Charitable lead annuity trusts (CLATs) have received considerable attention recently, in light of current low interest rates. If structured correctly, CLATs have the twin benefits of (1) providing payments to charity for a number of years, and (2) potentially transferring wealth to family members afterwards with no gift or estate tax.

CLATs are particularly attractive in the current environment of historically low interest rates, since the return on assets required for transferring wealth to family members without gift or estate tax is much lower than it would be in a higher interest rate environment. Low interest rates can therefore potentially enable a creator of a CLAT to transfer comparatively greater wealth to his children.

Clients interested in CLATs must also consider the CLAT's underlying asset allocation, which remains critical both to the CLAT's success as a wealth transfer technique and also to the avoidance of inadvertent taxes or penalties.

Here are the fiduciary, income tax and specific asset class considerations that CLAT trustees should understand to responsibly and effectively discharge their fiduciary duties.

What's a CLAT?

A CLAT is an irrevocable trust that annually pays out a fixed amount to a designated charity, typically for a set number of years, with the remainder directed to non-charitable beneficiaries, typically a grantor's children, either outright or in trust.1 The drafter may also structure the charitable annuity amounts to increase by an ascertainable amount.2

Clients may establish a CLAT during their life (an inter vivos CLAT) or upon death (a testamentary CLAT). Depending on its structure, the CLAT's income is taxed either directly to the grantor (a grantor trust) or to the trust (a non-grantor trust).

Unlike a charitable remainder trust, a CLAT doesn't provide the grantor with distributions. Accordingly, a CLAT may be appropriate for those who can afford to completely divest themselves of assets, since the corresponding cash flow and appreciation will benefit the charity first and family members later.

Those who seek to transfer certain assets down one generation may consider zeroed-out CLATs (see below). By contrast, those who seek to primarily benefit grandchildren may consider charitable lead unitrusts, which enable grantors to apply their generation-skipping transfer (GST) tax exemption at the time of the initial transfer to the trust (as opposed to the end of the charitable lead period, as required for CLATs).3

Low Interest Rates

Basically, the gift amount resulting from funding a CLAT equals the value of the property transferred, minus the present value of the annuity interest paid to charity. If the value of the charitable annuity interest equals the value of the property placed in trust, the CLAT is said to be “zeroed out” — that is, the value of the taxable remainder will be zero because the entire value of the property contributed to the CLAT will qualify for a gift tax charitable deduction. Any assets that remain in the trust at the end of the charitable lead period will pass to the remainder beneficiaries free of gift tax.

The value of the charity's interest is determined using the so-called “7520 rate,” an interest rate published by the Internal Revenue Service each month. If the return on a zeroed-out CLAT's assets exceeds the 7520 rate, there will be assets remaining after the end of the charitable lead period. For this reason, all other things being equal, low interest rates increase the chances of a positive remainder because the lower the interest rate, the lower the “hurdle” the investments will need to outperform.

For example, assume a grantor establishes a $1 million zeroed-out 20-year CLAT when the 7520 rate is 2 percent. If the CLAT assets produce a total return of 5 percent each year, there will be $630,983.97 remaining in the CLAT at the end of the term. By contrast, if the 7520 rate is 10 percent when the CLAT is established, there will be nothing left in the CLAT at the end of the term.

Fiduciary Considerations

Prudent investment and diversification concerns

In general, trustees have a duty to invest and manage the trust's assets prudently.4 This entails reviewing the performance of all the assets together, not simply a single asset in isolation.5 In the absence of special circumstances, trustees must also generally diversify trust assets to mitigate the overall investment risk of the portfolio.6

Core investment goals

CLAT trustees have fundamental fiduciary duties of loyalty and impartiality to both the charity as a current beneficiary and the individuals designated as remainder beneficiaries. They must balance the annual obligation of fixed annuity payments to charity with the goal of transferring assets to children. Although an aggressive portfolio has the potential to transfer more wealth to the remainder beneficiaries, its greater volatility increases the risk that the CLAT will be unable to make all the required annuity payments to charity.

