College; All income of estate: pay to my child” Form Charitable estate tax deduction Form No charitable income tax dedn LOGIC: A bequest is paid from assets owned at death Income is earned after death

Will: “I leave nothing to The College; But pay all income of estate to College”

Will: “I leave nothing to The College; But pay all income of estate to College” Form Yes charitable income tax dedn

Will: “I leave nothing to The College; But pay all income of estate to College” Form Yes charitable income tax dedn Form No charitable estate tax dedn

Will: “I leave nothing to The College; But pay all income of estate to College” Form Yes charitable income tax dedn Form No charitable estate tax dedn LOGIC: A bequest is paid from assets owned at death Income is earned after death

Will: “I leave $100,000 to The College; All income of estate: pay to my child” Form Charitable estate tax deduction Form No charitable income tax dedn Revenue Ruling an estate will not be able to claim either a charitable income tax deduction nor a DNI deduction for a distribution of corpus/principal to a charity (e.g., a typical charitable bequest)

Case Study $ 50,000 - interest & dividends

Case Study $ 50,000 - interest & dividends $100,000 – IRD from 401(k) plan (default beneficiary was the estate)

Case Study $ 50,000 - interest & dividends $100,000 – IRD from 401(k) plan (default beneficiary was the estate) $150,000 – Total taxable income

Case Study $ 50,000 - interest & dividends $100,000 – IRD from 401(k) plan (default beneficiary was the estate) $150,000 – Total taxable income ********** $300,000 – Charitable bequest; rest of estate is payable to children

THE ESTATE $800,000 – Cash and stocks
Case Study THE ESTATE $800,000 – Cash and stocks

Case Study THE ESTATE $800,000 – Cash and stocks
$100,000 – Cash from 401(k) plan $900,000 – Assets owned at death **********

Case Study THE ESTATE $800,000 – Cash and stocks
$100,000 – Cash from 401(k) plan $900,000 – Assets owned at death ********** $ 50,000 - interest & dividends $950,000 – Total to be distributed

Case Study DISTRIBUTIONS $300,000 – To charity $650,000 – To children
$950,000 – Total distributed **********

Case Study DISTRIBUTIONS $300,000 – To charity $650,000 – To children
$950,000 – Total distributed ********** Of the $150,000 of income, how much is distributed to the children? To the charity?

Case Study When the estate pays $300,000 to the charity, can it claim a charitable income tax deduction? If so, how much?

Case Study When the estate pays $300,000 to the charity, can it claim a charitable income tax deduction? If so, how much? Taxable income to either Charit Dedn Estate or Beneficiaries $ -0- $150,000

Case Study When the estate pays $300,000 to the charity, can it claim a charitable income tax deduction? If so, how much? Taxable income to either Charit Dedn Estate or Beneficiaries $ -0- $150,000 $ 100,000 $ 50,000

Case Study When the estate pays $300,000 to the charity, can it claim a charitable income tax deduction? If so, how much? Taxable income to either Charit Dedn Estate or Beneficiaries $ -0- $150,000 $ 100,000 $ 50,000 $ 150,

Will: “I leave $100,000 to The College; All income of estate: pay to my child” Form Charitable estate tax deduction Form No charitable income tax dedn Revenue Ruling an estate will not be able to claim either a charitable income tax deduction nor a DNI deduction for a distribution of corpus/principal to a charity (e.g., a typical charitable bequest)

Case Study When the estate pays $300,000 to the charity, can it claim a charitable income tax deduction? If so, how much? Taxable income to either Charit Dedn Estate or Beneficiaries $ $150,000 $100,000 $ 50,000 $150,

Income in Respect of Decedent
Amounts of income to which a decedent was entitled but which were not includible in gross income before the decedent’s death. Sec. 691(a)

Amounts of income to which a decedent was entitled but which were not includible in gross income before the decedent’s death. Sec. 691(a) Accrued savings bond interest Nonqualified deferred compensation Retirement plan accounts

Retirement Plan Accounts 1. Sec. 401 – Company plans (401(k)) 2. Sec. 408 – IRAs 3. Sec. 403(b) & 457– (Charity/govt employers)

