Introduction to Planned Giving
By Ellen K. Harrison, Pillsbury, Winthrop, Shaw Pittman LLP

Planned giving refers to gifts that are structured to take optimum advantage of the tax incentives offered for gifts to qualified charities, such as the Washington Home. These tax incentives significantly reduce the out-of-pocket cost to you and your family of making gifts to qualified charities. Some of the strategies that are designed to make use of these tax incentives are complicated. The more complicated planned giving strategies appropriate only for larger gifts made by donors who have the patience to deal with the details necessary to implement them properly. Unless these strategies are properly implemented, bad tax consequences can result. However, other planned giving strategies are relatively simple. As a general rule, where a simpler strategy serves your purpose, use it instead of a more complicated one. This is commonly referred to as the 'KISS' principle, which is an acronym for 'keep it simple, stupid!' However, even simple strategies require compliance with rules designed to prevent abusive schemes.

In this introduction to planned giving, I will give you a summary of the planned giving strategies available to you, beginning with the simpler ones and moving to the more complicated strategies in subsequent segments. Part I discusses lifetime gifts, Part II discusses bequests at death and Part III discusses charitable gifts of a partial interest in the donor's property and split interest gifts. Split interest gifts include a gift of a remainder interest to charity following a term interest (either a life estate or a term of years interest) held by one or more individuals (which may include the donor) and gifts of a term interest to charity with the remainder passing to one or more individuals.

I urge you to consult your tax advisor before implementing any of the planned giving strategies discussed in this article. This article of necessity focuses on the general rules, but there are many exceptions to the general rules and your particular circumstances may make one of these exceptions applicable. For example, there are ceilings on tax deductions for gifts to charity based on the amount of your income and the charitable deduction for higher income taxpayers is reduced. Special rules are applicable to charitable gifts of certain kinds of property, gifts of partial interests in property, and gifts of property that are subject to debt or certain other obligations. In general, a gift of property subject to debt will cause the donor to be treated as receiving cash equal to the amount of the debt. In addition, it is important to work with your tax advisor in implementing your gifts because the tax incentives I will be discussing are not allowed if you do not comply with reporting, appraisal and record keeping rules.

Part I Lifetime Gifts
1. Outright gift of cash or property during donor's lifetime. In general, a donor is allowed an income tax deduction for the amount of cash and the value of property given to a qualified charity. The value of property for purposes of the deduction usually is the fair market value of the property on the date of the gift, but there are important exceptions that could reduce the amount of the deduction. In general, a gift of appreciated property does not cause gain to be realized. The gift also is not taxable for gift tax purposes because a gift tax deduction is allowed for gifts to a qualified charity.

Example 1: Sara owns 100 shares of IBM that has a current fair market value of $91 per share, or a total value of $9,100. Sara's basis is $30 per share, or $3,000. If Sara sold the shares, she would have gain of $6,100 and owe capital gains tax (assuming a 15% federal tax rate and a 7% state tax rate) of $1,342. Sara would net $7,758. If instead of selling the shares, Sara gave the 100 shares to charity, she would be entitled to an income tax deduction of $9,100 which would offset her income from employment. Assume that Sara's combined marginal state and federal income tax rate on her earnings from employment is 42%. The gift to charity will save tax of $3,822 (42% times $9,100). The net cost of Sara's gift to charity is $3,936. This is the excess of the amount Sara would have put in her bank account had Sara sold the shares, paid tax on the gain and not made the gift to charity minus the reduction in her income tax that was created by her charitable gift.

2. Gift from Individual Retirement Account ('IRA'). The owner of an IRA who has attained age 70 1/2 may give up to $100,000 per year directly from her IRA to a qualified charity. (This rule is effective only until December 31, 2009 unless Congress extends it.) The payment from the IRA to charity does not cause any amount to be included in the IRA owner's gross income. The out-of-pocket cost to the owner of the IRA is the amount she would have been able to deposit to her bank account had she withdrawn the funds from the IRA, paid income tax on that withdrawal, and put the balance in her bank account. Withdrawals from an IRA are taxable at ordinary income tax rates. Example 2: Jane's IRA has a current value in excess of $100,000 and zero tax basis. (Jane's basis is zero because Jane deducted all amounts contributed to her IRA.) If Jane withdrew $100,000 from her IRA, Jane would owe tax of $42,000 attributable to her withdrawal. (No early withdrawal penalties would apply because Jane has attained age 70 1/2.) Thus, the amount that Jane would be able to deposit to her bank account after paying her taxes would be $58,000. If Jane gives the $100,000 directly from her IRA to the Washington Home, the out-of-pocket cost to Jane is only $58,000.

