PHILADELPHIA ESTATE PLANNING COUNCIL Donor ...
PHILADELPHIA ESTATE PLANNING COUNCIL Vol. VII, No. 3
SPRING 1998
President's Message recently read a management book. The Power of Alignment, by Labovitz and Rosansky. The authors' major premise is that successful enterprises must continually align their people, strategies and processes around their "main thing", much as a pilot must continually align flight factors. By all measures PEPC is a successful enterprise and our "main thing" is to provide our multidiscipline membership with the finest educational and networking opportunities. To keep ourselves properly aligned as we move into the 21st century will require the best efforts of all our membership. We must all remember that membership growth is not only the responsibility of the Membership Committee, but Warren Reintzel
Continued on page 6
Donor Advised Everything you to know
Funds.. wanted
by Eileen R. Heisman and Irv E. Geffen onor-advised funds — you may know a lot about them, or a little, or you may not have heard of them. No matter which category you fall into, you can benefit from a brief review of the basics. What you may not know is that donor-advised funds are utilized regularly by estate planning professionals who understand the power of charitable vehicles in helping their clients "do good by doing well." It goes without saying that donor-advised funds should be one of the took in your too! chest when you are developing an estate plan for your clients. HISTORY
Popularity of DAFs blossomed after the Tax Reform Act of 1969. In that Act, Congress placed new restrictions on the activities of private foundations. The restrictions included limiting the kinds of assets a donor could place in their private foundation; requiring the foundation to make minimum payouts; imposing a 2% excise tax on the income or sale of appreciated securities; and prohibiting the role that donors and other qualified persons could play in private foundation management. As a result of these changes, advisors and donors began to explore alternatives to private foundations. They sought to identify or develop other grant-making vehicles that could provide donors with benefits similar to that of a private foundation and yet avoid the severe new limitations. Thus DAFs were created, and since that time have become a commonly used tool. DESCRIPTIONS
Donor-advised funds (DAFs) and supporting organizations are two types of charitable giving vehicles housed under the umbrella of a public charity (sponsoring agency). Any public charity can create and maintain DAFs and Continued on page 3
P.0. Box 579, Moorestown, NJ 08057-0579 • Telephone: 609-234-0330 • Fax: 609-727-9504
Donor Advised Funds Continued from page 1 supporting organizations. For-profit corporations like Fidelity, Pitcairn Trust Company and Vanguard have also created DAF programs. A DAF is established with a gift of cash or property from a donor. The donor receives a federal income tax deduction the year the gift is made. Subsequent gifts can be made by the donor or others, and these too are eligible for federal income tax deductions. Depending on the specific rules of the sponsoring agency, the donor may assign rights to recommend distributions from their DAF to others, as well as maintain them for themselves. For example, a wife could assign rights of recommendation to her spouse and her sister; they can then recommend that grants be made to non-profit organizations whose work is important to them. After the sponsoring agency's board approves the grant recommendations, they are paid out to those organizations. Most sponsoring agencies require that the grants be made to organizations whom the IRS has approved as 501 (c) (3).
Supporting organizations are sometimes called "supporting foundations" or "affiliated foundations" and are described in section 509 (a) (3) of the Internal Revenue Code. They can be established in the form of either a nonprofit corporation or a trust. Depending on its structure, a supporting organization has to meet certain tests in order to be established. The tests ensure that the supporting organization is operated exclusively for the benefit of or to carry out the functions of the supported charity; that the supporting organization is controlled or operated in connection with the supported charity; and that the supporting organization is not controlled by disqualified persons. Supporting organizations are governed by boards, whose structure depends on the supporting organization type. The board adopts by-laws which govern all of its activities, including investment of assets, distribution of grants and general administration.
COMPARISON OF BENEFITS AND COSTS The following chart compares the benefits and costs of private foundations, DAFs, and supporting organizations. Of the three, DAFs require the least donor management and are less costly to set up and operate. Private foundations are more costly both to set up and to operate, but they do offer the donor maximum control over distributions and investments. Depending upon the supported charity, supporting organizations may be as expensive to set up and operate as private foundations. However, many supported charities provide technical and financial assistance to create and operate their supporting organizations. Responsibility for distributions, investments and management are assumed by the supporting organization board. Private Donor-Advised Supporting Foundations Funds Organizations Start-Up Costs Legal, accounting and Services are provided Legal, accounting for the donor, and administrative administrative costs are substantial, costs may be substantial. Income Tax Deduction
Cash gifts - Up to 30% of donor's adjusted gross income (AGI).
Cash gifts - Up to 50% of AGL
Cash gifts - Up to 50% of AGI.
Appreciated assets 20% of donor's AGI calculated on fair-market value, for publicly traded assets, on cost basis for nonpublicly traded assets.
Appreciated assets - Up to 30% of AGI based on fair-market value.
Appreciated assets - Up to 30% of AGI based on fair-market value.
100% of gift.
100% of gift.
Estate Tax Deduction 100% of gift. Excise Taxes
Usually 2% of annual income. No excise tax liability.
Distribution Required 5% of assets annually.
No required payout.
No excise tax liability.
No required payout.
Continued on page 4
Donor Advised Funds Continued from page 3
Donor's Administrative Responsibilities
Donor-Advised Funds Recommend beneficiary charities.
Private Foundations Manage assets. Keep records. Prepare IRS reports. Select charities. Verify not-for-profit status. Make/administer grants.
Supporting Organizations Supporting organization board may contract with advisors or rely on supported charity for administrative and technical support.
Annual Expenses
Variable, but can be quite high Variable, but estimated if accountants, attorneys and at 0-2% of assets. professional foundation managers are engaged.
Variable, but can be quite high if accountants, attorneys and investment advisors are engaged.
Initial
Significant because start-up costs.
Minimal-usually $5, 000 or less.
Significant because of the start-up costs.
Sponsoring agency's Board must approve. Usually a minimum distribution required.
Charities whose activities are consistent with supported organization - any amount.
Donor reserves right to recommend distribution. Sponsoring agency directs investments.
Supporting organization Board controls distribution and investments.
Gift
Minimums
of
Distribution Restrictions
Any charity - any amount.
Control
Donor or designee controls distribution and investments.
Duration
Unlimited.
the
Some sponsoring agencies impose limitations.
PLANNING CONSIDERATIONS Private foundations, supporting organizations, and DAFs all offer significant tax savings and other financial benefits to the donor. They all provide an effective mechanism for maximizing the charitable giving experience. In each case, donors can create their vehicle and make contributions to it when they choose. This allows the donor to transfer assets at the most opportune time, usually a year when there is more income, realized or unrealized capital gain. The donor can time the gift to maximize their income tax deduction, often at the full fair market value of appreciated property. If non-publicly traded assets such as closely-held stock are likely to be gifted to the vehicle, now or in the future, special consideration should be given to supporting organizations and DAFs because they have provided more favorable and consistent tax treatment in the past and will likely do so in the future. Many donors want their philanthropic interests continued by their children and future heirs. Each of the
to
be
Unlimited.
vehicles can provide this benefit to varying degrees; however, supporting organizations create a relationship initially between the donor and the supported charity, and ultimately can be used to create and maintain a relationship between the donor's heirs and that charity. This may be more difficult to achieve with a private foundation and usually can not be achieved with DAFs whose sponsoring agengy imposes generational limits on the right to advise. Many donors wish to involve their financial, legal and tax advisors in the set-up and ongoing management of the vehicle they have chosen for charitable giving. This may be accomplished with the private foundation and the supporting organization but generally not with the DAF. Selecting the Right Sponsoring Agency With all of the added benefits of DAFs, one might conclude that private foundations would disappear. This has not occurred primarily because, with DAFs, donors do surrender certain controls that they do not with private Continued on page 5
Donor Advised Funds Continued from page 4 foundations; however, if the umbrella charity's stated mission closely matches the donor's charitable inclinations, and if the charity's policies and procedures governing the operation of DAFs are acceptable, a partnership that can effectively serve both is created. Some of the sponsoring agencies have very broad charitable missions which can afford the donor great flexibility in making grants. Others define their mission more narrowly, which still may be a good match for the donor's charitable intentions. One area to consider is what assets the sponsoring agency will accept. Some sponsoring agencies will take any and all assets, while others will only take assets that are easily marketable. Either way, donors and their advisors have to carefully consider the appropriate sponsoring agency for them. Both the donor and sponsoring agency need to share the same mission — to support organizations and causes important to them. Where can you start one? Nearly 30 years after the Tax Reform Act of 1969, donoradvised funds can be found flourishing at community foundations. United Ways, Jewish Federations, national public charities created independently and by commercial organizations, universities and single-issue charities. What are the steps in creating a Donor-Advised Fund? Select a sponsoring agency — Are the donor's charitable interests defined by geography, a field of interest, such as children or the arts, by religion or by a single charity? Depending on the donor's interests, he or she may want to explore a few types of sponsoring agencies who operate DAFs. Most sponsoring agencies can provide written overviews of DAF administrative and reporting guidelines. Execute a Fund Agreement — A fund agreement needs to be completed and signed. At most sponsoring agencies, the fund agreement allows the donor to name the fund, decide whether it will function as an endowment fund or if principal can be spent, designate its charitable purpose and name successor advisors, if the next generation plans to be involved. (The donor may want to have outside counsel review the document. Most of the fund agreements are drafted carefully to comply with federal requirements.) Transfer Assets — Assets are gifted into the fund. If the assets are cash or puclicly traded appreciated securities, this can be done quickly. If the assets are more complex, such as closely-held stock, real estate or other items, this step could take more time. In the case of non-publicly traded assets, an appropriate valuation needs to be completed by a qualified appraiser and special IRS forms need to be filed.
Know and understand how to make grants - The sponsoring agency should provide clear and understandable instructions on how and when grant requests are processed. They might have forms and monthly or quarterly deadlines. The sponsoring agency may also provide other services for the donors including grant review and evaluation, facilitated family meetings or other services to assist in the grantmaking process. How to Add to the DAF or Terminate the Fund — The sponsoring agency should provide instructions in adding new assets to the fund and how a fund can be terminated. Some sponsoring agencies allow funds to be terminated by paying out principal and income to another public charity. Each option described offers a variety of benefits. As in any professional planning situation, you will need to counsel your client in consideration of his or her financial and personal goals. Irv E. Geffen is Vice President, Development, of the Albert Einstein Healthcare Network. Eileen R. Heisman is Senior Vice President of the National Philanthropic Trust, a national public charity headquartered in Jenkintown, PA.
President's Message Continued from page 1 of every council member. Our Council, unlike those in other areas, is an open group, eager to welcome new people. Tell your friends, associates and co-workers about the Council and bring them to our meetings and social gatherings. Good programs grow out of good ideas coupled with a person's desire to make them happen. When you hear a good speaker or identify a fine topic, share it with the program committee, or better yet, join the program committee and organize a luncheon program. Exciting new initiatives lie ahead for the Council. The Technology Committee, under Steve Leshner's leadership will soon have a Web page available for our membership. Bob Weinberg is chairing a liaison group with the Philadelphia Business Journal to publish an Estate Planning Supplement in the fall. Our Long-Range Planning Group, led by Bob Siwicki, is investigating an Estate Planning Day for 1999. Your participation could help to make these endeavors even more successful.
