life insurance policy

Charitable Gift Planning With Life Insurance

Although the considerations are complex, this strategy can provide tax and other financial benefits that other assets can’t

Life insurance has many uses in charitable gift planning, especially in high-end, sophisticated gift planning. As a way to provide a benefit to charity and also provide tax or other financial benefits to the donor, life insurance can be used in situations in which other assets can’t. Planning considerations with life insurance are complex, owing to issues based in tax, insurance and securities law. Here are various ways life insurance is used in charitable giving. 

 

How Charity Becomes Owner

A charity can acquire ownership of a life insurance policy in two ways:

 

1. The existing owner can execute a change of ownership form with the insurance company, causing the charity to become the new owner. 

2. The charity can acquire the policy as the original owner, with the insured’s consent.

 

The first approach is the only choice for an existing policy. Both approaches can work with a newly issued policy. For the second approach to work, the charity must have an insurable interest in the life of the insured. Insurable interest is determined as of a single point in time: when the insurance company issues the policy.1 Many, if not all, states afford a liberal insurable interest for charitable owned life insurance (CHOLI).2 If the question should arise as to which state’s law governs an insurable interest (for example, the insured’s or the charity’s), you may have to perform a choice-of-law analysis.3 Failure to comply with the applicable insurable interest law may require the insurance company to pay the death benefit, depending on the circumstance, and may allow the insured’s executor to recover the insurance proceeds.4

Stranger-originated insurance plans. In recent years, some charities have been approached by investor groups with the following proposal: The charity will ask a loyal, wealthy supporter to take out a sizable insurance policy on her life; the initial premium will be modest. After two years (the non-contestability period), the charity will ask the insured to sell the policy to a certain investor group (or trust). The charity’s promised reward may consist of annual payments from the investor group (trust) and a share of the life insurance proceeds. This sort of plan is one example of stranger-originated life insurance (STOLI). (Another variation is for the charity to be the original owner of the insurance policy, if state law affords a liberal insurable interest for CHOLI.)

Given that the insurable interest requirement is intended to prevent wagering on lives and that life insurance is intended to serve as a hedge against loss and not as an investment, one might think courts would be hostile to STOLI.5 Yet, in Kramer v. Phoenix Life Ins. Co.,6 the New York Court of Appeals held that it had no problem with a STOLI arrangement in which the insured was the original owner of the life insurance policy, given that an individual always has an insurable interest in her own life.

Subsequently enacted New York Insurance Law Section 7815 drives a stake through STOLI. It provides, “No person shall directly or indirectly engage in any act, practice or arrangement that constitutes stranger-originated life insurance.”

I’m not attempting to write a comprehensive piece on STOLI, so I’ll leave it at that. 

 

Tax Considerations

Giving an existing life insurance policy to charity may involve some tax traps. First, if the policy is subject to a loan, the gift will be treated as a bargain sale for an amount equal to the loan.7 This, generally, will cause the donor to realize ordinary income, given that the inside build-up in the value of a life insurance policy is regular income, not capital gain. Second, because no federal income tax charitable deduction is allowed with respect to unrealized ordinary income, if the value of the donated policy exceeds the donor’s basis in the policy, the donor’s federal income tax charitable deduction for the gift will be limited to her basis.8 Third, if the donor is going to claim a federal income tax charitable deduction of more than $5,000 for the gift, the donor must substantiate the claim with a “qualified appraisal,” as defined in Internal Revenue Code Section 170(f)(11)(E), because an insurance policy is neither cash nor a publicly traded security.9 Failure to obtain the needed appraisal may result in denial of the claimed deduction. One advantage of having the charity be the original owner of a newly issued policy is to avoid the need for a qualified appraisal, because the insured doesn’t give the policy to the charity and, therefore, doesn’t need to substantiate a claimed charitable deduction for such a gift.