Note that if Jane withdrew $100,000 from her IRA and then made a gift to the Washington Home, the same net result would be achieved because the income tax deduction for her gift would offset the income recognized from the withdrawal. What is achieved by making the payment directly from the IRA to the Washington Home? The primary benefit is that it avoids both the ceiling on charitable deductions by individuals and the cut back in charitable deductions for higher income taxpayers. The ceiling on the deduction for cash gifts to charities like the Washington Home is 50% of adjusted gross income. The ceiling is lower 30% of adjusted gross income - if the gift is of appreciated property rather than cash and the donor deducts the fair market value of the property given to charity. Excess deductions can be carried forward, however, for up to five years. If Jane's income is not sufficient to take full advantage of the charitable deduction, a direct payment to charity from the IRA is the better strategy.

Example 3: Jane's adjusted gross income is $50,000. If Jane withdrew $100,000 from her IRA, her adjusted gross income would be $150,000 and the limit on her charitable deductions would be $75,000 or less (depending upon the amount of her other tax deductions). Jane's gift of $100,000, unless made directly from her IRA, would not be fully deductible because it exceeds 50% of Jane's adjusted gross income even after the increase due to the IRA withdrawal.

If Jane does have sufficient other income to shelter all of the $100,000 gift to charity, Jane may be better off using appreciated assets (like the IBM stock that Sara gave in Example 1 above) to fund her gift and keeping the amount withdrawn from her IRA, because the tax savings are even more. However, if Jane's adjusted gross income for 2009 is more than $166,800, Jane's deductions will be reduced. The charitable deduction is an itemized deduction. Itemized deductions in 2009 are reduced by an amount equal to one-third of the lesser of (i) 3% of the amount by which Jane's 2009 adjusted gross income exceeds $166,800 or (ii) 80% of Jane's itemized deductions (including her charitable deductions). (This is referred to as the overall limitation on itemized deductions.)

Example 4: Jane withdraws $100,000 from her IRA. The withdrawal increases Jane's adjusted gross income by $100,000. Jane has other income of $300,000, so her adjusted gross income is increased from $300,000 to $400,000. Jane's itemized deductions total $50,000. Jane has 1,200 shares of IBM stock worth $100,000 with a basis of $25,000. If Jane gifts the IBM shares to the Washington Home, her itemized deductions increase from $50,000 to $150,000. Subject to the overall limitation on itemized deductions for high income taxpayers, Jane's charitable deduction for the fair market value of Jane's IBM stock ($100,000) is allowable for 2009 because it is less than 30% of Jane's adjusted gross income (30% of $400,000 = $120,000). However, the overall limitation on itemized deductions will reduce Jane's deduction by one-third of the lesser of (i) 3% of the excess of $400,000 over $166,800 = $6,996; or (ii) 80% of the sum of $50,000 + $100,000 = $12,000. Therefore, Jane's itemized deductions are reduced by one-third of $6,996 = $2,330; from $150,000 to $147,670.

The tax savings for Jane's contribution of IBM shares in the above example should take into account the fact that Jane will not have to pay capital gains tax on the unrealized appreciation in her IBM shares even though she was allowed a tax deduction for their current fair market value. At a tax rate of 15% federal and 7% state and current values, this saved Jane $16,500 in capital gains taxes. Thus, assuming Jane's combined federal and state tax rate is 42%, the total tax benefit of Jane's contribution is $16,500 (42% of $2,330) = $15,521.40. Had Jane withdrawn funds from her IRA and sold the IBM shares, and paid tax on both, Jane would have netted $58,000 from her IRA and $78,000 from her IBM shares, a total of $136,000. With the gift, Jane netted $99,021.40 from the IRA and zero from the IBM shares. Thus, the gift 'cost' Jane $36,978.60 and benefited the Washington Home by $100,000. This is less than the cost to Jane in example 3 ($58,000) illustrating a direct gift from an IRA.

