Archive for month: February, 2023

Thinking about a private foundation? First consider a donor-advised fund.

I have had a lot of experience with private foundations. During the first five years of my practice, I helped clients form more than 100 private foundations. In the following 20 years, that number probably hit 300.

A client who wants to sponsor her own scholarship program or send money to charities outside the US may need a private foundation. But I won’t form a private foundation now unless the client has had a meaningful discussion with a donor-advised fund sponsor. That’s because DAFs are likely to be more efficient.

So, what is a DAF?

It’s a giving account established at a public charity. Community foundations were pioneers in this area, but there are now more than 50 national DAF organizations. The largest ones are associated with investment firms such as Schwab, Fidelity, and Vanguard, which established tax-exempt related organizations to hold and manage grants from the accounts while the investment firms invest donated assets.

You put money into a DAF, take a charitable income tax deduction for the gift, and direct distributions to specific organizations over the years. You can create private foundation-like committees and structures, like boards, junior boards, and family councils, to engage family members in the family’s philanthropy. But you sidestep the administrative burdens of running a private foundation, such as filing annual state and federal tax returns, monitoring conflicts of interest, and worrying about the special taxes imposed on private foundations and their officers and directors.

Surprisingly, DAFs offer better tax deductions than private foundations.

A donor can only deduct a certain percentage of their adjusted gross income based on charitable donations. A private foundation donor’s deduction is limited to 30% of AGI (although, in some cases, the limit drops to 20% of AGI), while DAF donors can deduct up to 50% of AGI — or even 60% if their donation is in cash.

Forming a DAF is usually a simple process. I created mine online in about 15 minutes. If I had started a private foundation instead, I would’ve been lucky to get the foundation up and running in less than nine months.

What happens if I want to get rid of my DAF? I zero out the account by sending all the money to charities.

Getting rid of a private foundation is a substantial undertaking. It involves coordinating the IRS and your state’s taxing agency, Attorney General’s office, and secretary of state.

If you’re thinking of formalizing your charitable giving, let’s talk.

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Do you need an independent trustee?

Yes, you CAN name your brother as trustee of the irrevocable trust you created for your kids.

Next month marks 26 years of my being an estate planning lawyer. One of the statements I’ve heard repeatedly is that when you create an irrevocable gift trust, you *must* name an independent trustee.

That’s just wrong, and I’ll tell you why. But first, let me clarify that this post isn’t about whether trust companies and private fiduciaries are good ideas. This is just about requirements in the tax code.

Suppose I create an irrevocable trust meant to benefit my kids and give the trustee complete discretion. “Full discretion” means the trustee can distribute assets for any purpose or decide not to make any distributions. “Irrevocable” means I can’t change the trust once it’s in place.

Of course, I want to be the trustee so I retain control. But the tax code makes it clear: if I can control the “beneficial enjoyment” of the trust assets, they will be included in my estate for estate tax purposes. I gave the trustee complete discretion over the assets, so if I were the trustee, I would control the beneficial enjoyment of the assets, and the assets would be taxed as if I owned them.

I don’t want that. These kinds of trusts are meant to get assets OUT of my taxable estate.

So if I can’t be the trustee, can I control who will be? If I don’t think the trustee is doing a good job, can I remove them and put someone else in the role?

The tax code says I can remove the trustee and put someone new in the job, but I can only put an independent person in the role. Here, “independent” means someone who isn’t “related or subordinate” to me. My spouse, parents, kids, and siblings are all identified explicitly in the tax code as “related or subordinate” to me.

So, why do I say you can still have your brother be your trustee?

Because in 1995, the IRS issued a ruling that said I could name related people as my initial trustee and successor trustees so long as I did it in the trust document.

It’s only a problem if I can remove an acting trustee and replace them. I can name related people up front, but I can’t interrupt the administration of the trust by changing the trustee to someone else who is related to me.

That makes it look like I have the power to affect the beneficial enjoyment of the trust by playing games with who is the trustee.

This means that I can name a parent or a sibling as the trustee of my irrevocable trust. But once they’re in control as the trustee, I can’t pull them out and put someone else in who is related to me.

THAT is when I can only name an independent trustee.

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Here’s why I’m cautious about incentive trusts.

When you boil it down, an incentive trust encourages certain types of beneficiary conduct and discourages others.

How?

When the trustee likes what a beneficiary is doing, they’ll give bigger distributions. They’ll reduce or hold back distributions when they don’t like what they see.

Bribery is the word that comes to my mind. One colleague goes so far as to call it extortion.

Here are some classic incentive trust provisions:

“The trustee will pay you 50 cents for every dollar you earn.” (So what if you’re a teacher doing good work but not making much money? So what if you’ve decided to leave the workplace and serve as a caregiver for an ailing family member?)

