As a first-time columnist—and as someone taking over for a friend and colleague—I feel a brief introduction is in order. After all, you’re going to be trusting my knowledge in matters related to business and the law.
The quick facts: I was raised in Sacramento and my initial calling was education. After several years in the trenches teaching elementary school, I decided to pursue a law degree with the goal of ultimately helping bring the world “greater equality and social order”—a personal response to the turbulent ’60s of my youth. Fast forwarding 30 years, bringing tax and estate planning experience acquired from work in various legal and accounting venues, I joined the trusts and estates group of Dickenson Peatman & Fogarty. When Brandon Blevans bowed out of the Simply Legal column last year, I was offered the chance to step in. Please let me know if you have specific questions or topics you’d like to see covered. I’ll do my best to keep it current and relevant to business in the North Bay.
Ever think you’d want a CLAT?
Julia Walk, my DP&F trusts and estates colleague, and I recently put our heads together, searching for effective gifting strategies in gloomy economic times—periods of low asset values and low interest rates. Sound familiar? The Internal Revenue Code (IRC), as we rediscovered, generally favors charitable giving and provides a few incentives that are particularly effective these days.
Charitable planning techniques that can stretch the estate planning dollar include deferred timing techniques, which “split” the gift to provide benefits for different beneficiaries—a charitable and a non-charitable beneficiary—at different times. This results in a lower taxable value of the non-charitable portion than if the gift were outright, so gift tax, will also be less.
The value of a split-interest gift is established using special IRS valuation rates, codified in IRC § 7520 (IRS Rate). The December 2010 IRS Rate of 1.8 percent is historically low. A strategy that combines the low IRS rate with recent low market values offers a dynamite tax savings opportunity for gifting assets likely to appreciate in the future. What today’s IRS Rate tells us is, the IRS is betting the gift won’t appreciate more than 1.8 percent in the future. But if the gifted asset appreciates and/or produces income in excess of 1.8 percent per year over the term, the donor can pass the excess to either the charity or family—untaxed.
The IRS incentives require jumping through some hoops, but with solid tax/legal advice and proper structuring, the tax savings and financial gains can be significant. For example, you can make a gift via a charitable annuity trust. The nomenclature is titillating—the two types of charitable annuity trusts are “CRATs” and “CLATs” (that’s Charitable Remainder Annuity Trusts and Charitable Lead Annuity Trusts). The difference between them is the timing of the charity’s enjoyment—with a CLAT, the charity benefits now; with a CRAT, the charity benefits later. In the present economy, CLATs offer the biggest payout to the charity now and take the most advantage of the low IRS Rate.
CLATs work well for clients who are charitably inclined, particularly those already making periodic charitable gifts. The charity has the right to receive its benefits upfront—the “lead” interest—for a fixed number of years. The remaining assets pass outright to a non-charity, say family. The portion going to charity passes tax-free. The portion passing to family may be subject to gift tax, but in a low IRS Rate environment, the taxable value of the remainder passing to family is lower, so the gift tax is lower (or eliminated altogether). And with a CLAT, the charity gets a regular source of funding now.
Getting down to basics, let’s take Bob and Betty who are in the enviable position of having “enough to go around.” They’re confident they won’t need all of their current assets to sustain their comfortable lifestyle, so they wish to give something to their favorite charity, ARTSY. They don’t wish to cut too deeply into their children’s inheritance, and they fear possibly escalating estate taxes that might erode their estate at death. They’re concerned about structuring a possible charitable gift and about how to get the best leverage, given their objectives.
If Bob and Betty contribute $100,000 of likely-to-appreciate assets (say quality stocks) to a 10-year CLAT with a 6 percent payout rate, the CLAT will make annual payments to ARTSY of $6,000 (comprised of income and principal) over the next 10 years. After 10 years, the remaining assets will pass to Bob and Betty’s children. If the CLAT’s combined income and appreciation exceeds 2 percent per year over the 10 years, the children receive the excess, with no additional gift or estate tax.
For example, if the assets grow at a steady 4 percent, the children will receive $75,988 and ARTSY will receive $60,000. Using the 2 percent IRS Rate and calculation formula, when their CLAT is set up, Bob and Betty will be making a taxable gift to their children of $46,104 (not the full $75,988).
Assuming Bob and Betty have available lifetime gift tax exemptions ($1 million each), they wouldn’t pay any tax, but would each use $23,052 of exemption, leaving a hefty balance to shelter future taxable gifts.
If Bob and Betty stretch the same $100,000 CLAT to 20 years, ARTSY will receive $120,000 over 20 years, the children will receive $40,444, and the taxable value of the gift will be less than $2,000. The charity receives more in this example due to the extended term, Bob and Betty use very little of their exemption and still leave a comfortable amount to the children.
Of course, results will change if key terms are tweaked, including the payout rate, the growth of the assets, the CLAT term and the initial value of the contribution. For the charitably inclined, it’s well worth running the numbers to see if this strategy works before the low interest rates start to climb.
At the end, use of a CLAT is a win-win strategy and can be relatively painless with just a bit of planning.
Susan M. Teel is senior counsel at Dickenson, Peatman & Fogarty in the trusts and estates department and a member of its wealth management group. She’s specialized in estate planning, trust administration and probate for more than 25 years. You can reach her at steel@northbaybiz.com.
