Harnessing the Valuation Nightmare

Stephan R. Leimberg, Daniel B. Evans, 1999. All Rights Reserved.
Reprinted with Permission.

Section 7520 /1/ of the Internal Revenue Code, adopted as part of the Technical and Miscellaneous Revenue Act of 1988, significantly changed the way life estates, annuities, and remainders are valued for federal estate and gift tax purposes. It required the use of (a) a discount rate calculated monthly from the applicable federal rates derived from the yields on federal securities /2/ and (b) a mortality table to be revised periodically.

Section 7520(c)(3) mandated that Treasury issue revised actuarial tables not later than December 31, 1989, to take into account the most recent mortality experience available as of the time of the revision, and to revise those tables at least every 10 years thereafter to take into account the most recent mortality experience available at the time of the revision. The 100-plus page change in the valuation tables effected by proposed and temporary regulations (REG-103851-99; T.D. 8819), which were released April 29, 1999, and became effective as of May 1, 1999, is the result of that mandate. (For the full text of the proposed and temporary regs, see 1999 TNT 89-149 or Doc 1999-15969 (2 original pages.) It significantly affects the valuation of both inter vivos and testamentary transfers of interests dependent on one or more measuring lives. (Because of the uncommonly short notice, the temporary and proposed regulations provide transitional rules to alleviate adverse consequences from the regulatory change.) A complete set of the annuity and life interest factors will be found in the forthcoming Treasury 1999 guidance, Publications 1457, "Actuarial Values, Book Aleph," 1458 "Actuarial Values, Book Beth," and 1459, "Actuarial Values, Book Gimel." /3/

As noted, these new tables will have significant effects on both advisers and their clients and on the tools and techniques of financial, estate, and employee benefit planning. Specifically, the new tables, based on the 1990 census, change every actuarial factor in every table involving one or two lives. /4/

To those who are not mathematically oriented or who cannot find or create software to handle the task, working with time-value- of- money sensitive financial and estate planning tools and techniques can resemble a very bad dream. For instance, valuation of life estates, remainders, and annuities is done actuarially and is affected by the assumptions underlying the tables used by the IRS. In updating software used for valuing these interests, we discovered some very interesting consequences of the new tables, particularly in the choices that practitioners have for May and June 1999 under the transition rules that apply in those months.

This article will explain the problems and opportunities and illustrate ways to cope with this continuing nightmare.

We will cover:

o the changes that are required;

o the process for routine computations;

o the general implications of higher (or lower) interest rate
assumptions;

o the general implications of longer mortality assumptions; and

o how grantor retained annuity trusts (GRATs), qualified
personal residence trusts (QPRTs), private annuities,
charitable remainder and charitable lead interests, and other
time-value-of-money sensitive tools and techniques are
affected.

The Mortality Changes

To understand what has happened and to set the stage for the implications on planning, it is necessary to know how various interests are valued.

The actual value of a life annuity, life estate, or remainder interest to the owner of such interest will depend on:

o the rate of return actually earned on invested assets; and on

o how long the person whose life controls the term of such
interest lives.

Unfortunately (or perhaps, fortunately), neither the rate of return that will actually be earned nor the length of the controlling life are known at the time such interests are created. For tax purposes, however, some value must be placed on such interests when they are created despite these two critical unknowns.

The first step is to determine a proper interest rate that should be used to calculate the present value of future interests. This is called the "interest component" or "discount rate" of the formula. For calculations involving terms of years, the discount rate is the only variable. Factors for term estates, remainders, and term annuities can be calculated easily once the appropriate interest rate has been determined. For example, the future value of $1.00 can be calculated by compounding the annual interest that could be earned for the length of the term. The present worth of a remainder interest is the amount that must be invested presently to produce $1.00 at the end of the term of the trust. This is the future $1.00 divided by the compounded interest. The factor for an income interest, or an annuity for a term, can be calculated from the remainder factor.

When the income, remainder, or annuity is not measured by a term of years, but a life or lives, the calculation is more complicated. Contrary to what many people assume, the calculation of a life estate is not the same as a term for the life expectancy of the life tenant. Instead, it is a series of calculations, based on the probabilities of death in each future year. So the value of a remainder after a life estate is the sum of the value of the remainder at the end of the first year, multiplied by the probability of death in that first year, plus the value of the remainder at the end of the second year, multiplied by the probability of death in that second year, plus the value of the remainder at the end of the third year, multiplied by the probability of death in that third year, and so on.

The probabilities of death in each year are calculated using a mortality table. A mortality table is based on a study of the longevity of a large number of people over a selected period of time. It essentially indicates what probability a hypothetical individual who represents the average experience at each age of life has of surviving from one year to the next. This is called the "mortality component" of the formula.

Applying both the discount rate and the mortality table, a valuation table is constructed that converts these two factors (rate of interest and life expectancies) into one factor to be applied to the present value of the property to determine the values of the remainders and life estates, or the amount of the periodic payment to determine the present value of an annuity for a life or lives.

