Last time, we saw that there is the “plain vanilla” CLAT, for which the donor gets a gift tax charitable deduction but not an income tax charitable deduction. We also saw that it’s possible to set up a CLAT so that the donor does get an up-front income tax charitable deduction in addition to a gift tax charitable deduction. An income tax charitable deduction for the up-front present value of the payout to charity.
How is this done? It’s done by making the donor the owner of all trust assets and income for federal income tax purposes. In tax lingo, the CLAT is designed to be a “grantor trust.”
Wow, what does that mean? It means simply that the CLAT is set up in such a way that the donor has to report, each year, all trust income (dividends, interest, realized capital gains, etc.) on his or her personal income tax return … with no deduction for trust income paid to charity.
This can be done basically one of two ways. The first way is to set up the CLAT so that upon its termination, all CLAT assets are distributed back to the donor (or the donor’s estate). The problem with this approach is that the wealth transferred to the CLAT reverts to the donor, so there is no tax-saving wealth transfer downstream. The second way is a little funky but allows wealth to be transferred downstream. It’s to give some third party (maybe donor’s lawyer) the power to acquire trust assets by substituting other assets of equal value. The idea is not that this funky power will ever be exercised. The idea is that the mere existence of this power makes the CLAT a grantor trust. Even though the trust assets ultimately pass to children or other beneficiaries free or largely free of gift and estate taxes.
We’ve got to stop here to avoid getting too deep into the weeds. Please be assured, however, that wealthy, charitably motivated donors who have cracker-jack tax lawyers do set up this sort of funky CLAT … often using carefully designed insurance products. Insurance products are used in part because such products do not produce income to the CLAT for federal income tax purposes.
We’re going to leave CLATs at this point. If you’re interested in developing a strategy to market CLATs and want expert advice, be sure to be in touch with a Sharpe Group representative.
by: Jon Tidd