3. Gifts through a donor advised fund. There are many community foundations available that offer 'donor advised funds.' A community foundation is a qualified charity. A donor advised fund is a fund created on the books of the community foundation that represents a donor's contribution and where the community foundation allows an advisor, who may be the donor or another person designated by the donor, to recommend the distribution of the donor advised fund to other qualified charities, such as the Washington Home. Why do this rather than make a gift directly to the Washington Home? One reason is that you may have a single asset that is highly appreciated that you want to use to fund your gift but the value of the single asset is more than you wish to give to a single charitable organization, or more than you wish to give to a single organization all at once. The gift of the asset to the community foundation allows the sale of the asset to be made by the community foundation, and since the sale is made by a tax exempt charity, the proceeds are not taxed. The full amount realized is allocated to your donor advised fund and is available to distribute to any number of other charities. A substantial portion of the proceeds may remain in the donor advised fund for distribution in subsequent years. Generally, only 5% of the value of the fund must be distributed each year.

4. Endowments. A gift to a charity may be restricted. A common restriction is to direct that the gift be added to an endowment fund. The income of the endowment fund may be used by the charity for its operating expenses or other specific charitable purposes. The charity is not allowed to spend the principal. An endowment fund helps assure the long term continuity of a charity because the charity may use the endowment income to pay operating expenses even if revenues slump for any reason in a particular year. The Washington Home's endowment fund is an important source of stability for the organization and allows it to do more long range planning.

Part II Bequests
This is Part II of an Introduction to Planned Giving. Part I discussed how lifetime gifts can be structured to maximize the tax benefits of charitable giving. This Part II discusses bequests made at the donor's death. Part III will discuss charitable gifts of a partial interest in the donor's property and split interest gifts. A split interest gift is a gift of a term or remainder interest to charity.

I urge you to consult your tax advisor before implementing any of the planning ideas in this article. There are many technicalities that can prevent allowance of a tax deduction for gifts to a charity.

A bequest of cash or property to a qualified charity may be made upon your death under your will or revocable trust. In addition, a bequest at death can be accomplished by making the charity the beneficiary of all or a portion of property (such as life insurance or an IRA) that passes to a designated beneficiary upon your death. The amount of cash or value of property given to a qualified charity is deductible for purposes of calculating estate tax. There is no ceiling on the estate tax deduction or cutback in the amount of the estate tax deduction based on the value of an estate, as there is for income tax purposes. Whether the estate is large or small, the full fair market value of property that a qualified charity is entitled to receive will be deductible for estate tax purposes.

In Part I, I discussed the tax advantages of making lifetime gifts to charity with appreciated assets. In the case of bequests at death, as a general rule it does not matter whether the bequests are made using cash or property. This is because property acquired from a decedent acquires a new basis upon the decedent's death equal to its then fair market value and therefore can be sold at that value without generating taxable gain. An exception to the basis adjustment applies for certain types of assets, like IRA proceeds. As discussed below, such assets are good candidates to use to satisfy charitable bequests, but the bequest must be properly structured to achieve the optimum tax savings.

Below are some "traps" that could cause your bequest to charity to fail to meet your objectives: 1. The amount a charity is entitled to receive will be reduced if estate settlement expenses, including taxes, are payable from the bequest to charity. The charitable deduction cannot exceed the amount charity is entitled to receive net of such expenses.

Example 1: Joan's will leaves $5 million to a trust for her nieces and nephews and the residue to the Washington Home. Joan's will directs that debts, administration expenses and estate taxes be paid from the residue of her estate. The allocation of estate settlement expenses to the residuary estate reduces the amount that the Washington Home will receive. Consequently, the charitable deduction will be reduced by the estate settlement expenses charged to the residuary estate. If the debts and administration expenses are deductible for estate tax purposes, which is usually the case, the allocation of those amounts to the residuary estate will not cause estate tax to be owed but will merely substitute one deduction for another. However, the federal estate tax is an estate settlement expense that is not deductible in computing estate tax. The allocation of federal estate tax to the residuary estate will cause additional estate tax to be owed. That is, there is estate tax on estate tax. An interrelated computation is necessary to determine the amount of the charitable deduction. Under this computation, the charitable deduction will be reduced by estate taxes of $1,227,272.72 plus administration expenses.

