The Simplicity & Power of “Reversionary” Charitable Lead

The Simplicity & Power of “Reversionary” Charitable Lead Annuity Trusts

Presented to: 2017 AiP National Conference April 20, 2017

Bradford B. Gornto, Esq., LLM, President & Founder Effectual Giving, LLC & Gornto Law, PLLC 310 Wilmette Avenue, Suite 5 Ormond Beach, FL 32174 (386) 257-2554 Email: [email protected] www.effectualgiving.com

• Provide working knowledge of an additional CLT planning opportunity, particularly in the current estate tax planning environment • Emphasize the simplicity of this form of CLT in comparison to traditional wealth transfer CLTs, zeroed-out CLTs, and shark-fin CLATs • Identify the ideal clients/donors who can benefit from this simpler form of CLT

Charitable Lead Trust – Definition

• Working definition: a trust that makes a series of payments, at least annually, to charity for a term of years or over a lifetime, and then distributes the remaining principal assets of the of the trust either : (i) to the client’s family members (outright or in further trust); or (ii) back to the grantor of the trust (a so-called “reversionary interest”).

• CLTs have been around for nearly 40 years, but remain one of the least used planned giving strategies • Statistics : # of CLTs 6,498 vs. # of CRTs 105,866 (CLTs=6.1%) • *(based on IRS Form 5227 filings in 2012 ) • Why? Here are the major reasons: • Interest rates were very high when CLTs were first introduced • Traditional CLTs, which are primarily used for estate tax savings purposes, can become quite complex • Lack of use results in lack of familiarity • From charity’s perspective - its better to have the “tree” instead of some “fruit”

All content presented herein is copyrighted material of Effectual Giving, LLC 2017. “iCLAT®” is a registered trademark of Effectual Giving, LLC. All rights reserved. Two Categories of CLT’s for Income Tax Purposes

• “Grantor Trust” CLT (simple): • The terms of the CLT are drafted so that the grantor (the “creator”) of the trust is deemed to be the taxpayer for income tax purposes. • The grantor will receive the income tax deduction generated by the creation and funding of the CLT under 170(a) & 170(f)(2)(B) and the grantor will report all of the taxable income earned by the trust during the charitable term of the CLT. • A “reversionary CLT” is a form of grantor CLT

• “Non-Grantor” Trust CLT (more complex): • The terms of the CLT are drafted so that the trust itself is deemed to be a separate “taxpayer” for federal income tax purposes and the CLT will receive charitable deduction under 642(c)

Beginning Growth Distributions Ending Year Balance of CLT Rate (4%) to Charity (4%) Balance of CLT

1 $1,000,000 $40,000 $40,000 $1,000,000 2 $1,000,000 $40,000 $40,000 $1,000,000 3 $1,000,000 $40,000 $40,000 $1,000,000 4 $1,000,000 $40,000 $40,000 $1,000,000 5 $1,000,000 $40,000 $40,000 $1,000,000 6 $1,000,000 $40,000 $40,000 $1,000,000 7 $1,000,000 $40,000 $40,000 $1,000,000 8 $1,000,000 $40,000 $40,000 $1,000,000 9 $1,000,000 $40,000 $40,000 $1,000,000 10 $1,000,000 $40,000 $40,000 $1,000,000 TOTALS $400,000 $400,000 $1,000,000 • Total Amount to • Balance can Charities (over 10 either pass to year period) family or revert back to Client at end of term.

• For tax purposes, it is “a reversionary charitable lead annuity trust which, by its very terms, qualifies as a ’grantor trust’ for federal income tax purposes under IRC Section 673.”

• In other words, the iCLAT is a CLAT that simply REVERTS back to the client at the end of the charitable lead interest term in a non- taxable transaction, rather than pass to the next generation in the client’s family (like most CLTs).

• An iCLAT is a MUCH SIMPLER form of CLT for our clients/donors to establish and administer in comparison to traditional CLTs.

All content presented herein is copyrighted material of Effectual Giving, LLC 2017. “iCLAT®” is a registered trademark of Effectual Giving, LLC. All rights reserved. Why is an iCLAT unique in the CLT world?

