The Implications of Much Lower IRS Discount Rates
The IRS Discount Rate (also known as the “7520 rate”) has fallen from 3.6% in December of 2018 to 1.8% in October of 2019. This dramatic decline over a relatively short period of time has significant implications for split-interest gift arrangements. The charitable deductions for gift annuities and charitable remainder trusts go down when the discount rate goes down, but the deductions for charitable lead trusts and retained life estates go in the opposite direction. (The calculations for Pooled Income Funds are unaffected, as they do not use the discount rate.) The following paragraphs illustrate the impact of declining rates on various gift types.
Here’s an example of the effect from the drop in the discount rate: last December, a 72-year-old donor establishing a $10,000 gift annuity with a 5.8% payout rate (the rate recommended by the ACGA) would receive a charitable deduction in the amount of $4,337.30 based on the 3.6% discount rate; whereas the same donor establishing the same gift annuity on October 15 of this year would receive a charitable deduction of $3,519.30 if the calculations used the current month’s discount rate of 1.8%. Of course, the donor could “look back” to the discount rate of 2.2% in September, but that would only boost the deduction to $3,717.70. And if the discount rates of the next two months are 1.8% or lower, the donor would be limited to the deduction of $3,519.30.
Charitable Remainder Annuity Trust
Here’s another example: the same 72-year-old donor establishing a $100,000 charitable remainder annuity trust with a 5% payout rate last December would receive a charitable income tax deduction of $51,184.00, but in October, the deduction falls to $44,653.00 when using the 1.8% discount rate. In addition, with the dramatically lower discount rate, the annuity trust fails the 5% probability of exhaustion test, so the trust language would need to include the additional clause about mandatory termination should the principal value drop to below $10,000 (10% of the principal funding amount).
The numbers are not so dramatic for the charitable remainder unitrust – the deduction drops only by a few hundred dollars, which is due to the variable payout aspect of the CRUT.
Charitable Lead Trust
In contrast, the charitable deduction for a charitable lead trust would go up significantly with the drop in the discount rate: a donor establishing a 5% non-grantor $1,000,000 charitable lead annuity trust in December of 2018 with a 20 year term would receive a gift tax deduction of $704,230.00 based on the 3.6% discount rate, but now the deduction would go up to $833,570.00 using the 1.8% discount rate.
Retained Life Estate
For a retained life estate, a 72-year-old donor establishing an RLE for a $500,000 residence last December would receive a deduction of $286,100 using the 3.6% discount rate; but the deduction would increase to $346,612.50 in October for the same gift arrangement using the 1.8% discount rate.
Of course, there are a number of other factors affecting the charitable tax deductions of planned gifts – the age of the donor and the length of the term of years have significant impacts on the calculations. Moreover, it appears that significantly fewer planned giving donors are itemizing their deductions now, compared to the numbers of itemizers prior to the Tax Act of 2017. Having said that, we should still be aware of the effects on the deductions for those donors who continue to itemize their deductions; if the discount rate goes even lower than 1.8% for a period of time, the effects will be even more dramatic.