Last time, we looked at a Charitable Lead Annuity Trust example. An example of a 12-year CLAT funded with $1 million of cash, which is to pay $50,000 a year (a 5-percent payout) to charity and then distribute its assets to Donor’s daughter.

Question: How much will the daughter receive? No one knows for sure. It’s possible to make some assumptions, however, and get a picture of how things play out for the daughter under the assumptions. The simplest way to do this is to make one assumption, an assumption as to trust net earnings. If, for example, we assume 7 percent net earnings, the daughter will receive $1,357,769. If we assume 4 percent net earnings, the daughter will receive $849,742. And so on.

Question: Will there be any tax on the money distributed to the daughter? There won’t be any gift or estate tax; that was taken care of when the trust created. There will be income tax, however, on any amount the daughter receives which represents income of the trust for its final year on which income tax has not been paid. The daughter will pay this tax.

Question: What are trust net earnings? Basically, trust net earnings are equal to gross earnings (including both cash earnings and capital appreciation) minus expenses and taxes. Trust expenses typically include brokerage fees and the trustee’s commission.

Question: Does a CLAT pay any income taxes? It depends. Typically, the CLAT does pay income tax on its undistributed income for a year. This is true of a “plain vanilla” CLAT. If a plain vanilla CLAT has $55,000 net earnings of cash for a year and $12,000 of unrealized capital appreciation for the year, and the CLAT pays $50,000 cash to charity for the year, the CLAT will be allowed a deduction for the cash paid to charity and will be subject to tax only on the $5000 of undistributed cash. There will be no tax on the $12,000 unrealized, undistributed capital appreciation.

Question: What is a “non-plain vanilla” CLAT, and how does it work? We’ll look at all this next time.

Meantime, if you think there is an awful lot of detail to consider about CLATs, you’re right! There is. And prospective CLAT donors typically want to probe all the details. That gives you a clue as to the sort of person who is a typical CLAT donor.

by Jon Tidd

Read Pt 1 here
Read Pt 2 here
Read Pt 3 here
Read Pt 4 here
Read Pt 6 here