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Wednesday, May 1, 2024
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Case Studies |
Death of CLAT Donor Recaptures Charitable Deduction
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Case:
Dennis Collins, Jr., was a Gold Circle member of the local hospital. Currently, the local hospital approached Dennis about making a $1 million gift to their capital campaign. Dennis was very interested in helping the hospital and getting a charitable deduction. (His CEO salary was $2 million per year). However, he did not feel comfortable transferring a large portion of his wealth irrevocably to the hospital as he had done with prior gifts. Because Dennis cares deeply for the hospital, he stated that he would be open to any alternate options.
Taking Dennis' concerns into account, the gift planner for the local hospital suggested a grantor charitable lead annuity trust. Specifically, Dennis would create a 10-year charitable lead annuity trust and fund it with $2 million of cash and high-basis stock. The CLAT would have an annual 5% payout of $100,000. Accordingly, $100,000 would be distributed to the hospital for the next 10 years. At the end of the 10 years, the trust assets would revert back to Dennis.
Dennis would be allowed a charitable income tax deduction of $757,000 [as opposed to a charitable gift/estate tax deduction for a family CLAT (nongrantor CLAT)]. Furthermore, because this is a grantor CLAT, the trust income, if any, would be taxable to Dennis. However, the trust should produce little taxable income, since it would invest primarily in tax-free municipal bonds.
Dennis loves the plan, loves the deduction, loves the gift to the hospital, and loves the fact that he is going to get the $2 million back. Therefore, Dennis creates the trust.
Question:
Unfortunately, Dennis died unexpectedly four years later. What is the effect, if any, upon Dennis's $757,000 charitable income tax deduction?
Solution:
A grantor CLAT allows a donor to take a large charitable income tax deduction in the current year for the present value of distributions to charity over time. However, if the donor dies during the trust term (or ceases to be treated as the owner of the trust), then there is a recapture of part or all of the tax deduction.
Pursuant to the tax regulations, Dennis is treated as receiving an amount of income equal to his deduction minus the discounted value of the payments made to charity [See 1.170A-6(c)(4) for determining the computation of the discounted value]. Therefore, Dennis would have to recapture $757,000 minus the discounted value of four $100,000 payments. This recaptured amount would not require the filing of an amended return or the loss of the initial charitable deduction. The recaptured amount, however, would be required to be reported as gross income on Dennis' final income tax return.
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