Urgent News Re: Charitable Trusts

Charitable Lead Annuity Trust. A Charitable Lead Annuity Trust ("CLAT") is a charitable trust designed to pass significant wealth to the next generation without transfer tax. The CLAT was publicized after the death of Jacqueline Kennedy Onassis who had reportedly established a CLAT in her will or revocable trust for the benefit of her children.
Basically, the idea of a CLAT is to provide for sufficient annual payments from the trust to a charity over a period of years so that the remainder gift to children, at the end of the term, has a tax value of zero or close to it.
How Does This Work? I was alerted to the impact that the rapidly changing interest rates will have on a zero gift CLAT. Each month the IRS publishes the applicable interest rate for the next month based on Federal mid-term interest rates. For example, the applicable rate for May was 3.2%. For June and July, 2008 the rate is 3.8%, and for August, 2008 the rate is 4.2%. In calculating the value of the remainder gift to family, the IRS assumes that the earnings of the trust will be equal to the applicable interest rate ("AFR").
Example. Suppose $1 million is transferred to a twenty year CLAT with annual payments to a family foundation (or a public charity) at the May AFR of 3.2%. The annual payment to the charity from the $1 million trust would be $68,464.54 for a 20 year trust. Using the May AFR of 3.2%, the taxable gift would be zero. If the trust earns more than 3.2% there will be a tax free remainder at the end of the twenty year term. For example, if the trust earns 6.85%, the earnings will exceed the payments to charity and there will be $1 million remaining after 20 years. If the trust earns more than 6.85%, the remainder value will be greater than $1 million .
Similarly, if the trust earns less than 3.2% there will be no remaining assets for family. (How many financial advisors tell their clients that they can expect to earn less than 3.2% on their portfolio over a twenty year period?)
Why The Urgency? The IRS regulations permit the grantor of the trust to use the AFR for the month of the transfer or either of the two previous months. Thus, a CLAT done before the end of July, 2008 will qualify for the 3.2% rate.
Why is this important? If the grantor delays until August when the lowest AFR is 3.8%, the annual payment to charity would have to be $72,284.63 for the 20 year term in order to have a zero gift. That is a difference of $3,820.09 per year to accomplish the same result, a taxable gift valued at zero.
Using a compound growth rate of 5% for 20 years, that saving would amount to $126,312 (assuming an annuity in arrears). As they say, "this ain’t chicken feed!"
What Is The Benefit? Why would a client want to do a CLAT in the first place? First, this interests clients who are pretty sure to have an estate tax at death. That is, clients that have total assets more than $3.5 million (the exemption in effect for 2009 and likely to be in effect in the future).
Second, clients may have a charity or private foundation that they want to benefit. We have done CLATs benefitting both family foundations and public charities where there is a strong charitable interest.
Third, we have had clients who want to delay distributions of wealth to family members for various reasons. Among them are maturity of grandchildren, retirement funds for children, or delays for reasons of divorce credit or claims, etc. (Delays can also be useful in the case of incarcerated relatives but we assume that no readers of this newsletter would fall into that category.)
More On CLATS.
We have talked about why people would use a CLAT. CLATs come in two flavors. In the most commonly used CLAT in our experience, the donor does not claim an income tax deduction, but the trust gets an income tax deduction for all the payments to the charity. The alternate form provides a charitable deduction for the discounted value of the charitable payments, but the trust is taxed on the income. In either case the objective is the same: payments to a charity and a tax free gift to children at the end of the term.
In some cases clients may elect to use several CLATs of different terms if part of the objective is to use up the taxable gift exemption of $1 million, for example, by reducing the annual payments to charity, the length of the trust term, or some combination of both.
Conclusion. There is not a lot of time left to set up a CLAT before the end of July, 2008. However, with another jump in interest rates imminent, there is still a substantial advantage to a trust established in August, 2008, using the June rate of 3.8%. A CLAT can be an important estate planning tool for wealthy clients with a charitable intent. (There is an especially strong reason to use a CLAT if a client has a Private Foundation where the client’s family will retain an element of control over the activities of the Foundation.) You don’t have to be a Ford or a Rockefeller to establish a Private Foundation!
If you or your clients are interested in exploring the CLAT, or the organization of a Private Foundation, please call Jim Modrall or any of the attorneys listed below.
Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Edgar Roy, III, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., John M. Grogan, Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional advice.