Charitable split-dollar arrangements. As a general rule, tax penalties are imposed when a charity owns an insurance or annuity contract if any benefit under the contract is payable to a person who’s not a qualified charitable organization. No federal income tax charitable deduction is allowed for paying the premium on such a contract.10 Moreover, an excise tax is imposed on any such premium paid by the charity.11

A charity, however, may use funds received for a charitable gift annuity to buy a commercial annuity to enable it to make the gift annuity payments, provided the charity is the sole owner of and the sole recipient of payments from the commercial annuity.12 In the world of charitable gift planning, this is called “reinsuring the gift annuity.” In addition, a charitable remainder trust (CRT), as defined in IRC Section 664, may own an insurance or annuity contract provided: (1) the trust possesses all incidents of ownership in the contract, and (2) all benefits under the contract are payable to the trust.13 (For a discussion of the idea of a CRT investing in a commercial annuity, see the “Planning Considerations” section.)

Naming a charity as beneficiary of an insurance policy. No tax benefit is obtained merely for naming a charity as the beneficiary of a personally owned life insurance policy, nor for the payment of premiums on the policy. The policy proceeds will be included in the owner-insured’s gross estate, but will qualify for the federal estate tax charitable deduction under IRC Section 2055(a).

On the other hand, there’s a dandy tax-leveraged way to name a charity as beneficiary of group term life insurance. If an employee who’s covered by group term insurance irrevocably designates a charity to receive a specified portion of the death benefit in excess of the first $50,000 of death benefit, the employer’s cost of providing such coverage for charity isn’t taxable to the employee.14 Allowing a corporate executive to tack on group term coverage for charity can be a good perk for the executive and a low-cost way for the corporation to generate good public relations.

Premium payments. Once a charity owns an insurance policy, if further premiums are due on the policy, the charity may simply pay the premiums, or it may ask the insured to cover the premiums, which can be done by the insured’s making gifts to the charity and letting the charity make payment or by paying the premium directly. There are several issues here.

I prefer the donor-insured to cover the premium, so it doesn’t appear that the charity is speculating on the donor’s life by using the insurance policy as an investment. The problem here is a matter of appearance and should be addressed in the charity’s gift acceptance policy.

Assuming the donor-insured covers the premium payments, the most natural and best way to do so is for the donor to make gifts directly to the charity—for example, of cash or marketable securities. If the donor gives appreciated securities held for more than one year, so as to get a deduction for appreciated value while avoiding realization of gain, she shouldn’t condition the gift on the charity’s selling the securities and using the proceeds of the sale to pay the premium. Imposing such a condition creates an assignment-of-income risk for the donor, meaning the donor may realize gain on the sale by the charity.

If the donor pays the premium directly to the insurance company, the payment will be considered a gift “to” charity and not a less favorable gift “for the use of” charity.15 To be able to claim a federal income tax charitable deduction for the payment, the donor will need to substantiate her gift in accordance with the usual rules for substantiating cash contributions.16 The potential problem is that the donor won’t know to ask, and the charity typically won’t know to issue any needed gift acknowledgment. This is another matter that a charity’s gift acceptance policy should address.

Gifts of commercial annuities. Individuals often propose charitable gifts of commercial annuities, but they seldom make them, for three tax reasons: 

 

1. If the donor acquired the annuity after April 21, 1987, a donation of the annuity will be treated as sale or exchange, causing the donor to realize all investment gain on the annuity as ordinary income.17

2. If the donor acquired the annuity on or before April 21, 1987, her federal income tax charitable deduction for donating the annuity will be limited to her basis in the annuity.18

3. If the donor will claim a federal income tax charitable deduction of more than $5,000 for the gift, she’ll need to substantiate the claim with a “qualified appraisal,” given that the annuity is neither cash nor a publicly traded security.19

 

Donors typically believe a donation of a commercial annuity works like a gift of appreciated stock from a tax standpoint. When they discover it doesn’t, they usually either: (1) drop the idea of donating the annuity, or (2) cash in the annuity (assuming there aren’t punitive surrender charges) and then donate part or all of the cash.

