The idea of asking donors to make a "blended gift" is an emerging trend in the world of philanthropy. A blended gift is the combination of a current gift, or a commitment to make a series of current gifts, together with a planned gift, such as a bequest, charitable trust or charitable gift annuity. The current gift portion of the blended gift will provide the donor and charity with benefits today while the planned gift portion typically provides both current and future benefits. With a blended gift, a donor can make his or her giving go further.
Over the past decade, the focus of charitable capital campaigns has shifted so that many campaigns now include goals with respect to planned gifts. Campaigns now target 20% to 40% of the overall goal towards the receipt of planned gifts. Individuals who have made regular gifts in the past, who strongly support a charity or who have the capacity to make a large gift, may be asked to consider making a blended gift.
As the likelihood of a blended gift request grows, professional advisorsattorneys, CPAs, financial advisors and insurance agentswho work with potential donors will increasingly be asked to help their clients assess the feasibility, benefits and best structure for their clients to make these gifts. This article series will focus on twelve of the most common blended gifts arrangements and the potential donor benefits for each.
Part III of this series focuses on two types of blended giftsa current gift and a unitrust and an IRA rollover and a testamentary unitrust. This article will discuss some of the unique aspects of these gifts, the motivating factors and the benefits for the donor. It will also provide examples to illustrate these concepts. While there may be many issues holding a donor back from making a large outright gift, a blended gift may be the answer the donor is seeking. It enables the donor to make an immediate impact while also providing long-term support.
GIFT AND UNITRUST
As the previous two articles explained, a blended gift is often an effective means of achieving donors' objectives while furthering current and future charitable needs. For donors who desire to make a charitable impact today, but who would like to retain an income stream for future years, a gift coupled with a unitrust could be a perfect fit.
A charitable remainder unitrust is a tax-exempt irrevocable trust that is funded by a donor and makes income payments to individual beneficiaries for life, lives or a term of years. After all payments have been made, the remaining trust assets are transferred to one or more designated charities. A unitrust is a popular planned gift because it produces a charitable income tax deduction in the year (or years) in which the donor transfers assets to the trust, allows the donor to bypass capital gains tax if the trust is funded with an appreciated asset and also produces an income stream for the donor or the other selected beneficiaries.
To qualify as a charitable remainder unitrust, the trust must meet certain requirements. First, the unitrust payout percentage must be at least 5% and cannot exceed 50%. Second, the unitrust must produce a charitable income tax deduction that is equal to at least 10% of the trust's funding amount. In addition, the trust must file annual tax returns, submit to annual valuations and be managed by a trustee. The trustee can be an individual, a charity or a private trustee such as a bank and trust company.
There are four different payout types that can be established in the trust agreement. The first is a Standard Unitrust, which will make payments based on the unitrust percentage stated in the trust agreement. Each year, the trustee will determine the annual payment amount by multiplying the unitrust payout percent by the trust value. This type of trust is frequently used for gifts of public stock or other liquid assets.
The second way to structure trust payouts is to draft the trust as a Net Income Plus Make-Up Unitrust ("NIMCRUT"), which pays the lesser of trust income or the unitrust percentage. This method has become quite popular for donors who desire income control. Through careful selection of either growth or income assets, the trustee may allow growth for a period of time, such as prime earning years prior to retirement. When the donor desires to start receiving income payments, the trustee can shift from a growth to an income-producing investment strategy and begin making distributions. Note that if there are excess earnings over the unitrust amount, any payout deficit in the initial years can be repaid, or "made up," in later years.
The third type of unitrust is called a Net Income Only Unitrust (NICRUT) and pays out the lesser of trust income or the unitrust percentage, but does not include a make-up provision. As such, this type of trust is not frequently utilized.
The final type of trust is a FLIP Unitrust. This trust initially functions as a NIMCRUT and then switches or "flips" into a Standard Unitrust on January 1 following the occurrence of a specified trigger event or date in the future. The specified trigger event is often the sale of a non-marketable asset, but it could also be a different event, such as birth, death, marriage, divorce or a fixed date in the future. This type of trust is a popular choice for donors who would like to fund a unitrust with real estate. When real property is transferred to a FLIP unitrust, the trust can avoid making payments until the property is sold, at which time the trust subsequently FLIPs to a standard unitrust and will begin making payments the following January.
All charitable remainder unitrusts must adhere to the four-tier accounting rules contained in Sec. 664 of the Internal Revenue Code. The four tiers are: ordinary income, capital gain, tax-free income and return of principal. The basic rule is that all ordinary income must be distributed before any capital gain. Distributions of tax-free income and principal will only be made if there is no ordinary income or capital gain. As such, trust investments are carefully selected in order to minimize production of ordinary income and maximize recognized capital gain.