You may wish to exempt the bequest to charity from the obligation to pay estate tax. In example 1, this would mean that the estate tax imposed on the gift to the trust for Joan's nieces and nephews would be paid from the trust, so that the trust would not be funded with the full $5 million but only with the net remaining after paying tax on the $5 million bequest. Assuming that Joan's estate has a $3.5 million federal estate tax exemption and that Jane was a resident of Virginia (which has repealed its estate tax), the trust for Joan's nieces and nephews would be funded with $4,325,000 after paying estate tax of $675,000. This example points out the importance of paying attention to how estate taxes are apportioned.

Example 2: Joan's will leaves half of her residuary estate to the trust for her nieces and nephews and half to the Washington Home. Taxes are apportioned to the residuary estate. Here, it is very important that the will clarify whether the half that is payable to the Washington Home is calculated before or after the payment of estate taxes and whether estate taxes are to be apportioned to the trust for nieces and nephews or equally to the trust and to the Washington Home.

If the will is silent as to who pays the estate tax, state law 'fills in the gap.' Generally, state apportionment laws would not impose a share of the estate tax on the charity since the gift to the charity did not cause any estate tax to be due.

2. It is very important that the amount of the bequest to a charity be clear and certain. If not, the charitable deduction will not be allowed.

Example 3: Al's will directs his executor to make distributions to friends and family in such amounts that the executor determines to be appropriate in light of the level of love and attention that each provided to him during his last illness and to distribute the balance to the Washington Home. The charitable deduction will fail because the broad discretion given to Al to reduce the bequest to the Washington Home by making numerous bequests to Al's family and friends makes the amount of the bequest to the Washington Home impossible to calculate as of the date of Al's death.

Although an income tax deduction will be allowed for post death income accruing to the estate and allocable to the bequest to charity, the bequest does not generate as good a tax benefit as a lifetime gift because the tax deduction does not reduce the donor's income tax. However, with proper planning, we can achieve the same income tax savings allowed for lifetime gifts. See Example 4 below.

Example 4 bequest through IRA: Joe wants to make a bequest to the Washington Home of $100,000. Rather than bequeath $100,000 in his will, Joe designates the Washington Home as the beneficiary of his IRA to the extent of $100,000. The after tax cost of this bequest to Joe's family is quite small. Had Joe designated his children as the beneficiaries of the $100,000 in his IRA, the children would have owed both estate tax and income tax on the IRA distribution. Although the estate tax attributable to the IRA is deductible in computing a beneficiary's taxable income when a withdrawal is made, nevertheless, the IRA is still subject to 'double tax.' Ignoring state estate tax (which is still imposed by many jurisdictions, including Maryland and the District of Columbia), and assuming the taxable estate exceeds the federal estate tax exemption, the federal estate tax on the $100,000, if left to the children, would be $45,000. The estate tax would be deductible in calculating income tax. Of the remaining taxable income (and cash) of $55,000, the income tax will be about $23,100, assuming an effective combined federal and state rate of 42%, leaving only $31,900 of the $100,000 for the children to deposit to their bank accounts.

Many charities, including the Washington Home, have a legacy program a program where donors commit to make a bequest to the Washington Home. If the donor wishes to use the IRA funds to fulfill this commitment and take advantage of the tax benefit described in Example 4 above, it is a good idea to have a back up gift in the will or revocable trust in case the IRA funds are depleted below the amount of the commitment at the time of the donor's death. Especially for older donors, the risk that the IRA funds will be depleted is not insignificant. That is because IRA owners are required to withdraw certain minimum amounts from their IRAs and these amounts get larger as the IRA owner gets older.

