As everyone is painfully aware at this point, the $5.12 million gift tax exemption is scheduled to expire on December 31, 2012. Naturally, using the exemption before it expires is a very hot topic among high net worth families and their advisors. Jeffrey A. Baskies published in October 2012 an article regarding a year-end planning opportunity in the charitable giving area where individuals have some interesting planning opportunities.
One way to use some or all of the exemption that appears to be getting too little attention is the “taxable CLAT”. Taxable CLATs are inter vivos Charitable Lead Annuity Trusts (could be the grantor or non-grantor variety) where the remainder has a value in excess of $0. It may be that the timing has never been better to create and fund taxable CLATs.
What sorts of individuals might benefit from taxable CLATs? Well, many individuals might benefit from considering using them. Obviously, CLATs should appeal to individuals with significant charitable desires, particularly those with existing foundations or family funds at community foundations. Secondly, individuals who annually make substantial charitable gifts would benefit from funding CLATs. Finally, for individuals willing to gift more than their remaining gift tax exemption, the taxable CLAT presents a great opportunity.
CLATs: Gift Tax Issues. Inter Vivos Charitable lead annuity trusts (“CLATs”) are irrevocable trusts that make current distributions to charity of a defined annual amount (the “annuity”) for a predetermined term (which could be based on a life or based on a set term of years). At the end of the term, whatever is left in the CLAT (the remainder) passes to individual beneficiaries selected by the individual (presumably the individual’s family members).
CLATs work particularly well in periods of low interest rates (as we obviously are experiencing now) as the low rates increase the value of the income streams and thus reduce the value of the taxable gifts. Thus, CLATs allow individuals to transfer significant wealth at reduced gift tax cost, as a result of the gift tax deduction
CLATs: Income Tax Issues. In addition to the gift tax planning opportunities, CLATs also present income tax planning opportunities as well. CLATs come in two varieties: grantor CLATs and non-grantor CLATs.
With a non-grantor CLAT, the grantor gets no up-front income tax deduction (although of course does get the up-front gift tax deduction) but is not required to include the CLAT income on his returns during the CLAT term.
With a grantor CLAT, the grantor receives an up-front income tax charitable deduction equal to the actuarial value of the income stream, but in exchange for the up-front deduction, the individual will report the annual income on his return during the CLAT term. So the individual gets a deduction which can be taken in the year the CLAT is created, but the CLAT is taxed for income tax purposes as a “grantor trust”.
In some instances, grantor CLATs will be preferred. For example, for a individual expecting a big income tax hit in one year (e.g. selling a business or depreciated real property), bunching the deductions in the current year may be valuable. That individual may already be considering a large outright charitable gift, but perhaps will prefer the grantor CLAT instead.
CLATs: Don’t Forget the Charitable Component. Finally, in addition to the gift and income tax planning opportunities presented by CLATs, they are also a number of non-tax advantages that should not be overlooked.
First, taxable CLATs can take a lot of money that would otherwise have gone to taxes and instead focus that money on philanthropic purposes. That’s something positive for individuals, for their families and for our world, hopefully. Second, assuming most taxable CLATs will fund either donor advised funds at community foundations or family foundations, the funds passing via the income interest in the taxable CLAT will likely create a very substantial future stream of charitable distributions. Both are good and positive results.
Conclusion. If you are charitably inclined and still want to transfer assets to your children a CLAT may be a wonderful planning opportunity before the end of this year.