As mentioned above, pairing a charitable remainder unitrust with an outright gift may be a great solution for those donors who wish to contribute to the immediate needs of their favorite charities today, but also desire an income stream to ensure financial security for the future. Because unitrusts enable donors to select payout methods that fit their needs, this blended gift is a good fit for donors who want to defer income until retirement.
Phoebe has been a long-time volunteer at her favorite charity. The charity is currently raising funds to construct a new building. Phoebe has appreciated stocks that she would like to use to help the charity meet its needs today, but she worries that she might outlive her money and income during her retirement years.
After meeting with her advisor, Phoebe decides to gift a portion of the stocks to the charity. Not only does she receive personal satisfaction knowing she is helping a cause that is close to her heart, she also receives a charitable income tax deduction and avoids the capital gains tax liability that she would have faced if she had sold the stock herself. She uses the rest of her stock to fund a unitrust, which her attorney will draft as a NIMCRUT. The trust will produce an additional income tax deduction when she transfers the stock to the trust and will supply her with income when she retires. The unitrust will provide Phoebe with income for the rest of her life and then, when she passes away, the remainder will go the charity.
Some donors have appreciated real estate that they want to use for a charitable gift today but they are not comfortable giving such a highly valued asset without receiving anything in return. For these individuals, setting up a FLIP unitrust with a portion of the real estate and making an outright gift to charity of the remainder may be a great solution.
Chandler and Monica own development property that they purchased years ago for $300,000. Real estate prices have skyrocketed and the property is now worth $900,000. They want to make an outright gift to their favorite charity's current capital campaign but they also want avoid tax on the sale of the property and receive income. They work with their advisor and decide to make an outright gift of one third of the property and use the remaining two thirds to fund a FLIP unitrust. In order to accomplish this, their advisor guides them through executing two deeds to the charity. The first deed transfers one third (or $300,000) to the charity outright. This current gift will produce a $300,000 deduction which, based on their income tax rate of 35%, will save them $105,000. Because the property is appreciated and transferred before the sale, they also avoid payment of $37,600 of capital gains tax.
The second deed is transferred to the charity as trustee of Chandler and Monica's FLIP unitrust. By using the remaining two thirds of the property to fund the trust, Chandler and Monica will receive a deduction of $315,750 and income of $30,000 plus potential growth from the trust each year for the rest of their lives. Because the trust is drafted as a FLIP trust, the charity is able to avoid making income payments until after the property is sold (i.e., after the FLIP trigger event). Note that, because the charity is named in both deeds and has control over 100% of the property there should be no minority or lack of marketability discount that would affect Chandler and Monica's charitable deduction. After both Chandler and Monica pass away, the remainder will be distributed to charity.
IRA GIFTS AND TESTAMENTARY UNITRUST
Part I of our blended gift series introduced a blended gift that combined an IRA charitable rollover with a bequest. Another possible option is to pair an IRA rollover with a testamentary unitrust. This plan is a good fit for a donor whose goals include: (1) making a gift that meets the charity's current needs; (2) leaving a legacy gift to charity; and (3) providing family members with an inheritance.
An IRA rollover will enable a donor to use funds from his or her IRA to help the charity's pressing needs today without having to pay tax on the IRA distribution. A testamentary unitrust can be funded with an IRA after the donor passes away. The unitrust will pay income to family members and once all of the income payments have been made, the remainder will be distributed to the donor's favorite charity. Therefore, while an IRA charitable rollover and testamentary unitrust are both powerful giving concepts in themselves, when paired together they allow donors to make their giving and their legacy go further.
Recall that Part I of our series explained that an IRA charitable rollover can be an effective way to make charitable gifts in cases where the donor has an IRA and other sources of income and appreciated assets. (See Part I for an in-depth discussion of the IRA charitable rollover). IRA owners who have reached age 70½ or older are required to take distributions (required minimum distributions, or "RMDs") from their IRAs every year. The RMD is based on a percentage of the IRA's value and increases every year. Unfortunately for the IRA owner, this distribution is taxable at ordinary income rates and will increase the IRA owner's adjusted gross income (AGI) - unless the owner chooses to rollover the distribution to charity.
The IRA charitable rollover, which was made permanent in 2015 with the passage of the PATH Act, enables donors over the age of 70½ to make direct transfers from their IRAs to public charities without being taxed on the distribution and without recognizing the distribution as income for tax purposes. This Qualified Charitable Distribution (QCD) is allowed up to a total of $100,000 per year and may offset part or all of the donor's RMD. Note that, because the transfer is not included in taxable income, there is no additional charitable deduction.
