How Old Grads Can Use the Charitable Lead Annuity Trust (CLAT) to Reduce Income Taxes and Win the All Academy Challenge!
If you are like me, you recently received a notice from the Association of Graduates (AOG) about an inter-academy (USMA, USNA, USAFA, USCG and USMMA) planned giving challenge (All Academy Challenge). The current Chief Operating Officer of the AOG, Pat Ortland (D-1), is a former roommate who likes to remind me as well as everyone else that his worst year academically occurred while he was my roommate. Another classmate and Company D-1 classmate, Mike White(D-1), is the Director of Major Gifts. I was the D-1 Duck!
Unfortunately, during my career, I never enjoyed seeing Army beat Navy in any sport. I wondered if I was the blame for bringing Army “bad juju.” These days I hold on to this theory vicariously and follow the games on the radio or internet. Now Army has an opportunity to beat Navy and the other service academies in something else-planned giving.
The AOG is making a modest request to win the game, “three yards and a cloud of dust”, the Army version of ball control. I am proposing a triple option with a “pitch” to spring a large gift. This report outlines how a charitable tax planning technique known as the Charitable Lead Annuity Trust (“CLAT”) can be used to provide an Old Grad (or new for that matter) with the ability to provide a gift to USMA; provide an annuity payment to USMA for a period of years and have the donated property revert back to the Old Grad at the end of a period of time or death. The report will illustrate several case studies how Old Grad, Johnnie Gung Ho uses the CLAT to achieve substantial tax benefits while making substantial gifts to USMA.
Overview of the CLAT
The CLAT is a type of charitable trust. The taxpayer contributes cash or a capital asset to the CLAT and receives an income tax deduction for the donation. The CLAT pays a guaranteed annuity to qualified charity, the Association of Graduates in this case.
Scenario A. - The CLAT Using S Corporation Stock
Johnny Gung Ho, age 40, owns 100 percent of Acme, Inc, which is taxed as a S corporation. He is in a combined 40 percent marginal tax bracket. The company is worth $2.5 million. Johnny would like to make a gift of ten percent of the Company’s shares to a newly created CLAT. The Johnny wants to maximize the tax deduction ($250,000) of the charitable gift to the CLAT. The tax deduction in Year 1 is $250,000 which may shelter taxable income up to 30 percent of adjusted gross income (AGI).
Any excess deductions may be carried forward for five additional tax years. Even taxable income payable to the CLAT each Year is taxable to Johnny. The initial payout to the AOG is $1,427 (0.5715). the annuity is set to increase by twenty percent per year. The income payment to the AOG is $7,362 in Year 10 and $45,590 in Year 20. At the end of Year 20, the Acme stock revers back to Johnny. The projected value of the Acme stock is $1.23 million, approximately five times the original value of the gift.
Scenario B. - The CLAT Using Non-Qualified Stock Options
Johnny Gung Ho, age 40, is a senior vice president, at Acme Technology, a Silicon Valley startup. Johnny exercised non-qualified stock options (NQSO) which will be taxed as ordinary income absent any tax planning to mitigated taxation in the year of exercise. The NQSOs may not be transferred. The exercise of the NQSOs generated $3 million of income. Gung Ho is in the fifty percent marginal tax bracket. He would like to contribute the $2 million to the CLAT. He will receive an income tax deduction of $2 million in 2020. The deduction can be used up to 60 percent of AGI. The portfolio within the CLAT will be invested in a growth-oriented portfolio of other technology companies. The income payments to the AOG, a backend loaded with an initial payment $11,420 in Year 1. These payments will increase by twenty percent per year. The final payment in Year 20 is $364,720. The projected reversion of the portfolio in Year 20 is $9.85 million, four times the original gift to the CLAT.
Scenario C. - The CLAT Using Appreciated Stock
Johnny Gung Ho, USMA Class of 1982, would like to make a substantial gift to the Academy - $2.5 million of shares of Acme, Inc, a publicly traded company. He is a resident of California and will be in the top marginal tax bracket for federal and state purposes. He wants to know how much it would take in a charitable gift to remove the statue of George Patton and place a statue of Gung Ho. Unfortunately, $2.5 million is a generous gift but not enough to send General Patton’s statue on its way.
Gung Ho creates a Nevada non-grantor trust (Gung Ho Family Trust). The trust is structured in a manner so that the transfer of the stock is not considered a taxable gift for federal gift tax purposes. The non-grantor trust status means that the trust rather than Gung Ho will be taxed on the taxable gain when the trustee sells the shares for a significant gain. A trust is subject to the top marginal income tax bracket with only $12,900 of taxable income. The tax problem associated with the sale of Acme stock is averted by the charitable contributions of the trustee. The charitable deduction may be made up to 100 percent of net trust income. This charitable donation offsets 100 percent of the taxable income of the Trust.
Prior to the charitable contribution, the Trustee of the Gung Ho Family Trust, purchases a life insurance policy insuring Gung Ho. The policy is contributed to a Charitable Lead Annuity Trust (CLAT). The CLAT established by Gung Ho in 2020 provides for annual payments to the AOG for its unrestricted use over a twenty-year term. The payments to the AOG increase by twenty percent over the twenty-year term. At the end of this twenty-year period, the remaining trust corpus reverts to the Gung Ho Family Trust. Assuming a growth rate of 10.0 percent per year over the twenty -year period, the projected value of the reversion to the Gung Ho Family Trust is 12.3 million. The CLAT’s projected payments to the AOG over the twenty-year term is $2.66 million. Gung Ho was able to sell his appreciated stock without any gain due to the Gung Ho Family Trust’s charitable contribution to the CLAT.
Additional planning may allow the CLAT to accumulate the income and growth without taxation using specialty life insurance. The life insurance planning allows the CLAT to avoid any taxable income to the CLAT over the twenty-year term.
The eternal struggle to “Beat Navy” in every endeavor extends to Planned Giving. The article outlines some “secret weapons” to deliver the to put the Navy goat out of its misery. No insult intended to my friends at PETA! The CLAT creates a method to provide a gift to the AOG and receive an income tax deduction equal to the gift. The CLAT provides payments to the AOG over a term of years. The calculus of the strategy provides considerable financial leverage so that the reversion of the CLAT assets back to the taxpayer at the end of the income term payable to the AOG may be two-four times larger than the original gift depending upon investment results. Make your cash gift to the AOG in the All Academy Challenge but use the CLAT to provide a legacy!