The proposed regulations incorporate revised Table S (Single Life Remainder Factors) and Table U(1) (Unitrust Single Life Remainder Factors) based on data compiled from the 1990 census as set forth in Life Table 90CM. They also make conforming amendments to various sections to reflect the revised tables.

Code Sections Affected:

These changes will affect valuation under sections:

o 170 (charitable contributions valuation for income tax
purposes);

o 641 (special rules for charitable contribution deductions);

o 664 (charitable remainder trusts);

o 2031 (estate tax valuation);

o 2055 (charitable contributions valuation for estate tax
purposes);

o 2512 (gift tax valuation);

o 2522 (charitable contributions valuation for gift tax
purposes); and

o 2624 (valuation for generation-skipping transfer tax
purposes). /5/

Code Sections Not Affected:

It is important for planners to note that the new mortality tables were adopted solely for the purpose of section 7520 and do not affect transactions outside of the scope of section 7520, such as transactions requiring the application of the tables for expected return multiples found in the regulations under section 72. Specifically, the new tables do not apply for purposes of the required distribution or other pension and profit-sharing rules provided in sections 401 to 409 and "any other provision" specified by the IRS. /6/

The regulations, which have been issued under section 7520, state that the valuation rules of section 7520 do not apply to the income taxation of life insurance, endowment, and annuity contracts under sections 72 and 101(b), installment sales under sections 83 and 451, the valuation of deferred compensation under section 457, the income and gift taxation of below-market loans under section 7872, and the value of a nonqualified retained interest under section 2702(a)(2)(A), among others. /7/

Mortality Tables

The mortality tables used for section 7520 calculations are not tables of life expectancies, but tables of lives in being. The tables start with 100,000 births and then show the number of people who will be alive at each age after that.

The mortality table used from May 1, 1989, to April 30, 1999, was Table 80CNSMT, and could be found in the regulations at the end of Treas. reg. section 20.2031-7. The new table, Table 90CM, will be found in revised Treas. reg. section 20.2031-7, and the old Table 80CNSMT has been moved to Treas. reg. section 20.2031-7A.

     A comparison of the two tables showing the number of lives assumed surviving at the end of the year follows:

Age       Table      Table    Increase/
         80CNSMT     90CM     Decrease
_______________________________________

  0      100000     100000        0
  1       98740      99064      324
  2       98648      98992      344
  3       98584      98944      360
  4       98535      98907      372
  5       98495      98877      382
  6       98459      98850      391
  7       98426      98826      400
  8       98396      98803      407
  9       98370      98783      413
 10       98347      98766      419
 11       98328      98750      422
 12       98309      98734      425
 13       98285      98713      428
 14       98248      98681      433
 15       98196      98635      439
 16       98129      98573      444
 17       98047      98497      450
 18       97953      98409      456
 19       97851      98314      463
 20       97741      98215      474
 21       97623      98113      490
 22       97499      98006      507
 23       97370      97896      526
 24       97240      97784      544
 25       97110      97671      561
 26       96982      97556      574
 27       96856      97441      585
 28       96730      97322      592
 29       96604      97199      595
 30       96477      97070      593
 31       96350      96934      584
 32       96220      96791      571
 33       96088      96642      554
 34       95951      96485      534
 35       95808      96322      514
 36       95655      96150      495
 37       95492      95969      477
 38       95317      95780      463
 39       95129      95581      452
 40       94926      95373      447
 41       94706      95156      450
 42       94465      94928      463
 43       94201      94687      486
 44       93913      94431      518
 45       93599      94154      555
 46       93256      93855      599
 47       92882      93528      646
 48       92472      93173      701
 49       92021      92787      766
 50       91526      92370      844
 51       90986      91918      932
 52       90402      91424     1022
 53       89771      90885     1114
 54       89087      90297     1210
 55       88348      89658     1310
 56       87551      88965     1414
 57       86695      88214     1519
 58       85776      87397     1621
 59       84789      86506     1717
 60       83726      85537     1811
 61       82581      84490     1909
 62       81348      83368     2020
 63       80024      82169     2145
 64       78609      80887     2278
 65       77107      79519     2412
 66       75520      78066     2546
 67       73846      76531     2685
 68       72082      74907     2825
 69       70218      73186     2968
 70       68248      71357     3109
 71       66165      69411     3246
 72       63972      67344     3372
 73       61673      65154     3481
 74       59279      62852     3573
 75       56799      60449     3650
 76       54239      57955     3716
 77       51599      55373     3774
 78       48878      52704     3826
 79       46071      49943     3872
 80       43180      47084     3904
 81       40208      44129     3921
 82       37172      41091     3919
 83       34095      37994     3899
 84       31012      34876     3864
 85       27960      31770     3810
 86       24961      28687     3726
 87       22038      25638     3600
 88       19235      22658     3423
 89       16589      19783     3194
 90       14154      17046     2892
 91       11908      14466     2558
 92        9863      12066     2203
 93        8032       9884     1852
 94        6424       7951     1527
 95        5043       6282     1239
 96        3884       4868      984
 97        2939       3694      755
 98        2185       2745      560
 99        1598       1999      401
100        1150       1424      274
101         815        991      176
102         570        672      102
103         393        443       50
104         267        284       17
105         179        175       -4
106         119        105      -14
107          78         60      -18
108          51         33      -18
109          33         17      -16
110           0          0        0
_______________________________________

As can be seen, almost all ages have experienced an increase in the number of lives in being at that age. The most significant reductions in mortality can be found in infant mortality (before age 1) and in the late 50s through early 80s. At those ages, there is a substantial decline in mortality and a substantial increase in the number of lives surviving.

