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.

Strategy Examples

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.