CHARITABLE LEAD ANNUITY TRUSTS (CLAT) Prepared by. John R. Anzivino, CPA. November 2011

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1 CHARITABLE LEAD ANNUITY TRUSTS (CLAT) Prepared by John R. Anzivino, CPA November 2011

2 Characteristics of a Charitable Lead Annuity Trust Grantor Grantor Charitable Lead Annuity Trust Trust is for term of years or for a life, or lives Transfer Assets Annuity Payments to Charity (the Lead ) Charity Charity receives payments Remainder Remaindermen At end of term remaindermen receive remaining corpus, outright or in trust

3 Characteristics of a Charitable Lead Annuity Trust Grantor transfers property to an irrevocable trust The charity receives annuity payments based on a fixed annuity The charity could be a family foundation The trust pays a fixed amount to charity each year If the assets transferred to the trust outperform the IRS assumed interest rate ( 7520 rate), the excess earnings and growth will pass to the remaindermen at the end of the trust term free of gift and estate taxes The remainder trust property may pass outright or be held further in trust to postpone the transfer of assets to younger generations

4 Choosing Between a Term Certain and a Life Interest Life Interest If the actual measuring life expectancy is likely to be less than the IRS assumed life expectancy, a life interest is advantageous. Impossible to zero-out because of the actuarial possibility of the person(s) not surviving the term Term Certain Using a term certain results in a lower gift, when compared to life interest in person(s) with life expectancy equal to the term The CLAT can be zeroed out resulting in no gift at the creation of the trust

5 Choosing Between a Term Certain and a Life Interest EXAMPLE Assumptions: 7520 Rate of 1.4% CLAT 5.768% annuity payout $1,000,000 corpus Gift: Term certain of 20 years = $0 20 year life expectancy (61 year-old) = $170,432

6 Choosing Between an Inter-Vivos CLAT and a Testamentary CLAT Inter-Vivos CLAT Pros Can be used to fund client s lifetime charitable contributions Appreciation on corpus is excluded from the grantor s estate Gift taxes paid may be removed from the taxable estate Remaindermen generally receive assets earlier than they would from a testamentary CLAT Section 7520 Rate is known during planning Cons Trust receives carryover basis for assets contributed to the trust Grantor gives up use of corpus and any gift taxes paid

7 Choosing Between an Inter-Vivos CLAT and a Testamentary CLAT Testamentary CLAT Pros Grantor maintains control over assets until death Trust receives a stepped-up basis (equal to the estate tax value) for assets used to fund the trust Cons Lifetime appreciation is included in taxable estate and requires a larger estate tax deduction (and larger lead amount) to avoid estate tax 7520 Rate is not known until time of death

8 Charitable Lead Annuity Trust Income Tax Consequences Non-Grantor Type Trust (Most Often Used) Grantor does not report any income from the CLAT Grantor gets no income tax charitable contribution deduction Grantor avoids the adjusted gross income (AGI) percentage limitations and itemized deduction adjustments on charitable deductions that would be imposed if the grantor still owned the assets and the grantor made the payments to charity directly Trust is subject to income tax on income earned in excess of the annuity amount paid to charity

9 Charitable Lead Annuity Trust Income Tax Consequences Grantor Type Trust Grantor trust reports all income/gains during term of trust Grantor obtains an income tax deduction in the year of creation May be beneficial if future income or future income tax rates are expected to decline

10 Gift Tax Consequences Inter-Vivos - The fair market value of the property transferred to the trust less the present value of the qualifying annuity interest (the "Lead") passing to the charitable beneficiary is a taxable gift Testamentary - There are no gift tax consequences associated with the trust because the grantor does not make a gift during lifetime FMV of Property Transferred Present Value of the Qualifying Interest (the Lead) = Taxable Gift