We found it curious that the 1990 census figures show a reduction in the number of persons living past age 105. This appears to indicate an increase in mortality in those advanced ages. The authors are unaware of any explanation for this increase in mortality at a time when medical science seems to be continually increasing life expectancies. One speculation is that the increasing use of "living wills" and the increasing interest in quality of life is leading to less aggressive medical treatment of persons past 100.

Life Expectancies

Although Table 90CM is not a table of life expectancies, both Table 80CNSMT and Table 90CM can be used to construct a table of life expectancies.

Basically, life expectancy is calculated as the average number of years lived beyond a particular age. For example, life expectancy at age 50 can be calculated by taking the number of people who died before age 51 and multiplying by one-half (assuming that the each lived an average of one-half year), adding the number of people who died between age 51 and 52 multiplied by 1.5, adding the number of people who died between age 52 and 53 multiplied by 2.5, and so forth. The total is divided by the total number of people to determine the average number of years lived.

     The life expectancies reflected in Table 80CNSMT and Table 90CM are compared in the following table:

          Life Expectancies
          _________________

Age       Table      Table    Increase       Percentage
         80CNSMT     90CM     in Years       Increase
_______________________________________________________

  0        73.9      75.4        1.5           2.03%
 10        65.1      66.3        1.2           1.84%
 20        55.5      56.6        1.1           1.98%
 30        46.1      47.2        1.1           2.39%
 40        36.8      38.0        1.2           3.26%
 50        27.9      29.0        1.1           3.94%
 60        20.0      20.9        0.9           4.50%
 70        13.3      14.0        0.7           5.26%
 80         8.0       8.4        0.4           5.00%
 90         4.4       4.5        0.1           2.27%
100         2.7       2.5       -0.2          -7.41%
_______________________________________________________

As mentioned above, the new mortality table actually reflects a slight decrease in life expectancy after age 95. This is a significant factor that planners should consider in certain cases when deciding whether to use the old mortality table or the new mortality table for valuations in May or June 1999, as discussed below.

For those under age 95, the net effect of these life expectancy improvements will be to:

o increase the value of life estates;

o increase the value of annuities for life;

o decrease the value of remainder interests; and

o decrease the value of contingent reversions (such as are often
retained in QPRTs). /8/

Life Estates and Remainders

As explained above, the increasing life expectancies will increase the value of life estates and decrease the value of the remainders that follow those life estates.

     The following two tables, showing factors with a section 7520 discount rate of 6 percent, will help illustrate this impact of the mortality tables:

          Life Expectancies
          _________________

Age       Table      Table    Increase       Percentage
         80CNSMT     90CM     in Years       Increase
_______________________________________________________

  0      0.96256    0.96767    0.00510          0.53%
 10      0.95973    0.96210    0.00237          0.25%
 20      0.93508    0.93865    0.00356          0.38%
 30      0.89998    0.90468    0.00470          0.52%
 40      0.83957    0.84987    0.01031          1.23%
 50      0.75034    0.76498    0.01464          1.95%
 60      0.63326    0.64967    0.01641          2.59%
 70      0.49359    0.50993    0.01634          3.31%
 80      0.34151    0.35604    0.01453          4.26%
 90      0.21143    0.21508    0.00365          1.73%
100      0.13673    0.12678   -0.00994         -7.27%
_______________________________________________________

As can be seen, there is a small increase in the value of life estates for very young beneficiaries. This is due to the decline of infant mortality and generally better life expectancies.

The most significant declines in mortality have been in the post-retirement ages of 60 and above. The benefit of those mortality changes are discounted too heavily after 40 or 50 years to significantly affect the value of a life estate for a 20-year old or 10-year old. But the value of a life estate of an older individual, for example, an 80-year old, has increased significantly.

The factors for life estates and remainders always add up to one. So the value of a remainder interest will decrease, dollar for dollar, by the increase in the value of the life estate.

Charitable Remainder Unitrusts

The Taxpayer Relief Act of 1997 imposed a new requirement that the charitable remainder of a charitable remainder trust must have an initial present value of at least 10 percent of the gift to the trust. /9/ This was adopted by Congress to eliminate perceived abuses in the creation of charitable remainder trusts that were designed to minimize income taxes with little or no charitable deduction, and from which charities would most likely receive very little, if anything. However, a somewhat unintended consequence of this change in law was that it became impossible in many cases to create charitable remainder unitrusts (CRUT) for young beneficiaries (for example, those in their early 20s or teens).