Retirement Plan Accounts 1. Sec. 401 – Company plans (401(k)) 2. Sec. 408 – IRAs 3. Sec. 403(b) & 457– (Charity/govt employers) 4. Roth IRAs & 401(k)/403(b) ( Tax-free; not taxable IRD )

IRD payable to an estate? Double tax: Form Pay estate tax – asset owned at death

IRD payable to an estate? Double tax: Form Pay estate tax – asset owned at death Form Pay income tax – IRD is taxable income

IRD payable to an estate? Double tax: Form Pay estate tax – asset owned at death Form Pay income tax – IRD is taxable income * A single payment from a retirement plan to a taxable estate will be taxed twice: -- first on the federal estate tax return -- again on the income tax return, since it is IRD

IRD payable to an estate? Double tax: Form Pay estate tax – asset owned at death Form Pay income tax – IRD is taxable income * Argument: If IRD to charity, should be able to claim charitable deduction on both estate T/R and estate’s income T/R, if governing instrument has the right instructions

IRD payable to an estate? Double tax: Form Pay estate tax – asset owned at death Form Pay income tax – IRD is taxable income * Argument: If IRD to charity, should be able to claim charitable deduction on both estate T/R and estate’s income T/R, if governing instrument has the right instructions * Different from administrative expense dedn

IRD payable to an estate? Double tax: Form Pay estate tax – asset owned at death Form Pay income tax – IRD is taxable income * Argument: If IRD to charity, should be able to claim charitable deduction on both estate T/R and estate’s income T/R, if governing instrument has the right instructions * Law: Tax Reg: “Yes, IRD qualifies for the charitable income tax deduction” Reg ( c)-3(a) Logic: IRD is both corpus and income

Form 1041 Charitable Income Tax Deduction for Bequest of IRD?
Problem: There are situations when IRD was in fact distributed to a charity by an estate or trust, but the estate or trust was not allowed to claim a charitable income tax deduction to offset the income from the IRD.

Problem: There are situations when IRD was in fact distributed to a charity by an estate or trust, but the estate or trust was not allowed to claim a charitable income tax deduction to offset the income from the IRD. Reason: The governing instrument had no instructions to pay income to a charity.

IRS Chief Counsel Memorandum ILM Decedent left his IRA to a trust that benefited his six children and several charities Trust received cash from IRA; paid entire charitable share, leaving the six children as the only remaining beneficiaries of the trust. IRS: “Taxable income from IRA, but no charitable deduction.” Reason: trust had no instructions to pay income to charities

Instruction in Will or Trust : “If I make a charitable bequest, pay it first out of IRD, if any” (oversimplified) .. .

Instruction in Will or Trust : “If I make a charitable bequest, pay it first out of IRD, if any” (oversimplified) .. . Large dollar amount of IRD? Legal argument is strengthened if a separate checking account for IRD Only deposit IRD into that account Write all charitable checks from that account. So charitable payments can be traced to IRD.

Instruction in Will or Trust : “If I make a charitable bequest, pay it first out of IRD, if any” (oversimplified) .. . Will this instruction produce a charitable income tax deduction to offset the IRD? Case law and IRS rulings ? What about the “economic effect” regulation ?

Economic Effect Regulation
A 2012 regulation provides that when a governing instrument identifies a specific source of income to be used for a charitable distribution, the provision will control only if it has an “economic effect independent of income tax consequences.” Treas. Regs. Section ( c)(3)(b)(2)

What Has An Economic Effect?
Example of no economic effect: Instruction in Will or Trust : “I make a charitable bequest of $100,000. Pay it first out of IRD, if any”

Example of no economic effect: Instruction in Will or Trust : “I make a charitable bequest of $100,000. Pay it first out of IRD, if any” This clause does not have an economic effect The charity will receive $100,000 regardless of whether the estate has $40k, $30k, or no IRD

Example of an economic effect: Instruction in Will or Trust : “Pay all of the IRD of my estate to The Hospital”

Example of an economic effect: Instruction in Will or Trust : “Pay all of the IRD of my estate to The Hospital” This clause has an economic effect The amount that the hospital will in fact receive will depend on the amount of the IRD that the estate collects: $40k, $30k, $20k, or nothing

A 2012 regulation provides that when a governing instrument identifies a specific source of income to be used for a charitable distribution, the provision will control only if it has an “economic effect independent of income tax consequences.” That regulation governs the character of the income distributed to a charity from a trust’s or estate’s charitable income tax deduction.

