THE GLOBAL FOODBANKING NETWORK

TONI DIPRIZIO, ENGAGEMENT PARTNER

CANNY CHEN, AUDIT MANAGER

Preparing your 2012 Income Tax Return

Tips and Traps

A Fresh Look at Charitable Lead Trusts

BRIAN T. WHITLOCK CPA, JD, LLM

TAX PARTNER

What is a Charitable Lead Trust?

The Mechanics of the Math behind CLTs

• Time Value of Money

• Section 7520 Rates

Primary Uses of a Charitable Lead Trust

• Accelerating Income Tax Charitable Deduction – GRANTOR TYPE

• Excluding Income from tax = NON GRANTOR TYPE

Agenda

Charitable Lead Trust

Grantor(Donor)

CLT

• Irrevocable Trust

• Term of Years or Life

1) Return to Grantor

2) Return to Spouse

3) Outright Family

4) In Trust for next

generation

Charity(Donee)

Estate and Gift Tax Benefit

FMV of the transferred assets

- Value Income Stream (Charitable component)

= Reminder (Taxable gift of a “future” interest”

How are CLATs typically used

1) Reduce Federal Gift and Estate Tax

Structure the Income Stream in a way that will absorb the value of the

gifted property and reduce the present value of the remainder to zero

1) Front Loading Income Tax Deductions

Structure the Income Stream in a way that will create a large current

income tax deduction for the benefit of the creator of the trust that will

offset ordinary income (e.g., conversion of a regular IRA to Roth).

Gift and Estate Tax Still Significant

Federal Gift and Estate Tax

• $5,450,000 (2016) [indexed for inflation]

• 40% Flat Tax Rate

• Annual Gift Exclusion = $14,000 (2015) per person per year [indexed for inflation]

• Unlimited amount can be given to spouse

• Unused credit can be carried over to spouse, but only if you file IRS Form 706

Generation Skipping Tax

• $5,450,000 (2016) [indexed for inflation]

• 40% Flat Tax Rate

• Unused credit CANNOT be carried over to spouse

State Rules - vary significantly for state to state

• Unlimited amount can usually given to spouse.

• Indiana, Ohio, Arizona, Florida, Michigan and Wisconsin have no estate tax currently.

How CLATs and GRATs avoid Estate Tax

Gift and Estate Tax Benefit – CLT is Cousin to GRAT• PV of the income stream may be subtracted from the FMV of the transferred property

• The value of the remainder is a gift of a “future interest” and does not qualify for the gift

tax annual exclusion ($14,000).

• The value of the income interest + the value of the remainder interest = 100%

• The larger the income interest (Charitable Gift); the smaller the remainder (i.e.,

the Taxable Gift)

Leveraged Benefit (Time value of Money) CLT is Cousin to GRAT

• Where the Actual (economic) Rate of Return on a asset is greater than the IRS

applicable rate (Section 7520), the difference will cause the remainder to be discounted.

• The greater the diff. between ROR and AFR the greater the discount

• The longer the term of the CLT the greater the discount

IncomeCharitable Gift

RemainderTaxable Gift

How do we define the Income Interest?

The Income Interest is only deductible if it can be defined under Section

170(f)(2)(B) in the form of an annuity or unitrust paid over a term of years, the

life of a person(s), or the shorter of two periods

Annuity

• Fixed Payment Schedule – set by trust agreement for a term of years

• Amount of each Payment may be constant or it vary in predefined steps

Unitrust

• Fixed Payment Percentage

• Amount of each Payment is determined by multiplying payment percentage

by the FMV of the trust assets as of a defined date each year (i.e.,

beginning of year, end of year, etc.)

CLT Income Interest is Unlike the Income Interest in a CRT

• No 5% Minimum Payout

• No maximum Term (only limit is Rule Against Perpetuities)

• CLT may make payments to non-charitable beneficiaries, if income is

greater than annuity requirement.

