Why is a Charitable Lead Annuity Trust the ideal vehicle for Estate Planning, Income Tax Planning and charitable giving?

Piles of coins symbols on a wooden table and an arrow pointing a single coin with the word donate. Donation concept. 3d illustration.

Charitable lead annuity trusts (CLAT) have been around since the 1970s. But until recently, these trusts have not been used much by run-of-the-mill millionaires. Now that is changing rapidly over the course of the past few years, thanks to low interest rates and creative planners.

Many people want to do good and still maintain a legacy. If you want to give to charity, leave your family well provided for, and avoid having your legacy drastically reduced by estate taxes, consider a CLAT.

WHAT IS A CLAT?

A CLAT is a trust, which through its terms entitles a charity (or charities) to payments, for a period of time you choose, from assets you have given to the trust. When that period ends, any assets left go to beneficiaries you identified when the trust was created. Importantly, there should be no gift or estate taxes on the transfer of those assets when they go to your beneficiaries.

Benefits of a CLAT include:

  • The ability to structure the CLAT to give you an income tax charitable deduction, which can help reduce the tax bill associated with extraordinary taxable events (e.g., the sale of a business or real estate).
  • Locking in current asset valuation for estate and gift tax purposes. If your assets continue to appreciate, your heirs would receive any appreciation free of transfer taxes.
  • Assets that may grow free of income and capital gains tax if the CLAT is structured as a grantor trust—you would pay the tax on the income earned by the trust. This allows you to leave more to heirs and have a smaller taxable estate. (See “Types of Charitable Lead Annuity Trusts,” below)
  • Capacity to use a CLAT to fund a family foundation over time. All or part of the trust’s charity payments could go into the foundation. Using a CLAT to fund a foundation gradually gives the foundation time to get organized and select worthy causes.

How a CLAT works:

In designing and instating your CLAT the steps involved may be:

  1. Determining how long you want the CLAT to last, typically identifying a term of years.
  2. Funding the CLAT with cash, securities and/or other assets.
  3. Structuring a CLAT so that the entire contribution qualifies for a gift tax charitable deduction and will not therefore be subject to gift tax. Whether tax is due is based on how long the CLAT is to last, how large the annuity payments to charity will be, and the Internal Revenue Service’s estimate of how much of the trust’s assets will remain for your beneficiaries after the trust makes the required payments to charity, which in turn are based on interest rates at the time you fund the CLAT.
  4. Providing a fixed dollar amount to the charities of your choosing each year. If the growth of the assets in the CLAT exceeds the annual payout every year, the surplus at the end of the CLAT term may pass tax-free to family members.
  5. Passing the remaining assets to heirs at the end of the CLAT term, either outright or in trust. Because these assets were already technically subject to gift tax (Step 3 above), even if no gift tax was paid or lifetime gift tax exclusion was used, they are not subject to estate or gift taxes when passing to family, even though the assets may have appreciated considerably. Give to charity now—leave more for your family later.

FIVE KEY REASONS TO CONSIDER A CHARITABLE LEAD ANNUITY TRUST: A CLAT may be an appropriate strategy for you if you:

  1. Would like to benefit charity during your lifetime.
  2. Enjoy a level of income that exceeds your current and foreseeable needs.
  3. Would like to offset a large income tax bill.
  4. Want to minimize gift and estate taxes.
  5. Have assets that may appreciate rapidly or generate considerable income.

TYPES OF CHARITABLE LEAD ANNUITY TRUSTS:

Grantor Trust Structure: At creation, you receive a tax deduction based on the present value of the trust’s required future distributions to charity (typically, the entire amount gifted to the trust). During the CLAT’s term, you pay taxes on the trust’s income and/or capital gains each year. As a result, the CLAT assets are able to grow free of income tax.

Non-Grantor Trust Structure: At creation, you receive no tax deduction. During the CLAT term, the trust itself pays taxes on its income and capital gains. The trust’s tax liability is offset each year by a tax deduction as it pays the required annuity to charity.

Just like any other estate and income tax strategy, a CLAT is not for everyone. Each set of facts must be considered for the individual client, including client’s net worth, income and income tax, charitable inclination and long term legacy and charitable objectives. Nevertheless, the CLAT has been a powerful planning vehicle for the past decade while the interest rates have been fairly low.

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Fred F. Mashian is the founder and Principal of the Law Offices of Fred F. Mashian, APC. Mr. Mashian founded the firm in 1993. He has over 25 years of experience providing complex estate planning and probate services.