As I finish my term as president, I would like to extend my thanks to a few of the many, many people who have made my term such a pleasure. Madeline Janowski did an excellent job as Program Chair and her committee has put together a slate of six outstanding speakers for the 19981999 program year. Cliff Schlesinger took over the challenge of Membership Chair and created an organizational structure that will allow us to continue to grow in the future. Kim Fahrner continued to find new and interesting roundtable talks. Past Presidents, Chris Gleeson and Joe Bachtiger were always there when I needed advice and counsel. All my fellow Board Members spent countless hours working to make our Council the wonderful organization it has become. I would like to thank our retiring Board Members, Sharon Donohue, Herb Chasman, Bob Miller, Frank McGovern and Tim Speiss for their fine work. Lastly, to our Administrative Secretary, June Neff, who works tirelessly behind the scenes to make so much happen at every Council event.
What is Blockage? by Richard S. Grayev
F
rom time to time, attorneys and appraisers are confronted with valuing large blocks of publiclytraded stocks for various purposes. The valuation of traded stocks is usually a fairly uncomplicated process. Treasury regulations state that the mean between the highest and lowest quoted selling price on a given valuation date is the fair market value of that share of stock. Thus, the valuation of a few common shares usually calls for merely the multiplication of the mean price by the number of shares in the transaction. However, when the valuation involves a large number of shares, a large block of shares with a single owner, or a block of shares carrying some special restrictions, the difficulties mount. Is it realistic to value this large block of stock based simply on the market price quoted and on a series of small trades in the stock or should the valuation recognize the inherent issues surrounding the realistic pricing of that block? The concept of "blockage" has been developed in conjunction with the valuation of a large block of traded stock which is either so large or has such special characteristics (e.g., restricted stock) that would make it impossible or very difficult to sell in the normal course of trading. Theoretically, at the time of average market demand, the addition of a large block of stock of a company into the marketplace on top of the normal daily trading volume, should force the price of that stock to a lower level. The drop in price of that particular block could be significantly large if: • the block was very large relative to the daily trading volume; • if the stock was thinly traded even in an active market; or •
if there were other special restrictions which would limit the marketability of the block in question or delay its sale.
Large block trades have been academically studied in the past and several scholarly studies have shown that transactions involving large blocks of stock can lead to significant declines in stock price. The basic blockage concept states that the fair market value of a sizable block is not necessarily the same as the mere multiplication of the shares in that block times a published market price. Even after many decades of court cases and experience, the concept is still highly subjective in its
valuation
application. The Internal Revenue code and Treasury regulations do not provide guidelines nor does the IRS Valuation Guide for Income. Estate and Gift Taxes. As a result, there has been substantial disagreement between taxpayers and the IRS when it comes to quantifying blockage discounts. Consequently, the courts have been forced to decide on a case-by-case basis which factors, or variables, effecting the marketability of the block are important. Even after many years and numerous court decisions, no clear-cut benchmarks have been set. Based on a review of court cases, scholarly studies, and practical experience, a number of blockage "variables" can be identified which should be reviewed on a point-bypoint basis with weight given to the most appropriate variables. The following list of variables to be used in assessing the magnitude of a blockage discount should not be considered an all-inclusive list but merely a starting point. • the size of the block relative to the total shares publicly held; •
the size of the block relative to the average daily trade in the period preceding and following the valuation date;
• whether there are resale restrictions on the block; • volatility of the price of the stock; • the exchange on which the stock trades; • whether the block constitutes control of the entity; • dollar value of the entire block; • general market trend in terms of both price and volume, and market trend in the stock itself as of the valuation date; • industry trends as of the valuation date; and • the relevant company's earning capacity and ability to pay dividends. As discussed earlier, case law plays a significant role in the quantification of blockage discounts. The following table sets forth a brief summary of selected Tax Court decisions relating to blockage and blockage discounts. Continued on page 8
What is Blockage? Continued from page 7 Case Estate of: Saul R. Gilford William 0. Adair Prentice I. Robinson Rifkind vs. U.S. Saul P. Steinberg
Percentage of Discount Allowed Total Stock Ownership by Court
22.9% 2.1 3.2 2.0 6.1
33% 15 - 35 18 20 27.5
The basic question to be answered in any blockage analysis is whether the disposition of the subject block of stock over a reasonable period of time could be made at or near the quoted price as of the valuation date in light of the above factors. In arriving at this determination, expert testimony concerning market factors, ability of the market to absorb the block, and related data and analysis must be developed and presented. Richard S. Grayev is Director of Valuation Services at Curtis Financial Group Inc., a Philadelphia financial advisory services firm specializing in mergers and acquisitions and business valuations, primarily for family-owned businesses.
IRS Eases Requirements on Naming a Trust as a Beneficiary of a Retirement Plan
A
By Jonathan H. Ellis, J. D., LLM.(Taxation) Member Pennsylvania, New Jersey, and Florida Bars
n increasingly common problem in the estate planning process is to determine the best way to integrate retirement plan assets into the overall estate plan. The problem stems from the fact that estate plans frequently involved the use of trusts. One of the issues associated with naming a trust as the beneficiary of a retirement plan, is that special rules must be addressed or the assets within the retirement plan will have to be distributed more quickly than would otherwise be required. Since the tax deferred growth of investments within the retirement plan is what makes these plans so attractive in the first place, you certainly do not want to make withdrawals earlier than necessary. On December 31, 1997, the IRS issued new Proposed Regulations which were designed to make it easier to name a trust as a retirement plan beneficiary. The starting point in understanding the difficulties in estate planning for retirement assets is to realize that retirement assets are designed for retirement. The Internal Revenue Code ("Code") allows an individual to defer the income tax on both the contributions to these plans and the growth of the investments within the plan. Since the income tax is deferred, someone must pay this income tax at some point in time. The initial focus on who pays this tax will be the retirement plan participant. When the participant receives a distribution from the plan, it is treated as income. By the same token, when the participant dies, and except in the case of a spousal rollover, the beneficiary of the plan will recognize income on the distributions. In addition to the income tax on the distributions, the value of the retirement plan assets are includible in the estate of the owner. If the beneficiary of the retirement asset is anyone other than the spouse, the retirement assets will be subject to estate tax. To make matters worse, if the beneficiary has to take a distribution from the retirement plan in order to pay the estate tax, the amount of this distribution will have to be "grossed up" in order to take into account the income taxes which will also be due. The combined effect of the income and estate tax can have a devastating effect on the value of a retirement plan asset. When planning on how to take distributions from retirement plans, either during lifetime or at death, one of the cardinal tax rules to remember is to defer taking a
distribution for as long a period as possible. As indicated above, the reason has to do with the tremendous benefit of allowing the assets to accumulate within these plans on a tax deferred basis for as long a period as possible. This tax deferral is so beneficial, that the Code has a series of rules designed to force distributions from the retirement plans. These "minimum distribution rules" are generally designed to force distributions over the retirement plan participant's lifetime. For example, the first rule is that the participant must generally start taking distributions by April 1 of the year after reaching age 701/2, the "required beginning date". At that time, the retirement plan owner must start taking distributions designed to deplete the retirement assets over the owner's lifetime. This time period can be extended if the retirement plan has a "designated beneficiary". In this situation, the plan participant can choose to take distributions over the joint life expectancy of the participant and the designated beneficiary. While lifetime distributions are subject to additional limitations, distributions at death are based upon the designated beneficiary's actual life expectancy. Therefore, when the participant dies, the designated beneficiary can generally elect to take distributions over his or her life expectancy, a tremendous benefit given the value of the tax deferred growth of these assets. In situations where more than one individual is named as a beneficiary, the age of the oldest beneficiary is used for the calculations. Also, keep in mind that this is the maximum time frame upon which the assets must be withdrawn, the distributions can always be taken at a quicker rate. Given the fact that you would always want to elect to take the distributions over the designated beneficiary's life expectancy, it is important to have a designated beneficiary. The existing Proposed Regulations provide that only individuals may qualify as a designated beneficiary. A beneficiary who is not an individual, such as the estate of the plan participant, will not qualify as a designated beneficiary for purposes of determining the extended payout. This doesn't stop you from naming your estate as the beneficiary, it only prevents this choice from allowing the deferred payout. Given this result, there is almost no reason for naming the estate as the beneficiary of the retirement asset. Continued on page 10
Naming a Trust as a Beneficiary Continued from page 9 Since only an individual can satisfy the Code's qualifications as a designated beneficiary, and naming the estate as the beneficiary will not qualify, what happens if a trust is named as beneficiary? Since a trust is not an individual, it generally will not qualify as a designated beneficiary. However, the Proposed Regulations provide an exception whereby the beneficiaries of the trust will qualify as a designated beneficiary, as if named directly, provided certain tests are satisfied. It is these Proposed Regulations that have recently been relaxed, making it easier to name a trust as a beneficiary and coordinate retirement plans with the client's overall estate planning objectives. The IRS recently revised certain Proposed Regulations and added another. Specifically, these regulations relate to Section 1.401 (a) (9)-l Q&A D-5; D-6; D-7. Under the old Proposed Regulations, a trust would qualify as a designated beneficiary provided four tests would be satisfied at the later of the date on which the trust is named as beneficiary or the participant's required beginning date: 1. The trust must be irrevocable; 2. The trust must be valid under state law, or would be except for the fact that there is no corpus; 3. The beneficiaries must be identifiable from the trust instrument; and 4. A copy of the trust must be provided to the plan administrator. The new Proposed Regulations provide alternatives to the first and last requirement. The first rule relates to the time at which the trust must become irrevocable. The IRS relaxed the requirement that the trust be irrevocable by providing that the trust must either be irrevocable or will, by its terms, become irrevocable upon the death of the plan owner. This change has been in response to a general planning technique whereby retirement plan assets are paid to the client's revocable living trust. Under the old rules, this was a potentially dangerous technique if the participant lived beyond age 70 without revising their documents, since the trust was not irrevocable at the later of the two dates. Under these new rules, a revocable living trust can become an acceptable beneficiary choice. However, it would still be appropriate to include certain language
