In PLR 200152018, a donor requested a ruling on converting the income interest from a charitable remainder unitrust into a charitable gift annuity. The PLR had four specific requests. First, that the donor would receive an income tax deduction for a portion of the value of the income stream transferred to charity for the gift annuity. Second, that there would be a charitable gift tax deduction for the same portion. Third, that the transfer of the unitrust income interest for a gift annuity would not accelerate underlying capital gain in the income interest. Finally, that the percentage of capital gain and basis as of the date of creation of the trust could be utilized for calculating the tax-free portion of the gift annuity payouts.
In the ruling, the IRS found that there was an income tax deduction allowable for the present value of the remainder interest in the charitable gift annuity. It also found that there would similarly be a gift tax deduction and the transfer of the unitrust income interest in exchange for the gift annuity would not accelerate the underlying capital gain. On the last issue, the IRS found that a prorated basis would not be allowed and all payouts to the annuitant would be ordinary income and capital gain.
Reason 1: Donor Had a High Payout Standard Unitrust
There are several reasons why a donor may choose to convert his or her income interest in a charitable remainder unitrust to a gift annuity. If a donor established a unitrust years ago when it was more common to chose a high payout unitrust, the donor may now find that there is little or no growth in that unitrust. The donor may wish that he or she had chosen a lower 5% or 6% payout. Currently there is no authority, not even a PLR, that authorizes a donor to reduce the payout on an existing charitable remainder trust.
If the donor "rolls" over his or her income interest in the charitable remainder trust into a charitable gift annuity, he or she is effectively achieving the goal of reducing the annual payout from the charitable gift.
Example: Unitrust to Gift Annuity
Betty Barker, age 75, established a charitable remainder unitrust with a standard 10% quarterly payout in 2005. With the market performance over the last several years, Betty's unitrust value and her unitrust distributions have been decreasing. The unitrust that was originally funded with $500,000 is now valued at $350,000. Betty is currently living on a fixed income and would like to be certain that she will receive a minimum amount of income every year. Further, Betty is very charitable and she would like to ensure that her favorite charity receives a certain amount of the remainder. Upon speaking with her advisor, Betty is considering rolling over her unitrust income interest into a charitable gift annuity. To find the value of Betty's income interest in the charitable remainder unitrust, Betty's advisor would need to run a new one-life unitrust calculation using Betty's current age of 75.
To perform the calculation Betty's advisor will need to know her age, the appropriate AFR, the current value of the unitrust as of the date Betty will do the conversion, the payment frequency and the existing unitrust payout percent. When choosing the AFR, because a charitable deduction is allowable, the advisor may choose from the current month or one of the two prior months. Using the lowest rate of the month allowable will increase the present value of Betty's unitrust income interest. Betty's cost basis in the unitrust is unimportant for the calculation because Betty is rolling over her income interest in the unitrust, which is deemed a capital asset with a zero cost basis.
If Betty's advisor runs the calculation using a 3.2% AFR, the value of Betty's income interest is $212,625. This is the value that the advisor would now use as the "funding" amount for running the gift annuity calculation.
Reason 2: Donor Wishes to Make a Current Gift
Another reason a donor may choose to "rollover" a unitrust into a charitable gift annuity is to turn the deferred gift into a current gift to the charity. When the donor decides to utilize the unitrust rollover to the gift annuity, the existing unitrust is collapsed and the charity is entitled to receive the value of the calculated remainder interest at the time of the rollover. It is important to remember, however, that the donor is not entitled to a deduction for the value of the remainder interest. This is because the donor gifted the value of the remainder interest when the unitrust was first established and, thus, has already taken a charitable deduction for that value.
Example: Unitrust Current Gift
In the Betty Barker example above, when Betty chooses to roll over her unitrust into a charitable gift annuity, Betty is exchanging all income rights in the unitrust for the gift annuity. After this is accomplished, the charity will own both the income and the remainder interests and the unitrust will be collapsed. This will allow the charity access to the value of the present value of the remainder interest. In Betty's case the present value of the remainder interest is equal to the fair market value on the date of the conversion minus Betty's income interest value. Using the numbers from the prior example, the value of the remainder interest is $350,000 - $212,625. Thus, the charity has access to the $137,375 value of the remainder interest immediately. In doing the conversion, Betty has used her deferred gift to make a current gift to the charity.
