About the American Council on Gift Annuities (formerly the Committee on Gift Annuities). ACGA, formed in 1927, is an IRC §501(c)(3) organization described in IRC §170(b)(1)(A)(vi). ACGA’s board of directors and its legal counsel are all unpaid volunteers. ACGA is sponsored by over 1200 social welfare charities, health organizations, environmental organizations, colleges, universities, religious organizations and other charities.

About the National Committee on Planned Giving. NCPG is an IRC §501(c)(3) organization described in IRC §170(b)(1)(A)(vi). Its board members are all unpaid volunteers. NCPG is an association for professionals in the charitable gift-planning field. Its members are: planned and major gifts officers for charities, fundraising consultants, attorneys, accountants, financial planners and donor advisors. NCPG has a network of more than 130 local planned giving councils that provide community-based education. NCPG represents over 10,000 individual and council members.

I have been asked by the American Council on Gift Annuities and the National Committee on Planned Giving to submit a statement for the hearing record on the topic of charitable lead trusts and do so as a volunteer.

An issue raised at the hearing was whether the use of charitable lead trusts presented the potential for estate tax abuse. Can the current method of computing the value of the charity’s lead interest (payment of an income stream typically for a number of years) result in the value of the charity’s interest being overstated and the value of the family members’ eventual remainder interest being understated? If a better way can be developed to compute the values of the charitable and noncharitable interests, we would strongly support it. We believe the current methodology is effective, but would welcome any improvement.

At the outset, we stress that ACGA and NCPG oppose any abusive use of the charitable deduction. In fact, our organizations have in the past called to the IRS’s attention an abusive use of the charitable remainder trust. That led to new rules thwarting the scheme.

Listen to the words of Clinton A. Schroeder, Esq., a past chair of ACGA, at the final session of ACGA’s national conference on April 4, 2008: “Those who betray the charitable trust besmirch all charitable organizations. It goes without saying, responsible charities should not participate in plans that even have the slightest aroma of impropriety. The charities should — together with their national organizations — take steps on their own and together with the federal and state authorities to stop improper and questionable practices.”

ACGA and NCPG are unaware of any abuses regarding charitable lead trusts. Perhaps some advertising has stated that with the current low interest rates, it is now an advantageous time to create charitable lead trusts.

Some background before discussing the valuation issue. I am the author of the five-volume treatise, Philanthropy and Taxation and one of those volumes is devoted exclusively to charitable lead trusts. I have been involved with these trusts in my law practice, in my writings and lectures since their inception under the Tax Reform Act of 1969.

When that Act was being developed, I conferred with Dr. Laurence N. Woodworth, the Chief of Staff of the Joint Committee on Taxation, on the provisions of the Tax Reform Act of 1969 that created charitable remainder unitrusts, charitable remainder annuity trusts, charitable lead annuity trusts and charitable lead unitrusts. Before passage of that act, charitable remainder and lead trusts provided for the actual income earned by the trust to be paid to the beneficiary.

The annuity amount and unitrust amount substitutes were designed to make the value of the charitable and noncharitable interests more reflective of the parties’ actual interests.

Quick history of the IRS’s interest assumptions:

Currently the IRC §7520 rate is extremely low — making the value of a charity’s lead interest in a charitable lead annuity trust worth more than it had been when the rates were higher.

A two-edged sword. The same tables make the value of the charitable remainder interest in a charitable remainder annuity trust smaller than it had been. Thus the tables cut both ways. In some instances, charitable lead annuity trusts are more beneficial from a tax point than they had been, but at the same time charitable remainder annuity trusts are less beneficial from a tax point than they had been. The overwhelming majority of split-interest charitable trusts are charitable remainder trusts, not charitable lead trusts.

Both charitable lead and charitable remainder trusts are created by donors who want to incorporate charitable giving in their estate plans. The tax benefits reduce the cost of generosity and in many cases result in a larger charitable gift than would otherwise be made. But without donative intent, both charitable lead trusts and charitable remainder trusts don’t make financial sense.