11 Zeroed-Out CLAT Gift Tax Consequences Charitable Lead Annuity Trust (20 years) Transfer Date: Nov 2011 FMV of Trust: $1,000,000 Annual Payout: $ 57,680 PV of Qualifying Interest: $1,000,000 FMV of Property Transferred $1,000,000 Present Value of the Qualifying Interest (the Lead) $1,000,000 = Taxable Gift $0

12 Estate Tax Consequences Testamentary - The entire fair market value of the property transferred to the trust is included in the grantor s estate. However, the grantor is entitled to an estate tax charitable deduction equal to the present value of the qualifying annuity interest (the "Lead") passing to the charitable beneficiary. Inter-Vivos - Unless the grantor retains a reversionary interest in the trust, the trust is not included in the grantor s estate because the grantor does not retain any interest in or control over the trust.

13 Who May Serve As Trustee? Grantor or Grantor s spouse May serve as Trustee provided the Grantor possesses only routine administrative powers May not retain the power to change the charitable beneficiary or the remainder beneficiary Independent Trustee May have the power to select the charitable beneficiaries each year May have the power to sprinkle the remainder interest among individual beneficiaries

14 Why are They More Popular? Interest rates are currently at a record low, creating greater the opportunity to outperform the IRS 7520 rate. Earnings and growth in excess of that rate pass to the remaindermen free of gift and estate transfer taxes With 7520 rate at only 1.40% (November 2011) payouts necessary to zero-out CLAT are as follows: 10 year % 15 year 7.438% 20 year 5.768% Valuation discounts applicable to family limited partnerships and certain other entities can create the opportunity to leverage the benefits of CLATs

15 Zeroed-out CLAT Analysis Assume 1.4% 7520 Rate & $1,000,000 Funding Contribution Assume NO Discount 10 Years $107,870 Annual Payout 15 Years $74,380 Annual Payout 20 Years $57,680 Annual Payout Payment to Charity Remainder to Heirs Payment to Charity Remainder to Heirs Payment to Charity Remainder to Heirs 3% Growth $1,078,700 $107,308 $1,115,700 $174,580 $1,153,600 $256,228 5% Growth $1,078,700 $272,117 $1,115,700 $473,915 $1,153,600 $746,053 7% Growth $1,078,700 $476,771 $1,115,700 $889,935 $1,153,600 $1,505,065

16 Funding with Discounted Assets The valuation discounts for family limited partnerships and certain other investments create the opportunity to leverage the benefits of CLATs. Comparison of payouts necessary to Zero-out CLAT. Term 10 year 15 year 20 year Assets without Discount % 7.438% 5.768% Assets Discounted 33.33% 7.191% 4.959% 3.845%

17 Zeroed-out CLAT Analysis Assume 1.4% 7520 Rate & $1,000,000 Funding Contribution Assume 33.33% Discount 10 Years $71,910 Annual Payout 15 Years $49,590 Annual Payout 20 Years $38,450 Annual Payout Payment to Charity Remainder to Heirs Payment to Charity Remainder to Heirs Payment to Charity Remainder to Heirs 3% Growth $719,100 $519,548 $743,850 $635,647 $769,000 $772,945 5% Growth $719,100 $724,418 $743,850 $1,008,847 $769,000 $1,381,912 7% Growth $719,100 $973,611 $743,850 $1,512,883 $769,000 $2,293,408

18 Issues To Be Considered When Funding Trust With Discounted Assets Discounting Issues Appraiser who determines the value of the interest should consider cash flow distributions required from FLP/LLC to trust necessary to fund CLAT payments in determining the amount of discount Cash Flow Distributions from the partnership to the CLAT to make annuity payments will cause all partners of the partnership to receive distributions, including children or others who hold a limited partnership interest

19 Charitable Lead Annuity Trusts Donors may choose the 7520 rate for the month in which the transfer occurs or either of the two months preceding the month of transfer Donors may use the historically low November 2011 rate of 1.4% for CLATs created in November 2011, December 2011 and January 2012