The problem is that a CRUT must have a payout rate of at least 5 percent. But an adjusted payout rate of 5 percent results in a charitable deduction of less than 10 percent if the measuring life is 24 or younger. It is possible to set a nominal payout rate of 5 percent, but in actuality have an adjusted payout rate of less than 5 percent if there is a delay between the valuation date and the distributions from the trust. The greatest adjustment occurs if there is an annual distribution and a 12-month delay between the valuation date and the distribution (that is, the valuation is at the beginning of the year and the distribution is at the end of the year). However, even if the section 7520 rate were 9.8 percent (the highest rate recorded since the January 1991 effective date), the beneficiary would still need to be at least age 20 for the charitable remainder to be at least 10 percent of the initial value of the CRUT. For a more common 7520 rate of 6.0 percent, the beneficiary must be at least 22 years old for the trust to qualify.

With the longer life expectancies under the new mortality table, the minimum age for a CRUT with a 5 percent adjusted payout rate has increased from age 25 to age 26.

     The changes are even more dramatic for two life unitrusts, as illustrated by the following chart, which shows the minimum qualifying ages under the old mortality table and the new mortality table:

           Two Life Unitrusts
           __________________

First          Second Age          Required
Age                                Increase
                                   in 2nd
                                   Age
___________________________________________

       Table                Table
      80CNSMT               90CM

26       66                  82       16
27       59                  69       10
28       54                  61        7
29       50                  56        6
30       48                  53        5
31       45                  50        5
32       43                  47        4
33       42                  45        3
34       40                  43        3
35       39                  42        3
36       38                  40        2
37       37                  39        2
38       36                  38        2
___________________________________________

Charitable Remainder Annuity Trusts

Like CRUTs, a charitable remainder annuity trust (CRAT) must satisfy the requirement that the charitable deduction be at least 10 percent of the gift to the trust. However, unlike CRUTs, this requirement can be met as long as the section 7520 payout rate is 5.4 percent or higher, because a CRAT paying an annuity of 5 percent of the initial value of the trust will generate a charitable deduction of more than 10 percent even for a one-year old beneficiary.

     For a section 7520 discount rate of 6.0 percent, the following table shows the maximum payouts allowable from a CRAT (ignoring the 5 percent exhaustion test described below):

             Maximum CRAT
             Payout at 6%
          ___________________

Ages       Table        Table      Decrease    Percentage
          80CNSMT       90CM       in Points   Decrease
_________________________________________________________

  0        5.610%       5.579%       0.031        0.55%
 10        5.626%       5.612%       0.014        0.25%
 20        5.774%       5.752%       0.022        0.38%
 30        6.000%       5.968%       0.032        0.53%
 40        6.431%       6.353%       0.078        1.21%
 50        7.196%       7.058%       0.138        1.92%
 60        8.527%       8.311%       0.216        2.53%
 70       10.940%      10.589%       0.351        3.21%
 80       15.812%      15.166%       0.646        4.09%
 90       25.539%      25.106%       0.433        1.70%
100       39.494%      42.592%      -3.098       -7.84%
_________________________________________________________

As expected, the longer life expectancies below age 95 result in higher annuity factors, and so the maximum payouts are lower if the charitable deduction must be at least 10 percent.

In addition to the 10 percent charitable deduction rule, CRATs must also comply with a requirement announced by the IRS in Rev. Rul. 77-374, 1977-2 C.B. 329, that there can be no more than a 5 percent probability that the beneficiary will outlive the exhaustion of the trust fund, and that the charitable remaindermen will get nothing. Stated another way, the payout from a CRAT should not result in an exhaustion of the trust fund while there is a greater than 95 percent probability that the beneficiary is still alive. Fortunately, the increase in life expectancies below age 95 causes at most a one- year increase in the period during which a beneficiary has a 95 percent probability of survival, and sometimes causes no increase at all. This results in a very small decrease in the payout of a CRAT to comply with the 5 percent exhaustion test of Rev. Rul. 77-374.

     The chart below illustrates the maximum payouts from a CRAT for one life, based on a section 7520 discount rate of 6 percent, taking into account both the 10 percent remainder requirement and the 5 percent exhaustion test.

          Maximum CRAT Payout
          at 6%, with 5% test
          ___________________

          Table        Table      Decrease     Percentage
Ages     80CNSMT       90CM       in Points     Decrease
_________________________________________________________

  0       5.610%       5.580%       0.030         0.53%
 10       5.626%       5.612%       0.014         0.25%
 20       5.774%       5.752%       0.022         0.38%
 30       6.000%       5.968%       0.032         0.53%
 40       6.254%       6.239%       0.015         0.24%
 50       6.470%       6.441%       0.029         0.45%
 60       6.897%       6.839%       0.058         0.84%
 70       7.690%       7.570%       0.120         1.56%
 80       9.236%       9.236%       0.000         0.00%
 90      12.679%      12.679%       0.000         0.00%
100      17.913%      20.336%      -2.423       -13.53%
_________________________________________________________

Transition Rule Choices

For deaths, gifts, and other transactions in May or June 1999, the temporary regulations allow the taxpayer to select whether to use the old factors based on Table 80CNSMT or the new factors based on Table 90CM. There are some general rules about which table will yield the best results for different kinds of transactions. These general rules will also show how various tools and techniques of estate and financial planning are affected by the new tables.