 

Planning Considerations

Apart from outright gifts of life insurance products, various creative ways exist for these products to be used in charitable gift planning. Putting together one of these plans is typically a team effort, often involving the donor’s insurance agent or financial planner, the donor’s lawyer, the charity’s planned giving officer and the charity’s planned giving legal advisor.

CRT planning with life insurance as a trust asset. CRTs are used to hold life insurance policies and commercial annuities. The idea of transferring a life insurance policy to a CRT and having the CRT pay future premiums on the policy is interesting. There’s the possibility of getting a charitable deduction for all the transfers to the trust and of using appreciated securities to fund future premium payments. It will be necessary to use a charitable remainder unitrust (CRUT), which can accept additional contributions, rather than a charitable remainder annuity trust (CRAT), which can’t, if there are to be multiple contributions to the trust.20 It’s important to avoid the principal problem of having the trust classified as a grantor trust, because a CRT can’t be a grantor trust.21

Private Letter Ruling 9227017 (March 31, 1992) is a textbook example of how to avoid the grantor trust problem (naturally, one can’t rely on another’s PLR, but it’s often useful guidance). In this PLR, the husband (H) proposes to create a net income with makeup unitrust (NIMCRUT) (that is, a CRUT that pays out the lesser of its net income or a fixed percentage amount and makes up any payout deficiencies from prior years out of excess current income) and to transfer an insurance policy on his life and other assets to the trust. The NIMCRUT would pay 5 percent or its net income, whichever is less, to H and his wife (W) during their joint lives. Assuming W survives H, the NIMCRUT would continue for the remainder of her life. H would be the initial trustee of the NIMCRUT. (Note that income and capital gains derived from the other assets won’t be taxed, because a CRT is exempt from tax, except on unrelated business income (UBI), under IRC Section 664(c).)

The basic question presented for determination by the IRS is whether the intended NIMCRUT would fail to be a CRT by reason of being a grantor trust. At issue is IRC Section 677(a)(3), which provides that a trust will be a grantor trust if trust income is or may be used to pay premiums of insurance on the life of the trust settlor or the settlor’s spouse, without the consent of an adverse party, unless the insurance is irrevocably payable for a charitable purpose.

Now for a critical fact: The insurance proceeds (as well as any withdrawals from the policy and any amounts received upon surrendering the policy) would be credited to trust principal, not income, under the trust instrument. Furthermore, applicable state law allowed this and didn’t create a problem with an under-productive property statute. The IRS ruled the trust won’t be a grantor trust under IRC Section 677(a)(3).

In retrospect, this PLR reveals a planning opportunity, but raises this question: How would W, as surviving spouse, fare today, in a low-interest environment, as the surviving payout recipient of a trust that would never pay her more than its net income? The answer might be: reasonably well, depending on how the successor trustee invested; and, in particular, on whether the trustee was able to generate decent dividend income and realized gains from equity investments.22 PLR 8745013 (April 7, 1987) makes clear, by the way, that if the trustee of a CRT holding an insurance policy borrows against the policy and uses the borrowed funds to invest in other assets, income earned on those assets will be UBI. Under IRC Section 664(c), there’s a 100 percent excise tax on such UBI.

The grantor trust problem posed by Section 677(a)(3) is avoided if the CRT instrument requires all life insurance premiums to be paid from trust principal. In this situation, it’s still necessary to employ a net income unitrust or a NIMCRUT to avoid violating the charitable split-dollar rule of IRC Section 170(f)(10)(E), which requires that a CRT be entitled to all insurance policy payments, unless some other CRT arrangement can be designed to ensure the requirements will be met.

CRT planning with an annuity as a trust asset. Let’s consider the idea of creating a CRT and having the CRT acquire a commercial annuity. PLR 201126007 (Dec. 15, 2010) deals with a proposed CRAT provision that would allow the trustee, discretionarily, to use trust assets to buy a commercial annuity on the donor’s life. The annuity would make payments to the trust sufficient to enable the trust to meet its payout obligation to the donor. The IRS ruled that the proposed CRAT provision was permissible.