Character of income Tax rate Interest income 10% % Dividend income 0% % Long-term capital gains 0% % Tax-exempt interest zero %

A 2012 regulation provides that when a governing instrument identifies a specific source of income to be used for a charitable distribution, the provision will control only if it has an “economic effect independent of income tax consequences.” That regulation governs the character of the income distributed to a charity from a trust’s or estate’s charitable income tax deduction

A 2012 regulation provides that when a governing instrument identifies a specific source of income to be used for a charitable distribution, the provision will control only if it has an “economic effect independent of income tax consequences.” That regulation governs the character of the income distributed to a charity from a trust’s or estate’s charitable income tax deduction. The regulation does not prevent an estate or trust from claiming a Section 642(c) charitable income tax deduction when there is no economic effect. If show me in THAT REG lose charit inc tax dedn- MOST EXPENSIVE restaurant; IRS other arguments? Substance/form?

for Charitable Bequests of IRD
FREE ARTICLE: Google search: SSRN Hoyt IRD Income Tax Deductions for Charitable Bequests of IRD .pdf file; easy download; 11 page article; 32 footnotes

Pecuniary Amount If an estate or trust distributes appreciated property to satisfy a pecuniary obligation, the estate or trust has a taxable gain as if it had sold the property. Treas. Regs. Section 1.661(a)-2(f)(1); Kenan v. Commissioner, 114 F.2d 217 (2d Cir.1940).

Pecuniary Amount Example: “Pay $100,000 to my nephew”
Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to nephew

Pecuniary Amount Example: “Pay $100,000 to my nephew”
Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to nephew Conclude: distribution triggers taxable gain of $20,000.

Pecuniary Amount Somebody will pay tax on $20,000:
Example: “Pay $100,000 to my nephew” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to nephew Conclude: distribution triggers taxable gain of $20,000. Somebody will pay tax on $20,000:

Pecuniary Amount Somebody will pay tax on $20,000: Estate or trust,
Example: “Pay $100,000 to my nephew” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to nephew Conclude: distribution triggers taxable gain of $20,000. Somebody will pay tax on $20,000: Estate or trust, or nephew [if capital gain is distributed to nephew]

Pecuniary Amount - Charity
Example: “Pay $100,000 to The College”

Example: “Pay $100,000 to The College” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to College

Example: “Pay $100,000 to The College” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to College Conclude: distribution triggers taxable gain of $20,000.

Example: “Pay $100,000 to The College” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to College Conclude: distribution triggers taxable gain of $20,000. But can avoid any tax on gain if:

Example: “Pay $100,000 to The College” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to College Conclude: distribution triggers taxable gain of $20,000. But can avoid any tax on gain if * 642(c) charit inc tax deduction to estate ($20,000 gain is distributed to the college)

Example: “Pay $100,000 to The College” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to College Conclude: distribution triggers taxable gain of $20,000. But can avoid any tax on gain if * 642(c) charit inc tax deduction to estate ($20,000 gain is distributed to the college) * tax-exempt college pays no tax on gain

Example: “Pay $100,000 to The College” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to College Conclude: distribution triggers taxable gain of $20,000. But can avoid tax on gain if it is distributed to tax-exempt college -- Rev. Rul (charitable lead trust, with instructions to distribute income to charity)

Example: “Pay $100,000 to The College” Facts: Estate or trust owns stock with a cost basis of $80,000 that is now worth $100,000 The $100,000 stock is distributed to College Conclude: distribution triggers taxable gain of $20,000. But can avoid tax on gain if it is distributed to tax-exempt college boilerplate: distribute to charity any income generated by making the charitable bequest ..