Saving The Cottage

How Should the Cottage Be Preserved for the Family? In advising clients about "keeping the cottage in the family", I learned one thing - there is no one-size-fits-all. "Cottage" is a term we use in general to refer to a family’s "up north" property which has been enjoyed by at least two generations and usually more. There is often a great deal of emotion involved in the senior generation about trying to preserve family ownership of the property for use by grandchildren and later generations.
The practical aspects of how and whether a cottage is going to be "kept in the family" is a complicated challenge with many considerations.
How Should Family Ownership be Continued? When the senior generation is gone, the decision about continued family ownership and enjoyment usually comes down to consideration of many factors, among them:
Type of ownership
Property tax considerations
Income tax planning
Usage
Decision making - possible future sale
Ownership. Continued family ownership of the property involves a discussion of the pros and cons of ownership in one of three forms:
1) Trust
2) LLC (limited liability company)
3) Joint ownership
Of these joint ownership is generally the least satisfactory. Ownership as JTWROS - joint tenancy with right of survivorship - is often unsatisfactory became unanimity is required. Fractional ownership - tenancy in common - is generally ruled out because one owner can force a sale of the property.
Between ownership by a Trust and an LLC, there are arguments in favor of each. The LLC can provide for transferrable interests, but a property held by an LLC can never be a "homestead" for Michigan property tax purposes. A beneficiary of a Trust, on the other hand, can claim the homestead exemption if, in fact, the individual occupies the property. (This occupancy does not have to be exclusive.)
Property Tax Considerations. Property taxes are a major concern because of the uncapping of taxable value when the owner, or survivor of a married couple, dies. Although clients tell me that the SEV on lake front property has declined in the last year or so, the SEV is still much higher than the taxable value in the most instances. In considering property taxes, the homestead exemption is especially important and in many instances there is some member of the family who can claim the property as homestead. Continued ownership of the property is the often crafted around this objective, in order to keep long range property taxes at a minimum.
Income Taxes. The income tax aspect of a continued ownership needs to be reviewed. Property taxes and interest are generally deductible on individual tax returns. Usage fees are not deductible and consideration needs to be given whether contributions toward expenses are treated as usage fees or loans. If loans, are the loans to be secured or unsecured?
Expenses of Operation. Consideration needs to be given to how the property expenses are to be funded. Will there be an endowment that the parents provide and, if so, how long will the endowment last? In this respect, parents sometimes decide to endow the continued ownership for a limited period of operation - often three to five years so that the family has time and flexibility to decide how continued family ownership and operation will be handled.
If an endowment is not provided, then some mechanism of providing for usage fees or loans needs to be considered.
Decision Making - Property Usage. In considering continued family ownership, the senior generation needs to give thought to how decisions on property usage and operation are to be made. Is there a committee or board and, if so, how is that group chosen? Decisions have to be made on priority of usage. Is this going to be on a rotation basis, determined by lot, or some combination thereof?
Decision Making - Sale. Generally, the decision on sale is sometimes deferred until an exploratory period has passed. Some provisions generally are made for sale of the property some time in the future by a majority or super majority vote. This can be either on a per capita basis or on a family basis. In the latter case, for example, if there are four children, does each family have a 25% vote? If so, does a family have to vote its entire interest as a whole to prevent a splintering of a family interest? While these questions appear to be a little academic, they often provoke active discussions among family members as to how important decisions like sale of the family cottage are to be made. Needless to say, the articulation of the voting mechanics can get quite complicated, either in the case of ownership by Trust or an LLC.
Conclusion. Continued enjoyment of the cottage by a family, after the senior generation is gone is often an important estate planning challenge with many considerations and alternatives. If your cottage trust needs review, or if one of your clients inquires about making provisions of continued family ownership of the cottage, please call Jim Modrall or any of the attorneys listed below.
Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Edgar Roy, III, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., John M. Grogan, Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660 ©BRANDT, FISHER, ALWARD & ROY, P.C.This newsletter is provided for informational purposes and should not be acted upon without professional advice.