Lead Trusts are never simple – Read this carefully if you ever plan to talk to donors about lead trusts
Through an office contact, I was introduced to a “perfect” lead trust donor – a guy looking to get it done quickly, already vetted for this particular vehicle (or so he thought), all of the right factors. As usual with “perfect” lead trust donors, I start with the basics to just see if this is really a candidate and check off the boxes to see if this is even an appropriate discussion topic for this donor:
Do you and your wife have over $20 million in assets to even be concerned with estate taxes? Check.
Are you looking to pass assets in the future to your children? Check.
Do you have an immediate income tax need? Check, he’s selling a business (cash sale) and getting hit with huge income taxes this year.
Charitable? Check, has long-term ideas for giving.
So, we are talking about a Defective Grantor Lead Trust that will get both an upfront income tax deduction as well as future growth potential, and lots going to charity.
More questions:
What kind of investment for the Lead Trust itself do you have in mind? Real estate type – LLC or LLP or REITs – good choices. Check.
What kind of payout to charity? 6% annuity over 20 years sounds good to him. Great. Check.
Last round of questions:
What charity do you have in mind? Uh oh. Wants charitable annuity to flow to his private foundation. It’s doable but there are some caveats. 1. IRS only allows if the grantor recuses himself from final decisions on grants of these particular funds – doable. 2. The tax deduction ceiling for any lead trust that allows any payments to any private foundation is limited to the 20% of AGI (read this point again if it is new to you as it was to me!).
Yes, this donor would be limited to 20% of his AGI in charitable income tax deductions per year for this gift. Yikes. He was hoping to put $6 million in with a $5 million or so charitable deduction. But, he would only get to deduct $ 1 million of that deduction this year! He is facing over $10 million in ordinary income this year and was hoping to save much more on that end. In any case, he suspects that he won’t have enough future income to use up all of those carryover deductions!
What if he directs all of the annuity payments to a public charity? Does he get the 60% ceiling, which was hoping for? Nope! At best, he gets the 30% ceiling against his AGI! (Did you know that the income tax deduction for lead trusts is always treated as a “stock gift” for AGI ceiling purposes? I didn’t and I teach courses on lead trusts!!!)
My last suggestion? Look into an immediate gift to a donor advised fund for future giving and possibly half of his original intent into a lead trust.
Haven’t heard back from him. Oh well. This guy was as close to being a perfect defective grantor lead trust donor as you could find but the devil is in the details, as usual.
Great post! Quick note, the $5 million deduction with $10 million income using the 20% limit would allow a $2 million current year deduction (20% of $10 million), not $1 million (20% of $5 million). The 20% is a percent of a slightly modified version of AGI, not a percent of the deduction itself.
Good post Jonathan, and I agree with Dr. Russell James observation, the portion of the large 170c charitable deduction that can be claimed in year 1 (based on the 20% AGI limit) for this donor would be $2m, not $1m. Of course, the unused charitable deduction will be carried forward for the next 5 years – as you know.
However, I respectfully disagree with your opening phrase “Lead trusts are NEVER simple…” Some kinds of lead trusts can be simple, very simple in fact. As you understand, there are two different types of charitable lead trusts: (1) the traditional wealth transfer type, and (2) the lesser known, but much more applicable, reversionary type. The reversionary type is the simpler type because it is a “stripped-down” form of CLT in comparison to the traditional type of CLT. That is, it does not have nearly as many things for the donor to consider (and his advisors to explain – and charge for), nor does it have as many restrictions (under 2036 and other sections of the Code) in order to achieve one of its primary goals of saving estate taxes. So I will agree with the following modified version of your statement……. “the ‘traditional’ wealth transfer type of lead trusts are never simple.”
As you know, since the estate tax exemptions are so high now ($11.4M per spouse;$23M combined), less than 1/10 of 1% of the U.S. population has to worry about estate taxes in their estate plan now. Therefore, the estate tax benefits of a traditional wealth transfer CLT are only applicable to a very small group of donors these days.
Conversely, the “reversionary” type of CLT has absolutely nothing to do with saving estate taxes, nor estate planning at all for that matter. A reversionary CLT is solely used for accelerating “income tax” savings for future annual gifts to the current year. All donors have to worry about income taxes on an annual basis. In many ways, the reversionary type of CLT simply resembles the very common donor-profile of someone who is (i) considering a multi-year pledge, (ii) committed to making offering/tithe-like annual gifts to a church/temple/ministry or other charities.
Of course, reversionary CLTs are not for all annual donors. Typically, they should only be recommended for two classes of annual donors: (i) those annual donors who have a spike ordinary income tax event in the current year of $250,000 or more; OR (ii) those annual donors who regularly earn high levels of income and are about to retire (executives, doctors, athletes, other professionals or business owners, etc.) However, the total number of annual donors that fall into one of these two categories is quite significant. Certainly more than the number of annual donors out there who need to worry about the estate tax – and need to consider the more complex traditional lead trust. In fact, most of the reversionary CLTs that I’ve established over the past several years, are funded with less than $500k of assets, and typically make annual charity distributions between $10,000/year and $40,000/ year. Very modest donor entry levels for consideration. It also helps if the donor is a resident of one of the 33 states that has a full charitable deduction at their respective state income tax level.
I greatly value your insight and wisdom Jonathan, but on this particular post, I felt it was necessary to clarify your message – at least point out the differing levels of simplicity for these 2 different types of CLTs.
To borrow my car dealership metaphor that I’ve previously shared with you (and many others), the reversionary CLT is like a Honda Accord and the traditional wealth transfer type of CLT is like a Porsche (or these days with the higher estate tax exemptions – a Ferrari). Both are perfectly good options to consider for transportation, however, the potential market for the Honda Accord is much larger than the market for the Ferrari is smaller. The Ferrari is also more challenging to drive (administer) – and a Ferrari driver is more likely to get pulled over by the cops (IRS) if you break the traffic laws (Treasury Regs.)