Four observations as to PLR 201126007:  

 

1. The CRAT allows appreciated assets to be converted into a commercial annuity without realization of gain by the donor or the incurring of capital gain tax by the trust;

2. It’s not clear from the PLR whether or to what extent there will be an actual remainder benefit for charity upon termination of the trust. One gathers that the commercial annuity will distribute each year more to the CRAT than the CRAT will be obligated to pay to the donor. The trustee may, but isn’t obligated to, pay such excess to charity each year. It’s unclear, however, whether there will be a death benefit payable under the annuity to the CRAT.

3. One might think the annuity is a jeopardizing investment for the CRAT under IRC Section 4944. But, Section 4944 applies to an inter vivos CRAT only if a charity has an interest in the annual CRAT payout for which a gift tax charitable deduction is allowable.23

4. The commercial annuity here will be an immediate, not a deferred annuity, and there will be no possibility of using the annuity to manipulate the timing of CRAT payments to the donor.

 

This last observation brings us to consider the possibility of having a NIMCRUT acquire a deferred commercial annuity. In the 1990s, there was considerable interest among planners in using NIMCRUTs to manipulate the timing and taxability of trust payout distributions to the donor. One area of interest was “spigot trusts”—a NIMCRUT invested so that the trustee could turn on or off income distributions to the donor. Deferred annuities were a favored investment for spigot trusts. In
Notice 97-23, the IRS said it would no longer issue rulings with respect to NIMCRUTs when:

 

. . . a grantor, a trustee, a beneficiary, or a person related or subordinate to a grantor, a trustee, or a beneficiary can control the timing of the trust’s receipt of trust income from a partnership or a deferred annuity contract to take advantage of the difference between trust income under section 643(b) and income for federal income tax purposes for the benefit of the unitrust recipient.24

 

The IRS’ concern here was self-dealing under IRC Section 4941. Yet, not long after issuing Notice 97-23, the IRS issued Technical Advice Memorandum 9825001, in which it not only considered, but also approved, a NIMCRUT’s purchase of two deferred annuity contracts. The main issue was whether the purchase was an act of self-dealing under Section 4941. The IRS found that although the trustee’s purchase of the annuities was intended to defer the trust settlor’s income for five years, taking into account an installment sale by the settlor to a third party, the trustee acted independently of, and not under the control of, the settlor, and there was no harm to the trust, so that no self dealing occurred.

Four observations about T.A.M. 9825001:

 

1. The IRS also ruled that under applicable local (Tennessee) law, the mere right of the trustee to withdraw from or surrender the annuities wouldn’t give rise to trust accounting income (IRC Sec-
tion 643(b) income); that the trust would be in receipt of accounting income only as and when it actually received distributions from the annuities.

2. Because a natural person didn’t hold the deferred annuities here, all income on the annuity contracts was ordinary income to the NIMCRUT for federal income tax purposes under IRC Section 72(u). As a CRT, however, the NIMCRUT was exempt from federal income tax on this income.

3. The NIMCRUT was funded with closely held stock, meaning the NIMCRUT afforded a way for the settlor to convert the stock into the annuities (via the independent trustee) without realizing any gain. The trust realized gain upon sale of the stock, but the gain wasn’t taxed.  

4. In the wake of the flip unitrust regulations published in 1998, a donor in a situation like that presented in T.A.M. 9825001 might be inclined to use a flip trust, rather than a NIMCRUT. The flip trust could switch, for example, from a net income (with or without make-up) unitrust to a straight payout unitrust after five years.25 The flip trust might better suit the donor’s needs and objectives, given that its payout wouldn’t be limited to trust accounting income after the flip. Whether continuing to hold the deferred annuity after the flip made sense would be a judgment call for the trustee.

 

Charitable lead trust planning. One of today’s more sophisticated charitable gift plans with life insurance uses an unusual type of charitable lead annuity trust (CLAT). Another involves a charitable lead unitrust (CLUT). Let’s look first at the CLAT plan, which is sometimes called an “enhanced” charitable lead annuity trust (ECLAT).

