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.