Charitable and Marital Deductions

Introduction

The discussion covers charitable and marital deductions in estate planning.
The goal is to determine what items get shared and deducted.
Charitable deductions are found in section $2055$ .

Charitable Deductions - Section 2055

The estate gets a deduction for transfers to a charity.
A charity includes:
- The United States or any political sector (e.g., city or county).
- An entity organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, not disqualified by influencing legislation or participating in political campaigns. This is a 501(c)(3) entity, which is a state nonprofit entity organized and operated for religious, charitable, educational purposes.

2055(c) - Death Tax Payable Out of Bequest

If estate or death taxes are paid from the charity's bequest, it creates a circular computation.
The tax increases with the bequest, and the amount the charity receives is uncertain.
It's important to state this correctly: The tax increases the bequest.

Importance of Critical Thinking

A cautionary tale about relying solely on AI (like ChatGPT) for legal advice.
An example where AI cited irrelevant cases (Social Security and child care deductions) for a charitable deduction question.
The need to verify AI-generated content and rely on personal knowledge.

Split Interest Trusts

No charitable deduction is allowed for split interest trusts (charity and non-charity in the same trust).
These include charitable remainder annuity trusts (CRATs), charitable remainder unitrusts (CRUTs), and pooled income funds.
Definitions of charity can vary across estate tax, income tax, and gift tax.

Examples and Rules

Example 1: "The entire residue of this estate is to be distributed to such charities as his executors shall decide."
- Not qualified for charitable deduction unless it's a bona fide charity.
- State law may have a savings clause requiring executors to choose recognized charities.
Settlement Case: If it has to be a bona fide charity, state law determines.
Example 2: "The entire residue of his estate is to go to his son with the request that the son makes such charitable gifts as the son, in his sole discretion, deems advised."
- Does not qualify because the bequest goes to the son, not directly to a charity.
Example 3: "Will provides the rest of the state to go to the Western Center and State. It cannot be determined at the present time."
- Focus on when the determination is made (at the time of death).
- If the charity is disqualified at the time of death, it does not qualify.
Example 4: "The residue goes to the California State Bar Association."
- Not a charity; it's a trade organization (union); no charitable deduction.

Split Interest Trusts Revisited

Example 5: H transfers $1 million$ to G in trust; income to son for life; remainder to appointees under a general power of appointment; in default, to USC (tax-exempt).
- If the son doesn't exercise the power, does it qualify for the charitable deduction?

Practical Issues with Trusts

In past scenarios, charities received nothing due to the invasion of the principal for the son's benefit.

Charitable Remainder Annuity Trust (CRAT)

A fixed dollar amount per year (e.g., $100,000$ ).
No invasion of the principal.
Remainder goes to USC.
The charitable deduction is allowed because the amount going to charity can be mathematically determined.
- Example:
  - Trust: $30 million$
  - Annuity: $100,000$ per year
  - Life Expectancy: 40 years
  - 100,000 * 40 = $4,000,000
  - $30 million - $4 million = $26 million (to charity)

Charitable Remainder Unitrust (CRUT)

Fixed percentage (e.g., 5% of the fair market value of the trust on January 1st each year).
- Year 1: Trust is worth $30 million$ , son gets $1.5 million$ (5%).
- Year 2: Trust is worth $20 million$ , son gets $1 million$ .*
- There must be no invasion of principal.
Provides assurance that the charity will receive money.

Pooled Income Fund

Similar to a mutual fund run by USC.
USC pools all donors' money, invests it, and each donor gets a percentage based on their contribution.

Charitable Lead Trust (CLAT)

Income goes to charity (e.g., USC) for a set period (e.g., 30 years), remainder to the son.
No invasion of the principal for the son.
Qualifies for the charitable deduction based on the present value.
Can be a fixed dollar amount (annuity) or a fixed percentage.

Revisiting Example 10b

H transfers money to a trust; income to the son for life; son has a power of appointment; in default, it goes to USC.
Charitable deduction for the father? No, because the son has a general power of appointment.
When the son dies, the assets are included in his estate due to the general power of appointment.
Because it goes to USC, the son's estate gets a charitable deduction.

Gift Tax Considerations

If the transfer was made during lifetime, it's a gift tax issue.
If deemed a lifetime transfer of capital stock to a qualified charity reserving income for life, the stock is included in his estate under section 2036.
- There is a charitable deduction because it goes to USC.

Is This a Split Interest Trust?

Goes to charity for 20 years, then the remainder to the sons; the "income" part is misleading.
It has to be a fixed dollar amount (annuity) or a fixed percentage of fair market value each year.
If the charity receives $20,000$ a year out of income, but if there's not enough income, it's paid from the principal, it qualifies.

