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Planning With The Dynasty Trust & Charity
The Dynasty Trust, in various forms, has been with us for nearly a century as a multi-generational wealth transfer planning vehicle. In this edition of Gift Planner's Digest, trust officer Judith K. Ruud, Esq. and husband, development officer William N. Ruud, Ph.D. review the Dynasty Trust and how it can be combined with the Charitable Lead Trust to provide long-term benefits for both family and charity.
"Even if you're on the right track, you'll get run over if you just sit there." -- Will Rogers
Many families face obstacles when passing wealth to benefit future generations. Gift, estate, and other transfer taxes can deplete the amount of assets passing to each succeeding generation. Assets may also be mishandled by future beneficiaries and may be subject to the potential claims of their creditors. Each of these hurdles, and many others, challenge your ability to retain long-term wealth for your family. (Please note, this article was written as if you are the client/grantor.)
There is a way to accomplish your wealth-preservation goals through a Dynasty Trust. Simply stated, a Dynasty Trust is a long-term trust that allows you to combine the benefits of special provisions of federal tax law with those of certain state's laws so that you can build and preserve assets for your family. You can create a Dynasty Trust that lasts for only a few generations or that lasts forever.
While you might not initially think so, there are many reasons why you might want a Dynasty Trust that lasts forever; particularly, when you realize all the benefits that such a trust can provide. For example, while you might want your beneficiaries to have access to trust assets, you might not want their creditors to reach such assets if they get in an accident or financial trouble. In fact, with proper planning and drafting, you can even protect the assets from the reach of a divorced beneficiary's spouse.
You might want a trust that lasts forever to avoid the transfer taxes that would otherwise erode the assets as they pass from generation to generation. If the Dynasty Trust is drafted properly, you can obtain such transfer tax free benefits even if you decide to give the beneficiaries rights in the trust tantamount to outright ownership. It seems reasonable to assume that, if given the choice, you would prefer passing assets to your heirs instead of the IRS, something you can do with a Dynasty Trust.
You might want a trust that lasts forever in order to help a beneficiary succeed, become a useful and productive citizen, start a business, build a home, or raise a family. Yet, to prevent the beneficiary from becoming dependent on the trust for support, you might want to draft it to provide incentives for such accomplishments, but not full support. This feature often appeals to those wanting to protect their heirs from outright inheritances, inheritances that often act as inhibitors to personal achievement and ambition.
You might want a trust that lasts forever if it can supplement the income of an existing or yet unborn heir who engages in a socially beneficial, but lower paying profession. Such professions might include teaching, the ministry, police work, politics, or other public service professions.
While you might like these benefits, you might be concerned about having a Dynasty Trust that lasts forever because you believe each generation should decide how to pass assets to their respective heirs (e.g., from parent to child). With a properly drafted Dynasty Trust you can permit each generation to decide how to pass assets to the next, yet still protect those assets from transfer taxes.
And, you might initially hesitate to use a perpetual Dynasty Trust because you don't want to benefit heirs that you may never know, or because you're hesitant to amass a large fortune for your heirs. While these are sound reasons, you might change your mind once you understand that a Dynasty Trust that lasts forever can probably meet most of your objectives and address these concerns, while shifting assets that would otherwise be paid in transfer taxes to your heirs or charity.
Bottom line, like most people, you probably want your heirs to be safe and comfortable, to provide for their basic needs, to help them become established and successful in life, and to provide for their medical or housing needs if they meet unexpected emergencies. Like most people, you probably want your heirs to be self-supporting, but would like to provide a safety net should an heir face a serious accident or illness. A properly drafted Dynasty Trust can accomplish these objectives and more.
A Major Benefit Of A Dynasty Trust
While a Dynasty Trust can provide many non-tax benefits, it has one major benefit not available for outright gifts: transfer tax-free compounding. In essence, the assets in a Dynasty Trust can pass from generation to generation free of gift or estate taxes.
Our present transfer tax system taxes assets each person owns as they pass those assets to the next generation. Most people want to avoid this tax if at all possible. At a minimum, most people would probably prefer giving assets that would otherwise be paid in transfer taxes to a charity of their choice.
Under our present transfer tax system, if you don't own the assets they won't be subject to transfer tax in your estate. This is what happens with a properly structured Dynasty Trust and, as a result, the assets pass down the generations free of transfer taxes.