• The iCLAT is designed solely for “income tax” savings purposes, not for estate & gift tax purposes.

• Much simpler to implement and administer by the client because “RETAINED CLIENT CONTROL” is not a problem like it can be if estate tax savings were a primary client objective (i.e. 3rd party trustee might be necessary)

• In fact, the “i” in iCLAT stands for: • “i”ncome tax charitable deduction, and • “i”, meaning the trust principal returns back to the client (hence “i”) at the end of the charitable lead trust term. From the Client’s perspective, it has nothing to do with shifting assets to a spouse or kids. • “i”, meaning the Client continues to CONTROL the management of the iCLAT assets (with same advisors) and the granting of distributions to charities.

• The key benefit of an iCLAT is that the client/donor will receives a large accelerated charitable income tax deduction in the year that the iCLAT is established.

• This large accelerated charitable income tax deduction is equal to the present value of the annual payments to charity using the IRS’s §7520 interest rate, which remains at historically low levels (2.6%-April 2017).

• Let’s return to our prior simple example to show the amount of the Year 1 charitable income tax deduction to the client/donor……..

Beginning Ending Balance of Growth Distributions Balance of Year iCLAT Rate (4%) to Charity (4%) iCLAT 1 $1,000,000 $40,000 $40,000 $1,000,000 2 $1,000,000 $40,000 $40,000 $1,000,000 3 $1,000,000 $40,000 $40,000 $1,000,000 4 $1,000,000 $40,000 $40,000 $1,000,000 5 $1,000,000 $40,000 $40,000 $1,000,000 6 $1,000,000 $40,000 $40,000 $1,000,000 7 $1,000,000 $40,000 $40,000 $1,000,000 8 $1,000,000 $40,000 $40,000 $1,000,000 9 $1,000,000 $40,000 $40,000 $1,000,000 10 $1,000,000 $40,000 $40,000 $1,000,000 TOTALS $400,000 $400,000 $1,000,000 • Total Amount to • Balance will Charities (over 10 REVERT back year period) to client at end of the term.

All content presented herein is copyrighted material of Effectual Giving, LLC 2017. “iCLAT®” is a registered trademark of Effectual Giving, LLC. All rights reserved. What is the “Accelerated” Year 1 Charitable Income Tax Deduction?

• The Year 1 deduction is $351,658, even though the total payments of $400,000 is to be paid to charity(ies) over a 10 YEAR PERIOD. That’s a deduction of almost 88% of the total charitable payments in year 1.

• Again, the deduction is equal to the present value of the annual lead trust payments to charity, using the IRS’s historically low §7520 interest rates (currently 2.6% – April 2017).

• Subject to 30%/20% AGI limitations, with the normal 5 year carryover rules. The so-called “Pease limitation” on itemized deductions is also applicable.

• At 40% income tax rate, this will generate over $140,000 in actual income tax savings, potentially all in year 1.

Illustration of the iCLAT *10 year iCLAT with $40,000 annual charitable payments.

Charities Step #1: Client transfers asset to the iCLAT Trustee valued at $1,000,000, the Client can serve as trustee of the iCLAT.. Client will get a $351,658 charitable income tax deduction and potentially over $146,000 in income tax Step #2: For 10 years, iCLAT pays $40,000 savings in year 1. annually to client’s charities totaling $400,000.

iCLAT Client 10 year term *Client is trustee (new account)

Step #3: At the end of the 10 year term, the remaining iCLAT assets will revert back to the Client (with no tax consequences. * At 4.0% annual growth, 100% of the $1,000,000 principal will return back to the Client.

