By
Diane Kuhn Huff
A Charitable
Remainder Annuity Trust (also called a "CRAT") is an irrevocable trust
where the donor receives an annuity
payment for either the donor's lifetime or for a specified term of years. A
charity receives the remainder of the trust after the annuity payments end.
A Charitable Lead Annuity Trust (also called a "CLAT") is an
irrevocable trust where the charity receives the annuity payment and the remainder beneficiaries
(usually children or grandchildren) receive the remainder of the trust after the
annuity payments end.
Income Tax Benefits.
In both trusts, the donor receives an income tax deduction in the year he
or she transfers assets to the CRAT or CLAT.
The value of the income tax deduction is determined by calculating the
present value of the charity's interest. In
a CRAT, the deduction is the current value of the remainder interest.
In a CLAT, the deduction is the current value of all annuity payments.
Government regulations state the interest rate used to calculate the
deduction and this interest rate is known as the "Charitable Federal
Midterm Rate" or "Section 7520 Rate", named for section 7520 of
the Internal Revenue Code. As expected, the 7520 rate changes with the
prevailing interest rates.
Examples.
Lets compare the charitable deduction allowed on a Charitable Remainder
Annuity Trust using different 7520 rates. Both
CRATs are similarly structured as follows:
Trust term: 15 years
Amount transferred to Trust:
$100,000
Anticipated growth of assets: 6%
Percentage payout: 5%
Annual annuity payment to donor: $5,000
Total annuity payments to donor: $75,000
Value of trust at end of 15 years given to charity:
$123,276
In December
1989 when the 7520 rate was 11.6%, the present value of all annuity payments to
the donor was $34,794.50. Therefore,
the charitable deduction was $65,205.50.
The
charitable deduction varies even though the donor receives the same annuity
payment each year and for the same 15 years.
The charitable deduction varies even though the charity receives the same
remainder amount of $123,276 (assuming the trust grows 6% each year).
However, the income tax deduction varies with the prevailing 7520 rate.
As you can see, the Charitable Remainder Annuity Trust is more attractive
during times of higher interest rates.
Lets now
compare the Charitable Lead Annuity Trust using different 7520 rates.
Again, both CLATs are similarly structured as follows:
Trust term: 15 years
Amount transferred to Trust:
$100,000
Anticipated growth of assets: 6%
Percentage payout: 5%
Annual annuity payment to charity: $5,000
Total annuity payments to charity: $75,000
Value of trust at end of 15 years given to family:
$123,276
In December 1989 when the 7520 rate was 11.6%, the present value of all
the annuity payments to the charity was $34,794.50. Therefore, the charitable deduction was $34,794.50.
The present value of the gift to the family members was $65,204.50 (and
subject to gift tax), even though they will receive $123,276 if the trust grows
annually by 6%.
The
charitable deduction varies even though the charity receives the same annuity
payment each year and for the same 15 years.
The charitable deduction varies even though the family members receive
the same remainder amount of $123,276. The
amount of the taxable gift the donor must claim varies even though the family
members will receive the same remainder amount of $123,276.
As you can see, the Charitable Lead Annuity Trust is more attractive
during times of low interest rates.
Who can benefit from CRATs and
CLATs. Obviously, people who
use CRATs and CLATs have a charitable intent.
CRATs and CLATs also benefit people with highly appreciated assets who
want to minimize a large capital gain tax, business owners selling a business,
fortunate people who win the lottery, or anyone else who wants a large income
tax deduction, a stream of income to themselves or a charity, or a reduction in
estate and gift taxes. CRATs and
CLATs can be established during the donor's lifetime or at death.
Certianly,
there are other income and transfer tax consequences to CRATs and CLATs.
This article focuses solely on the relationship between the 7520 rate and
initial income tax deduction. If
you want to explore whether a CRAT, CLAT or similar trust can benefit you, we
urge you to discuss the issue with an attorney or tax advisor knowledgeable in
charitable trusts.