ECLAT holding life insurance. The ECLAT holds an insurance policy on its settlor’s life and is set up to run for the settlor’s life (as opposed to a term of years).26 It’s funded, typically, with a paid-up insurance policy and cash. The trust is designed to make a minimal (for example, 1 percent), though not de minimis, annual payout to charity during the settlor’s life.27 Upon the settlor’s death, a specified balloon payment is made to charity out of the insurance proceeds paid to the trust; the balance of the proceeds and other trust assets are distributed to the ECLAT remainder beneficiaries.

The ECLAT is made a grantor trust—typically by giving a non-disqualified person (within the meaning of Section 4946) the right, exercisable in a non-fiduciary capacity, to acquire trust assets by substituting other assets of equivalent value.28 This allows the settlor to claim an up-front federal income tax charitable deduction, as well as a federal gift tax charitable deduction, for the initial present value of the trust payout to charity.29 Because the ECLAT is a grantor trust, the settlor must report all trust income (with no offsetting charitable deduction for income distributed to charity) but, typically, trust income will be minor.30 

The upfront income tax charitable deduction helps leverage the purchase of the life insurance policy. The ECLAT itself keeps the insurance proceeds out of the donor’s gross estate, given that the power that makes the ECLAT a grantor trust for federal income tax purposes isn’t an IRC Section 2036 or 2038 power for estate tax purposes.31 The upfront gift tax charitable deduction shields a good part (if not all) of the asset value initially transferred to the ECLAT from federal gift tax. Thus, the ECLAT can be a powerful wealth transfer tool for the client who’s insurable at an acceptable cost, for whom underwriting limits aren’t a problem and who can make use of a favorable IRS “life expectancy” to determine the initial present value of the payout to charity.

CLUT holding life insurance. A clever way to leverage the purchase of a life insurance policy, ownership of which ultimately will be transferred back to the insured, is to establish a reversionary CLUT (for example, a 10-year CLUT). Because the CLUT is reversionary, it’s a grantor trust; meaning transfers to the CLUT qualify in part for the federal income tax charitable deduction.32

The settlor transfers, for example, $100,000 in cash per year to the CLUT, which buys a modified endowment contract (MEC) limit insurance policy on the settlor’s life (as well as makes a unitrust payout to charity). Because the insurance policy satisfies the MEC 7-pay rule,33 when the policy reverts to the insured at the end of the trust term, the insured can access the cash value of the policy, income tax-free, during retirement, leaving the death benefit of the policy estate tax-free to a favorite charity.34 This can be a dandy plan for meeting tax savings, retirement income and charitable giving objectives. 

 

Other Considerations

Wealth replacement. Using life insurance to replace an asset given to charity has been a fairly widespread practice for at least 40 years. The classic wealth replacement plan involves transferring highly appreciated, no-yield assets to a CRUT and using the newfound income of the trust payout to fund an insurance policy on the donor’s life. An irrevocable life insurance trust (ILIT) typically holds the insurance policy. The insurance replaces, in whole or part, for the benefit of the donor’s child or other heir(s), the assets transferred to the CRUT. The ILIT is usually a Crummey trust, which affords both federal gift and federal estate tax shielding.

The Bush-era reduction in capital gain tax rates lessened, somewhat, the tax leverage of the CRUT in this situation, and the bursting of the dot.com and real estate bubbles, followed by the big drop in interest rates post-2008, have made it more difficult for some donors to squeeze enough payout out of the CRUT to fund the life insurance. Nonetheless, the wealth replacement plan remains a viable planning tool.

Using life insurance to repay individual retirement account assets lent to charity. A novel gift plan involving life insurance surfaced in PLR 200741016 (July 12, 2007). Here’s an example of how the plan works:

 

• A donor causes her self-directed individual retirement account to lend $100,000 to a charity, which the donor doesn’t control and on whose board the donor doesn’t sit;

• The charity uses part of the borrowed money to buy an insurance policy on the donor’s life;

• The charity gives a promissory note to the donor’s IRA, calling for (reasonable) interest-only payments on the loan during the donor’s life. The note also conveys a security interest in the insurance policy to the IRA. The charity, in addition, makes a collateral assignment of a portion of the policy death benefit to the IRA. The note promises to repay the loan from the IRA, using a portion of the policy proceeds, within a specified time after the donor’s death;

• According to the plan, after repaying the loan, the charity will net a benefit from the remaining policy proceeds.