How The Dynasty Trust Grows
Dynasty Trusts are nothing new. In the first half of this century many wealthy financiers, such as Joseph Pulitzer and William Randolph Hearst, used dynasty type trusts to hold some of their assets thereby avoiding successive transfer taxes for many generations.1 These individuals could put all of their assets in such trusts lasting up to about 100 years and thereby build dynasties for their descendants.
From the government's perspective, that was just too good to be true. So, the laws were changed. Under today's transfer tax system each person can still use a Dynasty Trust, but only for assets valued at up to $1 million. However, today we have an additional benefit: In some states the trust can last forever, rather than just 100 years.
As mentioned earlier, the key to the Dynasty Trust's growth is transfer tax-free compounding--the longer the trust continues, the greater its benefits. The following example shows how this happens:
Example: Assume you transfer $1 million to a Dynasty Trust. Assume the trust will benefit your child, grandchild, and great-grandchild for their lives after which time the remaining assets will pass outright to your great great-grandchildren. Assume the trust balance grows by a net of 6% annually. In this case, when the trust ends, your great great-grandchild would receive about $84 million. If instead, you gave this $1 million outright to your child, who in turn passed it down through each succeeding generation, your great great-grandchild would receive only about $8 million. The Dynasty Trust has $76 million more in assets because of the magic of transfer tax-free compounding!
|Exhibit A||Dynasty Trust||Outright Gift|
|Grantor's gift of $1 million||$1,000,000||$1,000,000|
|Value at child's death||4,549,383||4,549,383|
|Less: 55% Federal Estate Taxes||0||(2,502,161)|
|Value at grandchild's death||$19,525,364||$8,786,414|
|Less: 55% Federal Estate Tax||0||(4,832,527)|
|Value at great-grandchild's death||$83,800,336||$16,969,568|
|Less: 55% Federal Estate Tax||0||(9,333,262)|
|Great great-grandchild receives:||$83,800,336||$7,636,306|
|Assumptions: 1) after making some distributions, the trust grows by a net of 6% annually; and 2) each generation lives 25 years longer than the prior generation.|
Once you understand the benefits of a Dynasty Trust, you may want to fund it with more than $1 million. This is possible if you fund the trust using leveraging techniques that our present transfer tax system also permits. These leveraging techniques include funding the trust with assets that you may discount for transfer tax purposes sucy as stock in a closely held corporation, units in a family limited partnership, a limited liability company, or life insurance.
Additionally, by combining the Dynasty Trust with a Charitable Lead Trust you may be able to fund it with far more than $1 million dollars while paying no (or minimal) transfer tax. This is a great idea if you have made gifts equal to your exemption equivalent amount and still want to benefit his/her heirs and charity.
In fact, by using creative estate planning techniques you can fund a Dynasty Trust with assets valued at several million dollars or you can structure it to hold assets with such value.
For example, assume that when Bill Gates had first started Microsoft he asked his mother to give $10,000 to a Dynasty Trust that he could use to start Microsoft. Assuming Bill Gates' ownership interest in Microsoft is $100 billion, that net worth would be owned by the Dynasty Trust instead of Mr. Gates personally. The assets in this Dynasty Trust would escape transfer taxes in perpetuity.
Maximizing The Dynasty Trust Tax Benefits
Forty-four states presently require that a Dynasty Trust terminate after about four generations or 90 years from creation. As mentioned earlier, while a Dynasty Trust can last forever, you might think this is just too long. For instance, you might live in a state that requires such trusts to terminate after about 90 years, a time period you find sufficient. Ninety years might seem long enough to provide for heirs that you might know and exclude those you may never know.
Additionally, as mentioned earlier, you might also believe that each generation should decide how to pass assets to their beneficiaries, just as you will be able to do.
However, you might change your mind if you know that a Dynasty Trust can be drafted to accomplish these and many more objectives, yet still give you the benefit of shifting assets from the IRS to your heirs. For example, each generation may decide how to pass assets to their heirs by including a trust provision like the following:
"At the death of each child of mine who is a beneficiary of a separate trust created under this Dynasty Trust, the assets remaining in such trust shall be distributed to, or for the benefit of, such child's issue, in such proportions and subject to such terms, trusts, and conditions as the child may appoint by his or her last Will, with specific reference to the power herein given." 2
The trust would then provide that if the child didn't exercise the power at the child's death, the property would be held in further trust for the benefit of the child's issue. You could then grant a similar power to each generation that becomes a parent.