IncomeCharitable Gift

RemainderTaxable Gift

Time Value of Money

Rule of 72 – the power of compounding interest

Rate of Return x Number of Years = 72

Anytime you multiply two numbers together

and the product of the two numbers equals

72 – MAGIC happens - money doubles

12

x6

72

4

x18

72

9

x8

72

8

x9

72

24

x3

72

6

x12

72

18

x4

72 3

x24

72

Time Value of Money

Rule of 72 – and Annuities

Measure the present value of the annuity payment using lowest Section 7520 over the

three month period = the month of transfer, the month preceeding transfer date and

the month following the transfer date

LOW AFRs continues to present Estate Planning Opportunities

• Section 7520 Rate for January 2016 is 2.2%

• Great Leverage for Assets producing a cash flow in excess of 8%

Depressed Valuations present Opportunities

• Real Estate is a great candidate for a GRAT or a CLAT

• Example #1:

• A built a warehouse and retail space in 2004 at a cost of $5.5 Million. Triple

Net Lease $600,000 yields a rate of return of 10.909%. After a drop in the

real estate market, current FMV of building is now $2,500,000. ROR = 24%.

• CLAT paying 10.909% for 11 Years in monthly payments. The PV of

Remainder is $ZERO.

• CLAT paying 24% for 5 Years in monthly payments. The PV of

Remainder is $ZERO.

A Fresh look at the Estate and Gift Tax Benefits of CLAT

LOW AFRs and Valuations present Estate Planning Opportunities

• Great Leverage for Assets producing a cash flow in excess of 8%

• Example #2:

• B has a rental property worth $1,000,000 with an 8% rate of return. He give

$40,000 per year to charity. If he transfers 50% of the real estate to a CLAT the

CLAT will receive $40,000 of rental income. What is the value of ½ of the

property. In inside of a FLP, what is the value of 50% of the LP. No Discount

40/500 = 8% ROR; 20% Discount = 40/400 = 10% ROR; 30% Discount = 40/350

= 11.42% ROR

• CLAT paying 10.909% for 11 Years in monthly payments. The PV of

Remainder is ZERO.

GRATs and CLATs are great for avoiding estate tax when rates are LOW

and RORs are high

Estate and Gift Tax Benefits of CLAT

LOW AFRs present Opportunities for even low yielding assets like marketable

securities but will require longer time periods in order to “zero” out the value of the

remainder.

• Examples:

• CLAT paying 6.162% per year for 20 Years. The PV of the Annuity is 100%. The PV of

the Remainder is ZERO.

• CLAT paying 4.386% for 32 Years. The PV of the Annuity is 100%. The PV of the

Remainder is ZERO

• CLAT paying 3.786% for 40 Years. The PV of the Annuity is 100%. The PV of the

Remainder is ZERO

• CLAT paying 3.318% for 50 Years. The PV of the Annuity is 100%. The PV of the

Remainder is ZERO

• Jackie Kennedy Onassis’ Estate Plan created a CLAT at her death that was

designed to last for 32 years

• Caution: in PLR 199922007 the Treasury ruled that if the remainder interest

passes to skip persons that the distribution is a “taxable termination”

subject to GST. The IRS also stated that Donor could allocate GST

Exemption to the discounted amount of the remainder at the time that the

trust is created.

Estate and Gift Tax Benefits of CLAT

Unless the Rate of the Unitrust Payment is set at 100%, you cannot structure a

CLUT where the PV of the Remainder would equal ZERO.

The Fixed payment Percentage required by the CLUT is multiplied by the FMV of the Trust assets in order to determine

the amount of the payment.

Example:

Jack transfers $500,000 to a CLUT pays 6% per year to charity for 20 years.

• In year 1 the payment is 6% x $500,000 = $30,000

• If in year 2, the FMV of the trust assets is $600,000. $600,000x 6% = $36,000

• If In year 3, the FMV of the trust is 400,000. $400,000x6% = $24,000

• Even if in year 19, the FMV of the trust was only 10,000. $10,000 x 6% = $600.

