MAXIMIZING CHARITABLE GIFTING IN TIMES OF LOW INTEREST RATES

By Diane Kuhn Huff

  Two types of charitable gifts use interest rates to determine the value of the charitable gift.  Those charitable gifts are Charitable Remainder Annuity Trusts and Charitable Lead Annuity Trusts. 

A Charitable Remainder Annuity Trust (also called a "CRAT") is an irrevocable trust where the donor receives an annuity payment for either the donor's lifetime or for a specified term of years. A charity receives the remainder of the trust after the annuity payments end.  A Charitable Lead Annuity Trust (also called a "CLAT") is an irrevocable trust where the charity receives the annuity payment and the remainder beneficiaries (usually children or grandchildren) receive the remainder of the trust after the annuity payments end.

Income Tax Benefits.  In both trusts, the donor receives an income tax deduction in the year he or she transfers assets to the CRAT or CLAT.  The value of the income tax deduction is determined by calculating the present value of the charity's interest.  In a CRAT, the deduction is the current value of the remainder interest.  In a CLAT, the deduction is the current value of all annuity payments.  Government regulations state the interest rate used to calculate the deduction and this interest rate is known as the "Charitable Federal Midterm Rate" or "Section 7520 Rate", named for section 7520 of the Internal Revenue Code. As expected, the 7520 rate changes with the prevailing interest rates. 

Examples.  Lets compare the charitable deduction allowed on a Charitable Remainder Annuity Trust using different 7520 rates.  Both CRATs are similarly structured as follows:

            Trust term:  15 years

            Amount transferred to Trust:            $100,000

            Anticipated growth of assets:  6%

            Percentage payout:  5%

            Annual annuity payment to donor:  $5,000

            Total annuity payments to donor:  $75,000

            Value of trust at end of 15 years given to charity:  $123,276

  In March 2003 when the 7520 rate is 3.8%, the present value of all annuity payments to the donor is calculated to be $56,377.50.  Therefore, the charitable deduction is $43,622.50.

In December 1989 when the 7520 rate was 11.6%, the present value of all annuity payments to the donor was $34,794.50.  Therefore, the charitable deduction was $65,205.50.

The charitable deduction varies even though the donor receives the same annuity payment each year and for the same 15 years.  The charitable deduction varies even though the charity receives the same remainder amount of $123,276 (assuming the trust grows 6% each year).  However, the income tax deduction varies with the prevailing 7520 rate.  As you can see, the Charitable Remainder Annuity Trust is more attractive during times of higher interest rates.

Lets now compare the Charitable Lead Annuity Trust using different 7520 rates.  Again, both CLATs are similarly structured as follows:

            Trust term:  15 years

            Amount transferred to Trust:            $100,000

            Anticipated growth of assets:  6%

            Percentage payout:  5%

            Annual annuity payment to charity:  $5,000

            Total annuity payments to charity:  $75,000

            Value of trust at end of 15 years given to family:  $123,276

              In March 2003 when the 7520 rate is 3.8%, the present value of all the annuity payments to the charity is $56,377.50.  Therefore, the charitable deduction is $56,377.50.  The present value of the gift to the family members is $43,622.50.  The gift of $43,622.50 to the family is subject to gift tax, but if the trust grows annually by 6%, the family will receive $123,276.

            In December 1989 when the 7520 rate was 11.6%, the present value of all the annuity payments to the charity was $34,794.50.  Therefore, the charitable deduction was $34,794.50.  The present value of the gift to the family members was $65,204.50 (and subject to gift tax), even though they will receive $123,276 if the trust grows annually by 6%.

The charitable deduction varies even though the charity receives the same annuity  payment each year and for the same 15 years.  The charitable deduction varies even though the family members receive the same remainder amount of $123,276.  The amount of the taxable gift the donor must claim varies even though the family members will receive the same remainder amount of $123,276.  As you can see, the Charitable Lead Annuity Trust is more attractive during times of low interest rates. 

            Who can benefit from CRATs and CLATs.  Obviously, people who use CRATs and CLATs have a charitable intent.  CRATs and CLATs also benefit people with highly appreciated assets who want to minimize a large capital gain tax, business owners selling a business, fortunate people who win the lottery, or anyone else who wants a large income tax deduction, a stream of income to themselves or a charity, or a reduction in estate and gift taxes.  CRATs and CLATs can be established during the donor's lifetime or at death.

Certianly, there are other income and transfer tax consequences to CRATs and CLATs.  This article focuses solely on the relationship between the 7520 rate and initial income tax deduction.  If you want to explore whether a CRAT, CLAT or similar trust can benefit you, we urge you to discuss the issue with an attorney or tax advisor knowledgeable in charitable trusts.