Another way to make a bequest and get the benefit of income tax savings is to make a lifetime gift to a qualified charity of a remainder interest in property. A taxpayer may be entitled to an income tax deduction for the present value of the gift to charity that will take effect upon his death, provided that the gift complies with the split interest gift rules, which will be discussed in Part III.

A split interest bequest also is sometimes advisable. For example, a spouse may wish to leave a term interest to a surviving spouse for his or her lifetime and to give the remainder to charity upon the death of the surviving spouse. Where the bequest takes the form of a qualified charitable remainder trust, the gift qualifies for both the marital and charitable deduction. As is the case with lifetime gifts, a donor may not wish to make a bequest in a lump sum to charity upon her death, but prefer that the funds be distributed to charity over a number of years. The donor may use a donor advised fund at a community foundation, discussed in Part I, to achieve this goal. A split interest gift is another way to avoid making a single lump sum distribution to charity.

Part III Split Interest Gifts
This is Part III of an Introduction to Planned Giving. Part I discussed how lifetime gifts can be structured to maximize tax benefits of charitable giving. Part II discussed the tax benefits and some tax traps involved in making bequests at the donor's death. Part III discusses charitable gifts and bequests of a partial interest in property and split interest gifts and bequests. A split interest gift or bequest is a gift or bequest to charity of a term or remainder interest. The balance of the split interest is either retained by the donor, in the case of lifetime gifts, or given to one or more individuals. Split interest gifts and split interest bequests provide some additional and valuable tax benefits.

I urge you to consult your tax advisor before implementing any of the planning ideas in this article. There are many technicalities that can prevent allowance of a tax deduction for gifts and bequests to a charity.

The general rule is that a deduction is not allowed for a charitable gift or bequest of a partial interest in property. However, there are a number of exceptions. One exception is for a gift of an undivided fractional interest of the donor's entire interest in property.

Example 1: Catherine owns a museum quality painting worth $6,000,000. Catherine donates a 25% undivided interest in the painting to the National Gallery of Art. Catherine is allowed to deduct an amount equal to 25% of the fair market value of the painting = $1,500,000. However, the income tax deduction for any subsequent gifts of an additional fractional interest cannot exceed such fraction multiplied by the value of the painting at the time of the first gift. Thus, if the painting appreciated in value to $8,000,000 when another 25% interest was given, the income tax deduction would be limited to $1,500,000 and not $2,000,000. In addition, the deduction is recaptured if the donee does not acquire all of the interests before the first to occur of the tenth anniversary of the donor's initial gift and the donor's date of death or if the donee does not have substantial physical possession of the painting and use the painting in a use related to a purpose or function constituting the basis for the organization's exemption.

A gift of a painting to the Washington Home would be deductible only if the gift is used in connection with the exempt purpose of the Washington Home.

A second exception applies to gifts of a qualified conservation easement. Among many other conditions that must be satisfied to obtain a deduction for a gift of a conservation easement is that the gift be made to a suitable qualified charity one that is capable of enforcing the conservation easement. Many qualified charities dedicated to protecting the environment and preserving open spaces are capable of receiving this type of gift, but the Washington Home is not among them.

A gift or bequest of a remainder interest in a personal residence or farm is deductible to the extent of the present value of the remainder interest. The residence or farm need not be a principal residence, and the remainder interest gift may be a portion of the remainder. Example 2: Charles and Alice own a home in Washington D.C. in which they reside. The residence has a current fair market value of $1 million. Charles and Alice make a gift to the Washington Home of a 50% remainder interest following the death of the survivor of them. Based on their remaining life expectancies and the applicable discount rate prescribed by the Treasury Department for valuing term and remainder interests for the month in which the gift is made, the present value of the remainder is $250,000. Charles and Alice will be allowed an income tax deduction of $250,000. Charles and Alice will continue to enjoy the rent-free use of the residence for their lifetimes. Upon the death of the survivor of them, the Washington Home will become the owner of a 50% interest in the residence.

The calculation of the deduction for a gift of a remainder interest is complicated. The value of the gift must be apportioned between the land and improvements and the deduction for the portion of the gift attributable to the improvements is subject to an adjustment for depreciation. IRS Publications 1457 and 1459 explain how to do this.