“When you get your bachelor’s degree, the trustee will pay you $25,000.” (So what if you’re a talented chef and chose to pursue that instead?)

“Every time you have a child, the trustee will pay you $25,000.” (So what if your brother and his wife can’t have kids? They get the short end of the stick here.)

These incentives can discourage a beneficiary’s personal interests by setting the example that life is only measured by having or getting more money.

The chef might take a more traditional path even though they’re good enough for a spotlight on Chef’s Table.

The teacher may feel judged by provisions that ignore work that society needs but undervalues.

The excellent student might decide that their natural curiosity has been hijacked and turned into a job. Their curiosity takes the hit.

Stanford psychology professors have spent three decades studying how externally imposed rewards can wreck an internal interest that already values the subject of the reward.

A school of wealth psychologists worries that intellectual and emotional pleasure diminishes when you find yourself on a treadmill someone else put you on – even if the treadmill encourages you do keep doing something you like.

I’m not saying incentive trusts are bad.

I’m not saying they don’t work.

They need to be implemented thoughtfully so they don’t backfire.

How about structuring an incentive trust that rewards contributions to art, science, culture, and education? It can be done – especially if you help a client figure out what things they value most in the world.

I’m pretty sure the answer will (almost) never be “I want my kids to measure their lives using money.”

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Are pot trusts still useful?

Why do I still talk to my clients about pot trusts?

Suppose a client dies while her three kids are still young. There are a few choices about how to hold assets for the kids.

The trust could say: create equal one-third shares, so each kid has their own share. That way, the kids are treated equally. If the oldest one gets into Harvard, their education costs come from their share without implicating the two other kids’ shares. It’s a widespread approach because it seems fair. Three kids, three shares.

But there’s a real risk of creating disparity. Let’s skip down the road a bit.

The oldest child has one son. When that child dies, the grandson will inherit a 33% share.

The middle child has two children. Those grandchildren will inherit shares worth about 16.5% of the estate.

The youngest child has five children. Each of them will inherit shares worth about 6.6% of the estate.

Does it still seem fair? Will the grandchildren with 6.6% shares receive the same benefits as the grandson with a 33% share?

As more families amass estates that should last beyond the kids’ lifetimes, it’s a meaningful discussion.

Would my client prefer a pot trust that allows all the kids and grandkids equal opportunity to benefit from the trust? Especially if the pot trust splits when the youngest child dies, meaning all grandkids end up with equal shares?

Clients generally aim to be fair to their kids and grandkids, and using a trust structure that focuses on those two generations is often a good idea.

It may only work sometimes, but clients should get to think about the possibility.

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Make sure your charitable contribution acknowledgment is complete.

The devil is most definitely in the details regarding income tax deductions for charitable contributions.

When you give more than $250 to a charity, the tax code says you cannot deduct that contribution unless the charity gives you a contemporaneous written acknowledgment for it.

The acknowledgment must contain three statements.

First, it must identify the amount of cash and a description (but not the value) of any property other than cash contributed.

Second, it must state whether the donee organization provided any goods or services in consideration, in whole or in part, for the contributions.

Third, a description and good faith estimate of the value of any goods or services provided to the donor.

It seems like three easy things to work into an acknowledgment form, but recently the tax court got nitpicky. It denied a donor’s entire deduction to a museum because the acknowledgment didn’t say explicitly that the museum hadn’t provided any goods or services in consideration of the contribution.

Talk with an experienced charitable planning attorney if you contribute significantly to charity. I’m here to help.

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What is “funding” a trust?

Early in my career, I had clients sign a funding acknowledgment when we signed their estate planning documents.

That acknowledgment was my way of telling clients it’s essential that they connect substantially all their assets to their trusts. Otherwise, the thing they wanted to avoid — probate — would be necessary.

In the last two weeks alone, I have talked with three clients who recently acquired new assets in their individual names. Not small assets. Big ones — a multi-million dollar house, an 8 figure investment account, and a controlling interest in a successful HVAC business.

If the client with the new house dies before we get the title transferred to his trust, that family is looking at probate legal fees of about $60,000.

I’m going to start using funding acknowledgments again because I don’t want family members to look at me as if I did something wrong. I can help clients keep their assets aligned with their trusts, but I’m not a mind reader. I don’t know when a client buys a new house. They have to tell me.

If your estate plan is in place, take a few minutes over the weekend to confirm that your assets are appropriately titled. If you aren’t sure, call your estate planning attorney for advice.

If you don’t have your estate plan in place, now’s the perfect time to take care of that.

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Why are estate planners so nosy?

Read more
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Keep it. Simple.

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