Eliminating Estate Tax - The T-CLAT
What Is A CLAT?The acronym CLAT stands for "charitable lead annuity trust." A CLAT is an irrevocable trust to which you transfer income producing assets. The income is paid to a charity. At the end of the term which you have selected, the assets remaining in the trust are paid to - typically - your heirs (or, better, an irrevocable trust for their benefit). The longer the term of the CLAT, the lower is the value of the gift over to your heirs.
Example Of A CLAT.Assume in June, 2010, you transfer $1,000,000 of income producing real property to a CLAT. The property is generating $50,000 per year. You pick a 10 year term and the remainder beneficiary is a trust for your children. That means at the end of the 10 year term your children's trust will get the property. What is the value of the gift? It is not $1,000,000, because the children's trust does not get the property until May, 2020. The IRS-approved software calculates the gift value at $577,810. That means that the charitable gift is $422,910.
What if, instead of a 10 year term, you pick a 15 year term? The value of the gift will be less because your children's trust will have to wait an additional 5 years. The gift to the children's trust is now $411,645.
What if you pick a 20 year term? The gift to the children's trust is now $269,695.
Why Use A CLAT?A CLAT is a useful way to transfer income producing assets to your heirs at a significantly reduced gift tax, as indicated in the preceding examples. It is also a way to transfer value to your favorite charity. This is often used to endow a chair at a university.
Note that in some situations a taxpayer will establish a CLAT to transfer income to charity with the assets remaining in the CLAT coming back to the taxpayer at the end of the term. This is a less commonly used type of CLAT.
What Is A T-CLAT?Adding the "T" in front of "CLAT" means that the charitable lead annuity trust does not begin until the parent dies. The CLAT is created in the parent's family trust (or Will). So the "T" stands for "testamentary" - the CLAT is created in the person's "testament." (Dictionary definition of testament: "an act by which a person determines the disposition of his or her property after death.")
Why Use A T-CLAT?The parent may not wish to do sophisticated estate tax planning during lifetime. The use of a T-CLAT can wipe out the estate tax at death.
The parent may have done extensive estate tax planning during lifetime, but may wish to be certain that the lifetime tax planning was completely effective.
The parent may wish to use the T-CLAT to fund a family foundation after death, with the assets going - after the foundation has been funded - to the heirs.
The parent may wish to "stage" the receipt by the heirs of the assets. So the parent may have some of the assets distributed outright to the children at the parent's death, with others going into a 10 year CLAT, some into a 15 year CLAT and some into a 20 year CLAT.
Example Of A T-CLAT.Assume the parent has $10,000,000 of income producing assets generating $500,000 per year. The parent establishes a children's trust and gives that trust an option to buy all of the assets from the estate. The parent's revocable trust provides that, at death, the trustee will sell the assets to the children's trust. The parent will transfer the $10,000,000 of assets to a family limited partnership. At death, the children's trust will buy the assets (the partnership interests) for a long-term promissory note. The deceased parent's trust will transfer the note to the CLAT, which will make payments to the family foundation, which the children will run. The children's trust will make the payments on the note to the CLAT for the entire CLAT term. At the end of the CLAT term, the note will be distributed to the children's trust, which means that the debt disappears. As a result of this transaction, the estate tax is zero.
Conclusion.A T-CLAT is a powerful tool that can be used to eliminate estate taxes, to stage the heirs' receipt of assets and to complement lifetime estate tax planning. As with all other types of planning, the first step is to gather all of the facts and goals and objectives, so that the planning can be customized to the individual client.