within the document. For example the trust should provide that it will become irrevocable upon the death of the grantor. While this would always be the result under state law, the new IRS regulations provide that the trust must become irrevocable "by its terms". As an exercise of caution, this provision should be included within the revocable trust document. The Trust should also include a provision directing the trustee to comply with the minimum distribution rules under the Code for purposes of taking distributions from the plan. The second change in the Proposed Regulations, relates to the fourth test in naming a trust as a beneficiary. The IRS added question D-7 to the Proposed Regulations which relates to the documentation that must be provided to the plan administrator. This new regulation provides two alternative approaches to addressing the documentation issue. The first option is to provide the plan administrator with a copy of the trust instrument and agree that if the trust is amended at any time in the future, the participant will, within a reasonable time, provide the plan administrator with a copy of each such amendment. There is no definition of what constitutes a reasonable time. The second option would be for the retirement plan participant to provide the plan administrator with a list of the beneficiaries of the trust (including contingent and remainder beneficiaries) and a description of the conditions to their entitlement. There must also be a certification that to the best of the participant's knowledge, the list is correct and complete and that the other requirements to naming a trust as beneficiary have been satisfied. The participant must also agree to provide corrected certifications to the extent that an amendment changes any information previously certified. Finally, the participant must agree to provide a copy of the trust to the plan administrator upon demand. The rules are slightly different if the required distributions are going to take place after the death of the participant. In this situation, certain information must be provided by the end of the ninth month after the death of the participant. First, the plan administrator must be provided with the final list of all the beneficiaries of the trust (including contingent and remainder beneficiaries) as of the date of death together with a description of the conditions to their entitlement. There must also be a certification that to the best of the trustee's knowledge this list is correct and complete and that the other requirements have been satisfied. Lastly, the participant must agree to provide a copy of the trust to the plan Continued on page 11
Naming a Trust as a Beneficiary Continued from page 10 administrator upon demand; or provide a copy of the actual trust document. The reason that the new Proposed Regulations are helpful is because many plan administrators do not want to hold on to the trust. While this documentation would frequently be provided, the administrators were not always happy to receive these documents from an administrative perspective. Under the new Proposed Regulations, this test can be satisfied by providing a certification. The new Proposed Regulations do not address a practical problem which exists with most plan administrators. Most plan administrators simply want to invest your money. They do not want to be bothered with the administrative requirements that go along with the investment opportunities. Accordingly, a plan participant's beneficiary information is typically listed on a computer screen where there is room for only limited information. It has not always been possible to include all of the required information within this limited space. Some plan administrators are reluctant to permit additional information to be included on supporting attachments to the beneficiary forms. The new Proposed Regulations provide some help in this area by limiting the supplemental information that must be provided. While this will not entirely address the issue, it is certainly a start. Another area that is left unresolved is the extent of the information that must be provided with respect to the beneficiary's interest. Do you simply have to list the name and the portion of the trust to which the beneficiary was entitled (i.e. one-third), or do you have to outline the terms of the trust within the beneficiary designation (i.e. health, education, welfare, etc.). Further guidance will be needed to address this issue. However, even if the IRS provides this guidance, plan administrators must expand the information which they will be willing to accept for each of their plan participants. A final issue to keep in mind is that successfully naming a trust as a beneficiary in a manner satisfying the designated beneficiary rules is only half the battle. Once this step is accomplished there are additional complications which arise from this combination. For example, the distributions from the retirement plan will be considered ordinary income for tax purposes. However, only the interest and dividends will be considered income for trust accounting purposes. The result being that if the terms of the trust require a distribution of only
income to a beneficiary, the trust accounting rules will dictate that some portion of the retirement distribution be considered principle, and therefore retained within the trust. These funds will then be taxed at the trust's income tax rates; a bad result given that the trust income tax brackets reach 39.6% at $8,350 of income. This is the scenario where the credit shelter trust is named as the beneficiary of a retirement plan. In essence, when using retirement plan assets to fund a credit shelter trust, the client is faced with the choice between saving estate taxes at the expense of paying extra income taxes. Another common use of trusts with retirement assets is naming a Q-TIP trust as the beneficiary. The IRS has issued numerous rulings detailing the provisions that must be included in the trust document in order for this technique to be successful. In essence, you must satisfy both the minimum distribution rules with respect to retirement plans and the Q-TIP rules with respect to income distributions from the trust. Therefore, the trust should contain language that distributions from the retirement plan be equal to the greater of (a) the income earned from the assets; or (b) the amount required to be distributed under the minimum distribution rules. Once this amount is distributed from the retirement plan to the trust, the income (i.e., interest and dividends) can then be distributed to the spouse. Additionally, some commentators argue that this language should also be contained in the beneficiary language of the retirement plan in addition to the trust document. As with the credit shelter trust example, to the extent that distributions from the retirement plan are less than the income to be distributed to the spouse, the excess will also be subject to income tax at the trust level. In summary, while the IRS has liberalized the requirements for naming a trust as a beneficiary of a retirement plan, there are numerous additional tax issues associated with this choice. It is important that anyone who considers this option be fully aware of the advantages and disadvantages of this selection. Having said this, it is not unusual to have a client who has 80% of his or her assets in some type of a qualified retirement plan. Given this limited asset mix, a viable estate plan may very well include the naming of a trust as a beneficiary of a retirement plan. With the new Proposed Regulations, the IRS has taken a helpful step in the area of planning. Jonathan H. Ellis is a Partner in the law firm Plotnick & Ellis, P.C. in Jenkintown, PA.
The Tax Act of 1997 and Charitable Giving By Francis}. McGovern, CFRE
ince the passage of the "Taxpayers Relief Act of 1997," on August 5th, much has been said or written about its effect on charitable giving. Basically, the bill is good news for charity and donors. The congress maintained nearly all the tax incentives for charitable giving in this law.
The following is a brief summary of some of the important items affecting charitable donors and their charities:
. Reduction in most capital gains taxes
Sale
Holding Period 12 months or (short-term gain)
less
More than 12 months (long-term gain) 15% bracket 28% - 39.6% bracket
TAX ON $1.000 CAPITAL GAIN Date Tax Rate
Any time
May 7-July 28, 1997
12+ to 18 months (mid-term gain) 15% bracket 28% - 39.6% bracket
After July 28, 1997
More than 18 months (long-term gain) 15% bracket 28% -39.6% bracket
After July 28, 1997
More than five years 15% bracket 28% -39.6% bracket
After December 31, 2000
More than five years 15% bracket 28% - 39.6% bracket
After January 1, 2006
Tax
Ordinary rates (15%-39.6%)
$150-396
10% 20%
$100 $200
15% 28%
$150 $280
10% 20%
$100 $200
8% N/A 8% 18%
Reprinted with permission of R. & R. Newkirk
$80
N/A $80 $180
Tax Act of 1997 Continued from page 14 . Staged increases in sums that can be gifted during life or left to non-charitable beneficiaries free of gift and estate tax. Over ten years, credit equivalent exemption amount moves from $600, 000 to $1, 000, 000. Year
1998 1999 2000, 2001 2002, 2003 2004 2005 2006
Unified Credit
$202, 050 211, 300 220, 550 229, 800 287, 300 326, 300 345, 800
Sheltered Gifts / Estates
$625,
000
650,
000
675,
000
700,
000
850,
000
950, 000
1, 000, 000
Reprinted with permission of R. & R. Newkirk .
Another example, if a donor to a public charity were to set up the following charitable remainder unitrust, it would fail to qualify because the 51% payout rate exceeds the 50% cap for payout: . Gift date - IRS Discount Rate = 2/9/98 - 6.8% . Lives and / or Fixed Term = 40 year old life beneficiary . Principal Value Donated - Cost Basis = $100, 000 $10, 000 . Gift Options =51% Charitable Remainder Unitrust . Date of Gift = February 9, 1998 . Payment Schedule = Quarterly; 3 months to 1st payment . Benefits: . Charitable Deduction = $396.00 . First Year's Income = $51, 000.00 . (Future Income Will Vary With Trust Value) . Percentage Deduction = A%* . (Computed Charitable Remainder Value)
Continuance of provisions affecting gifts to private foundations: The time period when the taxpayer can take a charitable income tax deduction based on the full fair market value of a gift of publicly traded stock to a private foundation has been extended through May 31, 1998.
* The 51% payout rate exceeds the allowable amount causing the trust to fail to qualify for various tax benefits and results in this minimal computed percentage passing to charity.
Maximum payment and minimum remainder amounts for some gifts to qualify for various tax benefits: An annuity trust or unitrust amount can be no higher than a 50% payout: the computed charitable remainder amount can be no lower than 10% of the amount given.
While the provision has received some negative publicity, this writer does not see it as particularly harmful to charity. For one thing donative intent by the donor is necessary; for another, the legislated minimum and maximum provide a safe harbor for donors, donees and planners.
For example, if a donor to a public charity were to set up the following charitable remainder unitrust, it would fail to qualify under the 10% minimum: . Gift date - IRS Discount Rate = 2/9/98 - 6.8% . Lives and/or Fixed Term = 40 year old life beneficiary . Principal Value Donated - Cost Basis = $100, 000 $10, 000 . Gift Option = 8% Charitable Remainder Unitrust . Date of Gift = February 9, 1998 . Payment Schedule = Quarterly; 3 months to 1st payment . Benefit : . Charitable Deduction = $9, 628.00 . First Year's Income = $8, 000.00 . (Future Income Will Vary With Trust Value) . Percentage Deduction = 9.6%* . (Computed Charitable Remainder Value)
Testamentary and inter vivos (literally between lives or while living) Charitable remainder trusts where youngsters are designated income beneficiaries would likely be affected by the new 10% minimum.
.
This is less than 10% of the value of the amount transferred to fund the trust; therefore/ trust fails to qualify for various tax benefits.
. Outright Gift of Cash: Little or no effect. For example, the cost of a $1.00 cash gift to a 31% taxpayer is still $.69—$1.00 minus $.31. . Outright Charitable Gift of Appreciated Property: Tax encouraged gifts of some appreciated property continue even though most capital gains are taxed at lower rates. For example, instead of avoiding a tax of $.28 on the $1.00 for a gift of low cost, low yield, highly appreciated stock, held long term (more than 18 months), the donor now avoids a tax of $.20 on the $1.00 if he / she files in the 28%, 31%, 36% or 39.6% bracket and $.10 on the $1.00 if he/she files in the 15% bracket. This is still a very practical government-provided inducement to give appreciated stock rather than cash if it is deemed prudent by the donor Continued on page 16
Tax Act of 1997 Continued from page 15 or his/her advisors. A 28% tax is avoided for donated assets held more than 12 months up to 18 months.
Tax Savings From Gift Property That Doubled in Value 28%
Tax Bracket Current Value of Stock
$1, 000$
31% $5, 000
Income Tax Savings
$280
Capital Gains Tax Avoided
100
500
Total Tax Savings
380
1, 900
$1, 400
$1, 000
36% $5, 000
$1, 000
$310
$1, 550
100
500
410
$360
100
2, 050
460
39.6% $5, 000
$1, 800
500 2, 300
$1, 000
$396
$5, 000
$1, 980
100 496
500 2, 480
Reprinted with permission of R. & R. Newkirk . Charitable Gift of Tangible Personal Property: Inasmuch as the maximum capital gains tax rate continues at 28% for a taxable transfer of this kind of property, e.g. painting, sculpture, etc., the donor still avoids a 28% tax for a gift of this property, held long term, if the gift is related to the charity's tax exempt purpose, e.g. gift of artwork to a museum. . Charitable Gift Real Estate: Because the new law allows a married couple to avoid tax on up to $500, 000 of gain on the sale of a house—$250, 000 per single taxpayer, there is almost no incentive for donors to make outright gifts or planned gifts of their principal residences if avoidance of capital gains tax was a prime mover. Moreover, the provision is usable as frequently as once every two years: also, there is no age requirement anymore. Owners of very expensive homes with substantial appreciation above the $500, 000 gain cap might still consider this, but it does not appear to be a big market. . Charitable Gift by Will: In this writer's experience, most planned gifts come from matured bequests. This will continue for the foreseeable future as these gifts are generally motivated by donative intent. Also, many advisors counsel their clients to use the will rather than the trust method of transfer at death. No big change here.