One common misconception about CLATs is that the investment return on the trust's assets must exceed the annuity amount for the trust to be successful in leaving any assets for the remainder beneficiaries upon termination. In other words, if the CLAT is structured to pay out $100,000 each year to charity, some trustees will invest the trust assets to aim for an annual return of over $100,000. In fact, trying to obtain an unduly high return may result in an unnecessarily risky portfolio that could impair the trust's ability to even provide the required payments to charity, let alone result in any remainder passing to the non-charitable beneficiaries.

Rather, CLAT trustees need only outperform the applicable 7520 rate. Doing so enables the trustee to:

  • meet its annual obligations to charity (with payments of income and principal), and
  • convey the balance of assets to the intended remaindermen with no gift or estate tax.

Accordingly, a CLAT's success depends on the ability to outperform the 7520 rate in a manner that doesn't jeopardize the ability to pay out the required annual distributions to charity.

Jeopardy investments

The excise tax on jeopardy investments that applies to private foundations (PFs) also applies to CLATs when the present value of the charitable interest exceeds 60 percent of the trust's total asset value.7 Zeroed-out CLATs, by definition, exceed this 60 percent threshold, as the present value of the annuity payments to charity equals 100 percent of the amount transferred to the CLAT. Accordingly, jeopardy investments are a potentially important issue to consider for CLAT asset allocation.8

Although certain investments may warrant close scrutiny,9 there's no category of asset class that would constitute a jeopardy investment per se.10 In addition, this determination doesn't occur in hindsight.11 If an investment is suitable when made, it doesn't subsequently acquire the status of a jeopardy investment merely because it later results in a loss.12

Instead, other factors, including the lack of diversity and extent of leveraging, have a strong bearing on the determination of whether an asset constituted a jeopardizing investment.13

As a result, it remains prudent to favor a diversified CLAT portfolio, without reliance on a single asset class that could endanger the purpose of benefiting the charity during the lead term.

Self dealing

The self-dealing prohibitions and associated penalties that apply to PFs also apply to CLATs.14 Any act of self-dealing between the CLAT and a “disqualified person” will incur an excise tax.15 For purposes of this excise tax, “disqualified persons” include the trustee, any substantial contributors and their children, grandchildren and great-grandchildren and certain entities in which any of those individuals have interests.16

Acts of self-dealing generally include, among other things, the sale or exchange of property between a CLAT and a disqualified person.17 For instance, the sale of stock or other securities by a disqualified person to a CLAT in a bargain sale is an act of self-dealing, regardless of the amount paid.18 Trustees must remain particularly wary of investing in funds affiliated with disqualified persons.19

Income Tax Considerations

Unlike certain other charitable entities, CLATs aren't tax-exempt: the income remains taxable to either the trust or the grantor, depending on the CLAT's structure. Accordingly, income tax efficiency arises as an important factor that normally doesn't apply in the charitable context.

Grantor CLATs

If the CLAT is structured as a grantor trust (meaning that the income, gain, loss and credits flow back to the grantor personally), then the grantor is entitled to an income tax deduction for the present value of the charitable lead interest when the trust is created.20 However, the grantor is then taxed on the trust income each year during the term of the trust, even though all or part of the income is payable to charity, and the grantor isn't entitled to any further deduction for those payments.21

The initial charitable income tax deduction to a charitable lead trust is subject to the 30 percent22 of adjusted gross income contribution limitation, with a five-year carryforward for any unused portion of the deduction.23

Since the grantor bears the income tax liability of a grantor CLAT, he should review the anticipated income tax liability of the CLAT's investments in light of his tax profile, including his carryforward capital losses and alternative minimum tax exposure.

Non-grantor CLATs

With a non-grantor CLAT, the grantor doesn't receive an income tax deduction when the trust is created, but the trust can deduct the portion of its income paid to charity without regard to the percentage limitations applicable to individuals.24 The trust's net income, after deductions, is then taxable to the trust.25 Trusts don't have a charitable contribution carryforward, so a deduction in excess of taxable income provides no benefit.