IRS Private Letter Ruling (May 5, 2014) Trust contains pecuniary bequests to two charities Probate court agrees to reform trust to qualify for favorable income tax treatment IRA distributions pay the pecuniary bequests IRS CONCLUDES: Use of IRA assets to pay pecuniary obligations triggers taxable income to trust IRS will not respect probate court reformation

Could they have avoided tax if there had been instructions in the governing instrument to distribute such income to the tax-exempt charity? Rev. Rul (charitable lead trust) Boilerplate: distribute to charity any income generated by making the charitable bequest

PLANNING TWO WAYS TO MAKE A CHARITABLE BEQUEST FROM A RETIREMENT ACCOUNT #1 – NAME CHARITY AS BENEFICIARY OF THE ACCOUNT #2 – PAY ACCOUNT TO ESTATE OR TRUST THAT THEN MAKES A CHARITABLE BEQUEST

PLANNING Hazard: Other beneficiaries cannot do stretch IRA if charity is beneficiary?

PLANNING Solutions: * cash out charity’s share by Sept 30 or
Hazard: Other beneficiaries cannot do stretch IRA if charity is beneficiary? Solutions: * cash out charity’s share by Sept 30 or * separate account for charity

PLANNING Even better solution:
Hazard: Other beneficiaries cannot do stretch IRA if charity is beneficiary? Even better solution: Have a separate IRA with 100% of beneficiaries as charities; other IRA for family members, trusts, others -- avoid worries over Sept 30 deadline, etc

PLANNING ADMNISTRATIVE HEADACHE – T
IRA administrators need to retitle decedent’s IRA to new beneficiary; new social security number, etc

PLANNING ADMNISTRATIVE HEADACHE – The Patriot Act, etc
IRA administrators need to retitle decedent’s IRA to new beneficiary; new social security number, etc Some refuse to cut check to charity without CFO’s name, address & personal social security number

PLANNING TWO WAYS TO MAKE A CHARITABLE BEQUEST FROM A RETIREMENT ACCOUNT #1 – NAME CHARITY AS BENEFICIARY OF THE ACCOUNT #2 – PAY ACCOUNT TO ESTATE OR TRUST THAT THEN MAKES A CHARITABLE BEQUEST

PLANNING It can be done! PLR 201611002 (Dec, 7, 2015)
Several IRAs listed a trust as the beneficiary Trust instrument states: “my IRAs shall be distributed to Foundation.” IRS: “We conclude that provided that Trust pays the entire lump sum distribution to Foundation in the year received, Trust is entitled to a deduction under § 642(c)(1) equal to the amount of IRD included in Trust ’s gross income as a result of the distribution of the IRAs.”

PLANNING Want to Avoid: Estate or trust has taxable income from receiving IRA distribution, but maybe there is no offsetting charitable income tax deduction when the IRA check is given to a charity.

IRS Chief Counsel Memorandum ILM Decedent left his IRA to a trust that benefited his six children and several charities Trust received cash from IRA; paid entire charitable share, leaving the six children as the only remaining trust beneficiaries. IRS: “Taxable income from IRA, but no charitable deduction.” Reason: trust had no instructions to pay income to charities

PLANNING Solutions: #1 –Drafting “pay bequests from IRD…”
Want to Avoid: Estate or trust has taxable income from receiving IRA distribution, but maybe there is no offsetting charitable income tax deduction when the IRA check is given to a charity. Solutions: #1 –Drafting “pay bequests from IRD…” #2 – Plan “B” – post-mortem strategies

Jump to the conclusion: Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of : “If I make a charitable bequest, pay it first out of IRD, if any.” (oversimplified)

WHY?

WHY? Law: For a trust or an estate to claim a charitable income tax deduction under Section 642( c), there must generally be instructions in the governing instrument to distribute an amount from gross income to charity .

WHY? Law: For a trust or an estate to claim a charitable income tax deduction under Section 642( c), there must generally be instructions in the governing instrument to distribute an amount from gross income to charity IRS rulings when IRD paid to charity: “No deduction since no instructions in gov. instmt” .