All content presented herein is copyrighted material of Effectual Giving, LLC 2017. “iCLAT®” is a registered trademark of Effectual Giving, LLC. All rights reserved. History of the §7520 Rate* May 1989 ‐ Jan. 2013

14.0%

12.0%

10.0%

8.0%

5 7 § 6.0%

4.0%

2.0%

0.0% 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 §7520 Rates 11.6% 9.60% 9.80% 8.20% 7.60% 6.40% 9.60% 6.80% 7.40% 7.20% 5.60% 7.40% 6.80% 5.40% 4.20% 4.20% 4.60% 5.40% 5.60% 4.40% 2.40% 3.00% 2.40% 1.40% 1.00%

*The §7520 Rate is the applicable IRS rate for all charitable planned giving strategies

13 www.effectualgiving.com Ideal Clients/Donors for an iCLAT

• Type of Donative Intent: • Income Tax Facts “Coupling”:

• Clients who tithe or make • Consistent or unusually large regular annual gifts adjusted gross income (AGI) in current year • Somewhat adverse to making a large outright gift of principal • Large traditional IRA or other assets to charity, but perhaps deferred comp. RMDs interested in the benefits of • ROTH IRA Conversion making a large annual gift, Planning naming rights, etc. • Highly compensated client (Dr., • Corporate clients who make executive, etc.) who is about to annual charitable gifts to retire (won’t get future deduction United Way, Community when AGI is gone) Foundations, or company’s • Sale of business or real estate own foundation or DAF • Exercise of stock options • Athlete/celebrity in final year of contract or endorsement deal • Lottery winnings

All content presented herein is copyrighted material of Effectual Giving, LLC 2017. “iCLAT®” is a registered trademark of Effectual Giving, LLC. All rights reserved. iCLAT – Planning Advantages (Simplicity = Fewer Barriers)

• Unlike traditional CLTs, an iCLAT will not disrupt your client’s estate plan. If the client dies during the term, the remaining iCLAT assets will simply “pour-over” into the client’s Will or Trust at the end of the charitable term. • Less disruptive to client’s financial lifestyle in comparison to traditional CLTs – GREATER RETAINED CONTROL • NO TAXABLE GIFT INVOLVED – Less restrictive appraisal requirements • An iCLAT has a MUCH BROADER CLIENT/DONOR BASE APPEAL than the traditional CLT, because it is purely an income tax savings strategy: • Fewer clients are subject to estate taxes now ($5.49M exemption unified credit amount, portability of unified credit between spouses and potential for outright repeal of estate tax) • All U.S. clients are subject to INCOME taxes, and saving income taxes is a much greater priority to most clients, in comparison to saving future estate taxes.

All content presented herein is copyrighted material of Effectual Giving, LLC 2017. “iCLAT®” is a registered trademark of Effectual Giving, LLC. All rights reserved. . IRS Filing Requirements & Rules for All Grantor CLTs

• The trustee of the grantor CLT will have to file IRS Forms 5227 & Form 1041 each year • However, only an “informational 1041” is typically necessary for the iCLAT. • As with all CLTs, the “private foundation rules” still apply to iCLATs (self dealing, excess business holdings, taxable expenditures, jeopardy investments rules & excises may apply)

• Grantor CLT will need to get a separate IRS EIN

• Potential recapture of the charitable income tax deduction if the Client dies during the term of the iCLAT - *powerful planning opportunities to address potential recapture concerns

• In this iCLAT strategy, the client simply uses his or her own donor advised fund as the beneficiary of the iCLAT.

• This plan gives the client’s family the ability to retain the grant-making advisory control/timing/privacy over the charitable payments, in addition to receiving the CLT principal assets back at the end of the CLT term

Client’s Donor Advised Fund

**KEY: On the Client’s time table, the client will advise the DAF to make the ultimate gifts to his/her favorite charities. Donor Advised Step #1: Client transfers asset to the iCLAT Fund Client’s Trustee valued at $1,000,000, the client can serve as trustee of the iCLAT.. Client will get a Charities $351,658 charitable income tax deduction and potentially over $140,000 in income tax Step #2: For 10 years, iCLAT pays $40,000 savings in year 1. annually to the Client’s Donor Advised Fund #2 totaling $400,000 (client’s DAF = charity)

iCLAT Client #1 10 year term

Step #3: At the end of the 10 year term, the remaining iCLAT assets will revert back to the client (with no tax consequences. * At 4.0% annual growth, 100% of the $1,000,000 principal will return back to the Client.