Non-grantor trust status may apply to CLATs established during life and always applies to testamentary CLATs, which are established upon death pursuant to a client's bequest.

For non-grantor CLATs, the trustee needs to monitor certain investments that generate unrelated business taxable income (UBTI). In general, income from an unrelated trade or business or from assets purchased with borrowed funds constitutes UBTI.26

Distributions to charity that include UBTI don't qualify for a full charitable deduction to the trust, and therefore UBTI may affect the tax efficiency of the CLAT's portfolio.27 (The deduction limitations with respect to UBTI don't apply to grantor CLATs, as their income is taxed directly to the grantor.)

UBTI typically arises from securities purchased on margin, encumbered real estate and hedge funds with debt-financed investments. UBTI doesn't include dividends, interest, certain other investment income, royalties, certain rental income and gains or losses from the disposition of investment property.28

Accordingly, for non-grantor CLATs, leveraged and certain partnership investments warrant a careful analysis of their after-tax yield.

Other Investment Considerations

In addition to fiduciary considerations, CLAT trustees must account for certain investment parameters specific to CLATs.

Liquidity

Liquidity within the CLAT portfolio remains critical since the trustee must make charitable distributions every year, regardless of prevailing market conditions.

A CLAT may satisfy its charitable lead payment obligation through in-kind distributions of appreciated property, but will recognize capital gain as if it sold the property. Grantors of grantor CLATs would recognize this gain directly. Non-grantor CLATs may be able to claim a charitable deduction to offset the gain. But regardless, the valuation of illiquid assets in meeting the payment obligation may entail additional time and cost, depending on the nature of the asset.

Investment horizon

CLAT trustees must focus on the length of the charitable lead annuity term, as it clearly affects the CLAT's investment horizon.

Certain types of trusts are structured to have a short term to mitigate the mortality risk of estate inclusion for federal estate tax purposes. By contrast, CLATs generally don't pose this mortality risk and so are typically structured to have a medium-to-long charitable lead period.

A longer term decreases the annual annuity obligation for a zeroed-out CLAT and allows greater potential accumulation of value to pass to the remaindermen.

Portfolio composition

The portfolios below illustrate the trade off between total return and volatility for a $10 million 20-year zeroed-out CLAT. The first portfolio example, below, reflects a lower equity allocation than the second growth-oriented portfolio.

  • Portfolio 1-Conservative

    Rates of pre-tax return-5.44 percent
    Asset allocation:
    U.S. equity-16 percent
    Non-U.S. equity-6 percent
    Taxable fixed income-76 percent
    Cash-2 percent

  • Portfolio 2-Growth

    Rates of pre-tax return-8.07 percent
    Asset allocation:
    U.S. equity-42 percent
    Non-U.S. equity-19 percent
    Taxable fixed income-28 percent
    High yield-5 percent
    Real estate investment trusts (REITs)-4 percent
    Cash-2 percent

The estimated29 growth rates of both portfolios would exceed a 2 percent 7520 hurdle rate, but with different levels of risk. Portfolio 2 has a higher expected return, but is also likely more volatile, which means that there's a greater risk that the CLAT will fail.

The hurdle rate posed by the applicable 7520 rate thus greatly affects the level of potential upside and risk tolerance necessary to leave assets for the remaindermen. With a low 7520 rate, even a conservative portfolio would be expected to result in wealth transfer to the remaindermen, whereas if the 7520 rate were higher, a more aggressive portfolio might be preferable.

Asset Suitability

It's important for clients to compare asset characteristics when they review their CLAT portfolios with their tax and legal advisors. “Comparing CLAT Assets,” (p. 56), distills the analysis in reviewing general investment characteristics and specific asset classes for CLATs.

Traditional Investments

CLATs benefit from the liquidity of marketable securities, since the trustee may often have to sell a portion of the corpus or distribute a portion of the corpus to meet the annual distribution requirements.

