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The Favorable Impact of the Current Low Interest trates on CLT Planning

Charity Advisor Resource Newsletter - Volume 1.1 2009

BY JONATHAN D. ACKERMAN

Donors have until the end of April, 2009 to take advantage of the most favorable interest rates for creating an inter vivos CLT since the monthly federal rate was established more than 20 years ago. In fact, the lower the interest rates applicable to a CLT contribution, the lower the present value of the remainder gift to heirs, or correspondingly, the larger the present value of the charitable lead interest.

Thus, if the donor is desirous of obtaining the largest charitable income tax deduction available, he or she would create either an inter vivos grantor charitable lead annuity trust (CLAT) or a super grantor CLAT. If however, the donor is desirous of transferring the maximum amount to children with the minimum estate and gift taxes, or even estate and gift tax-free, he or she would consider a non-grantor or super grantor CLAT. Click here to learn more about the different types of CLTs.

The perfect storm? Since many assets now owned by donors are significantly depressed in value, the funding of a CLT may present a unique opportunity, because any growth in value of the CLT's assets during the CLT term greater than the low interest rate factor will also pass to heirs estate and gift tax-free.

The relevant interest factor being referred to in this Article has been coined the "charitable mid-term federal rate" (CMFR). The CMFR is defined as 120% of the applicable mid-term federal rate, rounded to the nearest 2/10ths of a percent and is mandated under Code Section 7520 for purposes of determining the present value of gifts to a CLT (and other planned giving vehicles which are dependent upon the concept of present value, such as a charitable remainder trust). The CMFR is published monthly.

In addition, a donor to a CLT may elect the CMFR in the month of the CLT's creation or the CMFR for the two month’s preceding the CLT’s creation. For instance, a donor creating a CLT in the month of April, 2009, may affirmatively elect the CMFR for the month of February. Since February's CMFR was 2.0%, an historic low, creating a CLT by April, 2009 (and electing to use February's CMFR) is the most favorable economic calculation of present value to date.

Let me explain - in order to fully understand the benefits of creating a CLT, one must understand the economics of a gift to a CLT. A chart has been prepared with a detailed explanation of differing CMFR rates and differing economic calculations of present value when a CLAT or a CLUT is chosen as the desired planned giving vehicle.

When reviewing the chart below, please note that the first column represents the fair market value of the asset contributed to the CLT; the second column is the annual payout from the CLT to the charity; the third column is the term of the CLT; the fourth column is the CMFR; the fifth column is the taxable portion of the gift - that portion of the value of the contributed asset that is attributable to the gift to the remainder beneficiary, which would thus constitute a taxable gift; and the sixth column is the tax attributable to such a gift (assuming a gift tax would be imposed).

Please note that #1 CLAT illustrates that a $1 Million asset contributed to a CLAT, for a term of 15 years with a 7% payout rate and a CMFR of 10%, will render a taxable portion of $467,570. #2 CLAT shows that, by changing one number (the CMFR) to 2%, the taxable portion will be significantly reduced to $100,550. In #3 CLAT, the number of years of the CLAT term is increased to 17 and all estate and gift taxes associated with a contribution to the CLAT are zeroed out.

#4 CLUT illustrates that the taxable portion of creating a CLUT is increased to $344,230, as opposed to #2 CLAT with a taxable portion of $100,550. The CLUT is less favorable from an estate and gift tax perspective, because the lead payout is a unitrust amount, and thus is recalculated each year based upon the then fair market value of the trust's assets. One major reason for creating a CLUT, as opposed to a CLAT, is to attain the maximum benefit if you are combining generation-skipping planning with the CLT.

It is also important to remember that the taxable portion from the CLT gift can be reduced or eliminated by applying any unused gift tax exemption amount.

PLEASE NOTE THAT THE CMFR FOR A PARTICULAR MONTH IS PUBLISHED BY THE TREASURY ON OR AROUND THE 20th OF EACH MONTH. THUS, IF THE DONOR WAITS TO CREATE THE CLT UNTIL AFTER APRIL 2OTH, THE DONOR WILL EFFECTIVELY HAVE 4 MONTHS (FEBRUARY, MARCH, APRIL & MAY) TO CHOOSE THE MOST FAVORABLE CMFR FOR THE PURPOSE OF CREATING THE CLT.

IT IS ALSO ASSUMED IN THE CHART THAT EACH CLT IN THESE EXAMPLES IS A NON-GRANTOR CLT CREATED FOR THE PURPOSE OF MINIMIZING OR AVOIDING THE ESTATE AND GIFT TAXATION.

CHART ON THE ECONOMICS OF A GIFT TO A CLT:

As can be gleaned from this spreadsheet, the term of the CLT and the annual payment from the CLT to the charity can be altered. These factors will ultimately impact the taxable portion of the CLT. So, the donor in an inter vivos CLT can dictate when his or her heirs will receive the assets of the CLT and the amount to be paid out to charity, considering the nature of the assets being contributed to the CLT.

Click here to read the article Technical - Discount Planning and CLTs for a discussion of the impact of contributing a discountable asset to a CLT.

But don't forget that interest rates even after April of 2009 remain at historic lows, so the benefits discussed in this Article still apply. There are, of course, a variety of tax, financial and estate planning benefits associated with a gift to a CLT, as described above. In addition, by creating an inter vivos CLT, donors can develop and implement their philanthropic vision during their lifetime and experience firsthand the power of philanthropy in bettering the lives of others.

However, the CLT is a sophisticated gift planning vehicle, and as with all such vehicles, professional counsel should be retained to fully analyze the effectiveness of a particular vehicle given a particular set of circumstances.