8106 / Is the deduction for a gift to a charitable lead annuity trust of a right to payment taken in the year of the gift?

An immediate deduction of the present value of all the annual payments to be made over the period may be taken if the trust is structured so that the donor is taxable on the income of the trust each year (under the “grantor trust rules”). If the trust is structured so that he is not taxable on trust income, he will not get an income tax deduction for the gift.¹ The IRS has determined that a donor was to be treated as the owner of a charitable lead trust where the donor retained the power to substitute trust property. The donor was entitled to a current deduction in an amount equal to the present value of the unitrust interest.²

In general, the amount of the charitable contribution deduction allowable for the transfer of property to a charitable lead annuity trust is equal to the present value of the annuity payable to the charity.

Example 1. In September, Mr. Smith (age 85) transferred property worth $100,000 to a charitable lead annuity trust that is a grantor trust. The trust is to make biannual payments (at the end of each six-month period) of $2,500 to the charity during his lifetime. Assume the IRC Section 7520 interest rates for
September and the two preceding months, July and August, were 3.4 percent, 3.2 percent, and 3.0 percent. Mr. Smith elected to use the 3.0 percent rate because the lowest 7520 in the three-month period produces the highest charitable deduction for charitable lead trusts.

The value of the annuity payable to charity is calculated as follows:

(1) Find the single life annuity factor for a person age 85 at a 3.0 percent interest rate – 5.6054 (from Single Life Annuity Factors Table).

(2) Find the adjustment factor at a 3.0 percent interest rate for semi-annual annuity payments at the end of each period – 1.0074 (from Annuity Adjustment Factors).

(3) Multiply the aggregate payments received during a year by the factors in (1) and (2) – $5,000 × 5.6054 × 1.0074 = $28,234.

The amount of the charitable contribution deduction is equal to $28,234.

Example 2. If in Example 1, payments were to be made to charity at the beginning of each six-month period (instead of at the end of each period), one payment is added to the value of the annuity payable at the end of each period. The value of the annuity payable at the beginning of each period would be $30,734 ($28,234 + $2,500). The amount of the charitable contribution deduction would be equal to $30,734.

Example 3. If payments in Example 1 were to be made for 20 years rather than for Mr. Smith’s life, the value of the annuity payable to charity (at the end of each 6-month period) is calculated as follows:

(1) Find the term certain annuity factor for 20 years at a 3.0 percent interest rate – 14.8775 (from Term Certain Annuity Factors Table).

(2) Find the adjustment factor at a 3.0 percent interest rate for semi-annual annuity payments at the end of each period – 1.0074 (from Annuity Adjustment Factors Table).

(3) Multiply the aggregate payments received during a year by the factors in (1) and (2) – $5,000 × 14.8775 × 1.0074 = $74,938.

The amount of the charitable contribution deduction is equal to $74,938.

Example 4. If payments in Example 2 were to be made for 20 years rather than for Mr. Smith’s life, the value of the annuity payable to charity (at the beginning of each period) is calculated as follows:

(1) Find the term certain annuity factor for 20 years at a 3.0 percent interest rate – 14.8775 (from Term Certain Annuity Factors Table).

(2) Find the adjustment factor at a 3.0 percent interest rate for a term certain annuity payable at the beginning of each semi-annual period – 1.0224 (from Annuity Adjustment Factors Table B).

(3) Multiply the aggregate payments received during a year by the factors in (1) and (2) – $5,000 × 14.8775 × 1.0224 = $76,054.

The amount of the charitable contribution deduction is equal to $76,054.