. Charitable Gift Annuities: There should be no effect on these arrangements when funded with cash. There could be an increase in gift annuities funded with low cost appreciated stock. The reduction in the capital gains tax on the portion of the annuity deemed to be a sale should be a new incentive, for donors who are also beneficiaries, to establish these arrangements. . Pooled Income Funds Benefiting Charity: This writer sees no great change here. . Charitable Lead Trusts: For a senior donor who plans to support his/her charity and reduce or avoid estate or gift taxes as much as practical, the lead trust could still be helpful. Some persons will likely fund these trusts with appreciated stock and get the benefit of a lower capital gains liability. Why? Unlike a charitable remainder trust, a charitable lead trust (also referred to as charitable income trusts, and front-end charitable trusts) is not a tax exempt trust. If a person makes an inter vivos gift of appreciated assets to a non-grantor (donor not treated as owner) trust, and the trust subsequently sells the property within two years of the gift, the lead trust would be taxed at the donor's tax rates, instead of at the trust's rates on any gain realized. Continued on page 17
Tax Act of 1997 Continued from page 16 Because of higher tax rates, prospective donors were often reluctant to give to a lead trust a property that could not be sold off in stages, e.g., a little bit each year in order to make the payment to charity. The lower capital gains rate, 20%, could serve as an incentive for some prospective donors to consider transferring to a lead trust a capital asset that could be sold immediately by the trustees who would invest the proceeds of sale in income providing assets. Whether it would be prudent to do this would depend on whether the prospective donor's transfer tax (55%) or capital gains tax (20%) liability would be greater in terms of actual dollars of tax paid. If a donor does not want his heirs to have the immediate enjoyment of their legacies and said donor is philanthropically motivated, he/she might consider a charitable lead trust. Also, as the new unified credit amounts are phased in through the year 2006, a donor's tax liability on the non-charitable gift to the heir should be less making such arrangements more attractive. SUMMARY:
It is not about tax shelters. It is about government provided tax incentives to motivate taxpayers/ donors. While there is some logic to the notion that the charitable deduction constitutes a private expenditure of public funds, it should be remembered that it is for the public good. The government is already mired in health, education and welfare (HEW) programs, and these tax incentives are an effort, in this writer's opinion, to help decentralize or de-bureaucratize programs for public service. The net result of these incentives should be a greater percentage of the HEW dollar getting to the persons who need it in less time than it would take to flow through the bureaucracy. • Francis}. McGovern is Director of Capital Campaign at St. Joseph's Preparatory School, Philadelphia.
Current Events Current event items are distributed and discussed at PEPC luncheon meetings. However, since many of our members are not able to attend these meetings, they are reproduced here for your benefit. January 20, 1997 By Lawrence S. Chane Blank Rome Comisky &' McCauley LLP A. IRS Continues Attacks on Family Limited Partnerships In Technical Advice Memorandum 9551003, the IRS ruled that gifts of limited partnership interests were gifts of future interests and did not qualify for the annual gift tax exclusion. The ruling involved a typical Family Limited Partnership - the Limited Partners could not withdraw from the partnership or receive a return of capital before a specified date, or transfer or assign their partnership interests without the consent of the General Partner. Of importance to the IRS was that the Partnership Agreement provided for income to be distributed to the Limited Partners in the complete discretion of the General Partner and allowed the General Partner to retain income "for any reason whatsoever." The IRS reasoned that it was uncertain at the time of the gifts whether any income would be distributed to the Limited Partners. Thus, the income component of the Limited Partnership interests was not a present interest for purposes of the annual exclusion. B. IRS Amends Minimum Distribution Proposed Regulations on Trust as Beneficiaries of IRAs And Qualified Plans Under Proposed Regulations in existence since 1987, a Trust can qualify as a "designated beneficiary" provided that the following requirements are met: (1) the Trust is valid under state law; (2) it is irrevocable; (3) the individual beneficiaries are identifiable from the Trust instrument; and (4) a copy of the Trust instrument is provided to the Plan Administrator. In many cases, requirement (2) or (4) prevented the use of a Trust as a "designated beneficiary." Under the modified proposed regulations, a Trust will qualify if it is either irrevocable or becomes irrevocable by its terms at the death of the employee. The requirement of providing a copy of the Trust instrument to the Plan Administrator has been relaxed and may be met by providing the Plan Administrator with a list of the Trust beneficiaries. For employees who die before attaining age 70, this documentation can be provided during the nine month period after the employee's death.
C. Qualified Personal Residence Trust Regulations Finalized The Proposed Regulations prohibited the sale of the personal residence to the grantor, his spouse, the grantor spouse or any entity controlled by them after the termination of the grantor's retained interest in the Trust. The Final Regulations make it clear that this does not prevent the Trust from providing that if the grantor dies prior to the expiration of the original duration of the term interest, the residence can be distributed to any person including the grantor's estate, pursuant to the express terms of the Trust or pursuant to the exercise of the power retained by the grantor under the terms of the Trust. In addition, the Trust may provide for an outright disposition of the residence to the grantor's spouse after the expiration of the original duration of the term interest pursuant to the express terms of the Trust. D. "Estate Planning" Exceptions to The Realty Transfer Tax Create Traps for the Unwary Trap 91 - Transfers of real estate to a Revocable Living Trust used as a Will substitute, as well as transfers from a Living Trust to the beneficiaries are exempt from tax. (Transfers from an Estate to its beneficiaries have always been exempt). However, the Trust must prohibit distributions to any one other than the Settlor - the possibility of distributions to a spouse results in tax. Trap ff2 - Transfers of real estate to an ordinary trust are exempt. Direct transfers to the Trust beneficiaries would have been exempt, even if the contingent beneficiaries of the Trust are the intestate heirs of the Settlor. However, the Trust Agreement must be recorded at the time of the original transfer in order to exempt a later transfer from the Trust to the beneficiaries. Trap #3 - The recent changes are only effective at the State level, similar changes have not been enacted in Philadelphia (or Pittsburgh) which impose a separate tax.
Current Events (Continued) Administration's Budget Proposal February 17, 1998 By Robert J. Weinberg Pepper Hamilton LLP
I. EXCHANGES WITH RESPECT TO LIFE AND ANNUITY PRODUCTS
Generally, investors are taxed upon the sale or exchange of assets. Thus, gain is realized upon the sale of a share of stock or mutual fund even if the proceeds are used to purchase shares of a different stock or mutual fund. Special rules apply under IRC §1035 to investors in life insurance, endowment, and annuity contracts who exchange their contracts for other life insurance, endowment or annuity contracts. Life insurance contracts may be exchanged without recognition of gain for other life insurance, endowment or annuity contracts. Endowment contracts may be exchanged without gain for other endowment or annuity contracts. Annuity contracts may be exchanged without gain for other annuity contracts. Owners of variable life insurance and annuity contracts may exchange funds offered by the insurer within the contract without gain. Under the administration's proposal, any exchange of a life insurance, endowment or annuity contract for a variable contract would be a taxable exchange. Similarly, any exchange of a variable contract for a life insurance, endowment, or annuity contract would be a taxable exchange. In addition, each investment in a separate account mutual fund or in the insurance company's general account pursuant to a variable contract would be treated as a separate contract. The rules would apply to contracts issued after the date of first committee action. A material change in an existing contract would be treated as the issuance of a new contract. II. CORPORATE OWNED LIFE INSURANCE (COLI) RULES Under the Taxpayer Relief Act of 1997, a portion of corporate non insurance related deductions are disallowed based in part on the unborrowed cash value of corporate owned life insurance. An exception to this rule applies to insurance on 20% shareholders, officers and certain key employees or to joint insurance on the lives of such persons and their spouses. The administration's proposal would eliminate this exception except as to 20% shareholders. This would include policies that are splitdollared with the corporation. The elimination of the exception would apply to taxable years after the date of enactment. It is not clear whether there would be a grandfather provision for existing policies.
III. REDUCTION OF BASIS IN INSURANCE CONTRACTS FOR MORTALITY AND EXPENSE CHARGES
Generally, gain is recognized on the surrender of permanent life insurance policy prior to the death of the insured. Existing rules used to determine the basis in the policy under §72 allow the portion of the premium used to buy current insurance coverage or to buy an option to purchase a life annuity at guaranteed rates to add the policy owner's basis. The administration's proposal would subtract mortality and associated expense charges from the definition of basis. The proposal would apply to contracts issued after the date of first committee action. IV. ELIMINATE '"CRUMMEY" RULE Gifts up to $10, 000 per donee per year of a "present interest" in property qualify for an exclusion from gift tax. This is in addition to the $625, 000 lifetime estate and gift tax exemption. Gifts to trusts do not generally qualify as present interests. Under Crummey v. Commissioner. 397 F.2d 82 (9th Cir. 1968), a transfer to a trust under which the beneficiary has a right of withdrawal for a limited time period qualifies as present interest. The administration proposal would overrule the Crummey case and eliminate the qualification for the annual exclusion for gifts made subject to withdrawal rights. Only direct gifts of present interests to an individual or to a custodial account would qualify for the annual exclusion. The change would be effective for all gifts completed after December 31, 1998, regardless of when the trust was created. V. ELIMINATE NON-BUSINESS VALUATION DISCOUNTS The administration's proposal would eliminate the use of valuation discounts except as they apply to active businesses. Interests in entities would be required to be valued for transfer tax purposes at a proportional share of the net asset value of the entity to the extent the entity holds readily marketable assets (which is defined to include real property, annuities, royalty producing assets, art, collectibles, commodities, options and swaps). For active businesses, the discount could apply only to the reasonable working capital needs. The Treasury's general explanation contains a statement that no inference is intended as to the propriety of the discounts with respect to active businesses. The proposal would be effective for transfers made after the date of enactment. Continued on page 20
Current Events Continued from page 19 VI. ELIMINATE GIFT TAX EXEMPTION FOR PERSONAL RESIDENCE TRUSTS Under §2702, if an interest in property is transferred to a trust for family members while an interest is also retained by the grantor, the value of the retained interest is treated as zero unless the retained interest is in the form of a set annuity amount or a fixed percentage of the annual value of the trust. An exception applies if the property transferred to the trust is a personal residence. The administration's proposal would repeal the personal residence exception. The proposal would be effective for transfers in trust after the date of enactment.
1998 Mordecai Gerson Meritorious Service Award Clifford D. Schlesinger, Esq. Taxation Committee of the Probate Section of the Philadelphia Bar Association and Vice Chairman of the Legislative Committee of the PA Bar Association's Real Property, Probate and Trust Law Section. He also serves on the Board of The Rosenbach Museum and Library in Philadelphia where he holds the office of Treasurer. Mr. Schlesinger is a member of the Board and Treasurer of the Jewish Federation Foundation of Greater Philadelphia and a member of the Board of the Federation Endowments Corporation of the Jewish Federation of Greater Philadelphia.
PEPC President Warren Reintzel presents award to Cliff Schlesinger, Esq. at the PEPC March Luncheon. The Board of Directors is pleased to announce that the recipient of the 1998 Mordecai Gerson Meritorious Service Award is Clifford D. Schlesinger, Esq., a partner at Wolf Block Schorr and SolisCohen, LLP and current Treasurer of the Council. This award is presented to a Council member with a minimum of five years of membership who has rendered extraordinary service to further the work of the Council. Past recipients include Mordecai Gerson, Joseph H. Bachtiger, Joseph H. Yohlin, William T. Walsh and Karen A. Fahrner, Esq. These individuals continue to give of their time and talents to further the Council's work and their achievements are deserving of public recognition. Cliff has been a member of the Council's Board for the past seven years, currently chairing the Membership Committee and co-chairing the Program Committee. He has chaired the Bylaws and Newsletter Committees and has served as a member of the Holiday Party Committee, the PEPC/NAEPC Committee, Long Range Planning Committee, Annual Meeting Committee and has lectured at the request of the Council's Speakers Bureau. In addition to volunteer service with the Council, he has served on the Executive Committee as well as Chair of the
He graduated Pennsylvania Cum Laude, School, and York State.