Life Estates and Remainders

As noted above, the new mortality tables reflect longer life expectancies for those under 95 years of age. So the value of life estates will be greater for those ages, and the value of the remainders following those life estates will be less.

Whether to elect to use the old valuation tables in May and June 1999 will depend on the purpose of the valuation and whether a higher or lower value is desired. If the valuation is of an annuity included in the gross estate for federal estate tax purposes, during the transition period, the executor may wish to use the older tables, in order to reduce the value of the gross estate. However, there may be some purposes for which a higher value is desired, and so the new tables should be used.

Qualified Personal Residence Trusts

A QPRT is an irrevocable trust into which the grantor places a personal residence and retains the right to use the residence for a fixed period of time. At the end of the specified period of years, the residence will pass to a beneficiary such as a child. Essentially, the grantor is making a future interest gift of the residence at the end of the term (that is, the client is making a gift of the remainder) while retaining the right to the use of the residence during the term (the client is keeping an income for a fixed term of years). A QPRT is one of the exceptions to the valuation rules contained in Chapter 14 of the code. It is one of the few remaining ways in which a grantor can give a significantly discounted future interest in property to a child or other family member.

Because a QPRT is normally for a fixed term of years, the changes in the mortality table do not affect the value of the term interest. However, most attorneys draft the QPRT to provide that the grantor retains the right to a reversion of the trust back to the grantor's estate if the grantor dies during the term of the trust. This increases the estate's liquidity and ability to pay the tax. (If the grantor dies during the term of the trust, the residence will be included in the grantor's taxable estate anyway, because of section 2036.) Retention of the possible reversion has a significant pre-mortem planning impact. It further reduces the value of the remainder interests, and so reduces the taxable gift to the remaindermen.

     The new mortality table reflects a longer life expectancy for those 94 years of age and younger. That, of course, according to the new tables, makes it less likely that the grantor will die during the term of the trust than under the old tables. All other things being equal, the new mortality tables will result in a larger taxable gift if the grantor is less than 94 years of age or younger, but a smaller taxable gift if the grantor is 95 years or older. This can be illustrated by the following table, which shows the present values of the remainder interest using a 10-year QPRT and assuming the grantor retains a reversion upon the grantor's death during the term of the trust:

           QPRT Remainders
           _______________

Ages      Table        Table          Increase            Percentage
          80CNSMT      90CM           in Factor           Increase
____________________________________________________________________

45        0.51723     0.52180         0.00458                0.88%
50        0.50127     0.50743         0.00616                1.23%
55        0.47825     0.48600         0.00775                1.62%
60        0.44667     0.45713         0.01046                2.34%
65        0.40365     0.41656         0.01291                3.20%
70        0.34669     0.36157         0.01487                4.29%
75        0.26974     0.28799         0.01825                6.77%
80        0.17962     0.19838         0.01876               10.45%
85        0.09883     0.10835         0.00952                9.63%
90        0.04452     0.04578         0.00125                2.82%
95 0.01945 0.01526 -0.00419 -21.52%

Generally, during the transition period of May and June 1999, it is advantageous to use the old mortality tables for QPRTs with contingent reversions.

Private Annuities

A private annuity is an arrangement between two parties, neither of whom is an insurance company, in which the transferor (annuitant) conveys complete ownership of property to a transferee (the person who will then own the property and who will be obligated to make payments). Payments typically last for (no longer than) the life of the annuitant (or the joint lives of two annuitants).

Private annuities are typically used to transfer assets from older family members to younger family members when the older family members still need (or want) a stream of cash from the transaction. They are also incredible ways to shift rapidly appreciating property from one generation to another and freeze the estate of the senior generation. Private annuities are particularly indicated where, because of health or any other reason, the client has a lower than normal life expectancy and it's likely or probable that he/she will die sooner than the mortality tables would predict (but not so soon as to remove the transaction from the application of section 7520, based on the principles set forth in Treas. reg. section 20.7520-3(b)(3)).

The advantage of a private annuity is that it is not a gift (if properly valued) and, if the annuitant dies before normal life expectancy, the total of the payments made by the purchaser may represent less than the fair market value of the assets purchased. /10/

When a private annuity is used as part of an intrafamily transfer, the usual goal is for the annuity payments to be as low as possible. This makes it easier for the purchaser, typically a junior family member or sometimes an employee purchasing the stock of a business owner to pay as little as possible for the asset, and equally as important for the annuitant to have as little as possible added back to his or her taxable estate. In that case, the new mortality tables, which are based on a longer life expectancy, will produce a larger annuity factor and a correspondingly smaller annuity payment.

