In the current economic environment, IRS-prescribed monthly interest rates for certain intra-family transactions are at historic lows. As a result, an excellent opportunity exists to transfer wealth to lower generation family members while minimizing taxes. In this final installment in our three-part series, we discuss the planning technique known as “Charitable Lead Annuity Trusts” (CLATs). Like Intra-Family Loans and Grantor Retained Annuity Trusts (GRATs) described in Part One and Part Two, a CLAT is an excellent planning strategy in a low-interest-rate environment, and is particularly effective for individuals who are either currently making, or intend to begin making, sizeable annual gifts to charity, and who also wish to transfer assets to younger generation family members in hopes of minimizing taxes.

A CLAT is substantially similar to a GRAT in that it is established through an individual’s transfer of assets to a trust to be held for a period of time, after which the remaining trust assets, if any, will be distributed to younger generation family members. The biggest difference between a GRAT and a CLAT is that the annual annuity payments are paid by the CLAT to one or more charities rather than to the Grantor, the individual who established the trust. A charitable gift and income tax deduction is available for the present value of the annuity payments to be made to charity, using the 7520 rate in effect in the month of the transfer (or for one of the two preceding months, if that produces a larger deduction).

As with a GRAT, it is possible under current law to set the value of the annuity payments payable to charity to equal the initial value of the assets transferred to the CLAT, so that the value of the taxable gift made to the CLAT is zero or close to zero. So, if the appreciation in the assets contributed to the CLAT exceeds the 7520 rate, there will be excess assets remaining in the CLAT at the end of its term that may pass onto younger generation family members, just as with a GRAT.

The principal objectives in establishing a CLAT is to create a win-win situation whereby you receive a charitable income and gift tax deduction for the value of some or all of the assets placed into the CLAT, and also potentially benefit lower generation family members if the CLAT assets earn a rate of return greater than the 7520 rate during the CLAT term. Any excess appreciation will pass to non-charitable beneficiaries (i.e., younger generation family members) at the end of the trust term at no additional gift tax costs. Thus, a CLAT works best in a low-interest-rate environment since there is a greater probability of an investment return in excess of the 7520 rate. For this reason, CLATs are an ideal choice for individuals wishing to combine charitable pursuits with asset transfers to family members.