Net Income Only Unit Trust

The person is to get 6% a year, but if the income is less than 6%, it would be limited to the income; if more than 6% in the future, that amount can be made up.
A private foundation is okay.

Splitting the Remainder

If the remainder is split equally between USC and the nephew, split it into two trusts.
One trust qualifies, one does not.

Example E: Conditional Gift

The will gives $500,000$ to USC on the condition that USC pays $4,000$ a year to the son for life.
This is called an old-fashioned gift annuity, and it qualifies for a charitable deduction.

Example F: Disclaimer

The will creates a trust income to the son for life, remainder to USC.
The son disclaims six months after the death; it's treated as if it never touched the son's hands, and the whole thing qualifies.

Example G: Selling and Giving

H wants to sell stock to a closely held company; instead, he distributes it to a CRUT, and the trust sells it.
Best to do this before any contract selling the company.

Other Charitable Considerations

The trustee cannot be required to invest in tax-exempt funds.
The grandmother makes a will for $1 million$ to USC, unconditionally paying $50,000$ a year to the son for life.
Use actuarial tables unless the person is known to be affected at the time of transfer with an incurable illness, and there is a 50% probability of death within one year.

Important Cases

ARC Dash 24: Stock was valued at a certain amount, but the charitable deduction was less when it went to charity.
Ted Dash 24: 600 shares of stock were held in trust, and non-voting shares were given to charity, resulting in a discounted charitable deduction.

Marital Deduction

History

Prior to the law change in 1982, the marital deduction was only one half of the husband's separate property.
Post-1982, there is an unlimited marital deduction.

General Rules

The marital deduction has to be property which passes 100% from husband (H) to wife (W) under the theory that H and W are one economic unit.
If it goes outright to W, it qualifies for the marital deduction, and tax is deferred until the wife dies.
If in a trust for the wife, it will not qualify unless you make a Q-Tip election (meaning wife is treated as the owner, gets income for life, and wife is the only beneficiary).
If the surviving spouse is not a U.S. citizen, there is no marital deduction, but you can have a Q-Dot (Qualified Domestic Trust), which looks like a Q-Tip, but you'd have to have a U.S. trustee.

Examples

Example: Insurance

W is the sole beneficiary of a $100,000$ policy on H's life, under the will W receives $1 million$ ; she disclaims the bequest; the life insurance policy is directed to all proceeds payable to trust for her life, principal to the son at death. Does either qualify for the marital deduction?
If she disclaims, it doesn't qualify because it's treated as not going to her.

Example Disclaimer

A bequest is to the son, and he disclaims, and it goes into residue; that qualifies for the marital deduction.
The will said “I leave it to my son; if not to my daughter”; the son cannot direct to the mother; it goes as if he was deceased to the daughter.

Unified Credit Trust Example

A will states “I give all of my estate to you less than equal to the unified credit or bypass or credit shelter trust”. Values established for federal and state tax purposes. Blackacre 1 million and Whiteacre 1 million as of date of death.
But Whiteacre went to 2 million at the time it was distributed, but blackacre went to 1 million.

Date of Death vs. Distribution Values

There is a read from 6419 which says that you have to compute marital deduction based on the date of death values.
You have to have language in the trust or will that says the date of distribution has a minimum value of not less than the value computed in the state.
You can't say you want to bet. The will has to choose one or the other.

Family Situations

Happy family situation – you use the minimum value so you can put $1 million$ in the bypass trust when it's really worth $2 million$ .
Unhappy family situation – you want to do 50% of this asset and 50% of that asset going into bypass trusts using exact property to see if that makes any sense at all.

Example 11 GS

A 41 million dollar estate leaves 1 million to a son; it leaves the other half to the wife and nephew; computes marital deduction as well as all state and federal taxes to be paid from the residue.

Goal: The wife and nephew should each get 1/2 after the taxes.

The Circular Computation for Estate Taxes

Want you to see how it does that: circular, which increases, increases, increases, that it is in itself.
What happens in Step 1: 20 million to wife; 20 million to each gross estate is 41; take out a marital deduction of 20 and its taxable estate becomes 21. 40% of that is 8.4 million federal state tax charge to ½ to the wife is the residual beneficiary will have to be will be said in there; marital deduction equalize deduction is limited that of wife guess.

Step 2

Gross estate is 41 million, and your marital deduction is it not 20 million, it's 20-4.2 million because she's getting charged with it; so marital deduction is 15.8 million, and you take 41-15.8 million as the marital deduction; then you get 28.2 as a to to that, right; you know you should be able to get it with it; 25.2 to that right… You multiply by . What are those charges 40%. 40% means to save a federal state tax is breaks have; that’s because the 5.4 trillion. What you getting at; show it works or not again! You can put that any spreadsheet! We are doing exactly and getting get up Zero or will take that for you.