New York Estate Planning & Elder Law Blog
CHARITABLE LEAD ANNUITY TRUST
There are many great estate planning strategies that allow a person to avoid or lower estate tax liability and give money to charity at the same time. With the large estate tax exemption and portability of estate tax exemptions only a small number of Americans will face the possibility of paying the federal estate tax. For many New Yorkers, however, the federal estate tax is a secondary consideration in light of the lack of right to transfer any unused estate tax exemption from for the first deceased spouse to the next. Instead of a double benefit, New Yorkers face a potential double hit of not only having a lower estate tax threshold, but being taxed on the entire estate amount, sans estate tax exemption. For couples that face this possibility and for those with larger estates, few match the simplicity of the charitable lead annuity trust, often abbreviated as a CLAT. It is also a good fit for those who seek to defer the payout of their trust payments to relatives quite some distance in the future.
The CLAT works quite simply by funding the trust with a certain amount, usually a large amount (since it is generally used by families or grantors looking to reduce their estate tax liability) that is scheduled to be paid out to a charity over of a certain length of time. Once the payout period for the charity is over, a certain sum, plus any additional monies earned (minus taxes and expenses of course) is paid to the remainderman beneficiary of the trust.
The IRS presupposes that the CLAT will grow by approximately two percent per year, which is by necessity worked into the trust calculations, and if the trust investments earn more than the two percent, that additional money can pass to the beneficiary, but only taxed on the lower projection figures. The percentage rate that the IRS presupposes that your CLAT investments will grow each year changes from year to year. A CLAT can even be used to grant yourself a tax break. For example, if you know you will have a particularly high tax bill in one year, you may create a CLAT with certain income producing assets, have that income paid to a charity over a certain time period and then have the asset return to your control at your age of anticipated retirement. The IRS will grant the entirety of charitable deduction in the year that the CLAT is created.
It is difficult to understand these concepts in the abstract, so let us use an example with simple math. Grantor has an estate worth 15 million, which is composed of tax free or low tax government bonds. He wants to leave this to his children but doesn’t want to pay the large federal estate as well as the even larger New York state estate tax. He also has an affinity for Syracuse basketball, so he decides to leave his money to create a CLAT, with Syracuse basketball as the charitable beneficiary. He decides to give $750,000 per year to the program for 20 years ($15 million total). The IRS values the trust at the inception of the trust. With a two percent growth rate, the IRS values the estate that will transfer to the remainderman beneficiary at approximately $2.5 million.
If, on the other hand, the trust earns more than the two percent, the additional monies pass tax free. For example, if the trust earns five percent, the remainderman beneficiary will stand to inherit approximately $6.25 million, but only be taxed on the $2.5 million.