     The following chart illustrates annuity factors based on a section 7520 rate of 6 percent:

              Annuities
          __________________

Ages      Table        Table          Increase            Percentage
          80CNSMT      90CM           in Factor           Increase
____________________________________________________________________

  0      16.04272    16.12775          0.08504              0.53%
 10      15.99544    16.03497          0.03953              0.25%
 20      15.58475    15.64413          0.05938              0.38%
 30      14.99966    15.07800          0.07834              0.52%
 40      13.99280    14.16456          0.17176              1.23%
 50      12.50563    12.74970          0.24407              1.95%
 60      10.55432    10.82790          0.27358              2.59%
 70       8.22650     8.49883          0.27233              3.31%
 80       5.69179     5.93403          0.24223              4.26%
 90       3.52385     3.58466          0.06081              1.73%
100       2.27879     2.11304         -0.16574             -7.27%
____________________________________________________________________

So, for example, a private annuity transaction for a $100,000 asset between an 80-year old parent and a child would require annual payments of $17,569 under the old tables ($100,000/5.69179, so that the annuity times the factor will result in the $100,000 market value for the asset). Under the new tables, the annual payment for the same property would be only $16,852 ($100,000/5.93403), an annual reduction of $717.

Practitioners should remember that the tables under section 72 have not been amended and that the income tax consequences of a private annuity transaction are determined under section 72, not section 7520. So if a private annuity transaction results in capital gain, that capital gain is recognized (and the cost basis is recovered) using the same expected return multiples previously found in the regulations under section 72.

As shown in the above table, the shorter life expectancies above age 95 will result in smaller factors (and larger annuity payments) under the new tables if the annuitant is 95 or older, which means that the old tables are better in those cases and should be used during the transition period.

Charitable Lead Trusts

A charitable lead annuity trust is an irrevocable trust which provides guaranteed annuity of a fixed amount (regardless of how much is earned by the trust) payable each year to a qualified charity. At the end of the trust's term, any remainder is paid to a noncharitable beneficiary.

A charitable lead trust also can take the form of a unitrust. In essence this is a variable annuity paid to the charity for a specified number of years after which the remainder is paid to a noncharitable beneficiary. In this case the amount that must be paid to the charity at least annually is a fixed percentage of the fair market value of the trust, determined annually. As in the case with an annuity trust, the remainder in the unitrust after a specified number of years (or in some cases the life or lives of one or more living individuals) is payable to a noncharitable beneficiary such as the client's children.

In either case the donor receives a gift tax deduction for the present value of the annuity or the income interest provided to charity and pays gift tax only on the future interest gift to the noncharitable remainderman. (A current income tax deduction is allowed only if the trust is a "grantor trust," meaning that the donor is taxable on income received by the trust and payable to the charity, even though the donor receives no additional charitable deduction.)

If the charitable lead trust is for a term of years, then the new mortality tables are irrelevant. But if the charitable lead trust is measured by a life or lives, then the change in the mortality tables will change the value of the charitable deduction for the annuity or unitrust interest. Because the new mortality tables reflect longer life expectancies for those under age 95, charitable interests measured by lives younger than 95 will result in larger charitable deductions under the new tables. Charitable interests measured by lives 95 years of age or older will result in smaller charitable deductions.

An additional complication is that, for charitable lead trusts created in May or June 1999, the taxpayer can choose to value the trust using discount rates for either of the two preceding months. But if the taxpayer chooses to use discount rates from March or April 1999, the taxpayer must also use the old mortality tables for the valuation. For transactions in May 1999, this presents a dilemma. The reason is that the section 7520 discount rate for March was 5.8 percent. This should result in a larger charitable deduction than the 6.2 percent rate that applied in May. But the new mortality tables that apply in May should result in a larger charitable deduction than the old mortality table that applied in March. So which produces the larger charitable deduction, the lower discount rate or the longer life expectancy?

     Unitrusts are relatively unaffected by the changes in the section 7520 rates, and so charitable lead unitrusts created in May 1999 (and June 1999) should usually be valued using the new tables, as illustrated by the following chart, showing the charitable lead unitrust factors for a 6 percent payout with 12 months between the valuation date and the annual distribution.

___________________________________________________________
                   Charitable Lead
                      Unitrust
               _______________________

          Table           Table
          80CNSMT        90CM at      Increase/  Percentage
Ages      at 5.8%          6.2%       Decrease    Increase
___________________________________________________________

  0       0.96270        0.96754       0.00484      0.50%
 10       0.95992        0.96191       0.00200      0.21%
 20       0.93535        0.93839       0.00304      0.32%
 30       0.90034        0.90433       0.00399      0.44%
 40       0.84003        0.84942       0.00938      1.12%
 50       0.75089        0.76443       0.01354      1.80%
 60       0.63386        0.64907       0.01521      2.40%
 70       0.49417        0.50934       0.01517      3.07%
 80       0.34199        0.35555       0.01356      3.97%
 90       0.21177        0.21474       0.00297      1.40%
100       0.13696        0.12656      -0.01040     -7.59%
___________________________________________________________

As shown in the above table, the shorter life expectancies above age 95 will result in smaller factors (and smaller charitable deductions) under the new tables if the measuring life is 95 or older. That means that the old tables are better in those cases.