While it is true that it is now tax advantageous for an individual with donative intent to create an inter vivos charitable lead annuity trust, many charitable lead annuity trusts are in wills of living donors and those trusts will be created at the donor’s death. What the applicable mid-term federal rate will be at that time is unknown.

I submitted a statement for the record in connection with the November 14, 2007 Senate Finance Committee estate tax hearing at which I testified. I stated: “The remainder gift of the lead trust to family members is subject to the estate tax. Thus the changing estate tax exemption (and whether there will be an estate tax at the time the lead trust is created by an individual’s will) have created planning and drafting challenges.” Over 50 lawyers in my firm are involved in estate planning. We have found that it is the uncertainty of what the estate tax law will be — and not the valuation of the lead and remainder interests — that has been an issue for some clients in deciding whether to include a charitable lead trust in their plans.

The value of the charitable and noncharitable interests for both charitable remainder unitrusts and charitable lead unitrusts are not very sensitive to the changes in the applicable mid-term federal rate. Thus this statement deals solely with charitable lead and remainder annuity trusts.

Let’s do the numbers. Attachment “A” gives five examples of a $1 million charitable lead annuity trust paying $60,000 a year to charity for 15 years with the remainder to heirs at the end of the term. Three additional examples deal with charitable remainder annuity trusts. The examples have various assumed net returns on the trust assets and various applicable mid-term federal rates (AMFR).

Comments on the examples in Attachment “A”.

Regarding a Charitable Lead Annuity Trust:

1.     If the actual investment return equals the AMFR, the present value of what the donor’s heirs receive at the trust termination will be exactly the same as the taxable gift reported.

2.     If the actual investment return exceeds the AMFR, the present value of what the donor’s heirs receive at the trust termination will be larger than the taxable gift reported. This scenario would be advantageous to the donor.

3.     If the actual investment return is lower than the AMFR, the present value of what the donor’s heirs receive at the trust termination will be smaller than the taxable gift reported. This scenario would be to the disadvantage of the donor.

Regarding a Charitable Remainder Annuity Trust:

4.     If the actual investment return equals the AMFR, the present value of the distribution to the charity will be exactly the same as the charitable deduction.

5.     If the actual investment return exceeds the AMFR, the present value of the distribution to charity will be larger than the charitable deduction.

6.     If the actual investment return is lower than the AMFR, the present value of the distribution to charity will be smaller than the charitable deduction.

General:

7.     Actual returns in relationship to the AMFR cannot be known in advance. Sometimes the results will favor the individual beneficiaries; sometimes they will favor the charity. Over time the two should balance.

8.     When the AMFR is low, the charitable deduction from a charitable lead annuity trust will be higher. Conversely, the charitable deduction from a charitable remainder annuity trust will be lower when the AMFR is low. When the AMFR rises, these two investments are again affected in opposite ways. Again, over time the comparative advantages and disadvantages of a lower or higher AMFR tend to balance each other in these two types of trusts.

IRS guidance in 2007 and more to come in 2008 on charitable lead trusts. To our knowledge, the Internal Revenue Service does not deem charitable lead trusts to be abusive. Last year in Revenue Procedures 2007-45 and 2007-46, the Internal Revenue Service spelled out the rules for charitable lead annuity trusts — both inter vivos and testamentary. The revenue procedures provide specimen trusts with the assurance that charitable lead trusts that are “substantially similar” to the Service’s sample trusts (or properly integrate one or more of the IRS’s sample alternate provisions) will be qualified trusts and the donor will receive the applicable charitable deductions. The sample trusts, alternate provisions and annotations are a virtual course on charitable lead annuity trusts. Among other items, the revenue procedures cover computation of the estate and gift tax charitable deductions, taxation of excess income, the generationskipping transfer tax rules, prohibition against certain investments and rules for excess business holdings.