WHY? Law: For a trust or an estate to claim a charitable income tax deduction under Section 642( c), there must generally be instructions in the governing instrument to distribute an amount from gross income to charity IRS rulings when IRD paid to charity: “No deduction since no instructions in gov. instmt” Solution: Insert instructions in every gov. instrm

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of: Except as otherwise provided in this governing instrument, .

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of: Except as otherwise provided in this governing instrument, I instruct my fiduciary that all of my charitable bequests (if any) shall be paid first with taxable income in respect of a decedent (if any) included in gross income, .

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of: Except as otherwise provided in this governing instrument, I instruct my fiduciary that all of my charitable bequests (if any) shall be paid first with taxable income in respect of a decedent (if any) included in gross income, and second with any gross income generated by making the charitable bequest (if any), .

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of: Except as otherwise provided in this governing instrument, I instruct my fiduciary that all of my charitable bequests (if any) shall be paid first with taxable income in respect of a decedent (if any) included in gross income, and second with any gross income generated by making the charitable bequest (if any), so that this trust [or estate] shall be entitled to claim a charitable income tax deduction for such transfer under Section 642( c) of The Internal Revenue Code of 1986, as amended, or under any corresponding section of future income tax laws.

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of “pay my charitable bequests with IRD” The problem with putting boilerplate language in every trust or will is:

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of “pay my charitable bequests with IRD” The problem with putting boilerplate language in every trust or will is: The boilerplate language might conflict with other instructions that appear elsewhere in the governing instrument.

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of “pay my charitable bequests with IRD” There are times you do not want IRD to be payable to a charity

Case Study When the estate pays $300,000 to the charity, can it claim a charitable income tax deduction? If so, how much? Taxable income to either Charit Dedn Estate or Beneficiaries $ $150,000 $ 100,000 $ 50,000

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of “pay my charitable bequests with IRD” There are times you do not want IRD to be payable to a charity

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of “pay my charitable bequests with IRD” There are times you do not want IRD to be payable to a charity After Sept 30, limit IRA beneficiaries to DBs

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of “pay my charitable bequests with IRD” There are times you do not want IRD to be payable to a charity After Sept 30, limit IRA beneficiaries to DBs QTIP marital estate tax deduction – spouse entitled to all income

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of: Except as otherwise provided in this governing instrument, .

Proposal: All wills and trust instruments should include boilerplate language that states something to the effect of: Except as otherwise provided in this governing instrument (specifically, the provisions in [Articles] [Sections] [Paragraphs] 3.1, 5.3, and 9.1), .

Perhaps also instructions to get the desired outcome in case boilerplate language might conflict with another provision: This provision shall take precedence over any general provision in this governing instrument or under state law, such as the traditional policy that capital gains are to be retained by a trust or an estate rather than distributed to a beneficiary. If, however, there is a specific conflicting provision in this governing instrument (such as an instruction requiring retirement plan distributions to be paid only to “designated beneficiaries” after a specified date), then such provision will control over this provision.

PLANNING #2 – Plan “B” – post-mortem strategies
Want to Avoid: Estate or trust has taxable income from receiving IRA distribution, but maybe there is no offsetting charitable income tax deduction when the IRA check is given to a charity. Solutions: #1 –Drafting “pay bequests from IRD…” #2 – Plan “B” – post-mortem strategies

The basics : Charitable tax deductions IRD – What is it? Can a single charitable payment generate tax deductions on two separate tax returns? Does there have to be an “economic effect”? Pecuniary amounts trigger gain? Solution? Planning the charitable bequest Solutions when there are no instructions in the governing instrument to give income to charity

POST-MORTEM – WHAT TECHNIQUES AVOID INCOME TO THE ESTATE?
Solution #1 – Keep IRD off of estate’s or trust’s income tax return “Distribute” the IRA to charity Document (or state law) allows “non-pro rata” distribution of assets

Solution #1 – Keep IRD off of estate’s or trust’s income tax return “Distribute” the IRA to charity Document (or state law) allows “non-pro rata” distribution of assets Residue of estate to charity ? IRS PLRs

Solution #2 – Get a charitable income tax deduction to offset the IRD Was document drafted to get a deduction? (I instruct that IRD etc..)