  1. Taxable stocks and securities

    If the trustee anticipates the sale of assets to raise cash, a grantor's contribution of high-basis appreciated stock to an inter vivos CLAT may enhance its income tax efficiency, particularly because the charitable deduction available to the grantor or the CLAT may fully offset any gain. (The same couldn't necessarily be said of low-basis stock, in which the gain could exceed the charitable deduction.) By contrast, testamentary CLATs are generally funded with assets with stepped-up basis, so income tax efficiency doesn't play as much of a role in the selection of assets to fund a testamentary CLAT.

  2. Tax-exempt bonds and securities

    By generating tax-exempt income, municipal bonds and other tax-exempt securities usually appeal to investors subject to a high level of income tax. However, municipal bond income from private activity bonds may impact the alternative minimum tax liability for grantors of grantor CLATs.

While tax-exempt bonds in a grantor CLAT portfolio may potentially reduce the income tax burden to the grantor, the trustee must focus on the charity and the grantor's children as current and remainder beneficiaries, respectively. As explained below, tax-exempt securities may not meet the needs of these beneficiaries and therefore may not warrant inclusion in the CLAT portfolio.

As the sole asset class of a CLAT, tax-exempt securities may not provide sufficient growth for the remaindermen and also raise diversification issues for the trustee. In addition, for non-grantor CLATs that expect to pay all income received in the current year to charity, pre-tax yield is generally more important than post-tax yield because the income largely flows through to the charitable beneficiary. Therefore, municipal bonds may not serve as an ideal investment for meeting the CLAT's annual payment obligation, due to their generally lower pre-tax yield.

Alternative Investments

Alternative investments cover a broad range of strategies and structures that fall outside the boundaries of traditional asset categories and generally include hedge funds, hedge funds-of-funds, managed futures, private equity and real estate funds.

Alternative investments are typically sold by private placement to “accredited investors,” which include charitable organizations and trusts with assets in excess of $5 million.

Hedge funds and funds-of-funds

Hedge funds are typically structured as private limited partnerships that invest in a range of different investments, including stocks, fixed income, convertible debt, foreign currencies, exchange-traded futures, forwards, swaps, options and other derivatives. Hedge funds-of-funds combine several hedge funds into a single structure to utilize multiple strategies. Hedge funds may complement traditional investments and their market risks in providing portfolio diversity for a CLAT. However, depending on its management, a hedge fund may generate a high degree of ordinary income and short-term capital gains, which may affect the CLAT's overall tax efficiency on either the trust or grantor level. In addition, hedge funds may directly invest in active businesses and leveraged investments, and as a result may generate UBTI.

Private equity funds

Private equity funds generally consist of pools of actively managed capital invested in public and private companies with the intent of creating value in the companies in which they invest by improving operations, reducing costs, selling non-core assets and maximizing cash flow. Private equity fund managers generally assume an active role in the strategic management of the portfolio companies.

Private equity funds pose certain challenges for meeting the CLAT's annual payment obligations in light of the following characteristics:

  • Capital calls may be made on short notice, and the failure to meet such call may result in a total loss of the investment.
  • Private equity funds have limited liquidity as capital is typically locked up for a period of years. The cash flow typically follows a “J-curve” as capital outflows generally occur in the early years and capital distributions tend to occur late in the investment cycle.
  • A non-grantor CLAT, as an investing partner, must report as UBTI its allocable share of any income attributable to the private equity fund's unrelated trade or business activities.

CLAT trustees should weigh the potential appreciation and tax efficiency of private equity fund investments against the factors listed above.

Managed futures

Managed futures' managers invest in the global futures markets by trading futures contracts on a range of underlying assets, including currencies, stock indexes, interest rates and commodities such as petroleum and wheat.

Depending on the strategy employed, managed futures investments may experience high degrees of volatility, which CLAT trustees must consider in meeting their annual charitable lead payments.