Magna Cum Laude from the University of Wharton School, received his Juris Doctor, from the University of Pennsylvania. Law has received his C.P.A. license from New
Mr. Schlesinger and his wife. Dr. Susan Schlesinger, and their two children, Julie and Brett, reside in Radnor. This award was presented at the March 17 luncheon meeting at The Union League. •
SPRING 1998
President's Message recently read a management book. The Power of Alignment, by Labovitz and Rosansky. The authors' major premise is that successful enterprises must continually align their people, strategies and processes around their "main thing", much as a pilot must continually align flight factors. By all measures PEPC is a successful enterprise and our "main thing" is to provide our multidiscipline membership with the finest educational and networking opportunities. To keep ourselves properly aligned as we move into the 21st century will require the best efforts of all our membership. We must all remember that membership growth is not only the responsibility of the Membership Committee, but Warren Reintzel
Continued on page 6
Donor Advised Everything you to know
Funds.. wanted
by Eileen R. Heisman and Irv E. Geffen onor-advised funds — you may know a lot about them, or a little, or you may not have heard of them. No matter which category you fall into, you can benefit from a brief review of the basics. What you may not know is that donor-advised funds are utilized regularly by estate planning professionals who understand the power of charitable vehicles in helping their clients "do good by doing well." It goes without saying that donor-advised funds should be one of the took in your too! chest when you are developing an estate plan for your clients. HISTORY
Popularity of DAFs blossomed after the Tax Reform Act of 1969. In that Act, Congress placed new restrictions on the activities of private foundations. The restrictions included limiting the kinds of assets a donor could place in their private foundation; requiring the foundation to make minimum payouts; imposing a 2% excise tax on the income or sale of appreciated securities; and prohibiting the role that donors and other qualified persons could play in private foundation management. As a result of these changes, advisors and donors began to explore alternatives to private foundations. They sought to identify or develop other grant-making vehicles that could provide donors with benefits similar to that of a private foundation and yet avoid the severe new limitations. Thus DAFs were created, and since that time have become a commonly used tool. DESCRIPTIONS
Donor-advised funds (DAFs) and supporting organizations are two types of charitable giving vehicles housed under the umbrella of a public charity (sponsoring agency). Any public charity can create and maintain DAFs and Continued on page 3
P.0. Box 579, Moorestown, NJ 08057-0579 • Telephone: 609-234-0330 • Fax: 609-727-9504
Donor Advised Funds Continued from page 1 supporting organizations. For-profit corporations like Fidelity, Pitcairn Trust Company and Vanguard have also created DAF programs. A DAF is established with a gift of cash or property from a donor. The donor receives a federal income tax deduction the year the gift is made. Subsequent gifts can be made by the donor or others, and these too are eligible for federal income tax deductions. Depending on the specific rules of the sponsoring agency, the donor may assign rights to recommend distributions from their DAF to others, as well as maintain them for themselves. For example, a wife could assign rights of recommendation to her spouse and her sister; they can then recommend that grants be made to non-profit organizations whose work is important to them. After the sponsoring agency's board approves the grant recommendations, they are paid out to those organizations. Most sponsoring agencies require that the grants be made to organizations whom the IRS has approved as 501 (c) (3).
Supporting organizations are sometimes called "supporting foundations" or "affiliated foundations" and are described in section 509 (a) (3) of the Internal Revenue Code. They can be established in the form of either a nonprofit corporation or a trust. Depending on its structure, a supporting organization has to meet certain tests in order to be established. The tests ensure that the supporting organization is operated exclusively for the benefit of or to carry out the functions of the supported charity; that the supporting organization is controlled or operated in connection with the supported charity; and that the supporting organization is not controlled by disqualified persons. Supporting organizations are governed by boards, whose structure depends on the supporting organization type. The board adopts by-laws which govern all of its activities, including investment of assets, distribution of grants and general administration.
COMPARISON OF BENEFITS AND COSTS The following chart compares the benefits and costs of private foundations, DAFs, and supporting organizations. Of the three, DAFs require the least donor management and are less costly to set up and operate. Private foundations are more costly both to set up and to operate, but they do offer the donor maximum control over distributions and investments. Depending upon the supported charity, supporting organizations may be as expensive to set up and operate as private foundations. However, many supported charities provide technical and financial assistance to create and operate their supporting organizations. Responsibility for distributions, investments and management are assumed by the supporting organization board. Private Donor-Advised Supporting Foundations Funds Organizations Start-Up Costs Legal, accounting and Services are provided Legal, accounting for the donor, and administrative administrative costs are substantial, costs may be substantial. Income Tax Deduction
Cash gifts - Up to 30% of donor's adjusted gross income (AGI).
Cash gifts - Up to 50% of AGL
Cash gifts - Up to 50% of AGI.
Appreciated assets 20% of donor's AGI calculated on fair-market value, for publicly traded assets, on cost basis for nonpublicly traded assets.
Appreciated assets - Up to 30% of AGI based on fair-market value.
Appreciated assets - Up to 30% of AGI based on fair-market value.
100% of gift.
100% of gift.
Estate Tax Deduction 100% of gift. Excise Taxes
Usually 2% of annual income. No excise tax liability.
Distribution Required 5% of assets annually.
No required payout.
No excise tax liability.
No required payout.
Continued on page 4
Donor Advised Funds Continued from page 3
Donor's Administrative Responsibilities
Donor-Advised Funds Recommend beneficiary charities.
Private Foundations Manage assets. Keep records. Prepare IRS reports. Select charities. Verify not-for-profit status. Make/administer grants.
Supporting Organizations Supporting organization board may contract with advisors or rely on supported charity for administrative and technical support.
Annual Expenses
Variable, but can be quite high Variable, but estimated if accountants, attorneys and at 0-2% of assets. professional foundation managers are engaged.
Variable, but can be quite high if accountants, attorneys and investment advisors are engaged.
Initial
Significant because start-up costs.
Minimal-usually $5, 000 or less.
Significant because of the start-up costs.
Sponsoring agency's Board must approve. Usually a minimum distribution required.
Charities whose activities are consistent with supported organization - any amount.
Donor reserves right to recommend distribution. Sponsoring agency directs investments.
Supporting organization Board controls distribution and investments.
Gift
Minimums
of
Distribution Restrictions
Any charity - any amount.
Control
Donor or designee controls distribution and investments.
Duration
Unlimited.
the
Some sponsoring agencies impose limitations.
PLANNING CONSIDERATIONS Private foundations, supporting organizations, and DAFs all offer significant tax savings and other financial benefits to the donor. They all provide an effective mechanism for maximizing the charitable giving experience. In each case, donors can create their vehicle and make contributions to it when they choose. This allows the donor to transfer assets at the most opportune time, usually a year when there is more income, realized or unrealized capital gain. The donor can time the gift to maximize their income tax deduction, often at the full fair market value of appreciated property. If non-publicly traded assets such as closely-held stock are likely to be gifted to the vehicle, now or in the future, special consideration should be given to supporting organizations and DAFs because they have provided more favorable and consistent tax treatment in the past and will likely do so in the future. Many donors want their philanthropic interests continued by their children and future heirs. Each of the
to
be
Unlimited.
vehicles can provide this benefit to varying degrees; however, supporting organizations create a relationship initially between the donor and the supported charity, and ultimately can be used to create and maintain a relationship between the donor's heirs and that charity. This may be more difficult to achieve with a private foundation and usually can not be achieved with DAFs whose sponsoring agengy imposes generational limits on the right to advise. Many donors wish to involve their financial, legal and tax advisors in the set-up and ongoing management of the vehicle they have chosen for charitable giving. This may be accomplished with the private foundation and the supporting organization but generally not with the DAF. Selecting the Right Sponsoring Agency With all of the added benefits of DAFs, one might conclude that private foundations would disappear. This has not occurred primarily because, with DAFs, donors do surrender certain controls that they do not with private Continued on page 5
Donor Advised Funds Continued from page 4 foundations; however, if the umbrella charity's stated mission closely matches the donor's charitable inclinations, and if the charity's policies and procedures governing the operation of DAFs are acceptable, a partnership that can effectively serve both is created. Some of the sponsoring agencies have very broad charitable missions which can afford the donor great flexibility in making grants. Others define their mission more narrowly, which still may be a good match for the donor's charitable intentions. One area to consider is what assets the sponsoring agency will accept. Some sponsoring agencies will take any and all assets, while others will only take assets that are easily marketable. Either way, donors and their advisors have to carefully consider the appropriate sponsoring agency for them. Both the donor and sponsoring agency need to share the same mission — to support organizations and causes important to them. Where can you start one? Nearly 30 years after the Tax Reform Act of 1969, donoradvised funds can be found flourishing at community foundations. United Ways, Jewish Federations, national public charities created independently and by commercial organizations, universities and single-issue charities. What are the steps in creating a Donor-Advised Fund? Select a sponsoring agency — Are the donor's charitable interests defined by geography, a field of interest, such as children or the arts, by religion or by a single charity? Depending on the donor's interests, he or she may want to explore a few types of sponsoring agencies who operate DAFs. Most sponsoring agencies can provide written overviews of DAF administrative and reporting guidelines. Execute a Fund Agreement — A fund agreement needs to be completed and signed. At most sponsoring agencies, the fund agreement allows the donor to name the fund, decide whether it will function as an endowment fund or if principal can be spent, designate its charitable purpose and name successor advisors, if the next generation plans to be involved. (The donor may want to have outside counsel review the document. Most of the fund agreements are drafted carefully to comply with federal requirements.) Transfer Assets — Assets are gifted into the fund. If the assets are cash or puclicly traded appreciated securities, this can be done quickly. If the assets are more complex, such as closely-held stock, real estate or other items, this step could take more time. In the case of non-publicly traded assets, an appropriate valuation needs to be completed by a qualified appraiser and special IRS forms need to be filed.
Know and understand how to make grants - The sponsoring agency should provide clear and understandable instructions on how and when grant requests are processed. They might have forms and monthly or quarterly deadlines. The sponsoring agency may also provide other services for the donors including grant review and evaluation, facilitated family meetings or other services to assist in the grantmaking process. How to Add to the DAF or Terminate the Fund — The sponsoring agency should provide instructions in adding new assets to the fund and how a fund can be terminated. Some sponsoring agencies allow funds to be terminated by paying out principal and income to another public charity. Each option described offers a variety of benefits. As in any professional planning situation, you will need to counsel your client in consideration of his or her financial and personal goals. Irv E. Geffen is Vice President, Development, of the Albert Einstein Healthcare Network. Eileen R. Heisman is Senior Vice President of the National Philanthropic Trust, a national public charity headquartered in Jenkintown, PA.
President's Message Continued from page 1 of every council member. Our Council, unlike those in other areas, is an open group, eager to welcome new people. Tell your friends, associates and co-workers about the Council and bring them to our meetings and social gatherings. Good programs grow out of good ideas coupled with a person's desire to make them happen. When you hear a good speaker or identify a fine topic, share it with the program committee, or better yet, join the program committee and organize a luncheon program. Exciting new initiatives lie ahead for the Council. The Technology Committee, under Steve Leshner's leadership will soon have a Web page available for our membership. Bob Weinberg is chairing a liaison group with the Philadelphia Business Journal to publish an Estate Planning Supplement in the fall. Our Long-Range Planning Group, led by Bob Siwicki, is investigating an Estate Planning Day for 1999. Your participation could help to make these endeavors even more successful.
