“Incorporating Charitable Lead Annuity Trusts Into Your Estate Plan ” by Thomas D. Peebles, Jr and Emily J. Kembell

In recent articles, we have identified the tax advantages to be obtained through the use of Grantor Retained Annuity Trusts, or “GRAT’s”. With interest rates at record lows, GRAT’s are a very effective estate planning technique for transferring wealth to next generation beneficiaries without incurring any (or very little) transfer tax. For those clients who are charitably inclined, a Charitable Lead Annuity Trust, or “CLAT,” is also an excellent estate planning technique to consider when interest rates are low and asset values have depreciated.
Similar to a GRAT, a CLAT requires annuity payments to be made for a certain period of time (usually a term of years); however, unlike a GRAT, the CLAT annuity payment is made to a charity or charities instead of to the Grantor. At the end of the annuity term, the assets remaining in the CLAT are distributed to non-charitable beneficiaries, usually the Grantor’s children or grandchildren. The lead interest qualifies for the gift tax charitable deduction, but the remainder interest is a taxable gift whose value is determined at the time the CLAT is established.
To value the taxable remainder interest of a CLAT, the IRS assumed rate of growth (the “Section 7520 rate”) is used. Currently, the Section 7520 rate is very low – 1.8%. This means that if the assets transferred to the CLAT appreciate at an annual rate greater than 1.8% over the annuity term, then the actual value of the remainder interest transferred to the children/grandchildren will be higher than the value of the remainder interest used for gift tax purposes. The difference between the actual value of the remainder interest transferred to descendants over the gift tax value is, in effect, a tax-free transfer. The currently low Section 7520 rate, coupled with the depressed value of assets,allows clients to utilize this technique with a greater chance of success now than in the past.
A second advantage associated with CLAT’s is the ability to avoid paying income tax on assets transferred to the CLAT. Therefore, not only are clients able to avoid or minimize gift tax, but CLAT’s allow clients to decrease their income tax liability as well.
When considering whether a CLAT is an appropriate estate planning technique, clients should be aware that, for the annuity term, a charity or charities will receive the distributions from the trust, and, if the assets do not appreciate as expected, there may be nothing left for descendants at the end of the annuity term. Additionally, the administration of a CLAT requires the Trustee to abide by many IRS rules, some of which are dependent upon the type of charity that is receiving the annuity payment. If these rules are not followed, an excise tax could be triggered.
If you would like to discuss the potential use of CLAT’s in your particular circumstances, please contact a member of the CECB Estate Planning Practice Group.