This power, called a "limited power of appointment," if properly drafted, can provide each family with flexibility regarding the trust assets. With this power you can accomplish your goal of permitting each child to control the distributions passing to his or her issue. Such a power also lets each generation decide if the Dynasty Trust should continue or be terminated. If you prefer not to grant this flexibility, you can draft the trust accordingly.
This is only one example of the flexibility you can have with a Dynasty Trust. It illustrates that deciding whether or not a Dynasty Trust should last in perpetuity is a matter of deciding who should benefit from the assets: the IRS or your heirs and favorite charities.
Six states permit a Dynasty Trust to last forever. Currently six states permit a Dynasty Trust to last forever. 3 Even if you don't live in these states, you may be able to create a Dynasty Trust that takes advantage of their respective laws.
To do so the trust must have a nexus with the selected state. Such nexus can be created by naming a trustee having its business in the selected state, having the trustee administer the assets in the selected state, and having the trust state that the selected state's laws govern. There are other ways to create a nexus. The more connections you use, the more likely you are to establish the required nexus. Each state has particular rules that may affect certain assets (such as real estate), and your attorney needs to review these before drafting the trust.
In South Dakota, for example, a Dynasty Trust can last forever. Let's assume you are not a resident of South Dakota, but you want to create a Dynasty Trust subject to South Dakota's laws. To do this, you would create your Dynasty Trust and name a South Dakota corporation with trust powers as trustee. You would also have the agreement state that South Dakota law governs and you would move your assets to South Dakota for management. Moving the assets is simple, particularly if they are publicly traded securities. If you think about it, most people have assets with brokerage houses or banks, and are not even aware where the actual assets are located. The advent of Internet trading has made people very comfortable with this concept. Given today's communication tools, you should have no problems communicating with the South Dakota trustee. And, since the trust will last in perpetuity, beneficiaries will probably be scattered all over the country, so having a place of administration in one state should not be a hardship on anyone, in fact it should be beneficial.
Some states offer additional benefits for assets in a Dynasty Trust, including avoiding state income tax on the trust assets. Some states that permit Dynasty Trusts to last forever do not have a state income tax. Thus, if the Dynasty Trust is properly drafted, the trust assets may not be subject to state income taxes on undistributed income and capital gains, meaning more tax-free compounding!
For example, South Dakota has no state income tax. Therefore, if you are not a South Dakota resident, but your Dynasty Trust is subject to South Dakota law, then the trust assets might not be subject to state income tax. Some states imposed laws to preclude you from taking advantage of this additional advantage. In this respect, some states disliked this law because they lost revenue (i.e., a state cannot subject assets in another state to its own income tax). As a result, states like Minnesota enacted laws providing that if an existing resident establishes a trust in another state, the assets of such trust are still subject to Minnesota state income tax. Therefore, to avoid state income tax on the trust's assets, your advisors need to review your state's income tax laws. Keep in mind this only addresses imposition of a state income tax. The trust assets may still be subject to the situs of South Dakota and therefore avoid federal transfer taxes throughout the trust term.
How Much Is Enough For Your Descendants?
The disinheritors. The potential growth of the assets in a Dynasty Trust can be astounding, causing many to ask if their heirs need that much. The question this raises is, "How much is enough?" There are many different views on this:
"One thing is for sure. I won't leave a lot of money to my heirs because I don't think it would be good for them." Bill Gates, Forbes, May 19, 1997. Mr. Gates has apparently said he would leave each of his children $10 million. While $10 million seems like a lot of money, based on his present net worth of $100 billion, a $10 million bequest is 1/100th of 1%. This is comparable to someone with $1 million giving a child $100.
"If my kids want to be rich, they'll have to work for it." Home Depot Chair Bernard Marcus, Forbes, May 19, 1997. Mr. Marcus said he plans to leave almost all of his $850 million in Home Depot stock to the Marcus Foundation, which supports education and the handicapped.
"New Wealth individuals generally have a very different view from those with established wealth when planning for an inheritance for their children. New Wealth views the acquisition of wealth as a measure of one's success and achievement and believes wealth must be newly earned by each generation rather than inherited." James N. Donaldson, "Estate Planning Goals: New Wealth Prioritizes Limited Inheritance," Trusts & Estates, October 1997, page 10.
What Is The Best Way To Leave An Inheritance?