Comparisions:

• CLAT paying 6.162% for 20 Years. The PV of the Annuity is 100%. The PV of the Remainder is ZERO

• CLUT paying 7% for 20 years. PV of income interest is 76.2%. The PV of the Remainder is 23.8%

• CLUT paying 8% for 20 years. PV of income interest is 80.7%. The PV of the Remainder is 19.3%

• CLAT paying 3.741% for 40 Years. The PV of the Annuity is 100%. The PV of the Remainder is ZERO

• CLUT paying 4% for 40 years. PV of income interest is 80% The PV of the Remainder is 20%

• CLUT paying 6% for 40 years. PV of income interest is 91.3% The PV of the Remainder is 8.7%

Why not a Non-Grantor CLUT?

THE GLOBAL FOODBANKING NETWORK

Higher Individual Rates change the Game

• Marginal Income Tax Rates Married Filing Joint (MFJ) (indexed for inflation)Calendar Year 2016

•- up to $ 18,550…………………10%

•- $18,550 to $ 75,300…………..15%

•- $75,300 to $151,900…………..25%

•- $151,900 to $231,450…………28%

•- $231,450 to $413,350…………33% (plus NIIT)

•- $413,350 to $466,950…………35% (plus NIIT)

•- over $466,950 ………………….39.6% (plus NIIT)

• Net Investment Income Tax (NIIT) - 3.8% if MAGI above $200,000 (single)/$250,000 (MFJ)

3.8% Obamacare Excise Tax on Investment Income for Even Middle Class

• Pease Amendment – Itemized deductions phased out at 3% of AGI in excess of $311,300 in 2016

Itemized Deductions are limited for Middle Class

• State Income Tax Rates• Illinois Income Tax Rate – 5%

• Top California Income Tax Rate = 13.3% over $500k Single; over $1 million MFJ

All Income Tax Rates are Higher

Grantor Type Charitable Lead Trust (CLAT)

STEP 1: Gift assets to trust

CHARITY

• IRREVOCABLE TRUST

• NET INCOME AND CAPITAL GAINS ARE TAXABLE TO GRANTOR

• PV OF REMAINDER INTEREST IS A GIFT OF A FUTURE INTEREST AND MAY USE GIFT/ESTATE TAX CREDIT

• CAVEAT: GST MAY NOT BE ALLOCATED TO GIFT OF REMAINDER

CLAT

STEP 2: Distribute required

amounts to charity

REMAINDER BENEFICIARIES

(OUTRIGHT OR IN TRUST) IF

REMAINDER BENEFICIARY IS PERSON

OTHER THAN THE DONOR THEN GIFT

GIFT TAX IMPACT

FMV OF THE TRANSFERRED ASSETS

- PV OF ANNUITY INCOME STREAM

= GIFT OF A “FUTURE” INTEREST

INCOME TAX IMPACT

ALL INCOME WILL THROUGH DONOR’S IRS FORM 1040 EVERY YEAR UNTIL TERMINATION

STEP 3: Upon termination, the

remainder beneficiaries receive

the balance of assets

INCOME TAX DEDUCTION

DONOR MAY DEDUCT THE PV OF THE

INCOME STREAM ON HIS SCHEDULE A

OF HIS IRS FORM 1040 IN YEAR 1

Non-Grantor Type Charitable Lead Trust (CLAT)