As I finish my term as president, I would like to extend my thanks to a few of the many, many people who have made my term such a pleasure. Madeline Janowski did an excellent job as Program Chair and her committee has put together a slate of six outstanding speakers for the 19981999 program year. Cliff Schlesinger took over the challenge of Membership Chair and created an organizational structure that will allow us to continue to grow in the future. Kim Fahrner continued to find new and interesting roundtable talks. Past Presidents, Chris Gleeson and Joe Bachtiger were always there when I needed advice and counsel. All my fellow Board Members spent countless hours working to make our Council the wonderful organization it has become. I would like to thank our retiring Board Members, Sharon Donohue, Herb Chasman, Bob Miller, Frank McGovern and Tim Speiss for their fine work. Lastly, to our Administrative Secretary, June Neff, who works tirelessly behind the scenes to make so much happen at every Council event.
What is Blockage? by Richard S. Grayev
F
rom time to time, attorneys and appraisers are confronted with valuing large blocks of publiclytraded stocks for various purposes. The valuation of traded stocks is usually a fairly uncomplicated process. Treasury regulations state that the mean between the highest and lowest quoted selling price on a given valuation date is the fair market value of that share of stock. Thus, the valuation of a few common shares usually calls for merely the multiplication of the mean price by the number of shares in the transaction. However, when the valuation involves a large number of shares, a large block of shares with a single owner, or a block of shares carrying some special restrictions, the difficulties mount. Is it realistic to value this large block of stock based simply on the market price quoted and on a series of small trades in the stock or should the valuation recognize the inherent issues surrounding the realistic pricing of that block? The concept of "blockage" has been developed in conjunction with the valuation of a large block of traded stock which is either so large or has such special characteristics (e.g., restricted stock) that would make it impossible or very difficult to sell in the normal course of trading. Theoretically, at the time of average market demand, the addition of a large block of stock of a company into the marketplace on top of the normal daily trading volume, should force the price of that stock to a lower level. The drop in price of that particular block could be significantly large if: • the block was very large relative to the daily trading volume; • if the stock was thinly traded even in an active market; or •
if there were other special restrictions which would limit the marketability of the block in question or delay its sale.
Large block trades have been academically studied in the past and several scholarly studies have shown that transactions involving large blocks of stock can lead to significant declines in stock price. The basic blockage concept states that the fair market value of a sizable block is not necessarily the same as the mere multiplication of the shares in that block times a published market price. Even after many decades of court cases and experience, the concept is still highly subjective in its
valuation
application. The Internal Revenue code and Treasury regulations do not provide guidelines nor does the IRS Valuation Guide for Income. Estate and Gift Taxes. As a result, there has been substantial disagreement between taxpayers and the IRS when it comes to quantifying blockage discounts. Consequently, the courts have been forced to decide on a case-by-case basis which factors, or variables, effecting the marketability of the block are important. Even after many years and numerous court decisions, no clear-cut benchmarks have been set. Based on a review of court cases, scholarly studies, and practical experience, a number of blockage "variables" can be identified which should be reviewed on a point-bypoint basis with weight given to the most appropriate variables. The following list of variables to be used in assessing the magnitude of a blockage discount should not be considered an all-inclusive list but merely a starting point. • the size of the block relative to the total shares publicly held; •
the size of the block relative to the average daily trade in the period preceding and following the valuation date;
• whether there are resale restrictions on the block; • volatility of the price of the stock; • the exchange on which the stock trades; • whether the block constitutes control of the entity; • dollar value of the entire block; • general market trend in terms of both price and volume, and market trend in the stock itself as of the valuation date; • industry trends as of the valuation date; and • the relevant company's earning capacity and ability to pay dividends. As discussed earlier, case law plays a significant role in the quantification of blockage discounts. The following table sets forth a brief summary of selected Tax Court decisions relating to blockage and blockage discounts. Continued on page 8
What is Blockage? Continued from page 7 Case Estate of: Saul R. Gilford William 0. Adair Prentice I. Robinson Rifkind vs. U.S. Saul P. Steinberg
Percentage of Discount Allowed Total Stock Ownership by Court
22.9% 2.1 3.2 2.0 6.1
33% 15 - 35 18 20 27.5
The basic question to be answered in any blockage analysis is whether the disposition of the subject block of stock over a reasonable period of time could be made at or near the quoted price as of the valuation date in light of the above factors. In arriving at this determination, expert testimony concerning market factors, ability of the market to absorb the block, and related data and analysis must be developed and presented. Richard S. Grayev is Director of Valuation Services at Curtis Financial Group Inc., a Philadelphia financial advisory services firm specializing in mergers and acquisitions and business valuations, primarily for family-owned businesses.
IRS Eases Requirements on Naming a Trust as a Beneficiary of a Retirement Plan
A
By Jonathan H. Ellis, J. D., LLM.(Taxation) Member Pennsylvania, New Jersey, and Florida Bars
n increasingly common problem in the estate planning process is to determine the best way to integrate retirement plan assets into the overall estate plan. The problem stems from the fact that estate plans frequently involved the use of trusts. One of the issues associated with naming a trust as the beneficiary of a retirement plan, is that special rules must be addressed or the assets within the retirement plan will have to be distributed more quickly than would otherwise be required. Since the tax deferred growth of investments within the retirement plan is what makes these plans so attractive in the first place, you certainly do not want to make withdrawals earlier than necessary. On December 31, 1997, the IRS issued new Proposed Regulations which were designed to make it easier to name a trust as a retirement plan beneficiary. The starting point in understanding the difficulties in estate planning for retirement assets is to realize that retirement assets are designed for retirement. The Internal Revenue Code ("Code") allows an individual to defer the income tax on both the contributions to these plans and the growth of the investments within the plan. Since the income tax is deferred, someone must pay this income tax at some point in time. The initial focus on who pays this tax will be the retirement plan participant. When the participant receives a distribution from the plan, it is treated as income. By the same token, when the participant dies, and except in the case of a spousal rollover, the beneficiary of the plan will recognize income on the distributions. In addition to the income tax on the distributions, the value of the retirement plan assets are includible in the estate of the owner. If the beneficiary of the retirement asset is anyone other than the spouse, the retirement assets will be subject to estate tax. To make matters worse, if the beneficiary has to take a distribution from the retirement plan in order to pay the estate tax, the amount of this distribution will have to be "grossed up" in order to take into account the income taxes which will also be due. The combined effect of the income and estate tax can have a devastating effect on the value of a retirement plan asset. When planning on how to take distributions from retirement plans, either during lifetime or at death, one of the cardinal tax rules to remember is to defer taking a
distribution for as long a period as possible. As indicated above, the reason has to do with the tremendous benefit of allowing the assets to accumulate within these plans on a tax deferred basis for as long a period as possible. This tax deferral is so beneficial, that the Code has a series of rules designed to force distributions from the retirement plans. These "minimum distribution rules" are generally designed to force distributions over the retirement plan participant's lifetime. For example, the first rule is that the participant must generally start taking distributions by April 1 of the year after reaching age 701/2, the "required beginning date". At that time, the retirement plan owner must start taking distributions designed to deplete the retirement assets over the owner's lifetime. This time period can be extended if the retirement plan has a "designated beneficiary". In this situation, the plan participant can choose to take distributions over the joint life expectancy of the participant and the designated beneficiary. While lifetime distributions are subject to additional limitations, distributions at death are based upon the designated beneficiary's actual life expectancy. Therefore, when the participant dies, the designated beneficiary can generally elect to take distributions over his or her life expectancy, a tremendous benefit given the value of the tax deferred growth of these assets. In situations where more than one individual is named as a beneficiary, the age of the oldest beneficiary is used for the calculations. Also, keep in mind that this is the maximum time frame upon which the assets must be withdrawn, the distributions can always be taken at a quicker rate. Given the fact that you would always want to elect to take the distributions over the designated beneficiary's life expectancy, it is important to have a designated beneficiary. The existing Proposed Regulations provide that only individuals may qualify as a designated beneficiary. A beneficiary who is not an individual, such as the estate of the plan participant, will not qualify as a designated beneficiary for purposes of determining the extended payout. This doesn't stop you from naming your estate as the beneficiary, it only prevents this choice from allowing the deferred payout. Given this result, there is almost no reason for naming the estate as the beneficiary of the retirement asset. Continued on page 10
Naming a Trust as a Beneficiary Continued from page 9 Since only an individual can satisfy the Code's qualifications as a designated beneficiary, and naming the estate as the beneficiary will not qualify, what happens if a trust is named as beneficiary? Since a trust is not an individual, it generally will not qualify as a designated beneficiary. However, the Proposed Regulations provide an exception whereby the beneficiaries of the trust will qualify as a designated beneficiary, as if named directly, provided certain tests are satisfied. It is these Proposed Regulations that have recently been relaxed, making it easier to name a trust as a beneficiary and coordinate retirement plans with the client's overall estate planning objectives. The IRS recently revised certain Proposed Regulations and added another. Specifically, these regulations relate to Section 1.401 (a) (9)-l Q&A D-5; D-6; D-7. Under the old Proposed Regulations, a trust would qualify as a designated beneficiary provided four tests would be satisfied at the later of the date on which the trust is named as beneficiary or the participant's required beginning date: 1. The trust must be irrevocable; 2. The trust must be valid under state law, or would be except for the fact that there is no corpus; 3. The beneficiaries must be identifiable from the trust instrument; and 4. A copy of the trust must be provided to the plan administrator. The new Proposed Regulations provide alternatives to the first and last requirement. The first rule relates to the time at which the trust must become irrevocable. The IRS relaxed the requirement that the trust be irrevocable by providing that the trust must either be irrevocable or will, by its terms, become irrevocable upon the death of the plan owner. This change has been in response to a general planning technique whereby retirement plan assets are paid to the client's revocable living trust. Under the old rules, this was a potentially dangerous technique if the participant lived beyond age 70 without revising their documents, since the trust was not irrevocable at the later of the two dates. Under these new rules, a revocable living trust can become an acceptable beneficiary choice. However, it would still be appropriate to include certain language