 

In PLR 200741016, the IRS ruled, in connection with a similar fact pattern, that: (1) the plan didn’t involve any prohibited lending of IRA assets to a  “disqualified person,” and (2) the IRA didn’t make a prohibited investment in life insurance. In other words, the IRS gave the plan the green light.35 

As to the merits of this plan, two questions are: (1) what’s the likely net financial benefit to the charity, and (2) might the charity do just as well simply receiving at the donor’s death all or part of the donor’s IRA? The donor, after all, might make annual gifts to the charity and use the tax savings from the gifts to purchase life insurance outside the IRA—insurance that could provide an income tax-free and, possibly, estate tax-free benefit to her heirs. Leaving part or all of the IRA to charity and leaving insurance proceeds to the heirs could be good from the heirs’ standpoint.

Questions. One question in connection with the IRA life insurance plan is whether the insurance proceeds paid to the charity are unrelated income. After all, the insurance policy is acquired by the charity with borrowed funds.36 The answer is pretty clearly “no,” assuming no transfer-for-value problem, given that the insurance proceeds will be excluded from the definition of “income.”37

Another, quite different, gift planning question is whether it’s possible to make a tax-free exchange under IRC Section 1035 of a commercial annuity for a charitable gift annuity. Again, the answer is “no,” given that a commercial annuity is an investment product, while a gift annuity is merely a non-transferrable bundle of contract rights, meaning the two are  apples and oranges for the purpose of Section 1035.

 

Creative Opportunities

I like charitable gift planning with life insurance. It requires multi-dimensional thinking and is rife with opportunities for creativity. Like all gift planning, it brings into play both concepts and details. By the time this article is published, some creative planner will have designed yet another arguably airtight way to use life insurance in charitable giving.

 

Endnotes

1. Connecticut Mutual Life Insurance Co. v. Shaefer, 24 L.Ed. 251 (1876); Speroni v. Speroni, 406 Ill. 28 (1950).

2. See, e.g., N.Y. Code Section 3205(b)(3).

3. See, e.g., Mayo v. Hartford Life Insurance Co., 354 F.3d 400 (5th Cir. 2004). In the Mayo case, the applicable law chosen was the law of the state of residence of the insured.

4. The two-year incontestability period applicable to life insurance policies acts as a statute of limitations on the insurance company’s ability to assert lack of insurable interest. For an excellent discussion of this point and insurable interests generally under Michigan law, see “Update on Insurable Interests,” presented by Kenneth W. Kingma at the Michigan Institute of Continuing Legal Education, 2007, www.huschblackwell.com. As to the executor’s right to recover the insurance proceeds in the event of an insurable interest violation, see, e.g., N.Y. Code Section 3205(b)(4).

5. Stranger-originated life insurance involves using life insurance as an investment. One federal appeals court has held that if life insurance is promoted and marketed primarily as an investment, it will be treated as a security for purposes of federal securities laws. See Grainger v. State Security Life Insurance Co., 347 F.2d 303 (5th Cir. 1977).

6. Kramer v. Phoenix Life Ins. Co., 2010 N.Y. Slip Op. 8376 (Nov. 17, 2010).

7. Revenue Rulings 80-132 and 80-133.

8. Internal Revenue Code Section 170(e)(1)(A).

9. IRC Section 170(f)(11)(A)(ii).

10. IRC Section 170(f)(10)(A).

11. IRC Section 170(f)(10)(F).

12. IRC Section 170(()(10)(D).

13. IRC Section 170(f)(10)(E).

14. IRC Section 79(b)(2)(B).

15. Treasury Regulations Section 1.170A-8(a)(2) provides that a gift “for the use of” charity consists of a gift of an income interest in a trust (for example, a charitable lead trust interest), or consists of giving a charity an interest in a trust that receives the remainder of a prior trust. The insured’s direct payment of the premium due on a charity-owned life insurance policy confers a direct and immediate financial benefit on the charity and is, therefore, a gift “to” charity, and is subject to the most favorable deductibility limits under IRC Section 170(b). In full support of this view and interpretation is Davis v. U.S., 495 U.S. 472 (1990).