A gift or bequest to charity may be made subject to the charity's obligation to pay an annuity to the donor or another individual. (The person to whom the annuity is payable is referred to as the 'annuitant.') This is referred to as a 'gift annuity.' The annuity obligation is a general obligation of the charity and not secured by any asset. Therefore, a donor should take care that the charity has the resources to fulfill the annuity obligation. The Washington Home has an endowment of $____________ and an annual income of $____________, which provides support for gift annuities. Currently, the Washington Home has gift annuity obligations of $________ per year.

The deduction allowed for a gift annuity is the 'gift element' of the transaction the excess of the fair market value of the property conveyed to the charity over the present value of the annuity. The present value of the annuity is a function of the term of the annuity (which could be a term of years or the annuitant's remaining life expectancy) and the discount rate prescribed by the Treasury Department for the month in which the gift is made. The gift element must be at least 10%. The American Council on Gift Annuities publishes suggested gift annuity rates for single life and two lives, joint and survivor annuities.

The annuitant receives payments that partially represent a tax-free return of capital, partly interest and, if the fair market value of the property conveyed to charity in exchange for the annuity exceeds the donor's basis in the property, then a portion of each annuity payment will represent gain. However, if the property conveyed in exchange for the annuity is subject to debt, the donor will be treated as if he or she received a cash payment equal to the debt in the year the property is conveyed in exchange for the gift annuity.

A gift or bequest of a remainder interest can be made in trust as well as outright. A trust that gives charity a remainder interest will be deductible only if it is a gift to one of the following: (1) a pooled income fund; (2) a charitable remainder annuity trust; or (3) a charitable remainder unitrust.

A pooled income fund is a fund sponsored by a charity that pools contributions from many donors and pays the donors the income earned by the fund, excluding capital gains. Upon the donor's death, the balance of the donor's contribution belongs to the charity. A pooled income fund is an efficient way to make remainder interest gifts of smaller amounts.

A charitable remainder annuity trust is a trust funded by the donor that pays a fixed annuity amount each year to one or more individuals for a specified term of years or for the lifetimes of the payees. When the term interests expire, the remainder belongs to charity. The annuity must equal at least 5% and not more than 50% of the value of the assets conveyed to the trust and the present value of the charity's interest must be at least 10% of the value of the assets conveyed to the trust.

A charitable remainder unitrust is similar to a charitable remainder unitrust except that the amount payable to the holder of the term interest varies with the value of the trust. The annuity amount is not a fixed amount, but rather a fixed percentage of the value of the trust revalued each year. Thus, an annual revaluation of assets is required, which is not a problem if the assets are marketable securities. A charitable remainder unitrust is more flexible than a charitable remainder annuity trust because it can receive subsequent additions, which is not allowed for a charitable remainder annuity trust.

In addition, the trust may cap distributions to the term interest holder to the amount of income earned by the trust. The trust may provide for a make-up distribution to the holder of the term interest if and when income earned in a subsequent year exceeds the unitrust amount. Finally, the unitrust may provide that after the happening of an event the cap on distributions to the term interest holder will cease to apply.

One of the benefits of these three split interest trusts is that they generally are not subject to income tax. Thus, a charitable remainder trust is sometimes recommended as a tax-efficient way to diversify out of a single stock investment. The trust may sell the stock contributed to the trust without incurring capital gains tax. The distributions to the term interest holder are taxable to the extent they are deemed to consist of income earned by the trust. Ordinary income is deemed distributed first. Income earned on the reinvestment of the proceeds from the sale of the stock contributed to the trust is deemed distributed first, and if the distributions never exceed such income, the gains would never be taxed.

Current economic conditions are not favorable for gifts of remainder interests. Falling values, low capital gains tax rates and low interest rates all make the tax advantages of a gift of a remainder less desirable. However, the flip side of a charitable gift of a remainder interest is a charitable gift of a lead interest, and economic conditions are very favorable to charitable gifts of a lead interest.

