If the thought of filing your income tax return brings you an intense feeling of dread, it may be time to consider leveraging charitable giving to purposefully mitigate your tax exposure during a high-income year. Charitable lead annuity trusts, private foundations, and donor advised funds are three legacy planning techniques which may help you to accomplish both your philanthropic and tax objectives.
Charitable Lead Annuity Trust. A Charitable Lead Annuity Trust (CLAT) is an irrevocable trust that provides for a “lead” charitable interest in the form of an annuity payable to one or more charitable organizations, or a private foundation, for a fixed term of years. Assets remaining upon the expiration of the fixed interest term will be distributed to the non-charitable beneficiaries designated by the grantor (or held in trust for their benefit), such as children or other family members. The benefits of CLATs are three-fold in that they further philanthropic goals while simultaneously obtaining a federal income tax charitable deduction and benefitting family members at the end of the charitable benefit term.
Example. Assume that: (1) John funds a 15-year grantor CLAT with assets valued at $1 million; (2) the gifted assets appreciate annually at a rate of 4%; (3) the annuity payments to the charitable beneficiary will increase annually by 20%; (4) the CLAT is “zeroed-out” for gift tax purposes so that there is no gift tax triggered; and (5) the estate tax rate is 40%.
Based on these factual and financial assumptions, John may receive a federal income tax charitable deduction of $1 million in the year of funding. In addition, $304,272 will remain in the CLAT at the end of the 15-year term for transfer to John’s children, resulting in an estimated estate tax savings of $121,709 (40% of $304,272).
Private Foundation. A private foundation (Foundation) is a nonprofit corporation organized and operated exclusively for charitable purposes. As a legal corporation, the Foundation’s officers and directors must adhere to strict administration and compliance requirements. Similar to a CLAT, the Foundation donor receives a federal income tax charitable deduction based on the amount of the donation, but unlike the CLAT, a Foundation is typically intended to operate and exist in perpetuity. A Foundation also often becomes a multi-generational vehicle for further legacy management and family training in philanthropy and investment management while furthering philanthropic goals.
Donor Advised Fund. A donor advised fund is a simple and inexpensive method to facilitate charitable giving, but it has somewhat less utility and flexibility than a private foundation and is not generally perpetual in nature. A donor advised fund is a charitable-giving account administered by a sponsoring organization, such as a community foundation or financial services company.