Posts Tagged charitable trusts
Despite the estate tax reprieve, IRS records show steady creation of charitable remainder trusts, and experts expect a CRT boom ahead.
People who work with non-profit groups scoff at the idea that the rollback of federal estate tax fears is making wealthy families rethink their wills.
“I don’t think we should get overly exercised about the estate tax,” fundraising consultant Phil Murphy told me awhile back.
“While it does matter to Bill Gates, the estate tax never played a major role in most people’s philanthropic decisions anyway. It shouldn’t even be a consideration.”
As a result, Murphy says, charities he works with find it frustrating that Congress has yet to clarify the long-term future of the estate tax, but they aren’t hurting for bequests either.
According to philanthropic consultant Robert Sharpe, planned giving programs are doing record business for plenty of universities, hospitals and other non-profits. “
When people are worried about the future, religious-based causes actually do better,” he told me. “Food banks do better; arts do worse.”
While New York attorney Martin Shenkman has seen the role of charitable bequests in many estate plans decline over the years, it’s been less of a sudden crisis and more of a slow decade-long slide as the amount of assets exempt from the estate tax climbed from $650,000 in 2000 to $3.5 million last year.
“The histrionics were about ten years too late,” he told me.
“There are very few families left out there for whom this would make any difference, and I have a feeling they’re not letting it affect their charitable donations. Besides, nobody really believes the tax has been repealed forever.”
IRS statistics confirm that estate tax policy hasn’t made much of a dent in philanthropic activity.
Factoring out extremely wealthy families with $20 million or more, only about 20% to 25% of all the estates that paid estate tax between 2001 and 2007 — when estate tax exemptions were on the rise and overall rates were falling — also made charitable bequests.
While this represented a “slight downward trend,” it wasn’t exactly a jump off a cliff.
The “Comfort Food” of Planned Giving
Shenkman says everybody he talks to is a lot more worried about Congress raising income tax rates down the road.
If that happens, he wouldn’t be surprised to see charitable remainder trusts—which let people give money or appreciated property and get both an income stream and a tax deduction—start making headlines. “
As income tax rates start to go up, they become enticing again,” he told me.
He’s not alone. Springfield, Illinois estate planner Vaughn Henry also suspects charitable remainder trusts will be back “with a vengeance” next year, but as far as he’s concerned, the main sizzle isn’t the one-time income tax deduction but the way these trusts (and the income they throw off) ignore capital gains.
However, Henry isn’t really a fan of exaggerating the tax advantages of these trusts or any other philanthropic instrument.
“There’s not much point on selling somebody on doing something for pure tax reasons,” he explained.
“You cannot make money giving money away, and so people have to understand that they’re ultimately giving something away. The tax benefits are at best a sweetener.”
Still, as far as “sweeteners” go, Henry adds, the income stream that charitable remainder trusts—and their cousins, charitable gift annuities—provide make them pretty attractive to middle-market donors who have the money to spare but still want the added income while they’re alive.
Robert Sharpe agrees that the real appeal here is to people who probably haven’t been worrying about the estate tax anyway, especially in a volatile economic environment.
“Five years ago, these are people who might’ve made an outright gift to charity, but now they’re a little more worried about the future,” he told me.
“In difficult times, the average wealth level of people who do charitable remainder trusts goes up.”
There are people out there who recommend grantor retained annuity trusts instead, but Vaughn Henry says that’s mostly talk at this point. In any event, charitable trusts are already a robust business.
According to the IRS, the number of charitable trusts expanded 37% between 1999 and 2008, the most recent year for which data are available.
Most of that growth was at the lower end of the market; as of 2008, 69% of these trusts were worth under $500,000, and only 15% of them contained over $1 million in assets.
The income stream is why fundraising coach Phil Murphy calls these philanthropic vehicles “the comfort food of planned giving.”
He says some of his non-profit clients are actively courting them, but warns that a donor who’s counting on making a big posthumous gift can still deplete the trust if he or she lives a long time or picks an aggressive return rate, leaving the charity with nothing.
“There’s really really no guarantee that the trust won’t end up cannibalizing itself,” he explained. “There’s nothing wrong with them, but if the payment rate is too high, they can come back to bite the donor like the creature in Alien.”
