COVID-19 Has Changed Charitable Trust Planning

COVID-19 is a public health issue that goes far beyond the bounds of this blog. However, focusing only on the economic side of the equation, it is clear the SARS-COV 2 virus, and the needed response to contain it, have had and will have significant effects on the economy. As reported in the Atlantic on March 21, 2020, the U.S. government has seen applications for unemployment benefits jump 33%, and major financial institutions (Goldman Sachs and JPMorgan) are projecting zero growth and up to a 14-24% drop in GDP in the next full quarter. As of the close of trading on March 20, 2020, the S&P 500 had lost roughly 30% of its value from its high point in 2020. Finally, the Federal Reserve cut key interest rates to a range of 0-.25%.

Under these challenging circumstances, some charities will likely feel a two-fold attack: (1) reduced contributions to fund programs, and (2) higher demand for their programs. Additionally, the need to socially distance (either voluntarily or by mandate) could disrupt staffing and administration of services. Charities employ close to 12.3 million people in the United States, and create millions of jobs outside of the employees under their umbrellas, while spending close to $1 trillion annually. Giving to charities, however, suffers in economic downturns, as it did when it fell 13.2% in 2008 and 2009.

Even in a low interest rate environment with a reduced stock market, many fortunate individuals will want to give. The options available to do that have not necessarily changed, but their respective utilities have. There are essentially three ways to give to charity: (1) outright gifts of cash or property, (2) a charitable remainder trust, or (3) a charitable lead trust. While IRA distributions after age 72 and charitable gift annuities are also available, they are essentially outright gifts of cash or property though a charitable gift annuity pays the donor back an annuity payment.

An outright gift is a gift of both the present value and the future appreciation on cash or property. In other words, the charity gets the current value of the gift and can invest the gift and use any future appreciation from that investment. A charitable remainder trust is a trust in which the donor retains an annuity interest in the gift (the present value of the gift) and the charity receives the balance of the trust when the trust terminates (usually after a number of years or the death of the donor). Thus, a charitable remainder trust “splits” the interest inherent in an outright gift: the present interest and the future interest. A charitable lead trust also splits the interests by giving the charity an annuity interest in the gift (the present value of the gift) and the donor or family members receive the balance of the trust when the trust terminates (again, usually after a number of years or the death of the donor).

In either trust option, the donor is deciding to keep one of the present interest or the future interest. In that case, when the economy is doing well and interest rates are high, the charitable remainder trust can be better. This is because the trust can receive appreciated property, sell that property without paying capital gains, reinvest the proceeds tax-free, and then distribute the investments as annuity payments over a long period of time when the donor slowly recognizes the capital gains and income items of the trust the donor receives. Thus, the charitable remainder trust does well when the donor wants to defer paying capital gains on an appreciate asset. The donor also receives a charitable income tax deduction in the year of forming the trust equal to the charity’s interest. High interest rates increase the value of the charity’s interest under the tax rules of Code Section 664, and thus enhance the donor’s deduction. Pre-COVID-19, charitable remainder trusts were often the best option.

Now, under a suppressed interest rate and market environment, a charitable lead trust may be better for a donor. If a charitable lead trust pays the charity’s annuity payment in kind (rather than in cash) the payment is a deemed sale, and the donor must pay the taxes–if the donor wants to qualify for a charitable income tax deduction on forming the trust. Additionally, if a charitable lead trust sells contributed property, the sale is taxable to the donor who wants to qualify for a charitable income tax deduction on forming the trust. However, if the assets of the trust have little or no potential gains due to the market, there is no risk of saddling the donor with a significant capital gains bill. Also, in a low interest rate environment, the value of the charity’s interest in the trust, which is also the value of the charitable income tax deduction available to the donor, is increased under the rules of Code Section 7520. The bottom line is that under current circumstances a charitable lead trust is a better option for charitable giving than it was even two months ago.

As quickly as COVID-19 has changed the economic outlook in the United States, it has also reversed the utility of charitable planning tools. Whereas charitable remainder trusts were the best trust-based option two months ago, now charitable lead trusts may be superior. Of course, every situation is unique and there is no one-size-fits-all solution. As we head into uncharted territory, hopefully generous Americans will continue to support charities that are and will be on the font lines of supporting those most vulnerable to this crisis.

Brent Nelson assists U.S. and international individuals, families and financial institutions in tax, estate planning and family business matters. In addition, he frequently speaks and writes on estate and tax developments. Brent develops estate plans in a wide variety of circumstances, from basic estate plans to complex plans for high net worth individuals and families. He also assists them with related business succession and charitable goals. Read more about Brent here.

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