Mr. and Mrs. Ferraro, Part II the Charitable Remainder Trust
Last month we recounted the initial conversation with the Ferraro’s where a significant income tax opportunity—to the tune of $20 million—was identified. The Ferraro’s were giving away their estate at death, creating an enormous and unusable tax deduction on their final income tax return. Once the Ferraro’s comprehended the enormity of the issue, they were excited to hear about alternatives.
We pick up this month with the implementation of one of the strategies we employed to recover millions of dollars for current usage without interfering with the transfer at death of their estate to charity.
“You’re 75, Mr. Ferraro, and you’ve been buying 30 year municipals?” I asked.
“If there’s one thing I understand, it’s the bond market,” replied Mr. Ferraro. “The way Congress is spending, I’ve got a bull’s eye on my back for higher taxes. Further, I own too many stocks already. So, yes, I’ve been building my positions over the last few years. I’m happy to accept the returns on the insured municipals.”
“Okay, but isn’t there a pretty good chance that interest rates might go up with a bullet? You’ll take a bath to sell out.”
“Sell a good bond? I’ve never done it in my life and don’t plan on starting now. Interest rates don’t scare me,” Mr. Ferraro said with an air of finality.
“Reminds me of T. Boone Pickens: Eighty years old with a 40-year plan. Great strategy! Let’s see if we can improve on it.”
Then I asked, “What if we used those tax free bonds to go get a bunch of tax dollars for free?”
After the puzzled look, we adjourned as I told the Ferraro’s that I had some homework to do and that I’d see them in a week.
The Ferraro’s tax-free bond portfolio was just north of $20 million, with very long maturities. Clearly, this was the juiciest target for our first Charitable Remainder Trust (CRT). But I knew as steeped as Mr. Ferraro was in “traditional philosophies” when it comes to holding assets, I would have my work cut out for me. But always before us was that huge, unused deduction that we needed to reconfigure to use over their lifetimes.
Why did I first target the municipal bond portfolio and not zero in on their appreciated stocks when it came to implementing the first CRT? Several reasons:
- The tricky part is that there are some technical rules regarding CRT’s. If you put appreciated assets in a CRT, sell them and then try to buy municipal bonds, it backfires on you. The income gets re-characterized as taxable income (cap gains until the avoided gain is recaptured). By putting in FULL BASIS assets, though, the nature of the income produced by the CRT (tax-free) keeps its integrity.
- The deduction for gifts to CRT’s is not dollar-for-dollar. It is a “future gift,” so there are some calculations that are based on the age of the donors, and the percent of income the CRT is designed to produce annually. The older the donor and the lower the income, the higher the deduction. Mr. Ferraro stated he was happy with the returns of his municipals.
- Mr. Ferraro loved studying and buying his bonds nearly every morning for an hour or two. I was afraid if I took that work away from him he’d drive Mrs. Ferraro nuts with extra time on his hands. By simply creating a CRT in the name of the Ferraro’s as grantors, then simply re-titling the portfolio in the name of the CRT, BOOM, it’s a $10 Million deduction producing over $4.5 million in tax savings (a.k.a. cash). And, to Mrs. Ferraro’s profound relief, Mr. Ferraro still managed the portfolio (self-trusteed).
I won’t say that the meeting went swimmingly as I had to hear half a dozen times that it just didn’t compute to put full basis assets in a CRT that “everyone knows is designed to hold appreciated assets,” but in the end, logic did prevail.
Bottom Line: If you are planning on leaving a legacy gift at death, make sure your final tax return can absorb the deduction. If not, one strategy to consider is a charitable remainder trust (CRT) to enjoy tax savings right away. Finally, if you do consider a CRT and you hold municipal bonds, they may be an ideal candidate for your donation to the CRT. The IRS pays you for getting tax-free income. What a country!
–Jeffrey Smith, CPA, is the author of “Generation BIG, Bold, Innovative and Generous, The Rising Tide of Dreams to Action.” If you or your advisors would like to discuss this or any other strategy, just drop me a line at JSTAXCOACH@gmail.com.