The IRS’s priority guidance plan for the period July 1, 2007 through June 30, 2008, states that the Service will issue a revenue procedure under IRC §2522 containing sample charitable lead unitrusts. Presumably, that revenue procedure will be fully annotated as are the already-issued revenue procedures for charitable lead annuity trusts. I don’t have statistics on this, but in my experience charitable lead annuity trusts are much more frequently used than are charitable lead unitrusts.

The only abusive use of the charitable lead trust of which we are aware was stopped by Treasury regulations in 2001 — the so-called ghoul lead trust. The Internal Revenue Service became aware of situations in which a small number of taxpayers attempted to take advantage of the regulations by using an unrelated individual’s measuring life, as the term of a charitable lead trust, to artificially inflate the charitable deduction. Taxpayers selected as a measuring life an individual who was seriously ill but not “terminally ill” within the meaning of the IRC §7520 regulations.

Those charitable lead trusts were marketed in a package that included the name of a seriously ill individual and access to the individual’s medical records. A token payment was made to the ill individual who would serve as a measuring life.

IRS acted on those appointment-in-Samarra trusts with regulations in 2001 that prevent taxpayers from using the life of a seriously ill individual to measure the term of a charitable lead trust. When the scheme first came to light, I commented in my monthly newsletter that in addition to loss of tax benefits for ghoul lead trusts, the “donor” and his adviser should be sent to prison. The term would be equal to the difference between the actuarial life expectancy of the measuring life and the actual life of that individual.

Clearly charities and the people they serve don’t benefit from arrangements that generate big tax benefits for “donors” and little or no charitable benefit. If any abuses involving the charitable deduction come to light, ACGA and NCPG want to work with Congress and the IRS to nip them in the bud.

Examples of how charitable lead trusts help charities and the people they serve. So far, this statement has focused on the technical valuation issue. However, it is important to recognize the benefits to charities. Although far less common than charitable remainder trusts, lead trusts are an additional important source of support for many charities. They are called charitable lead trusts because the charity is the lead-off beneficiary and benefits for the entire trust term. The heirs wait until the trust terminates to benefit from the arrangement.

Here is a sampling from a spot check of ACGA’s and NCPG’s members on how individual charities have benefitted from lead trusts:

   •   This $1 million CLT is especially beneficial to our University in that the trust income to the University (total of which will be $600,000) will be matched by the State with $400,000 to create a $1 million endowed chair.

   •    A private school has a $5 million lead trust (20-year term) that pays 7.36% which is unrestricted. The trust value has grown since funding in 2004.

   •    A religious organization is the beneficiary of a $300,000 lead trust funded with cash last December. It is paying out an annual annuity of $60,000 for a term of five years to a church. Any remaining funds after the term will go to the donor’s child.

   •    A family came into sudden wealth following the sale of a business. The parents had never shared the potential wealth of their family with their two children — then “starving” college students in their early 20's. The parents felt overwhelmed by the sudden wealth distribution they received, and were searching both for effective tax strategies and for a vehicle that would help their children become acclimated to the wealth they would one day be responsible for stewarding. One of the first strategies they employed was a charitable lead trust that since 2002 has distributed its total annual distribution each year to a community foundation. The parents named the two children as the sole advisors to the fund, so they would bear the responsibility for making charitable recommendation decisions. The parents felt that the best way to prepare their children for the ultimate responsibility of the wealth that would come to them would be to give them 20 years of experience (the term of the trust) as charitable stewards, with the guidance and expertise of the community foundation to support them. This strategy has proven to be a huge success in meeting the goals of this family. The children have steadily grown in their comfort and sophistication as philanthropists, and with the community foundation’s support they have together granted nearly $300,000 over the past 6 years to a variety of worthy organizations across the country.

   •    A small college in the past 4½ years has received $119,315 from a lead trust — a $5,000,000 trust that includes a number of other beneficiaries. The payments support diverse religious education and activities on the campus.

