lead trusts

A Tale of Two Gifts


Right now, I am grappling with two potential complex gifts – as complex as they get.  One I am encouraging a smooth, careful approach to accepting it while the other I am pushing back against.  The question is why?

The smoothing sailing one is a gift annuity funded with real estate!  If you have ever taken my Planned Giving Boot Camp, you should know that I caution against even letting your donors know it’s an option.

So, what is different in this case?  I had one conversation with the donor and he relayed how he sincerely wanted to help the charity and cared deeply about their work, that he had done something similar already with a related charity, and that he was fine only receiving an annuity based on the net proceeds of the sale of the real estate. Oh, and he had a buyer who has purchased from him already – not bound legally but someone who has a track record with the donor.

In a ten minute phone call, all of the alerts were turned off. Donor isn’t pushing the envelope, is taking responsibility for the sale and its costs, and a clear winner in my eyes worth hundreds of thousands of dollars to my client.

Next is the one I am having trouble with.  This is for a private individual client but it is a charitable vehicle – a Shark-Fin Grantor Lead Trust funded with life insurance and an annuity.  This is as complex as they get and I should be ecstatic to be involved with this one.  Only problem is that I owe my client a duty to advise against doing anything that is likely to cause trouble with the IRS (or has good chance of being a disaster in anycase).

Firstly, what is a Shark-Fin Grantor Lead Trust funded with life insurance?  It is a lead trust (payments to charity, remainder to family) where the payments to charity are reduced during the “term” – usually the life of the donor – and where a balloon payment to charity happens when the term ends (i.e. the passing of the donor) – most of the balloon payment (from the life insurance owned by the trust) actually goes to the family as an estate tax-free gift.  This is in addition to a big upfront income tax deduction the donors take.

When all of the numbers are crunched, this is the most guaranteed “win, win” as you can find from a tax perspective!  Family gets big upfront deduction.  Annual income tax bite (Grantor trusts send all taxes on income in the trust back to the donor!) is lessened because it is based on small commercial annuity  payments to charity.  Family and charity are winners at the end.  No risks from a numbers perspective.  So, why am I being such a pain to the promoters of this plan?

Do a quick google search on Shark-Fin Lead Trusts and you might find several articles from competing attorneys and financial guys arguing whether these things work or not.  The conclusion from most of the articles is that there just isn’t enough guidance from the IRS.  That means proceed with caution.

In other words, the IRS may eventually look at these (it happens sooner or later) and decide that even though each of the steps in the deal are kosher and not nefarious, the program taken as a whole is a big tax avoidance scheme.  It works too well.

Several years ago, the IRS got wind that promoters had this deal where charities would own large insurance policies but would only be receiving around 10% of the death benefit – the other 90% would go to family tax-free!  The problem was that the donor was taking a 100% deduction for premiums paid through the charity but only giving 10% of the death benefit to charity (herein was the problem!).  Still, the promoters claimed there was nothing wrong and that the charities as owners of the policies could change beneficiaries at will.

IRS didn’t buy it and levied draconian penalties on the charities and families involved. Now, it is strictly forbidden for any charity to own life insurance policy that has any non-charitable beneficiaries. (in fact, it’s those same draconian penalties that makes us wonder if the IRS will somehow attack lead trust arrangements that own life insurance going to both family and charity)

So, with a team of high end promoters pressuring me more than I can withstand, I called the top charitable tax expert in the country (as according to me and many others). I assumed that before I even finished my first three to five words, that he would give me is usual stern warning of “stay away from this one Jonathan.” (meaning not only tell my client not to do it but also remove myself from the case altogether).

Strangely, his response was the opposite of what I expected!  He said as far as he could see, it worked.

So, I withdrew my objections and we’ll see.  Client still needs to decide to fork over a lot of $ to get this done as it requires purchasing a fully paid life insurance policy (as well as the annuity to pay the annual charitable amount). Oh, and the client will use a big law firm to draft and implement the trust (that’s our insurance policy if the deal ever goes sour!).

So, you never know – maybe I will be writing about two of the most complex gift scenarios very soon!

Why Lead Trusts are so rare

As I follow-up to my previous post, which proved from IRS statistics that very few charitable lead trusts are established annually, I want to briefly address the likely reasons for the small number of this wonderful giving option (thank you to those who commented for your input!).  If you aren’t sure what Lead Trusts are, search this blog for various posts on them – this post is directed at those who already understand them fairly well.

