Example: Caroline plans to create a $15 million non-grantor charitable lead annuity trust (CLAT). The CLAT will have a fixed payout of $300,000 per year, a 20-year term and Caroline’s children will be the remainder beneficiaries. Caroline funds the trust with $15 million of stock.
If Caroline funds the lead trust with her stock, the annual annuity payment will consist of dividend income and realized capital gain, totaling $280,000. Because the trust will pay out $300,000 per year to charity, it will be able to deduct the entire $280,000 from its taxable income. The trustee may sell $20,000 of the stock each year to make up the difference to charity. The tax on the $20,000 is offset by the Sec. 642(c) charitable income tax deduction.
Example: John sold a commercial building this year that he inherited many years ago from his parents. He has a spike in his taxable income due to the sale and would like to generate a charitable deduction to offset some of the taxes. John would also like to provide a nice inheritance for his children, but he wants to give his children time to mature and make their own way before receiving a large lump sum.
John decides to transfer $3,000,000 to a 15-year lead supertrust. The present value of the annual 3% payout to charity is $1,350,000. Because his income is about $3,300,000 this year, John will be able to use $990,000 of the deduction this year under the 30% of adjusted gross income limit. He will carry forward the remaining $360,000 to use in the next year. He can carry forward his deduction for up to five years.
The trust remainder will be transferred to his children at the end of the trust duration. John does not retain control over the income or a reversion in the trust. He gives his sister, Rebecca, a Sec. 675(4) power to reacquire the trust assets, enabling the trust to qualify as a grantor trust. In the year the trust is funded, John must file a Form 709 gift tax return. He will report a charitable gift tax deduction of $1,287,342, which reduces the taxable transfer to his children from $3,000,000 to $1,712,658. He uses part of his unified estate and gift exemption ($10 million plus indexed increases) to cover the $1,712,658 gift.
Over the 15-year period of the trust, assuming the invested assets produce a total return of 6%, the trust will grow to over $5,000,000. John will benefit from a sizeable income tax deduction, receive a gift tax deduction and be able to transfer over $5,000,000 to his children. The $5,000,000 to the children will be tax-free upon receipt, as John has paid all taxes during the term of the trust. The combined benefits of the plan make this an effective planning strategy for John.