We are, after all, advisors...the calm in the storm, the up in the down, the pearl in the muck. How can we help our clients pass wealth to future generations, divert funds from gift taxes to charitable purposes and at the same time take advantage of the Internal Revenue Service’s diligence in drafting the documents for us?

Given the current state of the economy and resulting low applicable federal rates combined with imbedded high gift tax rates, the Charitable Lead Annuity Trust, or CLAT, offers a "win-win" for everyone involved: donors, charities and heirs.

 

Simply Stated: What is a Charitable Lead Annuity Trust?

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A charitable lead trust is an irrevocable trust in which the donor requires the trustee to pay a certain amount of the income (the lead) to charity for a specified period. At the termination of that period, the trust property passes to individual (non-charitable) remainder beneficiaries. A charitable lead annuity trust requires that the lead interest be fixed as a dollar amount or percentage of the initial contribution, whereas the lead interest in a charitable lead unitrust varies as a percentage of annually valued trust property. Although a lead trust can revert to the donor or can be included in an estate plan as a testamentary disposition, this article is meant to encourage immediate gifting and therefore limits discussion to inter vivos transfers with remainders to the donor’s family. The IRS provides helpful sample inter vivos charitable lead annuity trust annotated forms in last year’s Revenue Procedure 2007-45 (sections 4, 5 and 6).

 

Taxable Gift or Not: Donor’s Choice

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The donor can set the amount of the gift tax charitable deduction by choosing the following:

• The duration of the trust term; the longer the term, the greater the charitable deduction.

• The charitable annuity amount; the larger the amount, the greater the deduction.

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The timing of the gift to take advantage of the lowest possible rate prescribed by the IRS to calculate the value of the charitable stream of income. (This is the Applicable Federal Rate determined under Internal Revenue Code, section 7520.) The donor may use the rate in effect in any month the trust is created or of the two previous months. The September 2008 rate of 4.2% was also the July and August rate.

Most often, the donor selects the trust term and payout rate that will "zero-out" the taxable gift, with the expectation that the trust will outperform the applicable federal rate. If this occurs, the gift to the family is leveraged. With each passing year, the fixed charitable annuity amount represents a smaller percentage of the compounding trust property, thereby amassing tax-free wealth for the children.

 

Client Profile: Have you seen this client?

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A wide variety of clients may be suited for a charitable lead annuity trust. In my experience, the following clients are receptive to establishing a CLAT if they desire to make a charitable gift:

• Clients with estates over $5 million who can make a gift of $1 million and not miss the income

• Clients who want to see charitable benefit immediately

• Clients with young children who can pick a 15 or 20 year trust term, avoid gift tax and have the assets pass to the child beyond majority

• Clients who have utilized their federal lifetime gift exemption of $1 million and still want to pass to the children as young adults

• Clients with noncitizen spouses who are limited in annual exclusion gifts

• Clients who support domestic partners, siblings or parents

 

A Perfect Charity: A Donor Advised Fund

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A donor advised fund at Silicon Valley Community Foundation is a perfect choice for the charitable lead interest. When your client establishes a donor advised fund, he or she will reap the following benefits: 

• Simplicity in IRS compliance with maximum potential for accommodating any philanthropic objective.

• An immediate payout of the annual amount to numerous charities of his or her choice.

• An accumulation of annual payments in an "endowment-like" fund to perpetuate the fund’s longevity or source for development of a strategic plan of regular and consistent funding. Furthermore, a client with young children may choose to delay distributions from the donor advised fund until the children are old enough to participate in a meaningful way in determining the family’s charitable goals.

A proactive advisor can use the fractured economy as an opportunity to encourage clients to make gifts that benefit both charity and heirs through implementing the charitable lead annuity trust.