16. The substantiation rules for cash contributions are set forth in Treas. Regs. Section 1.170A-13. All cash contributions must be substantiated. A written contemporaneous gift acknowledgment from the donee organization is required for cash contributions of $250 or more. Failure to substantiate can lead to loss of claimed charitable deduction.

17. IRC Section 72(e)(4)(C).

18. IRC Section 170(e)(1)(A).

19. IRC Section 170(f)(11)(A)(ii).

20. Treas. Regs. Section 1.664-2(b).

21. Treas. Regs. Section 1.664-1(a)(4).

22. A net income with makeup unitrust (NIMCRUT) never pays out more than its trust accounting income, as defined in the trust instrument or under applicable local law, as limited by Treas. Regs. Section 643(b)-1 (definition of income). In today’s low interest environment, the chief possible sources of trust accounting income for a NIMCRUT are ordinary dividends paid on stock and realized post-contribution capital gains (see Treas. Regs. Section 1.664-3(a)(1)(i)(b)(3) as to including realized gains in income). 

    For other Private Letter Rulings in the same vein, see PLRs 7928014 (April 10, 1979), 8745013 (Aug. 7, 1987) and 199915045 (Jan. 19, 1999). 

23. IRC Section 4947(a)(2)(A).

24. The reference to “the difference between trust income under section 643(b) and income for federal income tax purposes” has to do with the fact that the trust may not have accounting income until it receives actual distributions from the deferred annuity, while the trust recognizes earnings on the deferred annuity as ordinary income for federal income tax purposes under IRC Section 72(u)(1).

25. Any “make-up” of the NIMCRUT is lost following the flip. Treas. Regs. Section 1.664-3(a)(1)(i)(c)(3).

26. A lead trust may be established to run for the life of the settlor, of the settlor’s spouse or of a person who’s an ancestor of all the trust remainder beneficiaries. See Treas. Regs. Sections 1.170A-6(c)(2)(i)(A), 6(c)(2)(ii)(A).

27. As to lead trusts that make minimal, but not de minimis, payments for a period of time and then make a final balloon payment, see Revenue Procedure 2007-45.

28. See, e.g., PLR 200010036 (Dec. 13, 1999).

29. IRC Section 170(f)(2)(B).

30. As to the fact that the settlor gets no offsetting charitable deduction for enhanced charitable lead annuity trust (ECLAT) income paid to charity, see IRC Section 170(f)(2)(C).

31. The ECLAT takes advantage of the fact that certain grantor trust powers under IRC Sections 671-677 aren’t powers that pull transferred assets back into the transferor’s gross estate for estate tax purposes. Some might say the ECLAT is an intentionally defective grantor trust.

32. IRC Section 673 makes a reversionary charitable lead unitrust a grantor trust.

33. In general, a modified endowment contract (MEC) policy is one as to which cumulative premiums paid in the first seven policy years exceed, at any point during those years, the cumulative level annual premiums the insurance company would charge on a comparable policy for the first seven years. IRC Section 7702A(b)

34. After the policy reverts to the insured, because the policy satisfies the MEC 7-pay limit, the insured can make tax-free withdrawals from the policy via distribution of investment in the contract and policy loans. 

35. For an excellent discussion of this arrangement, see Steve Leimberg’s Charitable Planning Newsletter # 129 (Oct. 16, 2007) at www.leimbergservices.com.  

36. IRC Sections 512 and 514 subject debt-financed income to unrelated business income tax.

37. IRC Section 101(a)(1).

 
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