   •    The gift was from an alumnus from the Class of 1924 of a secondary school. Having no direct heirs, after his death in 1984, most of his estate went into a lead trust with three charitable beneficiaries. The current value of the trust is approximately $18 million and annual income to the school has ranged between $375,000 and $800,000 over the years. The trust ends when the last of the donor’s direct nieces and nephews passes away. Most of these descendants are in their 60s now. The managers of the trust (a local bank and trust company) have been very positive advocates for the school. They provide quality and timely financial statements and the performance under the trust has been adequate to good.

   •    A zoo and botanical garden has three lead trusts. The amounts placed in trust: $131,587, $133,757, $200,000 and the payout percentages: 16.6%, 16.6%, 13.08% respectively. The trust income is being used for first education capital, an endowed fund for programs, and an education endowment for programs.

   •    A humanitarian organization is the beneficiary of 12 lead trusts and uses the substantial annual payments for its mission dedicated to working with children, families, and their communities worldwide to reach their full potential by tackling the causes of poverty and injustice.

   •    A $2.5 million trust, 7.7% payout, benefits the College of Medicine. And a $150,000 trust, 6.7% payout, benefits the University Library.

   •    A $1 million (8%) lead trust supports medical research at a medical school.

   •    A health clinic receives 10% of the payout of a lead trust that it uses for delivery of its services.

   •    A group of 4 trusts pays out approximately $44,000 per trust annually to support a palliative care center for children with terminal cancer.

   •    Two trusts support a wide variety of organizations, ranging from a church to the local symphony to breast cancer research to the Boys and Girls Club.

   •    Another trust distributes over $210,000 annually to support literacy, food banks, the homeless and hospice care.

   •    A small community foundation is the beneficiary of a charitable lead annuity trust that will pay out $1.5 million over 15 years ($100,000 per year). The first five years of funds are for a specific program; the remainder is unrestricted.

   •    A small university has seven lead trusts established by one donor. Each was funded with approximately $75,000 in 2000. Each is meant to eventually benefit minor children and have staggered distribution dates going to 2018. The payout rate is 8%. Trust income is going to benefit a research fund for the sciences.

   •    A state university has five lead trusts with a total value of $5,659,674 (three with 7% payout and two with 8% payout). The annual payments provide scholarship support, support for the performing arts, faculty awards, support for the Alumni Center, the National Kidney Foundation and a local church.

   •    A small community foundation has one charitable lead trust. The amount placed in trust was $126,594. The payout percentage is 5%. The trust income is being used to provide grants to nonprofit organizations recommended by the donor and approved by the board of trustees.

   •    A university has a $1 million lead trust with a payout for 10 years at $100,000 per year. The income is being used for its new science building.

   •    A university benefits from a $200,000, 7% lead trust with the payout used to support library collections and athletics.

   •    A major university benefits from seven lead trusts. The beneficiaries are: the school of business; the Children’s Hospital, student scholarships, the history department and the school of education.

   •    A state university has an 8%, $1,705,308 lead trust that is used for scholarships.

Conclusion — a tale of four actuaries and a duck. I’m reminded of the four actuaries who went hunting. A duck flew overhead: the first actuary shot one foot above the duck, the second shot one foot below the duck, the third one foot to the left of the duck and the fourth one foot to the right of the duck. All the parties were happy. The duck, of course, was happy to get away with its life. And, the actuaries were ecstatic. They determined that on average, they killed the duck.

ACGA and NCPG believe that the current methodology of computing the value of the charitable and non-charitable interests for charitable lead and charitable remainder gifts is on average effective, but would welcome any improvement.

If a new method is to be considered, we ask that it be in the form of proposed legislation or proposed Treasury regulations. That way the government would get public comments on the pros and cons — and perhaps other suggested valuation methods.

Attachment “A”

Example 1

Example 2

Example 3

Example 4

Example 5

Example 6

Example 7

Example 8