Here are my top ten reasons why we see very very few lead trusts:

  1. The required payout rates to avoid all or most gift/estate tax are too high!  Even under today’s mega-low AFR environment, your lead trust still needs to pay the charity at least 6% annually for a 20 year trust, 8% for a 15 year trust.  Think about it – if your investment plan for the trust assets can’t guarantee well more than those rates, forget about a lead trust.
  2. The required terms to avoid all or most gift/estate tax are too long!  Really the same  point as the first point.  Most people considering lead trust don’t want to use any of their lifetime gift/estate tax exemption.  That being the case, your lead trusts need to be 15-20 years or more!  Someone in the Hess family did a 35-year lead trust!  Click here for article on that one.
  3. The investment returns to make lead trusts work are not realistic in most cases!  This is also connected to the first two points.  If you are ok with a 20-year term paying the charity a 6% annuity, you better feel confident that your trust can earn 8% or 9% or better.  If not, this may not be worth doing – it could actually reduce the heirs’ inheritance!
  4. Finding the right funding asset/investment is close to impossible!  Building on the previous point, you need to find an asset that will produce the cash flow to cover the 6%+ payout rate as well as grow.  To me, commercial real estate sounds like a great option.  Problem with commercial real estate is that most properties/interests in properties are leveraged in ways that prevent donors from using them for lead trusts (I had that happen to one of my perfect lead trust donors).
  5. Professional advisors are not knowledgeable about them.  I am not talking about one’s ability to talk like you know what you are doing – I am talking about really knowing them!  If you are an advisor, did you know that Lead Trusts are NOT done to avoid capital gains?  Did you know they are NOT done for income tax deductions?  If those two questions have you wondering, you DON”T understand lead trusts very well.
  6. Charity advisors aren’t knowledgeable about them.  This doesn’t bother me that much because charities should NEVER act as trustee for a lead trust.  In fact, while advice from a charity can help, a lead trust is a key piece of one’s estate plan which requires full participation of the estate attorney and very little practical help from the charity.  Still, charity advisors could teach the estate planning and professional advisor worlds about lead trusts and maybe encourage more to happen.
  7. It may not even be the best planning option for ultra-wealthy philanthropists with heirs.  I have one estate planning client who fits the bill for a lead trust – very charitable, concerned about estate tax, looking to pass assets to his heirs with a decent time delay and has assets that may soar in value.  But, at the end of the day, GRATs worked better for him because he needed more flexibility to swap assets in and out of the GRATs and worst case for him, the assets all passed back to him and he starts new GRATs.  He is setting aside assets for big giving and not bothering with lead trusts.
  8. Complex, complex, complex!  Did you know that a charitable lead trust is not a “tax-exempt” trust?  It is actually considered a complex trust for accounting purposes.  And complex it is.  And, the less people understand these things, the less likely they will happen.  Just my theory but it seems to work that way.
  9. Did I mention finding the right donors is also like finding a needle in a haystack?  Yes, you need to find a donor where all of the bells and whistles hit on target.  Facing significant estate taxes (with an estate well in excess of the federal $5.23 million per person exemption)? Otherwise, there is no reason to even consider them.  They need to be seriously charitable.  Like I said above, there are other similar, non-charitable options that work.  And, then you need the right asset/investment and a payout/term that makes sense to your donor. Would be nice, too, if your donor understood what a lead trust really is.
  10. Too many easier giving/planning options that make more sense to your donors.  When a donor or client gives me that blank stare (as lead trust discussions often cause), I know I’m not in good territory.  How about a CRAT?  How about a GRAT? Yea, that sounds good.  I get the message and quietly slink my lead trust pages away.  Donors and clients tend to stick with what they know and have done before.

Trust me, I would love to be working on lead trusts.  I’m not a naysayer by nature. All I am saying is learn what they are really about and see if you can ever sell one.  I wish you luck and offer to discuss any real lead trust scenario with you for free!  Send me an email if you think you have a live one (jonathan@plannedgivingadvisors.com) and I’ll give my advice, for whatever it’s worth.


Perfect Storm for Lead Trusts, Part 2

As mentioned in my previous post (and other ones on lead trusts – see http://theplannedgivingblog.wordpress.com/category/charitable-lead-trusts/) lead trusts are an amazing opportunity for both donors and nonprofits – albeit one that hasn’t really caught on in the planning world.

