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Wednesday, May 1, 2024
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Case Studies |
Marketing Ideas During Soft Markets and Dropping Interest Rates, Part 6 - Grantor Charitable Lead Annuity Trust
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Case:
Harold Henry, Age 67, is a very generous American. He is the stereotypical major donor that charities love to find. Coming from a wealthy and philanthropic background, Harold has given approximately $15 million to national and local charities over his lifetime. In addition, he currently sits on the boards of several charities and loves his role as a volunteer and donor.
With a $20 million estate, Harold's estate plan is very comprehensive and reviewed annually. Not surprisingly, Harold is always contemplating new gifts and tax-wise planning. In fact, during the past two years, Harold has been tinkering with the idea of creating a charitable lead trust to benefit one of his favorite charities. Harold loves the idea and the tax benefits associated with the gift. However, due to his busy schedule, he just has not found the time to complete the gift.
Fortunately, Harold's attorney, Stan Sutton, was aware of his gift intentions. Accordingly, Stan noticed the dropping applicable federal rates (AFR) this year and advised Harold that now may be the time to create the trust.
Question:
What advantage is there for creating a charitable lead annuity trust during dropping interest rates? What window of opportunity exists for completing this gift? How much can Harold save by completing this gift now? Although very wealthy, Harold has anxiety over the current state of the economy and asks if there is any way he could "get the money back" at the end of the trust term?
Solution:
A grantor charitable lead annuity trust (CLAT) produces a charitable income tax deduction equal to the present value of the charity's income interest. When computing the present value, an applicable federal rate must be used pursuant to Section 7520. With CLATs, the lowest AFR produces the largest charitable income tax deduction. During the past two years, the AFR rates have remained mostly in the 5% range. However, the AFR for May 2008 is a mere 3.2%. Therefore, it is a great time to create a CLAT.
For example, for a $2 million 10-year 5% payout CLAT, Harold's charitable deduction is approximately $422,000 when using the 3.2% AFR. However, if Harold had created the trust when the AFR was 6.0%, his deduction would be about $368,000 or $54,000 less! Thus, assuming a 40% federal and state combined income tax rate, Harold could save an additional $21,600 just for completing the gift now while interest rates are so low.
Since grantor CLATs are taxable to the donor, Harold decides to fund the trust with part of his portfolio of municipal bonds (alternatively, Harold could use stocks with little or no appreciation). The trustee will then receive and payout the income from these tax-free bonds. This tax-free investment decision allows Harold to avoid any phantom income problem during the trust's 10-year term.
To accommodate Harold's "get the bonds back" wish, the CLAT is drafted so that the trust assets will revert back to Harold at the end of the 10 years. Thus, Harold sleeps much easier at night knowing he will see his $2 million again.
Because a donor may elect an AFR of the current month or the prior two months, Harold could wait until July to complete the gift. He simply could elect to use May's AFR at that time. He could select the rate which would produce the greatest deduction. Therefore, Harold informs Stan to begin the gift process, which should be completed no later than July 31.
Lastly, $1,000,000 will be distributed to charity as a result of Harold's CLAT. He is amazed with this enormous benefit and decides that his CLAT will benefit his three favorite charities equally. In the end, Harold is completely happy with his plan. He turned falling stock markets and interest rates into a golden opportunity to help charity and himself.
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