Solution #2 – Get a charitable income tax deduction to offset the IRD Was document drafted to get a deduction? (I instruct that IRD etc..) Residue of estate to charity? Pay charity in LAST YEAR. Income tax deduction since 100% of income goes to charity.

Income-Based Charitable Bequests
charitable planning with retirement accounts: strategies, traps and solutions Taxable and Non-Taxable Estates: Planning a Charitable Bequest of IRD Non-Taxable Estates: Income-Based Charitable Bequests

BACKGROUND: Today the typical charitable bequest is a distribution from the estate’s corpus. For example, “pay $50,000 to the Charity, and the remainder of my estate to my children.” Charitable bequests are usually viewed as providing estate tax savings but no income tax savings.

EXAMPLE “Pay $50,000 to the Charity, and the remainder of my estate to my children.” $1,000,000 million estate

EXAMPLE “Pay $50,000 to the Charity, and the remainder of my estate to my children.” $1,000,000 million estate $ ,000 taxable income during administration of estate ($20,000 received from an IRA (“IRD”) and $40,000 of taxable interest and dividends) $1,060,000 – Total cash IRD to charity would get $20k dedn

Traditional Charitable Bequest Distributions: - Charity $ 50,000 - Child 1,010,000 -– Total $ 1,060,000

Traditional Charitable Bequest Distributions: - Charity $ 50,000 - Child 1,010,000 -– Total $ 1,060,000 Income taxed to: – Charity $ -0- – Child $ 60,000

What is an income-based charitable bequest?

What is an income-based charitable bequest? An income-based charitable bequest is a charitable bequest where the source of the payment is the estate’s [trust’s] taxable income, rather than a distribution of corpus. A wholesale change from the traditional way of drafting a charitable bequest.

EXAMPLE: [No charitable bequest from corpus] “All of this estate’s [trust’s] income (including capital gains and IRD) shall be distributed to the Charity. If the cumulative amount of income of this estate [trust] exceeds $50,000, then Charity shall receive only a cumulative amount of $50,000 and all excess income shall be retained or distributed to my beneficiaries at the discretion of the executor [trustee].”

The charity will receive $50,000 under either scenario, assuming that there is at least $50,000 of income. But with an income-based charitable bequest, the estate, trust and the children will not incur an income tax liability on $50,000 of income. Simplest case: generate a charitable income tax deduction to offset the income generated during the administration of an estate (or of a trust whose purpose is akin to settling a probate estate).

Traditional Charitable Bequest Distributions: - Charity $ 50,000 - Child 1,010,000 -– Total $ 1,060,000 Income taxed to: – Charity $ -0- – Child $ 60,000

Traditional Income-based Charitable Bequest Charitable Bequest Distributions: - Charity $ 50,000 - Child 1,010,000 -– Total $ 1,060,000 Income taxed to: – Charity $ -0- – Child $ 60,000

Traditional Income-based Charitable Bequest Charitable Bequest Distributions: - Charity $ 50,000 - Child 1,010,000 -– Total $ 1,060,000 Income taxed to: – Charity $ -0- $ 50,000 – Child $ 60,000 $ 10,000

Traditional Income-based Charitable Bequest Charitable Bequest Distributions: - Charity $ 50,000 $ 50,000 - Child 1,010,000 1,010,000 -– Total $ 1,060,000 $ 1,060,000 Income taxed to: – Charity $ -0- $ 50,000 – Child $ 60,000 $ 10,000

Why focus on non-taxable estates? -- Why not taxable estates?

Why focus on non-taxable estates? -- Why not taxable estates? Taxable estate: trade-off of tax-savings from charitable deduction between estate tax (40%) and income tax (perhaps at beneficiary lower rate) With a non-taxable estate there is no estate tax. So the tax planning is to take steps that reduce the only tax that a non-taxable estate and its beneficiaries will incur: the income tax

The Obvious Question Client wants a $100,000 charitable bequest

The Obvious Question Client wants a $100,000 charitable bequest
Expect quick administration of estate -- Only $30k of income? Or $31k? Or $32k?