within the document. For example the trust should provide that it will become irrevocable upon the death of the grantor. While this would always be the result under state law, the new IRS regulations provide that the trust must become irrevocable "by its terms". As an exercise of caution, this provision should be included within the revocable trust document. The Trust should also include a provision directing the trustee to comply with the minimum distribution rules under the Code for purposes of taking distributions from the plan. The second change in the Proposed Regulations, relates to the fourth test in naming a trust as a beneficiary. The IRS added question D-7 to the Proposed Regulations which relates to the documentation that must be provided to the plan administrator. This new regulation provides two alternative approaches to addressing the documentation issue. The first option is to provide the plan administrator with a copy of the trust instrument and agree that if the trust is amended at any time in the future, the participant will, within a reasonable time, provide the plan administrator with a copy of each such amendment. There is no definition of what constitutes a reasonable time. The second option would be for the retirement plan participant to provide the plan administrator with a list of the beneficiaries of the trust (including contingent and remainder beneficiaries) and a description of the conditions to their entitlement. There must also be a certification that to the best of the participant's knowledge, the list is correct and complete and that the other requirements to naming a trust as beneficiary have been satisfied. The participant must also agree to provide corrected certifications to the extent that an amendment changes any information previously certified. Finally, the participant must agree to provide a copy of the trust to the plan administrator upon demand. The rules are slightly different if the required distributions are going to take place after the death of the participant. In this situation, certain information must be provided by the end of the ninth month after the death of the participant. First, the plan administrator must be provided with the final list of all the beneficiaries of the trust (including contingent and remainder beneficiaries) as of the date of death together with a description of the conditions to their entitlement. There must also be a certification that to the best of the trustee's knowledge this list is correct and complete and that the other requirements have been satisfied. Lastly, the participant must agree to provide a copy of the trust to the plan Continued on page 11
Naming a Trust as a Beneficiary Continued from page 10 administrator upon demand; or provide a copy of the actual trust document. The reason that the new Proposed Regulations are helpful is because many plan administrators do not want to hold on to the trust. While this documentation would frequently be provided, the administrators were not always happy to receive these documents from an administrative perspective. Under the new Proposed Regulations, this test can be satisfied by providing a certification. The new Proposed Regulations do not address a practical problem which exists with most plan administrators. Most plan administrators simply want to invest your money. They do not want to be bothered with the administrative requirements that go along with the investment opportunities. Accordingly, a plan participant's beneficiary information is typically listed on a computer screen where there is room for only limited information. It has not always been possible to include all of the required information within this limited space. Some plan administrators are reluctant to permit additional information to be included on supporting attachments to the beneficiary forms. The new Proposed Regulations provide some help in this area by limiting the supplemental information that must be provided. While this will not entirely address the issue, it is certainly a start. Another area that is left unresolved is the extent of the information that must be provided with respect to the beneficiary's interest. Do you simply have to list the name and the portion of the trust to which the beneficiary was entitled (i.e. one-third), or do you have to outline the terms of the trust within the beneficiary designation (i.e. health, education, welfare, etc.). Further guidance will be needed to address this issue. However, even if the IRS provides this guidance, plan administrators must expand the information which they will be willing to accept for each of their plan participants. A final issue to keep in mind is that successfully naming a trust as a beneficiary in a manner satisfying the designated beneficiary rules is only half the battle. Once this step is accomplished there are additional complications which arise from this combination. For example, the distributions from the retirement plan will be considered ordinary income for tax purposes. However, only the interest and dividends will be considered income for trust accounting purposes. The result being that if the terms of the trust require a distribution of only
income to a beneficiary, the trust accounting rules will dictate that some portion of the retirement distribution be considered principle, and therefore retained within the trust. These funds will then be taxed at the trust's income tax rates; a bad result given that the trust income tax brackets reach 39.6% at $8,350 of income. This is the scenario where the credit shelter trust is named as the beneficiary of a retirement plan. In essence, when using retirement plan assets to fund a credit shelter trust, the client is faced with the choice between saving estate taxes at the expense of paying extra income taxes. Another common use of trusts with retirement assets is naming a Q-TIP trust as the beneficiary. The IRS has issued numerous rulings detailing the provisions that must be included in the trust document in order for this technique to be successful. In essence, you must satisfy both the minimum distribution rules with respect to retirement plans and the Q-TIP rules with respect to income distributions from the trust. Therefore, the trust should contain language that distributions from the retirement plan be equal to the greater of (a) the income earned from the assets; or (b) the amount required to be distributed under the minimum distribution rules. Once this amount is distributed from the retirement plan to the trust, the income (i.e., interest and dividends) can then be distributed to the spouse. Additionally, some commentators argue that this language should also be contained in the beneficiary language of the retirement plan in addition to the trust document. As with the credit shelter trust example, to the extent that distributions from the retirement plan are less than the income to be distributed to the spouse, the excess will also be subject to income tax at the trust level. In summary, while the IRS has liberalized the requirements for naming a trust as a beneficiary of a retirement plan, there are numerous additional tax issues associated with this choice. It is important that anyone who considers this option be fully aware of the advantages and disadvantages of this selection. Having said this, it is not unusual to have a client who has 80% of his or her assets in some type of a qualified retirement plan. Given this limited asset mix, a viable estate plan may very well include the naming of a trust as a beneficiary of a retirement plan. With the new Proposed Regulations, the IRS has taken a helpful step in the area of planning. Jonathan H. Ellis is a Partner in the law firm Plotnick & Ellis, P.C. in Jenkintown, PA.
The Tax Act of 1997 and Charitable Giving By Francis}. McGovern, CFRE
ince the passage of the "Taxpayers Relief Act of 1997," on August 5th, much has been said or written about its effect on charitable giving. Basically, the bill is good news for charity and donors. The congress maintained nearly all the tax incentives for charitable giving in this law.
The following is a brief summary of some of the important items affecting charitable donors and their charities:
. Reduction in most capital gains taxes
Sale
Holding Period 12 months or (short-term gain)
less
More than 12 months (long-term gain) 15% bracket 28% - 39.6% bracket
TAX ON $1.000 CAPITAL GAIN Date Tax Rate
Any time
May 7-July 28, 1997
12+ to 18 months (mid-term gain) 15% bracket 28% - 39.6% bracket
After July 28, 1997
More than 18 months (long-term gain) 15% bracket 28% -39.6% bracket
After July 28, 1997
More than five years 15% bracket 28% -39.6% bracket
After December 31, 2000
More than five years 15% bracket 28% - 39.6% bracket
After January 1, 2006
Tax
Ordinary rates (15%-39.6%)
$150-396
10% 20%
$100 $200
15% 28%
$150 $280
10% 20%
$100 $200
8% N/A 8% 18%
Reprinted with permission of R. & R. Newkirk
$80
N/A $80 $180
Tax Act of 1997 Continued from page 14 . Staged increases in sums that can be gifted during life or left to non-charitable beneficiaries free of gift and estate tax. Over ten years, credit equivalent exemption amount moves from $600, 000 to $1, 000, 000. Year
1998 1999 2000, 2001 2002, 2003 2004 2005 2006
Unified Credit
$202, 050 211, 300 220, 550 229, 800 287, 300 326, 300 345, 800
Sheltered Gifts / Estates
$625,
000
650,
000
675,
000
700,
000
850,
000
950, 000
1, 000, 000
Reprinted with permission of R. & R. Newkirk .
Another example, if a donor to a public charity were to set up the following charitable remainder unitrust, it would fail to qualify because the 51% payout rate exceeds the 50% cap for payout: . Gift date - IRS Discount Rate = 2/9/98 - 6.8% . Lives and / or Fixed Term = 40 year old life beneficiary . Principal Value Donated - Cost Basis = $100, 000 $10, 000 . Gift Options =51% Charitable Remainder Unitrust . Date of Gift = February 9, 1998 . Payment Schedule = Quarterly; 3 months to 1st payment . Benefits: . Charitable Deduction = $396.00 . First Year's Income = $51, 000.00 . (Future Income Will Vary With Trust Value) . Percentage Deduction = A%* . (Computed Charitable Remainder Value)
Continuance of provisions affecting gifts to private foundations: The time period when the taxpayer can take a charitable income tax deduction based on the full fair market value of a gift of publicly traded stock to a private foundation has been extended through May 31, 1998.
* The 51% payout rate exceeds the allowable amount causing the trust to fail to qualify for various tax benefits and results in this minimal computed percentage passing to charity.
Maximum payment and minimum remainder amounts for some gifts to qualify for various tax benefits: An annuity trust or unitrust amount can be no higher than a 50% payout: the computed charitable remainder amount can be no lower than 10% of the amount given.
While the provision has received some negative publicity, this writer does not see it as particularly harmful to charity. For one thing donative intent by the donor is necessary; for another, the legislated minimum and maximum provide a safe harbor for donors, donees and planners.
For example, if a donor to a public charity were to set up the following charitable remainder unitrust, it would fail to qualify under the 10% minimum: . Gift date - IRS Discount Rate = 2/9/98 - 6.8% . Lives and/or Fixed Term = 40 year old life beneficiary . Principal Value Donated - Cost Basis = $100, 000 $10, 000 . Gift Option = 8% Charitable Remainder Unitrust . Date of Gift = February 9, 1998 . Payment Schedule = Quarterly; 3 months to 1st payment . Benefit : . Charitable Deduction = $9, 628.00 . First Year's Income = $8, 000.00 . (Future Income Will Vary With Trust Value) . Percentage Deduction = 9.6%* . (Computed Charitable Remainder Value)
Testamentary and inter vivos (literally between lives or while living) Charitable remainder trusts where youngsters are designated income beneficiaries would likely be affected by the new 10% minimum.
.
This is less than 10% of the value of the amount transferred to fund the trust; therefore/ trust fails to qualify for various tax benefits.
. Outright Gift of Cash: Little or no effect. For example, the cost of a $1.00 cash gift to a 31% taxpayer is still $.69—$1.00 minus $.31. . Outright Charitable Gift of Appreciated Property: Tax encouraged gifts of some appreciated property continue even though most capital gains are taxed at lower rates. For example, instead of avoiding a tax of $.28 on the $1.00 for a gift of low cost, low yield, highly appreciated stock, held long term (more than 18 months), the donor now avoids a tax of $.20 on the $1.00 if he / she files in the 28%, 31%, 36% or 39.6% bracket and $.10 on the $1.00 if he/she files in the 15% bracket. This is still a very practical government-provided inducement to give appreciated stock rather than cash if it is deemed prudent by the donor Continued on page 16
Tax Act of 1997 Continued from page 15 or his/her advisors. A 28% tax is avoided for donated assets held more than 12 months up to 18 months.
Tax Savings From Gift Property That Doubled in Value 28%
Tax Bracket Current Value of Stock
$1, 000$
31% $5, 000
Income Tax Savings
$280
Capital Gains Tax Avoided
100
500
Total Tax Savings
380
1, 900
$1, 400
$1, 000
36% $5, 000
$1, 000
$310
$1, 550
100
500
410
$360
100
2, 050
460
39.6% $5, 000
$1, 800
500 2, 300
$1, 000
$396
$5, 000
$1, 980
100 496
500 2, 480
Reprinted with permission of R. & R. Newkirk . Charitable Gift of Tangible Personal Property: Inasmuch as the maximum capital gains tax rate continues at 28% for a taxable transfer of this kind of property, e.g. painting, sculpture, etc., the donor still avoids a 28% tax for a gift of this property, held long term, if the gift is related to the charity's tax exempt purpose, e.g. gift of artwork to a museum. . Charitable Gift Real Estate: Because the new law allows a married couple to avoid tax on up to $500, 000 of gain on the sale of a house—$250, 000 per single taxpayer, there is almost no incentive for donors to make outright gifts or planned gifts of their principal residences if avoidance of capital gains tax was a prime mover. Moreover, the provision is usable as frequently as once every two years: also, there is no age requirement anymore. Owners of very expensive homes with substantial appreciation above the $500, 000 gain cap might still consider this, but it does not appear to be a big market. . Charitable Gift by Will: In this writer's experience, most planned gifts come from matured bequests. This will continue for the foreseeable future as these gifts are generally motivated by donative intent. Also, many advisors counsel their clients to use the will rather than the trust method of transfer at death. No big change here.
