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Sunday, May 5, 2024
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Case Studies |
Falling Markets and Interest Rates Give Rise to a Blue Chip CLAT
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Case:
David Chang, 38, is a very successful businessman. He owns and operates 24 corporate jets, and he leases them out full time to Fortune 500 clients. David's salary as President and CEO is $250,000 a year. As a result of his successful corporate jet company, David, at the age of 38, has an estate of $15 million. His business is appraised at $8 million, and David owns a home in Carmel valued at $2 million. He also has personal property and cash totaling $2 million. The rest of his estate is composed of stock holdings in blue chip companies, which six months ago were valued at $3 million. However, over the past two quarters, David's stocks have taken a beating. With the uncertainty of the economy and meltdown of tech stocks, it seems that even blue chip stocks could not avoid the meltdown. Consequently, David's holdings dropped from $3 million to $1.5 million in less than a year. As unsettling as the current situation is, David believes in his investments and knows that, when the market turns around eventually, his stocks will rebound very nicely. As a result, he has chosen to leave his diversified portfolio of blue chip stocks untouched.
During this time, David met with his attorney to discuss his estate plan. David never married and has no children. However, his younger sister, Susan, 34, has two children, ages 12 and 10, who David absolutely adores. David wants to make sure his sister is "well taken care of" and that his two nephews have the "best education money can buy." He wants to make lifetime gifts to them, but abhors the idea of paying gift taxes.
Question:
How can David transfer over $1 million in a mere five years to his family without paying any gift taxes? Can David potentially leverage the down market to pass an additional $1 million of value to his family without having to file a gift tax return?
Solution:
David's attorney, Stan Drucker, suggested using a Charitable Lead Annuity Trust (CLAT). David would transfer $1 million of his stock portfolio to the CLAT. The CLAT would be drafted to pay an 8% annuity to charity ($1m x 8% = $80,000) for five years. David's five-year CLAT will produce a charitable gift tax deduction of $338,832. Thus, the taxable gift is $661,168 ($1m - $338,832). This gift requires David to file a gift tax return. However, because David will apply his applicable exemption amount to the transfer, no gift tax will be due. Therefore, David can transfer $1 million to his sister and nephews in five years with no adverse tax consequences.
David is very pleased with this solution, but realizes that the real opportunity lay below the surface. David believes that the current stock market is oversold and artificially undervalued. He foresees that within one to three years, his blue chip companies will surge back to their beginning-of-the-year valuations. If his forecast materializes, the CLAT stock holdings could easily double in value to $2 million! Thus, by taking advantage of a down market, David would pass an additional $1 million to his family in just five years with no extra gift tax return required. While recognizing the risk, David is extremely excited about this plan and decides to create the CLAT this month.
Lastly, Stan informed David that $400,000 ($80,000 x 5) would be passing to charity as a result of David's CLAT. David is amazed with this "additional windfall." As President of a successful company, David is frequently approached by local charities for contributions. Therefore, David decides to fund a donor advised fund with the yearly CLAT payments. In this way, he can recommend distributions to the local charities that approach him, and support the local community.
In the end, David is completely happy with his plan. He turned a falling stock market and interest rate into a golden opportunity to help family and charity.
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