What is a Charitable Lead Annuity Trust (CLAT) and can it help you defer taxes?

A Charitable Lead Annuity Trust (CLAT) opens up several perks that will significantly reduce your tax liabilities. If you want to get more value out of your highly-appreciated assets, here’s how you can defer taxes with Charitable Lead Annuity Trust and how you can get one started.
Charitable Lead Annuity Trust (clat)

Understanding the Charitable Lead Annuity Trust (CLAT)

For those looking for a long-term way to defer taxes, among the most powerful ways to do it is with a  Charitable Lead Annuity Trust or CLAT.

A CLAT has many benefits, from integrating your charity work into your estate to saving you more money from your tax liabilities.

A CLAT opens up several perks that will significantly reduce your tax liabilities. If you want to get more value out of your highly-appreciated assets, here’s how you can defer taxes with a Charitable Lead Annuity Trust and how you can get one started.

What is a Charitable Lead Annuity Trust?

To understand the CLAT, we need to understand the many different types of trusts used in estate planning and how they relate to you. There are several types you can use to defer taxes, some of them including:

  • A Charitable Lead Annuity Trust (CLAT) is an advanced estate planning tool used to provide for charity while potentially offsetting future tax liability.
  • By gifting assets to a CLAT, the grantor is removing them from his/her taxable estate.
  • Charitable Remainder Trust (CRT)
  • Charitable Remainder Annuity Trust (CRAT)
  • Charitable Lead Trust (CLT)
  • Charitable Lead Annuity Trust (CLAT)

Today we will be touching on the CLT and CLAT. Without going into a deep dive, CLT pays an annuity to charitable beneficiaries, with the rest paid to non-charitable beneficiaries, which are either you or heirs. CLAT pays a fixed amount each year to charitable beneficiaries using the lead interest, known as an “annual annuity stream.”

As you gift your assets or cash to the trust, you can get a full charitable deduction up to the entire value of your donation. Through CLAT, you can get a tax write-off for some or almost all of your taxes. You can also seed the trust with nearly every type of asset you can think of, from cryptocurrency, real estate, public equities, and more.

While you are liable for the taxes that the trust generates, a qualified tax planning team can help you minimize the tax exposure that the trust creates. Once the predetermined number of years finishes, the trust’s remainder will return to you or a beneficiary.

These non-charity beneficiaries can be your children, which will receive little to no estate/gift tax.

Why Set Up A CLAT Over Other Trust Types?

When it comes to trusts, CLAT has some clear advantages over others. It’s generally considered the most flexible trust type, with two immediate benefits.

First, you can get a full charitable income deduction through CLAT. Unlike other trusts, you can only get a small deduction from your assets. Depending on how you structure your CLAT, you can time a significant upfront deduction, up to 100% of the current value of the assets. This works incredibly well if you have a year with a big bonus, are selling a business, or even exercise your stock options.

This acceleration of charitable deductions gives you a chance to make deductions on a year where you’re at a high tax bracket. This “spreads out” the income over many years. While the math is quite complicated, this lets you earn more than the value you give to charity through reinvestment avenues.

Second, you can structure your CLAT to fit your charitable intent. For example, a charitable remainder trust (CRT) requires a minimum annuity distribution value of at least 5 percent and no more than 50 percent of the trust’s assets.

With CLAT, you can pick the amount you’re comfortable with, which can either be a fixed dollar amount or a fixed percentage of the trust’s fair market value. You can even make it vary every year and change the value as you see fit.

How Does a CLAT Work?

CLATs are trusts set up by your wealth manager or real estate attorney, either of which will also govern it. You can set up a trust and provide a specific period of time that the trust will give charitable donations. The time period usually goes anywhere from 15 to 25 years – some even set it up for a lifetime and terminates upon death.

The CLAT conveys its first benefit here: a big upfront tax deduction. This tax deduction can go for as much as 100% of the total value of the initial donation. You can then spread it out for as much as five years.

The money will then become the property of the trust, with the responsibility of paying these payments to the designated charity. The trust will be irrevocable but also available for reinvestments.

Once the trust is set up, the donor will have named a charitable beneficiary, the trust assets recipient. The donor will specify how much CLAT will pay to the charity each year and when.

When the CLAT is set up, the charitable organization will receive the annuity payment, which is a fixed amount every year. The amount of the annuity payment depends on various factors, including the current value of the trust assets.

The annuity payment calculation includes the current value of all assets, including money, property, investments, and collectibles. The trust’s assets must be reasonably valued, and the trustee will determine the current value.

Through this period, the trust can reinvest the money and grow with a consistent income. The middle years of your CLAT are spent providing the set annual donations to your charity of choice while increasing in value through reinvestments.

Once the entire period finishes, you or a beneficiary will be subject to a massive payout. This value will include what’s left out of the initial value, plus whatever income received from the reinvestments. This money will be subject to long-term capital gains tax after its completion.

How To Set Up A CLAT

If you’re looking to set up a CLAT, there are several requirements that you need to fulfill. The setup is primarily hands-free because you will likely do it with qualified wealth advisors.

First, you’ll need to find a reputable wealth manager or estate planning attorney. Both will have the knowledge required to set up a CLAT properly. They will also take care of the documentary requirements for the trust.

You’ll need to have the necessary assets for the trust, including a mix of cash, securities, and real estate. These assets can be held physically, in an IRA, or another type of trust.

Finally, you’ll need to designate your charity. The charity must be qualified to receive tax-deductible donations, and you’ll want to research that charity’s credentials. You can pick the charity of your choice, subject to specific qualifications.

The Bottom Line

If you’re looking to do long-term estate planning, a charitable lead annuity trust is one of the most efficient ways to do so. Setting up a CLAT requires more than just assets, energy, and paperwork. You’ll need the help of a team of wealth experts.

With a qualified team in place, you can accelerate your tax deductions and reap the fantastic benefits that CLATs can provide.

Matthew Odgers

Matthew Odgers

Attorney Matthew W. Odgers is a partner and co-founder of Opelon LLP, a firm based in San Diego, California that focuses its energy on Estate Planning, Trust Administration, and Probate

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