POSTED IN ESTATE PLANNING AND WEALTH TRANSFER
In this final installment in our three-part series, we
discuss the planning technique known as Charitable Lead Annuity Trusts (CLATs).
Like Intra-Family Loans and Grantor Retained Annuity Trusts (GRATs) described in previous blogs, a CLAT is an
excellent strategy to use during a low-interest-rate environment, and is
particularly effective for individuals who are either currently making, or
intend to begin making, sizeable annual gifts to charity and who also wish to
transfer wealth to younger generation family members in hopes of minimizing
estate and gift taxes.
A CLAT is similar to a
GRAT in that it is established through an individual’s gift of assets to a
trust to be held for a defined period of time, after which the remaining CLAT
assets, if any, will be distributed to younger generation family members. The
primary difference between a GRAT and a CLAT is that the annual annuity
payments paid by the CLAT are not paid to the individual establishing the trust
(the grantor), but rather are paid to one or more charitable organizations.
A charitable income tax
deduction is available for the present value of the charitable annuity
payments. The present value calculation uses the IRS-prescribed interest rate
known as the “7520 rate,” which references the Internal Revenue Code section
detailing how the rate is determined, in effect for the month of the grantor’s
gift to the CLAT (or for one of the two preceding months, if that produces a
larger deduction). The November 2016 7520 rate is 1.6%.
As with a GRAT, it is
possible under current law to set the present value of the charitable annuity
payments to equal the initial value of the assets transferred to the CLAT, so
that the value of the taxable gift made to the CLAT is zero or close to zero.
So, if the CLAT assets appreciate at a rate greater than the 7520 rate, there
will be residual assets remaining in the CLAT at the end of its defined term to
pass to younger generation family members, just as with a GRAT.
The principal objectives
in establishing a CLAT are to create a win-win situation whereby you receive a
charitable income and gift tax deduction for the value of some or all of the
assets gifted to the CLAT, and also benefit lower generation family members to
the extent the CLAT assets earn a rate of return greater than the 7520 rate
during the defined CLAT term. Any excess appreciation will pass to
non-charitable beneficiaries (i.e., younger generation family members) at the
end of the CLAT term at no additional gift tax cost.
Thus, a CLAT works best in
a low-interest-rate environment since there is a greater probability of an
investment return in excess of the 7520 rate. For this reason, CLATs are an
ideal choice for individuals wishing to combine charitable pursuits with (tax
efficient) transfers of wealth to family members.
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