Let me share something with you from my estate planning background dealing with a few high net wealth private clients – especially ones that were already charitable.  Several times I was very excited to bring up the idea of a lead trust with the client and it never flew.  Partly, as an attorney I can recommend or suggest ideas but ultimately, my job is do what the client asks me to do.  But, there is something else that the promoters of lead trusts won’t tell you.

Here is the secret problem with lead trusts (and read to the end of this post to hear why the problem is less of an issue right now): For wealth transfer purposes, lead trusts are not necessarily the best option even for the charitably inclined. In fact, when you start wondering about what kind of asset will produce enough investment returns to make the lead trust work well (generally 8% or greater annual returns), you have to wonder  if it makes sense at all if you don’t have a guaranteed high rate of income/growth for the potential lead trust assets.

In fact, a GRAT (Grantor Retained Annuity Trust – the non-charitable version of a lead trust) actually presents less risk for wealth transfer reasons.   Why?  A GRAT pays its “annuity” back to the grantor (not to charity like lead trusts) and the remainder goes to children (hopefully at zero gift/estate tax).  GRATs, unlike lead trusts, need to be done in relatively short periods because should the client pass away during the term of the GRAT, all assets in the GRAT get hit with estate taxes (one point where lead trusts are clearly better than GRATs).  Clients typically do 3 to 5-year “rolling” GRATs – basically gambling that one of these will work out for the kids.  If they don’t work out (i.e. the GRATs income/growth are not high enough to produce a gift for the heirs at its termination), all assets end up back in the hands of the client and he starts again.  The point is this: the only real risks for GRATs are dying during the term (never a good thing) and the legal fees for setting them up (not as much as I would like!).

What is the risk with lead trusts for clients considering GRATs, too, for wealth transfer purposes?  If the lead trust fails (i.e. all assets of lead trust are distributed to charity and none or very little for heirs), your client has made some nice gifts to charity, yes.  But, he did not get a charitable income tax deduction for that giving (generally speaking).  And, if he used any of his lifetime gifting exemption, that exemption is lost (as far as I know – an interesting question).

In other words, it may be that a standard multi-year pledge combined with non-charitable estate planning gets the best result for the client from a total tax perspective.

So, what is different today and why am I still touting lead trusts?  Firstly, right now more than any time in recent years, estate planners should be encouraging their clients to use (or potentially lose) their lifetime giving exemptions – today!   All of the lead trust vs. GRAT discussion up until now was with the understanding that these trusts would be designed as zero gifts (on paper, of course) to heirs.  That makes us use very high annuity payments and lessens the chances of success for the trusts.

Part of the perfect storm today for lead trusts has to do with this opportunity.  If your donors are willing to use some of their lifetime exemption on creating a lead trust, then they can choose more a reasonable annuity payout to charity (for example, instead of 7% over 15 years, go with 3% over 10 years).  Now, instead of needing an 8% or better return for the lead trust to have any wealth transfer effectiveness, your lead trust can succeed on much more conservative assumptions.  And, because GRATs still have the risk of estate taxes in case of death of the grantor and therefore still need to use short payment periods, lead trusts finally jump ahead of GRATS because of their new found flexibility.

Lastly, with the advent of “Shark-Fin” lead trust strategies using laddered payments to charity or balloon payments at the end of the  lead trust, a lot of investment risk can be lessened.  Combined with using more conservative payment rates to charity by using some of the donor’s lifetime exemption, I would feel much more comfortable with a client intending invest their lead trust assets in equities.


Fundraising Tip of the Day: Payments from Lead Trusts

As a follow-up to my prior Lead Trust posts, here is a more practical fundraising tip that happened to me today.

In looking through the most recent gifts spreadsheet, a relatively small (less than $10,000) gift showed up with the name of a lead trust as the donor.

Watch for these!  Without paying attention, a receipt will get sent to the donor – in the name of the lead trust.  And, maybe a standard thank you letter to the donor himself.

Wait a moment!  There is no way this lead trust payment is the full amount that this lead trust is granting to nonprofits ever year.  Maybe this lead trust gives the power to the donor to choose which charity gets every year and for how much?

And, people don’t do lead trusts unless they are looking to move millions of dollars out of their names and towards their children.  And, they don’t do them unless they are very philanthropic.

The point is this: you see a check that indicates it’s from a lead trust, your development staff needs to make sure there is proper follow-up with the donor.

This point is why fundraisers and planned giving staff should be educated on lead trusts, at least to understand the basic concepts.