. Charitable Gift Annuities: There should be no effect on these arrangements when funded with cash. There could be an increase in gift annuities funded with low cost appreciated stock. The reduction in the capital gains tax on the portion of the annuity deemed to be a sale should be a new incentive, for donors who are also beneficiaries, to establish these arrangements. . Pooled Income Funds Benefiting Charity: This writer sees no great change here. . Charitable Lead Trusts: For a senior donor who plans to support his/her charity and reduce or avoid estate or gift taxes as much as practical, the lead trust could still be helpful. Some persons will likely fund these trusts with appreciated stock and get the benefit of a lower capital gains liability. Why? Unlike a charitable remainder trust, a charitable lead trust (also referred to as charitable income trusts, and front-end charitable trusts) is not a tax exempt trust. If a person makes an inter vivos gift of appreciated assets to a non-grantor (donor not treated as owner) trust, and the trust subsequently sells the property within two years of the gift, the lead trust would be taxed at the donor's tax rates, instead of at the trust's rates on any gain realized. Continued on page 17
Tax Act of 1997 Continued from page 16 Because of higher tax rates, prospective donors were often reluctant to give to a lead trust a property that could not be sold off in stages, e.g., a little bit each year in order to make the payment to charity. The lower capital gains rate, 20%, could serve as an incentive for some prospective donors to consider transferring to a lead trust a capital asset that could be sold immediately by the trustees who would invest the proceeds of sale in income providing assets. Whether it would be prudent to do this would depend on whether the prospective donor's transfer tax (55%) or capital gains tax (20%) liability would be greater in terms of actual dollars of tax paid. If a donor does not want his heirs to have the immediate enjoyment of their legacies and said donor is philanthropically motivated, he/she might consider a charitable lead trust. Also, as the new unified credit amounts are phased in through the year 2006, a donor's tax liability on the non-charitable gift to the heir should be less making such arrangements more attractive. SUMMARY:
It is not about tax shelters. It is about government provided tax incentives to motivate taxpayers/ donors. While there is some logic to the notion that the charitable deduction constitutes a private expenditure of public funds, it should be remembered that it is for the public good. The government is already mired in health, education and welfare (HEW) programs, and these tax incentives are an effort, in this writer's opinion, to help decentralize or de-bureaucratize programs for public service. The net result of these incentives should be a greater percentage of the HEW dollar getting to the persons who need it in less time than it would take to flow through the bureaucracy. • Francis}. McGovern is Director of Capital Campaign at St. Joseph's Preparatory School, Philadelphia.
Current Events Current event items are distributed and discussed at PEPC luncheon meetings. However, since many of our members are not able to attend these meetings, they are reproduced here for your benefit. January 20, 1997 By Lawrence S. Chane Blank Rome Comisky &' McCauley LLP A. IRS Continues Attacks on Family Limited Partnerships In Technical Advice Memorandum 9551003, the IRS ruled that gifts of limited partnership interests were gifts of future interests and did not qualify for the annual gift tax exclusion. The ruling involved a typical Family Limited Partnership - the Limited Partners could not withdraw from the partnership or receive a return of capital before a specified date, or transfer or assign their partnership interests without the consent of the General Partner. Of importance to the IRS was that the Partnership Agreement provided for income to be distributed to the Limited Partners in the complete discretion of the General Partner and allowed the General Partner to retain income "for any reason whatsoever." The IRS reasoned that it was uncertain at the time of the gifts whether any income would be distributed to the Limited Partners. Thus, the income component of the Limited Partnership interests was not a present interest for purposes of the annual exclusion. B. IRS Amends Minimum Distribution Proposed Regulations on Trust as Beneficiaries of IRAs And Qualified Plans Under Proposed Regulations in existence since 1987, a Trust can qualify as a "designated beneficiary" provided that the following requirements are met: (1) the Trust is valid under state law; (2) it is irrevocable; (3) the individual beneficiaries are identifiable from the Trust instrument; and (4) a copy of the Trust instrument is provided to the Plan Administrator. In many cases, requirement (2) or (4) prevented the use of a Trust as a "designated beneficiary." Under the modified proposed regulations, a Trust will qualify if it is either irrevocable or becomes irrevocable by its terms at the death of the employee. The requirement of providing a copy of the Trust instrument to the Plan Administrator has been relaxed and may be met by providing the Plan Administrator with a list of the Trust beneficiaries. For employees who die before attaining age 70, this documentation can be provided during the nine month period after the employee's death.
C. Qualified Personal Residence Trust Regulations Finalized The Proposed Regulations prohibited the sale of the personal residence to the grantor, his spouse, the grantor spouse or any entity controlled by them after the termination of the grantor's retained interest in the Trust. The Final Regulations make it clear that this does not prevent the Trust from providing that if the grantor dies prior to the expiration of the original duration of the term interest, the residence can be distributed to any person including the grantor's estate, pursuant to the express terms of the Trust or pursuant to the exercise of the power retained by the grantor under the terms of the Trust. In addition, the Trust may provide for an outright disposition of the residence to the grantor's spouse after the expiration of the original duration of the term interest pursuant to the express terms of the Trust. D. "Estate Planning" Exceptions to The Realty Transfer Tax Create Traps for the Unwary Trap 91 - Transfers of real estate to a Revocable Living Trust used as a Will substitute, as well as transfers from a Living Trust to the beneficiaries are exempt from tax. (Transfers from an Estate to its beneficiaries have always been exempt). However, the Trust must prohibit distributions to any one other than the Settlor - the possibility of distributions to a spouse results in tax. Trap ff2 - Transfers of real estate to an ordinary trust are exempt. Direct transfers to the Trust beneficiaries would have been exempt, even if the contingent beneficiaries of the Trust are the intestate heirs of the Settlor. However, the Trust Agreement must be recorded at the time of the original transfer in order to exempt a later transfer from the Trust to the beneficiaries. Trap #3 - The recent changes are only effective at the State level, similar changes have not been enacted in Philadelphia (or Pittsburgh) which impose a separate tax.
Current Events (Continued) Administration's Budget Proposal February 17, 1998 By Robert J. Weinberg Pepper Hamilton LLP
I. EXCHANGES WITH RESPECT TO LIFE AND ANNUITY PRODUCTS
Generally, investors are taxed upon the sale or exchange of assets. Thus, gain is realized upon the sale of a share of stock or mutual fund even if the proceeds are used to purchase shares of a different stock or mutual fund. Special rules apply under IRC §1035 to investors in life insurance, endowment, and annuity contracts who exchange their contracts for other life insurance, endowment or annuity contracts. Life insurance contracts may be exchanged without recognition of gain for other life insurance, endowment or annuity contracts. Endowment contracts may be exchanged without gain for other endowment or annuity contracts. Annuity contracts may be exchanged without gain for other annuity contracts. Owners of variable life insurance and annuity contracts may exchange funds offered by the insurer within the contract without gain. Under the administration's proposal, any exchange of a life insurance, endowment or annuity contract for a variable contract would be a taxable exchange. Similarly, any exchange of a variable contract for a life insurance, endowment, or annuity contract would be a taxable exchange. In addition, each investment in a separate account mutual fund or in the insurance company's general account pursuant to a variable contract would be treated as a separate contract. The rules would apply to contracts issued after the date of first committee action. A material change in an existing contract would be treated as the issuance of a new contract. II. CORPORATE OWNED LIFE INSURANCE (COLI) RULES Under the Taxpayer Relief Act of 1997, a portion of corporate non insurance related deductions are disallowed based in part on the unborrowed cash value of corporate owned life insurance. An exception to this rule applies to insurance on 20% shareholders, officers and certain key employees or to joint insurance on the lives of such persons and their spouses. The administration's proposal would eliminate this exception except as to 20% shareholders. This would include policies that are splitdollared with the corporation. The elimination of the exception would apply to taxable years after the date of enactment. It is not clear whether there would be a grandfather provision for existing policies.
III. REDUCTION OF BASIS IN INSURANCE CONTRACTS FOR MORTALITY AND EXPENSE CHARGES
Generally, gain is recognized on the surrender of permanent life insurance policy prior to the death of the insured. Existing rules used to determine the basis in the policy under §72 allow the portion of the premium used to buy current insurance coverage or to buy an option to purchase a life annuity at guaranteed rates to add the policy owner's basis. The administration's proposal would subtract mortality and associated expense charges from the definition of basis. The proposal would apply to contracts issued after the date of first committee action. IV. ELIMINATE '"CRUMMEY" RULE Gifts up to $10, 000 per donee per year of a "present interest" in property qualify for an exclusion from gift tax. This is in addition to the $625, 000 lifetime estate and gift tax exemption. Gifts to trusts do not generally qualify as present interests. Under Crummey v. Commissioner. 397 F.2d 82 (9th Cir. 1968), a transfer to a trust under which the beneficiary has a right of withdrawal for a limited time period qualifies as present interest. The administration proposal would overrule the Crummey case and eliminate the qualification for the annual exclusion for gifts made subject to withdrawal rights. Only direct gifts of present interests to an individual or to a custodial account would qualify for the annual exclusion. The change would be effective for all gifts completed after December 31, 1998, regardless of when the trust was created. V. ELIMINATE NON-BUSINESS VALUATION DISCOUNTS The administration's proposal would eliminate the use of valuation discounts except as they apply to active businesses. Interests in entities would be required to be valued for transfer tax purposes at a proportional share of the net asset value of the entity to the extent the entity holds readily marketable assets (which is defined to include real property, annuities, royalty producing assets, art, collectibles, commodities, options and swaps). For active businesses, the discount could apply only to the reasonable working capital needs. The Treasury's general explanation contains a statement that no inference is intended as to the propriety of the discounts with respect to active businesses. The proposal would be effective for transfers made after the date of enactment. Continued on page 20
Current Events Continued from page 19 VI. ELIMINATE GIFT TAX EXEMPTION FOR PERSONAL RESIDENCE TRUSTS Under §2702, if an interest in property is transferred to a trust for family members while an interest is also retained by the grantor, the value of the retained interest is treated as zero unless the retained interest is in the form of a set annuity amount or a fixed percentage of the annual value of the trust. An exception applies if the property transferred to the trust is a personal residence. The administration's proposal would repeal the personal residence exception. The proposal would be effective for transfers in trust after the date of enactment.
1998 Mordecai Gerson Meritorious Service Award Clifford D. Schlesinger, Esq. Taxation Committee of the Probate Section of the Philadelphia Bar Association and Vice Chairman of the Legislative Committee of the PA Bar Association's Real Property, Probate and Trust Law Section. He also serves on the Board of The Rosenbach Museum and Library in Philadelphia where he holds the office of Treasurer. Mr. Schlesinger is a member of the Board and Treasurer of the Jewish Federation Foundation of Greater Philadelphia and a member of the Board of the Federation Endowments Corporation of the Jewish Federation of Greater Philadelphia.
PEPC President Warren Reintzel presents award to Cliff Schlesinger, Esq. at the PEPC March Luncheon. The Board of Directors is pleased to announce that the recipient of the 1998 Mordecai Gerson Meritorious Service Award is Clifford D. Schlesinger, Esq., a partner at Wolf Block Schorr and SolisCohen, LLP and current Treasurer of the Council. This award is presented to a Council member with a minimum of five years of membership who has rendered extraordinary service to further the work of the Council. Past recipients include Mordecai Gerson, Joseph H. Bachtiger, Joseph H. Yohlin, William T. Walsh and Karen A. Fahrner, Esq. These individuals continue to give of their time and talents to further the Council's work and their achievements are deserving of public recognition. Cliff has been a member of the Council's Board for the past seven years, currently chairing the Membership Committee and co-chairing the Program Committee. He has chaired the Bylaws and Newsletter Committees and has served as a member of the Holiday Party Committee, the PEPC/NAEPC Committee, Long Range Planning Committee, Annual Meeting Committee and has lectured at the request of the Council's Speakers Bureau. In addition to volunteer service with the Council, he has served on the Executive Committee as well as Chair of the
He graduated Pennsylvania Cum Laude, School, and York State.
Magna Cum Laude from the University of Wharton School, received his Juris Doctor, from the University of Pennsylvania. Law has received his C.P.A. license from New
Mr. Schlesinger and his wife. Dr. Susan Schlesinger, and their two children, Julie and Brett, reside in Radnor. This award was presented at the March 17 luncheon meeting at The Union League. •