Real estate

Real estate investments typically consist of two broad categories: direct ownership and indirect investment, for example, via mortgage-backed securities or real estate investment trusts (REITs). Depending on the cash flow of the underlying property, real estate investments may generate income and growth to help sustain the CLAT's charitable lead interest. However, risks specifically associated with real estate include greater volatility due to leverage, adverse changes in general economic or local market conditions and changes in governmental, tax, real estate and zoning law or regulations.

For debt-financed real estate investments, rental income attributable to acquisition indebtedness generally constitutes UBTI. As an exception, dividends earned on REIT shares constitute dividend income for purposes of UBTI and are therefore exempt from UBTI, regardless of the character of income to the REIT. As a result, REITs enable CLAT trustees to invest in debt-financed property without generating UBTI. A REIT may also benefit a CLAT because a REIT's usually unfavorable ordinary income is likely to be distributed to charity.

Closely Held Business Interests

A closely held business interest that generates cash flow and is poised to appreciate in value may constitute a productive component of a CLAT portfolio. However, federal tax regulations impose several caveats on the suitability of such interests, especially for S corporation stock, as noted below, and require careful navigation to avoid adverse tax consequences.

First, similar to the jeopardy investments excise tax, the excess business holding excise tax applies to CLATs when the present value of the charitable income interest exceeds 60 percent of the trust's total asset value.30

The excess business holding tax will apply to a CLAT if it and all of its disqualified persons own more than 20 percent of the voting stock in a corporation.31 The 20 percent threshold also applies to holdings in business enterprises established as partnerships, joint ventures or other unincorporated enterprises.32

If the CLAT acquires excess business holdings by gift or bequest, it has five years to reduce its holdings to the allowable 20 percent or lower level.33 However, the CLAT generally can't dispose of the stock by selling or otherwise transferring it to a disqualified person.34 Accordingly, the CLAT trustee would have to monitor any penalty impact of receiving closely held stock.

UBTI

A CLAT's ownership interest in an unrelated trade or business through a partnership, limited liability company or S corporation, may give rise to UBTI, which would limit the deductibility of a non-grantor CLAT's charitable lead payments. Therefore, for non-grantor CLATs, the trustee would need to evaluate the after-tax yield of investing in a closely held business.

Self-dealing

Particularly within an actively managed closely held business, CLAT trustees would need to scrutinize payments to and any other transactions with the grantor and other related parties for self-dealing. For instance, family members' receipt of unwarranted management fees from a partnership in which the CLAT invests may constitute self-dealing.35

Transferring interests subject to a valuation discount may trigger self-dealing tax liability if the discount is successfully challenged as too high. Transferring interests at an inflated discount could be considered using assets for the benefit of the remaindermen as disqualified persons.36 Accordingly, obtaining and recording a qualified appraisal of an entity interest remains critical to upholding any valuation discount and defending against any assertion of self-dealing.

S corporation stock

Grantor CLATs may hold S corporation stock as grantor trusts.37 Non-grantor CLATs may only own S corporation stock as electing small business trusts (ESBTs). However, they may not deduct any S corporation income paid to charity.38 This limitation, combined with the fact that the highest tax rate applicable to trusts and estates applies to all the income of ESBTs,39 may diminish the appeal of S corporation stock as an investment for non-grantor CLATs.

Life Insurance

CLAT trustees considering the purchase of life insurance by the CLAT must consider the affordability of the premiums in light of its mandatory annual charitable distributions, the effect of local law governing insurable interests and the suitability of the asset from a jeopardy investment perspective, particularly in light of the potentially large cash outlay involved.

Tangible Personal Property

Tangible personal property includes art and other collectibles. Unless the trustee anticipates a quick sale of the tangible property, it may pose liquidity problems in having to make the annual payments to charity.