While the IRA rollover is an excellent gift on its own, when paired with a testamentary unitrust it allows a donor to both provide for family and benefit charity well into the future. With a testamentary unitrust, a donor is able transfer his or her IRA to a unitrust at death. Since the unitrust is tax exempt, no income tax is paid when the IRA is distributed to the trust. The full IRA value is invested and produces new income to family for one life, two lives or a term of up to 20 years. After all payments are made, the remainder is transferred to designated charities.
To ensure that the transfer of an IRA is effective at death, the IRA owner will need to complete an IRA beneficiary designation form naming the trustee of the unitrust as beneficiary of the IRA. The IRA owner should work with an advisor to create the necessary documents in accordance with state law. It is not acceptable to merely write a request on the beneficiary form instructing the executor of the donor's estate to create a unitrust. The IRS has disallowed charitable estate deductions for such requests, since the unitrust must exist as of the decedent's date of death. Therefore, it is necessary to create an actual trust document and then to designate the trustee of the unitrust as the beneficiary of the IRA. For example, an IRA owner could create an unfunded unitrust for the IRA owner's life plus a term of 20 years for the owner's children and then fill out a designation form naming the trustee of the unitrust as beneficiary of the IRA. When the IRA owner passes away, the IRA will fund the unitrust and begin making payments to the owner's children. The unfunded trust will be set up as a FLIP trust or a NIMCRUT and will not require any administration during the life of the IRA owner. Note that whether or not the IRA owner will be able to set up an unfunded or nominally funded unitrust will depend on state law. If the IRA owner sets up a funded trust, then normal trust administration and accounting will be required (i.e., the trust will need to be managed and invested by a trustee, follow four-tier accounting principles, make payments to the income recipients and file annual IRS Form 5227).
An alternative option to setting up an unfunded or funded unitrust during life is to include a trust document in the IRA owner's will or revocable trust. The unitrust should be clearly identified within the will or revocable trust as a separate charitable remainder unitrust effective only upon the death of the testator or trust grantor. The IRA beneficiary designation should name the trustee of the testamentary unitrust as beneficiary of the IRA (e.g., "To ABC Bank as trustee of the charitable remainder unitrust for Cindy Child identified as 'Attachment D' of George Adam's Will dated June 1, 2017.")
In nearly all cases, IRAs represent 100% untaxed ordinary income and the entire IRA distribution will be allocated to the tier-one ordinary income layer of the unitrust for four-tier accounting purposes. Thus, distributions to the donor's children will be ordinary income. However, since the unitrust is tax exempt, the full value of the IRA will be available to earn the new income for the children.
Combining a testamentary unitrust with current gifts made through IRA charitable distributions can give a donor peace of mind, knowing that he or she is both providing for family and leaving a charitable legacy while helping a favorite charity meet its immediate needs today.
Rachel White is 75 years old. She has an IRA and began taking her RMDs when she reached age 70½. Because she is receiving rents and profits from her investment properties, she does not need her RMDs and does not like that she is being pushed into a higher tax bracket because of her distributions. She also wants to contribute to a local charity to support them this year, as well as to leave a legacy gift after she passes away. However, she wants to be certain that she provides an inheritance for her daughter, Emma.
She meets with her attorney to see how she can accomplish her goals. Rachel's attorney told her about the IRA charitable rollover and explained that she could transfer up to $100,000 from her IRA each year to a qualified charity without paying tax on the distribution or including the distribution in her AGI. Rachel was thrilled and decided to contact her IRA custodian right away to ensure that her RMD will be directly transferred to the local charity. She plans to continue making these IRA rollovers for the rest of her life.
Rachel also asked her advisor to help her come up with a plan that would enable her to use her remaining IRA balance when she passes away to provide an inheritance for Emma and also pass on funds her favorite local charity. Rachel's attorney assists her in creating an unfunded unitrust for her life plus a term of 20 years. Under state law, the unfunded trust is valid but will not be active until Rachel passes away. Rachel fills out a beneficiary designation form for her IRA naming the trustee of the unitrust as beneficiary of her IRA. This trust will receive the IRA after Rachel passes away, enabling the trust to make payments to Emma for a period of 20 years. At the end of that time, the balance of the trust assets will be distributed to the charity.
A blended gift is a great way for donors to contribute toward a charity's capital campaign while maintaining assets for use later in life. Donors are able to make an immediate impact on their favorite charities and also establish planned gifts that will continue to benefit those charities for years to come. In addition to the satisfaction of knowing that they are furthering charitable purposes, blended gifts donors who combine immediate gifts with unitrusts will see substantial tax benefits from their gifts and guarantee that income will be available for personal or family needs in the future. Not only do blended gifts accomplish donors' personal and financial goals, they enable donors to support the causes that matter most to them and leave a lasting legacy.