It also appears that the charitable deduction will be larger for ages around 29 years if the payout is 14 percent or more, but such a trust would be very odd, and the calculation is unlikely to arise.

     A charitable lead annuity trust is much more sensitive to changes in discount rates than a charitable lead unitrust, and so the choice between the March 1999 tables and the May 1999 tables is much more delicate, as illustrated by the following chart:

                 Annuities
          ______________________

          Table           Table
          80CNSMT        90CM at      Increase/  Percentage
Ages      at 5.8%          6.2%       Decrease    Increase
___________________________________________________________

  0      16.55545        15.63961     -0.91584      -5.53%
 10      16.48875        15.56464     -0.92412      -5.60%
 20      16.04162        15.20544     -0.83618      -5.21%
 30      15.40836        14.68185     -0.72651      -4.72%
 40      14.33666        13.82562     -0.51104      -3.56%
 50      12.77282        12.48187     -0.29095      -2.28%
 60      10.74154        10.63713     -0.10441      -0.97%
 70       8.34059         8.38062      0.04003       0.48%
 80       5.74900         5.87382      0.12481       2.17%
 90       3.54833         3.56005      0.01172       0.33%
100       2.29029          2.10325     -0.18704       -8.17%


These calculations show that, for ages 67 through 90, the new mortality table produces a larger charitable deduction for a charitable lead annuity trust, notwithstanding the higher discount rate of 6.2 percent, than the old mortality tables and the 5.8 percent discount rate that applied in March 1999. However, for measuring lives that are either 66 or younger or 91 or older, the March 1999 valuation tables will produce a larger charitable deduction. (These results are for annual payments at the end of the year, and different pay periods may result in different recommendations.)

Charitable Remainder Trusts

A charitable remainder trust provides a current income (or estate) tax deduction for the value of the remainder gift to charity that follows the client's (or the client's designated beneficiary's) retained interest. The retained interest can be for a given person's life or for a fixed term of years.

A CRAT is required to pay the noncharitable beneficiary a fixed amount (not less than 5 percent of the initial fair market value of assets in the trust) regardless of trust earnings or must pay a fixed percentage of the initial value of the trust's principal (measured at inception) each year. The client receives a current charitable deduction for the value of the remainder interest to charity, discounted by the appropriate rate, to reflect its present value.

A CRUT pays a fixed percentage amount (not less than 5 percent) of the value of the trust as revalued annually. Similar to the case of charitable lead unitrusts, changes in the section 7520 discount rate will have little or no effect on the amount of the charitable deduction.

If the charitable remainder trust is for a term of years, then the new mortality tables are irrelevant. But if the charitable remainder trust is measured by the life of the beneficiary (or beneficiaries), then the change in the mortality tables will change the value of the charitable deduction for the remainder interest. Because the new mortality tables reflect longer life expectancies for those under age 95, charitable interests measured by lives younger than 95 will result in smaller charitable deductions under the new tables. Charitable interests measured by lives 95 years of age or older will result in larger charitable deductions.

As in the case of charitable lead trusts created in May or June 1999, the taxpayer can choose to value charitable remainder trusts in those months using a discount rate for either of the two preceding months. But if discount rates from March or April 1999 are used, the taxpayer must also use the old mortality tables for the valuation. However, there is not the same dilemma as there is for lead trusts. This is because the section 7520 rate of 6.4 percent for April 1999 was the highest rate for the period for March through June. April's higher discount rate produces a larger charitable deduction. The old mortality table also produces the larger charitable deduction in most cases. So charitable remainder trusts in May or June should usually be valued using the April 1999 discount rate and the old mortality tables.

It therefore appears that charitable remainder trusts created in May or June 1999 should almost always be valued using the section 7520 discount rate (and old mortality table) for April 1999, if the measuring life is 94 or younger, and should be valued using the discount rate for the month of the gift (and the new mortality table) if the measuring life is 95 or older.

Grantor Retained Annuity Trusts (and Grantor Retained Unitrusts)

A grantor retained annuity trust (GRAT) is an irrevocable trust to which the grantor makes a gift of money or property, reserving the right to receive a fixed annuity for the term of the trust, which is usually a term of years. A grantor retained unitrust (GRUT) is similar, except that the retained interest is a fixed percentage of the value of the trust assets, revalued annually. In other words the grantor has retained a variable annuity. Whenever the remaindermen are members of the grantor's family, the GRAT, GRUT, and QPRT (discussed above) are the only forms of trust for which the grantor can claim a discount for the gift tax value of the remainder interests, because of the valuation restriction imposed by section 2702.

Although GRATs and GRUTs are usually established for a term of years, the IRS has taken the position that the value of the trust must be determined based only upon the amounts the grantor is likely to receive during his or her lifetime. The result is that the trust must be valued as though it were established for the shorter of a term or life. See Example 5 of Treas. reg. section 25.2702-3(e).