Inter vivos CLATs

The rule that generally delays income tax charitable deductions for personal property contributions to a CRT doesn't apply to personal property transferred to a CLAT.40 However, the deduction amount for personal property contributed to a CLAT remains limited to the lesser of its current fair market value and cost basis.41

Endnotes

  1. Internal Revenue Code Sections 170(f)(2)(B), 2055(e)(2)(B) and 2522(c)(2)(B).
  2. Internal Revenue Service Revenue Procedures 2007-45 and 2007-46.
  3. IRC Sections 2642(a)(2) and 2642(e).
  4. Restatement (Third) of Trusts, Prudent Investor Rule Section 227 (1992).
  5. The Uniform Prudent Investor Act (UPIA) Section 2(b).
  6. UPIA Section 3.
  7. IRC Sections 4947(a)(2), (b)(3)(A); Treasury Regulations Sections 20.2055-2(e)(2)(vi)(e), 25.2522(c)-3(c)(2)(vi)(e).
  8. In addition, the IRS provides sample charitable lead trust forms that prohibit the acquisition or retention of jeopardizing investments. Rev. Proc. 2007-45, Rev. Proc. 2007-46, Rev. Proc. 2008-45, Rev. Proc. 2008-46.
  9. The regulations identify transactions including specifically trading in securities on margin, trading in commodity futures, the purchase of puts, calls, and straddles, the purchase of warrants and selling short. Treas. Regs. Section 53.4944-1(a)(2)(i).
  10. Treas. Regs. Section 53.4944-1(a)(2)(i).
  11. Treas. Regs. Section 53.4944-1(a)(2)(i).
  12. Ibid.
  13. General Counsel Memoranda 39537 (March 11, 1986) (certain securities that comprised 75 percent of a foundation's investments constituted jeopardy investments due to the large loans to buy the stock, the lack of sufficient diversification of the foundation's investments and the nature of the corporation as less than “blue chip” quality); Technical Advice Memorandum 8718006 (gold mining stock that lost most of its value in two of three years was not a jeopardy investment since the foundation's total portfolio contained 21 stocks that produced income despite the gold stock losses); TAM 9205001 (shares in one closely held company constituted 100 percent of the foundation's investments and a jeopardy investment because: there was no reasonable expectation of a return from the investment; the investment didn't allow for diversification of M's investments; and the investment didn't consider the risk of investing in the particular industry); TAM 9627001 (all of a foundation's assets were placed in a margin account for the purpose of collateralizing the founder's investments in futures contracts, which are “closely scrutinized” investments under the regulations. Placing all of foundation's assets at risk in the foundation's undermarginalized accounts did nothing to improve its investment portfolio or economic posture, but, instead, jeopardized the foundation's exempt purposes of M, and, therefore constituted a jeopardizing investment.)
  14. IRC Section 4947(a)(2).
  15. IRC Sections 4941(a)(1) and (2).
  16. IRC Section 4946.
  17. IRC Section 4941(d)(1).
  18. Treas. Regs. Section 53.4941(d) and 2(a)(1).
  19. Private Letter Rulings 9325061 and 9008001.
  20. Treas. Regs. Sections 1.170A-6(a) and 1.170A-6(c). If the grantor dies or relinquishes certain grantor trust powers and as a result the grantor ceases to be taxed on the trust's income, the remaining unrecaptured portion of the charitable deduction is accelerated and taxed as ordinary income. IRC Section 170(f)(2)(B); Treas. Regs. Section 1.170A-6(c)(4).
  21. IRC Sections 671 through 679.
  22. Treas. Regs. Section 1.170A-8(a)(2). The same 30 percent deductibility ceiling applies to lead trusts benefitting private foundations, but the ceiling on deductibility is 20 percent of adjusted gross income when the trust is funded with long-term capital gain property. IRC Section 170(b)(1)(D).
  23. IRC Section 170(b)(1)(B).
  24. IRC Section 642(c).
  25. IRC Section 641.
  26. IRC Sections 511(a)(1) and 514(a)(1); Treas. Regs. Section 1.511-1.
  27. The unlimited deduction for any amounts paid to charity is disallowed to the extent attributable to unrelated business taxable income (UBTI) Section 681; Treas. Regs. Section 1.681(a)-2(b). Under another provision, however, a non-grantor charitable lead annuity trust (CLAT) may deduct charitable payments attributable to UBTI but the deduction is subject to limitations similar to the adjusted gross income (AGI)-based limitations applicable to an individual's charitable gifts, with the CLAT's UBTI substituted for the individual's AGI. IRC Section 512(b)(11) (that is, subject to the 50 percent ceiling if paid to a public charity).