Expect quick administration of estate -- Only $30k of income? Or $31k? Or $32k? Drafting: “The first $100k of income to charity. If less than $100k of income, pay charity balance from corpus so that it receives total of $100k”

Expect quick administration of estate -- Only $30k of income? Or $31k? Or $32k? Drafting: “The first $100k of income to charity. If less than $100k of income, pay charity balance from corpus so that it receives total of $100k” Write check to charity for $100,000

Expect quick administration of estate -- Only $30k of income? Or $31k? Or $32k? Drafting: “The first $100k of income to charity. If less than $100k of income, pay charity balance from corpus so that it receives total of $100k” Write check to charity for $100,000 Q: Charitable income tax deduction for all of the estate’s income (up to $100,000) ? -- Confident? Not confident?

The Obvious Question Client wants a $100,000 charitable bequest Charitable income tax deduction for all income?

The Obvious Question Client wants a $100,000 charitable bequest Charitable income tax deduction for all income? TAX CERTAINTY: If trustee has discretion to divide income between charity and individual. - Give all of the income to the charity Treas. Reg. § 1.662(b)-2 , Example 1 - Give discretionary $70,000 corpus to charity IRS can argue “substance over form” ; taxpayers are always stuck with “form”

The Obvious Question Client wants a $100,000 charitable bequest Charitable income tax deduction for all income? TAX CERTAINTY: If trustee has discretion to divide income between charity and individual. - Give all of the income to the charity Treas. Reg. § 1.662(b)-2 , Example 1 - Give discretionary $70,000 corpus to charity CHALLENGE: Economic certainty. Will a trustee who is family/beneficiary in fact give the extra $70,000 to charity? IRS can argue “substance over form” ; taxpayers are always stuck with “form”

Bottom line: For a non-taxable estate, a very large income-based charitable bequest offers the potential to eliminate the income tax liability for all income earned during the administration of an estate Would be helpful to have guidance with PLR, revenue ruling, court decision, etc

Two tax challenges:

Two tax challenges: Does estate or trust qualify for a charitable income tax deduction under Section 642( c) ?

Two tax challenges: Does estate or trust qualify for a charitable income tax deduction under Section 642( c) ? Under the two-tier system for taxing DNI distributions to non-charitable beneficiaries (e.g., children), are the beneficiaries in the second tier so they can benefit from the charitable income tax deduction ?

Two-Tiers for DNI Distributions
Tier-One: A tier-one beneficiary will be taxed on “the amount of income for the taxable year required to be distributed currently to such beneficiary, whether distributed or not.” Section 662(a)(1).

Tier-One: A tier-one beneficiary will be taxed on “the amount of income for the taxable year required to be distributed currently to such beneficiary, whether distributed or not.” Section 662(a)(1). Examples: -- “distribute half of the income each year to “A”, or -- “distribute annuity from income annually to “B”

Tier-One: A tier-one beneficiary will be taxed on “the amount of income for the taxable year required to be distributed currently to such beneficiary, whether distributed or not.” Section 662(a)(1). Tier-Two: All other non-charitable beneficiaries who receive distributions For example, a beneficiary who might receive discretionary amounts of income or corpus is a tier-two beneficiary. Section 662(a)(2). Child – 50; sister– 50 – only $60k income – NOT 30-30, but (+40 tax-free corpus)

Tier-One beneficiaries . Tier-Two beneficiaries

Tier-One beneficiaries The charitable income tax deduction is an “intermediate tier” between tier-one and tier-two. O'Bryan v. Commr, 75 T.C. 304 (1980). Tier-Two beneficiaries

Tier-One beneficiaries The charitable income tax deduction is an “intermediate tier” between tier-one and tier-two. O'Bryan v. Commr, 75 T.C. 304 (1980). “Section 662(a) is structured so that first-tier beneficiaries do not benefit from the charitable deduction” O'Bryan v. Commr, at 309

Tier-One beneficiaries The charitable income tax deduction is an “intermediate tier” between tier-one and tier-two. O'Bryan v. Commr, 75 T.C. 304 (1980). Example: a “conduit trust” that receives retirement plan distributions has a tier-one beneficiary; no benefit from charit deduction

