Overview
Main Menu Name: CLAT
Determines the value of the deduction for a transfer of cash or other property to a charitable lead annuity trust. It also shows the future interest gift made to the non-charitable remainderman. It also shows the percentage of principal that is deductible for gift tax purposes.
In this article:
Background
You create a CLAT by transferring cash or other assets to an irrevocable trust. A charity receives fixed annuity (principal and interest) payments from the trust for the number of years you specify. At the end of that term, assets in the trust are transferred to the non-charitable remainder person (or persons) you specified when you set up the trust. Usually, this person is a child or grandchild but can be anyone, even someone who is not related to you.
You can set up a CLAT during your lifetime or at your death. Both corporations and individuals may establish lead trusts.
You can set up a CLAT so that you will receive an immediate and sizeable income tax deduction. In the second and following years, you must report the income earned by the trust even though it is actually paid to the charity in the form of an annuity.
What is the advantage of a trust that produces a high deduction in the first year but requires you to report income you don't receive in later years? One advantage is the acceleration of the deduction. For example, suppose you have just won the lottery, closed an incredibly large case, or sold a very highly appreciated asset. Perhaps you reasonably expect that in future years, your income will drop considerably. It's good planning to have a very high deduction in a high bracket year even if you have to report that income in lower bracket years. You are spreading out the income (and the tax) over many years.
Another advantage of the CLAT is that it allows a "discounted" gift to family members. Under present law, the value of a gift is determined at the time the gift is made. The family member remainderman must wait for the charity's term to expire; therefore, the value of that remainderman's interest is discounted for the "time cost" of waiting. In other words, the cost of making a gift is lowered because the value of the gift is decreased by the value of the annuity interest donated to charity.
When the assets in the trust are transferred to the remainderman, any appreciation on the value of the assets is free of either gift or estate taxation in your estate.
Many people of wealth set up CLATs at death through their wills. The present value of the charity's annuity stream is deductible for estate tax purposes. Since your heirs don't pay estate taxes on the charity's portion, the money that otherwise would have been paid in estate taxes can instead be invested. During the term of that trust, increased investment income can help pay for the fixed annuity promised to the charity - and if there is any "surplus", that extra income can be compounded for your heirs and pass to them - gift tax free - when the trust ends.
Getting Started
When a charitable lead trust is established, a donor transfers cash or other assets to a trust, and a charity receives payments from the trust. Assets in the trust transfer to a non-charitable remainderman (usually a child or grandchild).
For calculations involving a term, the length of the economic schedule is limited to that term. Otherwise, the economic schedule illustrates the trust for life expectancy. If the number of lives is greater than one, then the length of the economic schedule will be determined by the joint life expectancy of the first two ages provided by the user. Single life cases will use the single life expectancy. The economic schedule will end if the trust is depleted of funds prior to the end of the schedule.
Individuals establishing a lead trust receive an immediate income tax deduction and a lower gift tax for transferring the trust assets to the remainderman. A lead trust may also be established at death as a form of bequest. Both corporations and individuals may establish lead trusts.
A lead annuity trust pays a specified percentage of the initial trust value to one or more charities.
Income, gift, and estate tax deductions are only permitted for transfers to lead trusts if one of the following requirements is met:
- The income interest is paid out in the form of a guaranteed annuity.
- The income interest is a fixed percentage of the fair market value of the trust's assets (calculated annually) and is paid at least annually.
Income tax rules also require the donor to be the owner of the income earned by the trust. In other words, the donor receives an immediate, large income tax deduction, but in later years, must report the income of the trust as it is received. Consequently, the typical lead trust produces little if any net income tax deductions since future income taxes are likely to counterbalance the initial deduction.
Despite future tax obligations, however, the charitable lead trust can be beneficial. For example, if a donor is in a high-income year, but in future years is expecting a drop in income, his tax bracket will most likely also drop. Consequently, deductions are received in a high bracket year, and taxes are paid in low bracket years. This premise also applies if a drop in income tax rates is expected.
Another advantage of the charitable lead trust is that it allows a discounted gift to family members. Under present law, the value of a gift is set at the time the gift is complete. The family member remainderman must wait for the charity's term to expire; therefore, the value of that remainderman interest is discounted for the cost of waiting. In other words, the cost of making a gift is lowered because the value of the gift is decreased by the value of the income interest donated to charity.
When the assets in the trust transfer to the remainderman, any appreciation on the value of the assets is free of estate taxation in the client's estate.
Entering Data
- Trust Type: Select a type of trust (Term, Life, Shorter) If you select Life, the Economic Schedule runs from year one until the Life Expectancy or until the remainder is zero (whichever happens first). If you select Term or Shorter, the Economic Schedule runs from year one until the end of the Term or until the remainder is zero (whichever happens first).
- Transfer Date: Enter the month and year.