Scott Martin, senior editor, The Trust Advisor. Steven Maimes contributed to the research and editing.
Even though the number of fiduciary returns declined during the recession, the number of audits surged. A field visit can easily cost a trust an extra $221,000 and a good-sized estate $800,000.
The Internal Revenue Service learned last year that it can basically soak up free money by sending a field agent out to examine a trust or estate’s records, and it has no incentive to go easy on fiduciaries this year.
Audits on estate tax returns filed for the 2009 fiscal year translated into an extra $1.65 billion for a cash-hungry federal government, according to recent IRS numbers crunched by Bernard Garbo and the staff of Trust Regulatory News.
That’s about 9 times what the IRS recovered from all individuals, trusts and corporations put together, Garbo says.
“Overall, obviously, the government needs revenue, and people may be checking more closely in the areas where they know they can get it,” he explains.
And in the face of last year’s estate tax holiday, those auditors may redouble their efforts to squeeze that revenue out of irrevocable life insurance trusts, charitable trusts — whatever they can find.
Trusts and estates file Form 1041 on their income, whereas taxable estates have to file Form 706 as well.
Although only 1 in 800 Form 1041 returns were singled out for special attention in 2007, that audit rate soared 40% over the last few years.
This year, the IRS staff who used to comb through Form 706 returns will have a lot more time on their hands — and a roughly $1.4 billion hole in their productivity to fill.
The game of auditor roulette just got more dangerous
The IRS has yet another motive to lavish special care on every Form 1041 return it receives: there are a lot fewer of them out there than there were even a few years ago.
In 2007, trusts and estates filed 3.9 million 1041 forms, but by last year, that number had dropped to 3.1 million.
Nobody seems to know why.
“It may very well be that this is due to the recession,” says Sonja Pippin, a taxation professor at the University of Nevada – Reno.
“The threshold for filing is quite low, but I guess it is possible that some trusts and estates did not have enough gross income and no taxable income,” she adds.
Still, 2.4 million of all fiduciary returns filed in 2009 had no taxable income — their trustees submitted the paperwork even though they didn’t have to — and close to 1 million reported no income at all.
All Bernard Garbo knows is that while the number of 1041 filings was dropping 20%, the number of audits jumped 15%.
“They are obviously checking the ones they have closer,” he says.
If that trend continues, it would be an ominous echo of what happened with estate tax audits over the last decade.
The number of Form 706 returns the IRS got plunged from 108,000 to 38,000 between 2001 and 2007, which makes sense as the exemption climbed and fewer and fewer estates were taxable.
But over that period, the number of estate tax audits soared. By 2009, IRS examiners were looking at a full 10% of estate tax returns — and those were all in-depth field audits that required an on-site interview.
Trusts tended to get postal or “correspondence” audits, at least in part because these long-distance reviews cost the IRS less and rarely recover quite so much lost tax revenue.
Field audits can be lethal. The vast majority (85%) of estate and fiduciary returns that get an on-site visit contain substantial enough errors to cost a big estate $800,000 and the average trust $221,000 in unpaid tax, Garbo says.
“As one might expect, they find more errors that way than someone just looking over the numbers somewhere might find,” he explains.
Red flags remain mysterious
The IRS continues to keep its audit triggers under tight wraps in order to keep preparers from gaming the system.
As a result, trustees who prepare 1041 returns may simply have to resign themselves to a greater possibility that their math will be checked more carefully this year.
“The amount examiners have been finding has been increasing and the average change per return has been increasing,” Garbo says.
Sonja Pippin agrees that the risk of an audit simply increases with higher income, and so the bigger the trust — or the wealthier the beneficiaries — the more likely it (and your clients) will be to trigger IRS attention.
“The relatively high revenue capture seems to be a factor,” she says.
“They have started a program of matching the information on returns to uncover pass-through income that is not reported.”
So if the audit can come out of the blue, the key is to minimize errors that can cost a trust hundreds of thousands of dollars.
Even professional preparers can mismatch names and even fiscal years on complex 1041 returns, especially when multiple K-1 schedules are in play, Pippin says.
Scott Martin, contributing editor, The Trust Advisor Blog. Jerry Cooper and Steve Maimes contributed to the editing and research.