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Kathleen ReynoldsKeymasterOctober 24, 2022 at 5:34 pmPost count: 428
This calculation determines the value of the annuity (nondeductible) and the value of the charitable remainder interest (deductible) for a gift made through a charitable remainder annuity trust.
When a charitable remainder annuity trust is established, a gift of cash or property is made to an irrevocable trust, and the donor (and/or another non-charitable beneficiary) retains an annuity interest in the property for a specified number of years or for the life or lives of the non-charitable beneficiaries. At the end of the term, the qualified charity specified in the trust document receives the property in the trust.
For calculations involving a term, the length of the economic schedule is limited to that term. Otherwise, the economic schedule illustrates the trust for life expectancy. If the number of lives is greater than one, then the length of the economic schedule will be determined by the joint life expectancy of the first two ages provided by the user. Single life cases will use the single life expectancy. The economic schedule will end if the trust is depleted of funds prior to the end of the schedule.
Most gifts made to a charitable remainder annuity trust qualify for income and gift tax charitable deductions (or in some cases an estate tax charitable deduction). A charitable deduction is permitted for the remainder interest gift only if the trust meets certain criteria.
A trust qualifies as a charitable remainder annuity trust if the following conditions are met:
- The trust pays a specified sum to at least one non-charitable beneficiary who is living when the trust is created. Sums are paid annually, semiannually, quarterly, monthly, or weekly.
- The sum paid annually must also be at least 5%, but less than 50% of the initial net fair market value of the property placed in the trust. The charity’s interest at inception also must be worth at least 10% of the value transferred to the trust. (See 26 U.S.C. 664(d)(1)(A).)
- The sum is payable each year for a specified number of years (no more than 20) or for the life or lives of the non-charitable beneficiaries.
- No sum is paid to anyone other than the specified non-charitable beneficiary and a qualified charitable organization.
- When the specified term ends, the remainder interest is transferred to a qualified charity or is retained by the trust for the use of the qualified charity.
- The Internal Revenue Service has also ruled that a trust is not a charitable remainder annuity trust if there is a greater than 5% chance that the trust fund will be exhausted before the trust ends.
The annuity paid must be a specified amount expressed in terms of a dollar amount (e.g., each non-charitable beneficiary receives $500 a month) or in terms of a fraction or percentage of the initial fair market value of the property contributed to the trust (e.g., beneficiary receives 5% each year for the rest of his life).
The grantor will receive an income tax deduction which is permitted immediately for the present value of the remainder interest that will ultimately transfer to the qualified charity. Government regulations determine this amount which is essentially calculated by subtracting the present value of the annuity from the fair market value of the property and/or cash placed in the trust. The balance is the amount that the grantor can deduct when the grantor contributes the property to the trust.
Income or Estate Deduction
The program will allow for either type of calculation and illustrate how the deduction can be used. If you select to include Income Tax reports, additional inputs are required, and additional results are provided.
If you want to include Income Tax calculations, make sure you fill out the input section.
- Trust Type: Select a type of trust (Term ,Life, Shorter) If you select Life, the Economic Schedule runs from year one until the Life Expectancy or until the remainder is zero (whichever happens first). If you select Term or Shorter, the Economic Schedule runs from year one until the end of the Term or until the remainder is zero (whichever happens first).
- Transfer Date – Enter the month and year. See Transition Period Notes.
- §7520 Rate – The program automatically shows the correct §7520 discount rate, as well as the rates for the two previous months, if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520, and automatically selects the rate that should result in the largest charitable deduction, but you can override that selection if you wish.
- FMV of Trust- Enter the initial Fair Market Value (FMV) of the assets placed in the trust when established.
- Growth of Trust – Enter a growth percentage or investment yield for the assets of the trust for the purpose of the economic schedule.
- Term – If you chose a term or shorter trust, enter the number of years that the trust will last.
- Percentage Payout/Annual Payout – Enter the payout (percentage) that will go to the beneficiary during the life of the trust. This rate must be no less than 5% and no more than 50% (valid inputs are 5% to 50%). Or, enter the amount (dollar) that will go to the beneficiary during the life of the trust. This amount must be at least 5% and not greater than 50% of the trust (valid inputs are $101 and higher).
- Payment Period – Select the number of payments that will be made during a normal full year to the beneficiary (Annual, Semiannual, Quarterly, Monthly, and Weekly).
- Payment Timing – Select when the payment is made during the selected payment period (Begin or End). A Begin case is assumed to be the same as an End case with an additional payment made at the beginning of the period.
- Number of Payments – The program calculates the number of payments based on the term and the payment period. If you would like to have a trust that makes additional payments (beyond the normal term), use this input field to indicate the total number of payments to be made. For example, if you have a trust making quarterly payments for 10 years, this data field would default to 40. If you wished to make payments for 10 years and 1 quarter, you would change the value to 41.
- Lives – If you choose a life or shorter trust, enter the number of lives (up to ten) used to determine the charitable deduction.
- Ages – Enter the age(s) of the person(s) whose life is being used to measure the term of the trust as of the nearest birthday. You may enter up to five ages (Valid ages are 0-109.)