- Note: For May or June of 2009, you have the choice of using mortality Table 90CM or 2000CM (see https://www.irs.gov/irb/2009-20_IRB). After June 2009, the program will automatically use Table 2000CM. For dates before May 2009 and after June 1999, the program will use Table 90CM. For May or June of 1999, you have the choice of using Table 80CNSMT or Table 90CM. For dates before May 1999 and after April 1989, the program will automatically use Table 80CNSMT. For dates before May 1989, the program uses Table LN from Treas. Reg. section 20.2031-7A(d)(6).
- §7520 Rate: The program automatically shows the correct §7520 discount rate, as well as the rates for the two previous months, if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520, and automatically selects the rate that should result in the largest charitable deduction, but you can override that selection if you wish.
- Note: For transactions in May or June of 2009, if you select a §7520 discount rate from March or April, the program will apply mortality Table 90CM and not 2000CM, as required by regulations. For transactions in May or June of 1999, if you select a §7520 discount rate from March or April 1999, the program will apply mortality Table 80CNSMT.
- FMV of Trust: Enter the initial Fair Market Value (FMV) of the assets placed in the trust when established.
- Growth of Trust: Enter a growth percentage or investment yield for the assets of the trust for the purpose of the economic schedule.
- Term: If you chose a term or shorter trust, enter the number of years that the trust will last.
- Percentage/Annual Payout: Enter the projected payout that will go to the charity during the life of the trust. If you enter a 101 or less, the payout will be treated and displayed as a percentage. If you enter a number greater than 101, the payout is treated and displayed as a dollar amount of an annual payout.
- Unlike the CRAT, there is no minimum payout required. The program defaults to 0.001% as the lowest rate you can enter. Likewise, there is no maximum number the payout can exceed. Users can vary the payouts per year, and have them grow by a constant over time, or enter their own payouts. One strategy is to have little to payouts till the end of the term, and then set the percentage to 100% to simulate a Sharkfin CLAT. This field will allow for either a percentage or dollar amount based on the following:
- Values entered as 0.001 to 99.99999%, will be used as a percentage. Using a percentage entry, there will be 5 significant digits allowed. When trust balances get very large, entering the payouts as dollar amounts yields a higher precision.
- If you enter a value over 100, it will be treated as a dollar amount.
- It should be noted, that if you choose to use the optimizer for this model, it will by default set the payout to dollar amounts for more precision.
- Vary Annuity Payments?: Select the check box if you want to vary annuity payments. When you indicate there are varying annuity payments which do not grow by a constant rate, the program always uses the Illustrated Method for the purposes of the exhaustion test. If you select this check box, the Edit button will appear.
- Edit: This button appears when you select to have varying annuity payments. You can choose to grow annuity payments by a constant rate or enter your own yearly payout rates for Shorter or Term cases. The program allows the entry of a value more than 20% greater than the preceding value, but displays a warning on the screen.
- Payment Period: Select the number of payments that will be made during a normal full year to the beneficiary (Annual, Semiannual, Quarterly, Monthly, and Weekly).
- Payment Timing: Select when the payment is made during the selected payment period (Begin or End). A Begin case is assumed to be the same as an End case with an additional payment made at the beginning of the period.
- Number of Payments: The program calculates the number of payments based on the term and the payment period. If you would like to have a trust that makes additional payments (beyond the normal term), use this input field to indicate the total number of payments to be made. For example, if you have a trust making quarterly payments for 10 years, this data field would default to 40. If you wished to make payments for 10 years and 1 quarter, you would change the value to 41.
- Lives: If you choose a life or shorter trust, enter the number of lives (up to five) used to determine the charitable deduction.
- Ages: Enter the age(s) of the person(s) whose life is being used to measure the term of the trust as of the nearest birthday. You may enter up to five ages (Valid ages are 0-109.)
- Exhaustion Method: Choose the IRS method or the Illustrated method to perform the exhaustion test.
- 0 Remainder: Click on this button to have the program calculate the payout percentage that will result in a remainder value of zero for a term trust. This button will not appear if the calculation trust type is Life or Shorter.
- Use Life Exp. for Econ. Sched: If selected, the life expectancy based upon the entered ages is used. If the case has more than two lives, the youngest two ages are used as the life expectancy. This life expectancy is then used to determine how many years the economic schedule displays. If not selected, you can enter the number of years to display the economic schedule.
Results
The Summary Tab displays the deduction allowed to a donor for a transfer of cash or other property to a charitable lead annuity trust. Also shown is the future interest gift that will pass to the non-charitable remainderman. The deduction allowed is calculated both as a dollar amount and as a percentage of the amount transferred. The trust's payout frequency factor, payout rate, and the annuity factor are also shown.
The program uses one of two methods to perform the exhaustion test on the trust.
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