March 7520 Rate Flat at Record Low 1.4%

February 22, 2012

Rates & Tables

Summary

In Rev. Rul. 2012-9, the Service announced that the March Section 7520 rate will remain at 1.4% for the third month running. The rate first touched 1.4% in October, 2011, and though it rose briefly to 1.6% in December, it has stayed at this record low figure for five of the past six months.

Extended Summary

The rate fell at least 20 basis points for five consecutive months to 3.0% (in March through May of 2011), and then bottomed out at a record low 1.4% in October, 2011. The previous record low was 1.8% in December, 2010.

Prior to the financial collapse in late 2008, the 7520 rate rarely dipped below the 4.2% mark at which it stood in September of that year. As recently as August, 2007, the rate was at 6.2%. From September, 2008 to February, 2009, the rate dropped 220 basis points to 2.0%, then a historic low, for which the IRS had not yet published actuarial tables (see our earlier commentary).

IRS "Book Aleph" (Publication 1457) contains actuarial factors for calculating the present values of life estates, term annuities, income interests, and corresponding remainderinterests. IRS "Book Beth" (Publication 1458) contains similar factors for unitrust interests. IRS "Book Gimmel" (Publication 1459) contains factors used for the standard remainder factor for valuing gifts of depreciated property. None of these publications include factors forapplicable federal rates below 2.2%. In February, 2009, the Service issued Notice 2009-18, supplementing those publications with factors for AFRs down to 0.2%. The calculator on our website includes those factors.

Gift Annuities

A dramatic downward revision of ACGA recommended gift annuity rates took effect January 1 of this year (see our earlier commentary). The new rates are substantially lower than the recommended rates that took effect on July 1, 2011. Those rates were, for the most part, lower than the rates that came into effect in April, 2010, in each case reflecting lowered investment return assumptions.

A charity issuing a gift annuity will incur unrelated business taxable income under the acquisition indebtedness rules unless the present value of the residuum is at least 10%. While annuities paid at the rates recommended under the previous ACGA schedule to some younger annuitants would fail to qualify under this rule when the 7520 rate fell below 3.6%, the new rate schedule produces at least a 10% residuum at even the youngest ages.

However, effective July 1, 2011, the ACGA also adopted a much more stringent requirement: that the present value of the residuum to the issuing charity be at least 20% (see our earlier commentary). With the 7520 rate at 1.4%, a gift annuity (payable quarterly, at the end of the period) issued to an annuitant aged 59 years at the new recommended rate of 4.3% would fail this second requirement. However, the gift annuity would meet the requirement using the December 7520 rate of 1.6% under the two-month lookback, if the annuity contract were closed within the next eight days.

Although a lower 7520 rate will yield a lower charitable income tax deduction for a gift annuity, it yields a higher exclusion ratio, assigning a larger portion of each annuity payment to the return of principal. Thus, planners should compare results under both available rates (again keeping in mind that the December 1.6% rate will no longer be available in March).

Charitable Remainder Annuity Trusts ("CRATs")

Using a 7520 rate of 1.4%, a CRAT with a minimum 5% annuity (payable annually, at the end of the period) over the life of the annuitant would fail the 5% probability of exhaustion test set forth in Rev. Rul. 70-452 and Rev. Rul. 77-374 if the annuitant was younger than age 75. A similar CRAT for an annuitant as young as 74 would satisfy the test using the 1.6% rate for December, 2011.

A 5% CRAT (payable annually, at the end of the period) for a 75-year-old donor would yield a deduction of 50.139% under the 1.4% rate. However, it would yield a deduction of 50.880% under the 1.6% December, 2011 rate, which is a spread of only 0.741%.

Planners who have been waiting for the Service to announce the March rate before closing on a CRAT may want to close now in order to take advantage of the December rate under the two-month lookback.

Lead Trust Planning

Lower 7520 rates are advantageous for lead annuity trust planning, including charitable lead annuity trusts ("CLATs") and grantor retained annuity trusts ("GRATs"), and to a lesser extent, retained life estates and qualified personal residence trusts ("QPRTs"). Planners wishing to take advantage of lower 7520 rates for CLATs or retained life estate gifts may want to act before rates rise.

Unitrusts, whether lead or remainder, are only marginally affected by changes in the 7520 rate, depending on the frequency of the payout.

CPC Commentary

We are not quite certain that the calculation of the rate is correct. Perhaps it is because the Service has rounded to the nearest full basis point at each stage of its calculations that the 7520 rate did not fall to a record low of 1.2% for March.

The 7520 rate is set at 120% of the federal mid-term rate, rounded to the nearest two-tenths of one percent. The mid-term rate, in turn, is the average market yield during the preceding calendar month on Treasury securities with maturities between three and nine years.

The mid-term rate for March is 1.08%, and 120% of that figure is actually 1.296%. But because the Service has rounded this result to 1.30%, and the 7520 rate is then itself rounded to the nearest two-tenths of a percent, we get a rate of 1.4% for March, rather than 1.2%.

On the other hand, Reg. Sec. 1.7520-1(b) does say that the 7520 rate is to be "compounded annually," though it is unclear whether the compounding is to be made from the monthly mid-term rate, or from the quarterly or the semi-annual rate. In any event, compounding would bring the rate slightly above 1.30%, which would then round to 1.4%.

If yields on Treasuries continue to fall, we may yet see Section 7520 rates lower than 1.4%.