The Concept of Giving
Many individuals have philanthropic desires and are very much enamored with various charitable and educational causes. Obviously, it is important to balance income needs and the needs of beneficiaries with the tax benefit of gifting now as well as the ability to enjoy the act of giving during one’s lifetime.
Before one decides the manner in which to give, it is important to analyze the tax implications of the decisions involved. Giving as much as one wants to charity during lifetime and after death may help to reduce federal Estate and Gift Taxes significantly. Gifts made to charities specifically are exempt from gift taxes.
Generally speaking, lifetime gifts can result in an income tax deduction, but before one makes a sizable gift, he/she should be sure to seek tax advice from a professional. There is a limit for itemized deductions for charitable contributions up to a certain percentage of adjusted gross income for cash contributions. Another limit applies for contributions of appreciated securities or properties in any one year. One may be able to carry forward amounts that exceed the limit and deduct them over the next five years. Highly appreciated securities may be good candidates to give to charity during one’s lifetime. In addition to income tax deductions, one can pass the capital gains tax that would be owed if they cashed them in themselves.
Charitable Remainder Trusts (“CRT”)
A Charitable Remainder Trust addresses both income and capital gains concerns while guaranteeing future income for retirement. The plan also provides for contributions to favorite charities as well as a possible comfortable distribution from insurance for heirs that will pass to them free of Gift and Estate Taxes. The goals achieved by the CRT include generating income tax deductions, reducing federal estate taxes, selling appreciated assets tax-free, protecting assets from creditors and maximizing the timing of taxable income.
The CRT has a trustor or maker of the trust which is usually the donor. It has an independent trustee of the Trust who manages the assets and follows the instructions of the trust document. Contributions to the CRT provide a significant annual income tax deduction.
One very exciting way to overcome the fact that the heirs may lose the principal amount of the charitable contribution trust on death to the charity is to establish an Irrevocable Life Insurance Trust (“ILIT”) and purchase a policy on the life or lives of the donor. By using the extra cash flow and tax savings from the CRT they can make annual gifts to the ILIT from the policy to cover the premium costs. Upon the death of the donor, the proceeds of the CRT are distributed to the charity. At the same time, the proceeds from the ILIT will pass to the children estate tax free to make up for their loss of the principal of the charitable donation that goes to the philanthropic organization. Contributions of low basis assets can be significant with respect to capital gains tax savings.
There are limitations of how much can be deducted for income tax purposes with respect to charitable giving. Once a value is obtained for the amount of the gift, the assets can be sold by the CRT free of capital gains tax. The proceeds then become part of the trust and are available for security to the donor and a greater charitable contribution to the donee charity.
The trust provides guaranteed income to the donor during his or her lifetime. Upon the death of the donor, the remaining assets in the trust are given to the charity that has been selected.
The Charitable Lead Annuity Trust Or Charitable Lead Trust (“CLT”)
With a Charitable Lead Trust or a CLT, property is transferred to a trust that distributes income to a charitable beneficiary for a period of time or for the life of the donor. The remainder interest upon the death of the donor reverts back to the donor’s beneficiaries or a charity. If created during life, the grantor can claim charitable deductions for the present value of the total anticipated income during the lead period. A grantor trust is created by means of setting up the trust and the value of the assets of the CLT are generally not included in the estate of the decedent for estate tax purposes. The non-charitable beneficiary can be a grantor, spouse, child or other person. This can be an excellent strategy for highly appreciating assets and can offset the income from these assets. When interest rates are low, this increases the valuation of the deductible interest donation.
Just because an individual has a CRT that is no longer a good fit it does not mean that the CRT should not have been set up to begin with. Because CRTs are irrevocable assets they can be in place for decades. Most people report some type of misalignment with the CRT at one point or another. Regardless of whether the severity of that misalignment warrants the pursuit of a rollover or sale, the CRT grantor should be aware of available secondary planning options so that they are in a position to make changes should the need arise. In this regard, we can help work out meaningful and very effective strategies should the need arise.
Testamentary Charitable Lead Annuity Trust (“TCLAT”)
The TCLAT is a Testamentary Charitable Lead Trust set up to take effect at death in order to zero out estate taxes. By donating a portion of the financial interest to a charity, the heirs can control more than twice as much capital rather than letting the assets pass to the IRS. For example, assume that a donor has an estate in excess of the unified credit (which is now approximately $11.4 million). The donor’s estate planning documents can give this amount to the donor’s heirs without incurring any estate tax. The balance of the estate is subject to estate tax unless it is contributed to a TCLAT. The TCLAT can be invested and can make substantial revenue. In this regard, the beneficiary and the charity gain much value and benefit. At the end of a specified year term of the TCLAT, the principal is distributed back to the heirs. The heirs can manage substantial income for the benefit of the charity while at the same time receiving back any principal that is left after the term. Why wouldn’t someone rather set up the TCLAT than pay this extra money to the Internal Revenue Service? The TCLAT definitely makes sense for anyone who has the possibility of paying estate taxes.
Super CLAT
A Super CLAT is a Charitable Lead Annuity Trust set up during the lifetime of the donor. Contributions to the Super CLAT are available to reduce income taxes as well as reducing the estate tax.
The assets of a donor’s retirement plan will normally be included in his/her estate for estate tax purposes and also the beneficiaries must pay income tax on proceeds of the retirement. However, the retirement plan assets can be put into a profit sharing plan with a high cash value insurance contract that has a minimal death benefit. The profit sharing plan could then distribute the policy with the donor paying no current taxes because the Super CLAT converts paying the taxes into giving to the charity. The Super CLAT works well for retirement rescue because there is no tax payable on retirement plan distributions or the money paid from the retirement plan held in the Super CLAT long enough to generate returns for charity that are roughly equal to the future value of what would have been paid in taxes. Once the charity has received payments over a period of time that justify the tax write off, the policy can be distributed from Super CLAT to a non-charitable trust. The non-charitable trust then can be set up for the benefit of the heirs and they will have access to the cash value of the insurance policy while enjoying the security that comes from knowing that the policy will eventually pay this tax free benefit. The Super CLAT is “super” because it generates income tax deductions along with 100% estate tax deductions. For persons of wealth, the Super CLAT is a definite possibility.
The Private Foundation
Some people want a more specialized way of making gifts and taking charitable deductions. They consider establishing a private foundation. The foundation manages and retains control over the investment of the foundation assets as well as giving grants from the foundation to charities. Besides tax savings, an additional benefit of the private foundation is that it continues on a philosophy of philanthropy for the family. Children and grandchildren can be involved with respect to managing and directing the funds of the private foundation. This will give them a legacy of the philanthropy while at the same time promoting the causes that the parents feel are important to them and their family.
It is important to understand that a charity can be the beneficiary of a relatively simple revocable trust or irrevocable trust. Other gift strategies involving charitable trusts can provide benefits to charity as well as to the family and oneself.
Conclusion
Determining which type of strategy to utilize and how much to give to the structure and how the structure should be managed are all very technical issues and require the assistance of a qualified attorney who is familiar with these strategies. The strategies result in great benefits, but they have to be structured properly because the Internal Revenue Service is very vigorous in their regulation and review of these types of strategies.
For more information on Charitable Trusts In The State Of California, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (714) 384-6500 today.