Treas. Reg. § 1.662(b)-2 , Example 1
A trust instrument provides that $30,000 of its income must be distributed currently to Person One and the balance may either be distributed to Person Two, distributed to The Charity, or accumulated. Accumulated income may be distributed to Person Two and to The Charity. The trust for its taxable year has $40,000 of taxable interest and $10,000 of taxable dividends*, with no expenses. The trustee distributed $30,000 to Person One, $50,000 to The Charity, and $10,000 to Person Two. * [modified – regulation uses tax-exempt interest rather than dividends]

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ “The trustee distributed $30,000 to Person One, $50,000 to The Charity, and $10,000 to Person Two”

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ “The trustee distributed $30,000 to Person One, $50,000 to The Charity, and $10,000 to Person Two” Income Allocation $30,000 – Tier One – Person One $20,000 – Intermediate Tier – The Charity Sec. 642( c) charitable income tax deduction zero - Tier Two – Person Two

(b) Distributable net income for the purpose of determining the character of the distribution to Person One is $30,000 (the charitable contributions deduction, for this purpose, being taken into account only to the extent of $20,000, the difference between the income of the trust for the taxable year, $50,000, and the amount required to be distributed currently, $30,000)… (e) In determining the amount to be included in the gross income of Person Two under section 662 for the taxable year, however, the entire charitable contributions deduction is taken into account, with the result that there is no distributable net income and therefore no amount to be included in gross income.

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ “The trustee distributed $30,000 to Person One, $50,000 to The Charity, and $10,000 to Person Two” Income Allocation $30,000 – Tier One – Person One $20,000 – Intermediate Tier – The Charity Sec. 642( c) charitable income tax deduction zero - Tier Two – Person Two

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ CHANGE FACTS: No Tier One Beneficiary

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ CHANGE FACTS: No Tier One Beneficiary “The trustee distributed zero dollars to Person One, $50,000 to The Charity, and $40,000 to Person Two”

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ CHANGE FACTS: No Tier One Beneficiary “The trustee distributed zero dollars to Person One, $50,000 to The Charity, and $40,000 to Person Two” Income Allocation zero – Tier One – Person One

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ CHANGE FACTS: No Tier One Beneficiary “The trustee distributed zero dollars to Person One, $50,000 to The Charity, and $40,000 to Person Two” Income Allocation zero – Tier One – Person One $50,000 – Intermediate Tier – The Charity Sec. 642( c) charitable income tax deduction

$50,000 income: [$40,000 (80%) taxable interest - $10,000 (20%) dividends] ************************************************ CHANGE FACTS: No Tier One Beneficiary “The trustee distributed zero dollars to Person One, $50,000 to The Charity, and $40,000 to Person Two” Income Allocation zero – Tier One – Person One $50,000 – Intermediate Tier – The Charity Sec. 642( c) charitable income tax deduction zero - Tier Two – Person Two

Two tax challenges: Does estate or trust qualify for a charitable income tax deduction under Section 642( c) ? Under the two-tier system for taxing distributions to non-charitable beneficiaries (e.g., children), are the beneficiaries in the second tier so they can benefit from the charitable income tax deduction ?

Example: “All of this estate’s [trust’s] income (including capital gains and IRD) shall be distributed to the Charity. If the cumulative amount of income of this estate [trust] exceeds $50,000, then Charity shall receive only a cumulative amount of $50,000 and all excess income shall be retained or distributed to my beneficiaries at the discretion of the executor [trustee].” [Tier-two beneficiaries]

#1 - Lifetime charitable gifts usually produce more tax benefits than charitable bequests #2 - If charitable bequest, make it with assets that generate IRD #3 - Non-taxable estate? Make income-based charitable bequests

University of Missouri - Kansas City
Retirement Accounts *In First and Second Marriages: The Fun Begins * Maximizing Tax Savings With Charitable Gifts The Hutchinson Community Foundation Hutchinson, Kansas – September 6, 2018 CHRISTOPHER R. HOYT University of Missouri - Kansas City School of Law

University of Missouri - Kansas City

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