     Because GRATs and GRUTs must be valued as the shorter of a term or life, a longer life expectancy will increase the amount that the grantor can expect to receive from the trust. This in turn reduces the value of the remainder. The new mortality table, with the longer life expectancies for those 94 years of age and younger, will therefore result in smaller taxable gifts than the old mortality table, and should be used for GRATs and GRUTs created during May and June 1999. This can be illustrated by the following table, which shows the remainder value of a 10-year GRAT paying an annuity of 10 percent of the initial value of the trust, using the May 1999 section 7520 discount rate of 6.2 percent:

           GRAT Remainders
         ___________________

          Table        Table      Decrease     Percentage
Ages     80CNSMT       90CM       in Points     Decrease
_________________________________________________________

 50      0.29516      0.29157      0.00359        1.21%
 55      0.30738      0.30305      0.00433        1.41%
 60      0.32521      0.31939      0.00583        1.79%
 65      0.34954      0.34158      0.00796        2.28%
 70      0.38388      0.37432      0.00956        2.49%
 75      0.43119      0.41931      0.01188        2.75%
 80      0.49930      0.48324      0.01606        3.22%
 85      0.57959      0.56379      0.01580        2.73%
 90      0.66013      0.65362      0.00650        0.99%
 95      0.72988      0.73043     -0.00055       -0.08%
100      0.77326      0.78967     -0.01641       -2.12%
_________________________________________________________

Summary

Most estate planning tools and techniques affected by the assumed longevity of a client are affected by the new mortality table and the new actuarial tables. Fortunately, the changes are not radical, and will not significantly affect many estate planning recommendations in the future.

However, the choice between the old tables and the new tables for transactions during the transition period in May and June 1999 will require careful consideration to be certain that the optimum tax strategy is elected.

About the Authors: Daniel B. Evans is a practicing estates and trusts lawyer and a consultant to Leimberg and LeClair Inc.

Stephan R. Leimberg is CEO of Leimberg and LeClair Inc. a software company in Bryn Mawr, Pa., and President of Leimberg Associates Inc., a publishing and professional marketing advisory firm.

The authors express appreciation for the comments and contributions of Steve Oshins, Esq. of Oshins & Associates, Las Vegas, Nev.

FOOTNOTES

/1/ Internal Revenue Code of 1986; section 5031(a) of the Technical and Miscellaneous Revenue Act of 1988, and related legislative history; Notice 89-24, 1989-10 IRB 16. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended, and the regulations promulgated thereunder. Computations courtesy: Estate Planning Tools software: 1-800-879-6665.

/2/ Specifically section 7520(a)(2) requires the use of a discount rate equal to 120 percent of the applicable federal mid-term rate defined by section 1274(d)(1), but rounded to the nearest two-tenths of a percent. A complete history of these rates and the current month's rate can be found at http://www.brentmark.com/AFRs.htm.

/3/ Those publications were scheduled to be available for purchase from the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402, by July 1, 1999.

/4/ Sections 2031 and 2512 state that the federal estate and gift taxes are levied upon the fair market value of the property transferred. Likewise, sections 170, 2522, and 2055, respectively provide that the amount of the charitable deductions allowable for income, gift, and estate tax purposes depends on the value of the interest assigned to charity. Sections 2056 and 2523, respectively state that the value of amounts transferred in an appropriate form to a surviving spouse qualify for the federal estate tax and gift tax marital deductions. See "IRS Actuarial Valuation Tables -- The New Look," Tax Management Memorandum, Vol. 30, No. 7, Mar. 27, 1989, p. 95.

/5/ Special flexibility is allowed under section 7520(a) for valuing property if "more than an insignificant part of the property qualifies for a charitable deduction." See also H.R. Rep. No. 1104, page 13. In such cases, in addition to the month of the actual transfer a client may elect to use the rate for either of the two
months preceding the month in which the valuation falls. This gives the client the choice of months from which to choose.

However, to prevent manipulation against the government, if the transfer involves an interest other than a charitable interest the client must use the same rate with respect to each property interest. In other words, the client cannot use the monthly rate producing the highest value for the deductible charitable interest in, say a lead trust, and a different (lower) monthly rate in computing the gift tax value of the noncharitable remainder interest.

/6/ Section 7520(b).

/7/ Treas. reg. section 1.7520-3(a); Treas. reg. section 20.7520-3(a); Treas. reg. section 25.7520-3(a).

/8/ Although contingent reversions are also often retained in grantor retained annuity trusts or grantor retained unitrusts, the value of the contingent remainder does not affect the value of the gift for federal gift tax purposes. See section 2702; Treas. reg. section 25.2702-3(e), Example 1.

/9/ Section 664(d)(1)(D), added by section 1089 of the Taxpayer Relief Act of 1997.

/10/ Extensive information on private annuities can be found in The Cutting Edge (610) 527-5216; and Tools and Techniques of Estate Planning (800) 543-0874.

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Last modified: November 15, 2006