A charitable lead annuity trust is a trust that pays a fixed amount to charity each year either for a term of years or for the lifetime of one or more persons and gifts the remainder to one or more persons. A charitable lead unitrust is a trust that pays a fixed percentage of the value of the trust assets to charity each year for a term of years or for the lifetime of one or more persons and gifts the remainder to one or more persons. A charitable lead trust is an effective way to benefit charity and pass wealth to your descendants without incurring gift or estate tax. Because values are now depressed and because the Treasury tables used to value the gift of the remainder assume low interest rates, there is a better than usual chance that the remainder beneficiaries will receive value that has not been subjected to gift or estate tax.

Example 3: Carley funds a charitable lead annuity trust with a portion of her stock portfolio worth $1,000,000. At the time of the gift, the interest rate that is required to be used to value the lead and remainder interests is only 2%. If the trust pays charity $61,156.85 for 20 years, and the trust earns 8% (rather than the 2% assumed by the prescribed interest rate), at the end of 20 years the remainder interest passing to Carley's children will be worth $1,862,300 even though the taxable gift on funding will be zero. The taxable gift on funding will be zero because, at the assumption of a 2% yield, nothing will be left after the charity's interest expires.

The annuity amount or unitrust percentage payable to charity need not be as much as 5% and may vary from year to year, as long as the amount or percentage is fixed in the trust instrument. Thus, the return to the remainder beneficiaries may be enhanced by end-loading the payments to charity that is, by making the payments in the earlier years smaller and the payments in the later years greater. This gives the trust more funds on which to earn a yield higher than 2%. Example 4: Assume the same facts as in example 3 except that the annual payments increase by 30% per year. At the end of the charity's interest, the amount expected to be available to Carley's children, assuming an 8% return, is $2,624,070.

A charitable lead trust is not tax exempt. The charitable lead trust may be structured to be a grantor trust or a nongrantor trust. A grantor trust is a trust that is treated as owned by and taxable to the grantor for income tax purposes. If the trust is a grantor trust, then the grantor is allowed to deduct the present value of the lead interest given to charity. In examples 3and 4 above, if the charitable lead trust is a grantor trust, Carley could deduct $1 million in the year she funds the trust. However, the quid pro quo for this is that Carley must pay tax on the income accruing to the trust for the next 20 years and she will not get another deduction for the amount given to charity each year when the lead interest is paid. In addition, if Carley dies before the 20 year term expires, some of her charitable contribution deduction is recaptured. However, there are circumstances where this trade off is wise, such as where the donor is in a higher income tax bracket in the year of the gift. In addition, the donor's payment of income tax on income accumulated in the trust enhances the value to the remainder beneficiaries.

The other alternative is to structure the trust as a nongrantor trust. In this case, the donor does not deduct the value of the gift to the trust, but is entitled to exclude from income the income accruing to the trust. The trust is a separate taxpayer. The trust is allowed to deduct the lead payments made to charity in computing its taxable income. Unlike the charitable deduction allowed for individual taxpayers, a trust may deduct all of the lead payments made to charity. Thus, a nongrantor charitable lead trust is tax efficient for philanthropists who give more than their contribution limits to charity and for high income donors who have their charitable contributions cut back under the overall limitation on deductions previously discussed.

Whether the lead trust is a grantor trust or a nongrantor trust, it should be structured to avoid being included in the donor's estate upon his or her death. This means that the donor should not retain the power to select the recipients of the lead payments, although the donor may give this right to another person.

Charitable lead trusts, particularly charitable lead annuity trusts, are very effective for minimizing gift and estate tax in this low interest rate environment. Unfortunately, these trusts are not as helpful for minimizing a third transfer tax the generation-skipping transfer tax. This is a tax that is imposed when a gift is made to persons who are more than one generation younger than the donor, such as grandchildren. Without careful planning, the assets may avoid gift and estate tax only to be subject to generation-skipping transfer tax when the lead interest ends.

Charitable lead and remainder trusts are subject to a complicated set of rules. However, compliance is made somewhat simpler because the IRS has published sample language for such trusts.

The Charitable Gifts Department of the Washington Home stands ready to assist you along with your regular tax advisors, in structuring the plan for giving that best suits your goals and circumstances.