STEP 1: Gift assets to trust

CHARITY

• IRREVOCABLE TRUST

• NET INCOME AND CAPITAL GAINS ARE TAXABLE TO TRUST, BUT TRUST GETS DEDUCTION FOR CURRENT CHARITABLE DISTRIBUTION

• PV OF REMAINDER INTEREST IS A GIFT OF A FUTURE INTEREST MAY USE GIFT/ESTATE TAX CREDIT

• CAVEAT: GST MAY NOT BE ALLOCATED TO GIFT OF REMAINDER

CLAT

STEP 2: Distribute required

amounts to charity

REMAINDER BENEFICIARIES(OUTRIGHT OR IN TRUST) IF REMAINDER

BENEFICIARY IS PERSON OTHER THAN THE DONOR THEN GIFT

GIFT TAX IMPACT

FMV OF THE TRANSFERRED ASSETS

- PV OF ANNUITY INCOME STREAM

= GIFT OF A “FUTURE” INTEREST

INCOME TAX IMPACT

INCOME IS EXCLUDED FROM DONOR IRS FORM 1040 AND

STATE INCOME TAX

STEP 3: Upon termination, the

remainder beneficiaries receive

the balance of assets

INCOME TAX DEDUCTION

NONE

A Fresh Look at Charitable Lead Trusts

Grantor(Donor)

CLT

• Irrevocable Trust

• Term of Years or Life

1) Return to Grantor

2) Return to Spouse

3) Outright Family

4) In Trust for next

generation

Charity(Donee)

Income Tax Benefit

Make Charitable gifts with Pretax $

AN EXCLUSION IS BETTER THAN

A DEDUCTION.

NON-GRANTOR CLATs do not produce an individual Income

Tax deduction for the Grantor/creator of the trust

NON-GRANTOR CLATs permits the creator of the trust to

fund charitable gifts with “Pre-Tax Income”

Using Pre-Tax Income is more efficient then using taxable income and

trying to offset the income with a deduction.

• Charitable deductions do not reduce NII

• Charitable deductions do not reduce State Taxable Income

• Charitable deductions are be limited by a % of AGI

• All deductions are phased out when AGI is more than $300,000

• Personal Exemptions are phased out for high income taxpayers.

Similar to Charitable contributions made from an IRA, Flexible Spending

Accounts (FSA) for Medical Premiums and Childcare, or HSA for Medical

Expenses

Fresh look at the Income Tax Benefitsof Non-Grantor CLATs

Example: Josephine has $350,000 of income. $100,000 is from

interest, dividends, and rents. She gives $30,000 to charity each

year.

The charitable gift do not reduce her 3.8% NII, or her 5% Illinois Income Tax in

addition she loses $900 of itemized deductions and a portion of the personal

exemptions for herself and her husband.

• Josephine transferred income producing assets into a CLAT that will receive

$30,000 of investment income and transfer $30,000 to her Donor Advised Fund

or various charities.

• The remainder interest in the CLAT passes to Josephine’s husband at the end

of 5 years.

No gift and estate tax savings since the remainder passes to spouse, but

NOTE: Income tax savings = 10% or over $3,000 per year for 5 years = $15,000

by using pre-tax dollars instead of tax deductible dollars.

Fresh look at the Income Tax Benefitsof Non-Grantor CLATs

1. REDUCE FEDERAL INCOME TAXES

An Exclusion from Gross income may be better than a deduction

• Charitable Deductions can be limited to % of Adjusted Gross Income (AGI)

• Itemized Deductions can be phased out at higher levels of income

• (Pease Amendment – 3% of AGI over threshold of $311,300 in 2016)

• Exclusion from AGI lowers AMTI and removes income from NII (Obamacare Passive Income)

2. REDUCE STATE INCOME TAXES

Exclusion from Federal AGI usually reduces State Gross Income

• States rarely permit a State Income charitable deduction

3. REDUCE ESTATE, GIFT, and GST TAXES

• PV of Income payment (annuity) allows leveraged gifts to future generations where the actual

income is greater than the required annuity payment.

WIN - WIN - WIN

Bottom Line of Fresh look at the Benefits of Non-Grantor CLAT

Questions?

Brian T. Whitlock, CPA, JD, LLMPlante & Moran, PLLC

10 S Riverside Plaza

Chicago, IL 60606

Phone (312) 207-1040

E-mail: brian.whitlock@plantemoran.com