Reason 3: Donor Would Like an Additional Charitable Deduction
In the prior reason for converting a CRT to a CGA, it was noted that the donor is not entitled to a charitable deduction for the present value of the remainder interest in the charitable remainder trust that is being rolled over into the gift annuity. However, when the gift annuity is created from the unitrust, the donor is entitled to a deduction for the newly created gift annuity.
Example: Unitrust Extra Deduction
Continuing with the Betty Barker example, Betty's present value in the income interest from the unitrust was calculated to be $212,625. This will be the funding amount for the charitable gift annuity. Given Betty's age of 75, the ACGA rate on the new gift annuity will be 6.3%. If Betty's gift annuity is to payout quarterly using a 3.2% AFR, her new charitable deduction will be $93,896.21. Remember that Betty's gift annuity will have a zero cost basis and, thus, her payout from the gift annuity will be all ordinary income and capital gain. However, given Betty's age, over 71% of her payout will be capital gain.
Reason 4: Donor Wishes to Get Off The Stock Market Roller Coaster
Over the last few years the stock market has been just like a roller coaster. It has gone up and down, up and down. Many senior donors were first delighted at the idea that the unitrust could produce an increased income stream if the trust principal grew. However, after retiring they are no longer sure they want to risk the market fluctuations and would now be happy with a fixed income steam. By converting an existing unitrust income interest to a charitable gift annuity, donors are able to receive a fixed payment every year. It is important to remember, however, then when a donor converts a unitrust into a gift annuity, the gift annuity payout will not be based on the full fair market value of the unitrust at the time of the conversion, but rather the smaller income interest value. In some states, it may be possible, however, to pay higher than the recommended ACGA gift annuity rates. If the charity is willing to offer a higher rate, it should first check to see that it is not violating any state regulations by offering the higher rate. Offering a higher rate may allow the payout to the donor to be closer to the unitrust payout the donor was previously receiving. Another issue to remember is that in order to have a qualified gift annuity under the IRC, the deduction for the new gift annuity must at least be 10% of the gift annuity funding amount.
Example: UT to Gift Annuity
When Betty Barker converts her standard unitrust income interest into a charitable gift annuity the ACGA recommended rate is 6.3%. However, neither the charity nor the donor resides in a state that restricts the gift annuity rates the charity can offer. Given Betty's age of 75 and all the prior assumptions, the charity is able to offer Betty a rate of 10.14%. With a gift annuity funding amount of 212,625, Betty is able to receive an annual payout of $21,560.20. Further, because the gift annuity is backed by all of the charity's assets, Betty is almost certain to receive that fixed amount for the rest of her life.
Reason 5: Donor Had a NIMCRUT That Was Invested in a Commercial Annuity
The fifth reason a donor may convert a unitrust into a charitable gift annuity is because the unitrust was established as a Type II or NIMCRUT and the trust assets were invested in a commercial annuity as an easy way to control income. The problem with these types of trusts is if the commercial annuity has gone down in value, the donor may not be able to receive any distribution from the trust until the commercial annuity has increased in value to make up for the losses. That is because the trust language reads, "Pay the lesser of net income or the unitrust amount." In trust accounting, ordinary losses must be netted with ordinary gains. Therefore, in order for a NIMCRUT to make a distribution in the current scenario the commercial annuity not only has to make up for the prior losses, but also has to produce income on top of that in order for the trust to make a distribution. Due to those limitations, it is unlikely that the donor will receive a distribution from the trust in the near future. By rolling over the NIMCRUT into a charitable gift annuity, the donor can start to receive distributions from the gift annuity in the year of the rollover and every year thereafter for the rest of his or her life.
Example: UT Commercial Annuity
If Betty Barker's charitable remainder unitrust in the first example had been established as a NIMCRUT and the trust had been invested in a commercial annuity that lost value, Betty would currently not be receiving any distributions from the trust. However, with a NIMCRUT the value of the income interest is calculated using the lesser of the unitrust payout percent or the AFR. With a 3.2% AFR, the value of the income interest is much lower and Betty may hesitate to complete the rollover. However, since the unitrust is not making current payments, she may still decide to rollover to a gift annuity.
There are many more reasons why a donor may choose to roll over an existing unitrust into a charitable gift annuity. The five listed above are the more common reasons why a donor may choose to do the rollover. Generally, if a donor is unhappy with an existing unitrust for any of the above given reasons, rolling over the unitrust to a gift annuity may make the donor a happier person and provide a substantial current gift to the charity.