  28. IRC Section 512(b).
  29. The assumed 7520 rate is 2 percent and estimated inflation rate used for this example is 1.7 percent. Results shown are hypothetical and are provided for illustrative purposes only. Actual results will vary depending on the specific composition of the investor's portfolio when the portfolio is implemented and actual market conditions. The risk return statistics presented are derived from the October 2010 UBS capital market assumptions associated with the corresponding asset classes. The asset class return results shown are based on estimated forward-looking return capital market assumptions, which are based on UBS proprietary research. The development process includes a review of a variety of factors, including the return, risk, correlations and historical performance of various asset classes, inflation and risk premium. These capital market assumptions don't assume any particular investment time horizon. The process assumes a situation where the supply and demand for investments is in balance and in which expected returns of all asset classes are a reflection of their expected risk and correlations regardless of timeframe. Please note that these assumptions aren't guarantees and are subject to change. UBS has changed its risk and return assumptions in the past and may do so in the future. Neither UBS nor your financial advisor is required to provide you with an updated analysis based upon changes to these or other underlying assumptions.
  30. IRC Sections 4947(a)(2) and (b)(3).
  31. IRC Section 4943(c)(2).
  32. For a partnership or joint venture, profits interest is substituted for voting stock, and for any other unincorporated enterprise, beneficial interest is substituted for voting stock. IRC Section 4943(c)(3).
  33. IRC Section 4943(c)(6). The trustee has an additional five years if it meets certain requirements to demonstrate its diligence to dispose of a particularly large gift of excess business holdings. IRC Section 4943(c)(7).
  34. IRC Section 4941. Self-dealing doesn't include certain transactions involving an estate. Treas. Regs. Section 53.4941(d)-1(b)(3).
  35. IRC Section 4941(d)(1)(D).
  36. Andrew M. Grumet, “Choosing the Best Charitable Lead Trust to Meet a Client's Needs,” Estate Planning Journal, February 2003.
  37. IRC Section 1361(c)(2)(A).
  38. IRC Section 641(c)(2) flush language; Treas. Regs. Sections 1.641(c)-1(g)(4) and 1.641(c)-1(l) Ex. 4.
  39. IRC Section 641(c)(2)(A).
  40. IRC Section 170(a)(3), which addresses future interests in tangible personal property, doesn't apply to gifts to a charitable lead trust, which provides for a lead interest to the charity.
  41. Unless tangible personal property is put to a “related” use, the deduction is limited to the lesser of current fair market value and cost basis. IRC Section 170(e)(1)(B)(i).

Julia Chu is a director within the Advanced Planning Group of Wealth Planning and Investment Strategy at the Weehawken, N.J. office of UBS Financial Services, Inc.

Comparing CLAT Assets

Discuss these issues when you review your charitable lead annuity trust portfolio with your tax and legal advisor

General Attributes of an Effective CLAT

Able to sustain charitable lead payments in all market cycles

Outperforms 7520 rate at CLAT's establishment for maximum accumulation for the remaindermen

Diversified

Liquid

Income tax efficient

Doesn't give rise to unrelated business taxable income (for example, not debt-financed) for non-grantor CLATs

Specific Asset Classes for CLATs

EASY ASSETS DIFFICULT ASSETS GENERALLY UNSUITABLE
Cash Tax-exempt securities S corporation stock for non-grantor CLATs
Taxable stocks and securities (high-basis preferred to low-basis for inter vivos CLATs) Hedge funds and funds-of-funds Tangible personal property, for example, art and collectibles for grantor CLATs
Real estate investment trusts (REITs) Real estate, direct and indirect investments, other than REITs Closely held business interests
Managed futures Private equity
Life insurance

Julia Chu