Substantial legal fees and other Minimal paperwork and usually can start-up costs involved. Typically Start-Up Fees and Complexity be established with less than $10,000 takes many months to create and get and an initial deposit 501(c)(3) determination letter Extensive ongoing fees and time involved to administer. Must file Ongoing Administrative Varies with parent organization and annual tax returns; conduct & Management Fees level of service; typically low meetings, to manage and administer all functions AGI Limits for Claiming 50% of AGI (adjusted gross income) 30% of AGI for cash gifts; 20% for Charitable Income Tax for cash gifts, 30% for gifts of assets, gifts of assets, stock or real property Deduction for Contributions securities or real property Must expend 5% of net assets Required Annual Distributions NONE valued annually, regardless actual to Charities investment returns Complete confidentiality available No anonymity. Annually filed Privacy Benefits for client and for the grant Form 990s are public records for recipient charities grants, expenses, staff salaries, etc. Excise tax of 1% to 2% of net Excise Tax NONE investment income. Punitive penalties Fair market value for cash and Fair Market Value (provided client publicly traded stock; cost basis for Valuation of Gifts owned contributed asset more than other gifts including closely held 1 year) stock and real estate

• If the grantor dies during the term of the CLT, the Code (170(f)(2)(B) and Treas. Regs. (1.170A-6(c)(4)* require a portion of the accelerated income tax deduction to be recaptured by the grantor’s estate, and then the CLT will get annual charitable deductions for remaining payments under 642(c).

• With proper planning, this possibility can be prevented…..

**KEY: On the Client’s time table, the client Step #1: Client will advise the DAF to make the ultimate gifts to his/her favorite charities. transfers $1M Donor Advised assets to a new Client properly organized Fund single member LLC Client’s that files an S Charities corporation election. #1 Step #3: For 10 years, iCLAT pays $40,000 annually to the Client’s Donor Advised Fund #3 totaling $400,000 (client’s DAF = charity) Step #2: LLC later transfers $1M to an iCLAT that it creates as grantor. Will iCLAT generate Client #2 $351,658 10 year term deduction which LLC will flow out to client based on client’s AGI, Step #4: At the end of the 10 year term, the remaining resulting in over iCLAT assets will revert back to Client LLC (with no tax $140,000 in tax consequences). * At 4.0% annual growth, 100% of savings, the $1,000,000 principal will return back to the Client potentially all in LLC, thereafter, client can decide whether to dissolve year 1. LLC.

• In addition to cash or marketable securities, an iCLAT can also be funded with rental real estate, closely held stock, LLC or LP interests (generally, not operating businesses), mineral rights/oil & gas leases royalties.

• Less stringent appraisal requirements than traditional CLTs and CRTs (no gift involved), significant appraisal cost savings to client.

• Client can serve as trustee and retain CONTROL over the iCLAT assets.

• The more focused iCLAT discussions will often engage the client and lead to more complex CLT planning – such as “Super-CLAT” or a separate sale of the reversionary interest. • “What if I don’t need the assets to revert back to me?”

• The client does not need to be a person….An LLC, S Corporation, and C corporation (even a publicly traded company) can establish an iCLAT to obtain the large accelerated charitable income tax deduction.

• The iCLAT’s annual payments to charity do not need to be fixed, the payments to charity can increase, even balloon (“shark-fin” or “balloon” CLAT- Rev. Proc. 2007-45). This variation helps increase value of reversionary amount returning back to the client at end of term.

• Client can receive a tandem fixed annual payment stream from the iCLAT during the lead term (permitted under the treasury regulations). Additional complexity involved, but for some clients this can provide additional income/comfort. Client can also take a trustee fee.

• An iCLAT is an excellent “PLAN B” strategy • For example, if the sale transaction already occurred or “prearranged sale doctrine” is already applicable

• NOW is the time to have these discussions with your donors/clients • Trump Tax Plan’s “potential” for major limits on large charitable income tax deductions Proposed caps on itemized deductions: • $100,000 for single persons and $200,000 for married couples • As interest rates start to rise, the charitable deduction generated by iCLAT will decrease