- Exhaustion Method- Choose the IRS method or the Illustrated method to perform the exhaustion test. The IRS Annuity Factor Method This is the method which appears to have been used by the IRS in §25.7520-3(b)(2)(v), Example 5. It uses published annuity factors to determine when the trust exhausts, and what the payment is in the last period of the trust. The Illustrated Method This method creates the schedule of payments based on the assumption that the trust will grow at a rate equal to the §7520 rate. You can use this method to illustrate when the annuity is expected to exhaust. Exhaustion Test
- Optimize – Click this button to have the program calculate the highest payout rate that passes the 10% test for the AFR you select. This feature is useful in creating a new trust if you have not designed one before.
- Charity Type Choose 50%, 30%, or 20%. All qualified non-profit organizations will fit within one of thse types (IRS Publication 78). There is also special consideration for Cash, 60%. For more information, visit: https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions#:~:text=ln%20most%20cases%202C%20the%20the%20amount,not%20subject%20to%20this%20limitation
Income Tax Inputs (Optional)
- Sunset in 2026? The Tax Cut and Jobs Act of 2017 sunsets in 2026. Indicate whether or not you wish to assume that the income tax provisions of that act will sunset.
- Adjusted Gross Income Enter the total estimated amount of adjusted gross income for the year in which taxes are being calculated.
- Total Itemized Deductions Enter the estimated total of allowable itemized deductions.
- Deductions Not Subject to Phaseout Enter the estimated total of allowable medical, casualty, or theft losses, and investment-interest deductions (subject to the regular limits and restrictions discussed above).
- Total Long-term Capital Gain Enter the total net gain from the sale or disposition of capital assets held for more than one year that has been included in adjusted gross income.
- 28% Rate Capital Gain Enter the total net gain from collectibles and section 1202 that has been included in adjusted gross income. (See IRC section 1(h)(4).)
- Qualified Dividends For years 2003 and following, enter the total amount of dividends that are included in adjusted gross income and qualify for the special tax rate for long-term capital gains.
- Unrecaptured §1250 Gain Enter the amount of long-term capital gain included in adjusted gross income that would be ordinary income if section 1250 applied to depreciation in excess of 100% straight-line depreciation. (See IRC section 1(h)(6).)
- Net Investment Inc. For tax years after 2012, enter the amount of net investment income as defined by IRC section 1411(c) that has been included in adjusted gross income. In general, net investment income is investment income such as interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses trading financial instruments or commodities, and businesses that are passive activities to the taxpayer (within the meaning of section 469), reduced by deductions properly allocable to those incomes, such as investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, fiduciary expenses (in the case of an estate or trust), and state and local income taxes.
- Filing Status Choose the applicable filing status (Single, Joint, Separate, Head of Household).
- Age in Tax Year Enter the taxpayer’s age at the end of the tax year being calculated.
- Spouse’s Age in Tax Year Enter the age of the taxpayer’s spouse at the end of the tax year being calculated.
- Personal Exemptions Enter the number of allowable personal exemptions for the taxpayer and any dependents.
- Estimated Inflation Enter an inflation rate to be applied to bracket amounts and other deductions in future years. For the current year or past years, this input is not applicable.
The Summary Tab displays the value of the annuity (nondeductible) and the value of the charitable remainder interest (deductible) generated from a gift of a term of years charitable remainder annuity trust. To calculate these values, the calculation first determines the amount of the annuity and the appropriate factor for the term specified at the Payment Year input. It then uses the payment period (annual, semi-annual, quarterly, monthly, or weekly) and payment occurrence (beginning or end) to calculate and display the exact amount of charitable deduction allowed. The deduction is shown as a dollar amount and as a percentage of the amount transferred to the trust.
Results if Income Tax is included:
If the transfer date is greater than 7/97 and the Charitable Remainder is less than 10% of the initial FMV, a message appears stating “Fails the 10% minimum Charitable Benefit Test.” If the transfer date is greater than 7/97, and the Charitable Remainder is less than 10% of the initial FMV, a message appears stating “Does not pass the 10% Test. (Donor’s Deduction is set to 0.) When this message appears, the result entry Donor’s Deduction as Percentage of Amount Transferred appears on the Summary tab. There are actually three error messages regarding the 10% test that can appear. This is because of the fact that with charitable remainder trusts, the user has the option of using an AFR from the transfer month or from one of the previous two months. The wording of the Taxpayer Relief Act of 1997 does not make it clear which AFR should be used for valuing the remainder interest when performing the 10% test. The software performs the test using both the transfer month’s AFR and using the AFR the user selected, and informs the user if either (or both) of these tests are failed.
The program uses one of two methods to perform the exhaustion test on the trust.
If a calculation is of the “Life” or “Shorter” type, if there is more than one noncharitable beneficiary, and if their interests are all “vested” and not subject to revocation by the grantor, then there may be a taxable gift equal to the present value of all noncharitable interests other than any interests retained by the grantor. The program assumes that the first measuring life is that of the grantor and shows the value of all succeeding noncharitable interests, which is calculated by subtracting the present value of the interests retained by the grantor (calculated using only the first measuring life) from the total present value of all noncharitable interests.
Note: Taxpayer Relief Act of 1997 added a requirement that the remainder interest be at least 10% of the initial fair market value of all the property placed in trusts to charitable remainder trusts. The 10% Minimum Charitable Benefit Test applies to transfers made after 7/28/97.
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