Only you can decide how much is enough to leave your heirs. This is a personal decision that typically entails asking how much is enough to assist and encourage your heirs to become self-sufficient and independent adults, yet, not ruin their desire to succeed.
How do you accomplish the objective of encouraging your heirs to become self-sufficient and independent adults; yet, not ruin their desire to succeed?
- Is it to avoid the Dynasty Trust, thereby preventing descendants from amassing large fortunes; or
- is it to use a Dynasty Trust and the flexibility it affords to accomplish your objectives?
If you believe that leaving a large inheritance is an inhibitor to personal achievement and a way to extinguish ambition, but if you want to make sure your heirs are safe and comfortable; and they have the opportunity to succeed, then you can accomplish these goals with a Dynasty Trust. It is possible to accomplish your objectives by using a Dynasty Trust because you can select its terms, including:
- Deciding how much the beneficiaries should receive annually.
- Deciding the reasons for which beneficiaries should receive trust distributions.
- Deciding when beneficiaries should receive trust distributions.
- Deciding if the trustee must consider the beneficiary's ability to work or his/her outside resources before making trust distributions.
- Deciding the beneficiary's role in making investment or distribution decisions.
For example you could draft a Dynasty Trust as follows:
Example: Assume that you want to supplement a beneficiary's lifestyle, but not provide full support. In such case, you can draft a Dynasty Trust with "incentive provisions," provisions that permit distributions if a beneficiary meets certain criteria that you establish. For example, graduating from college or trade school, maintaining a certain lifestyle, staying drug free, or any other number of criteria you select. The trust can also help finance a beneficiary's entrance into politics, going on a religious mission, starting a business, engaging in periodic educational travel, or building a home. The trust could supplement the income of those descendants who chose to stay home and raise a family. The trust could provide these benefits to your heirs for as long as you desire.
You have the choice to decide how the Dynasty Trust can benefit your heirs while addressing your concerns. The important thing to understand is that you can do this with a properly drafted Dynasty Trust.
Including Charitable Beneficiaries In The Dynasty Trust
"I will contribute to my community. I will be a giver. I will give money. I will give time. I will try to make a difference. I want to help make the place I live become a better place for everyone." Harvey Mackay, Pushing the Envelope, Ballentine Publishing Company, 1999.
Sharing the wealth. Even with the beneficiaries receiving distributions, the Dynasty Trust's growth may still be astonishing because the assets grow transfer tax-free. The beneficiaries benefit from this tax savings because the Dynasty Trust retains such savings for their benefit.
Defining your goals. If your goal is to assist your descendants, but not fully support them, and if you do not want to amass an astronomical fortune for your heirs, then you might consider having the Dynasty Trust distribute some of its transfer tax savings to charity. Some benefits of this are:
- Your beneficiaries have the opportunity to engage in a systematic and planned method of charitable giving.
- Your beneficiaries may engage in a common goal, other than themselves.
- Your beneficiaries will learn how to deal with affluence.
- Your beneficiaries will develop a healthy understanding of the benefits of wealth, benefits that go beyond personal consumption.
- Your beneficiaries will develop feelings of self-worth that were not otherwise attained by personally accumulating the wealth.
Obtaining your goals. Assume the assets in a Dynasty Trust avoid transfer taxes that would otherwise be imposed about every 25-30 years when each generation dies. In such case, you could require that the trust distribute some of this tax savings to charity at such times. Alternatively, the trust could require more frequent distributions of this tax savings.
If the trust in Exhibit A, that lasts only about 90 years, distributes 10% of the transfer tax savings to charities every 25-30 years, charities would receive millions of dollars. You and your heirs are simply giving to charities a small portion of the assets that would have otherwise been paid in transfer taxes.
You could require the trust to make distributions to a charity that you name in the trust, or you could permit the beneficiaries to select the charities under guidelines provided in the Dynasty Trust.
If the beneficiaries select the charity, you might require that they tour the facility they want to benefit; they meet the recipients of that charity's distributions; they understand the needs of the recipients first hand; and/or that they actively participate in the charity to whom they want distributions made.
The trust can provide each beneficiary with an opportunity to research and select some charitable beneficiaries annually. This opportunity gives the beneficiary a sense of involvement, making the process more meaningful to him or her. This process also helps each beneficiary to become involved in the community and involved in a purpose other than him/herself.
Alternatively, if you want the beneficiaries to have control over the distributions once the trust makes them, you could have the trust make distributions to an entity like a private family foundation,4 an advised fund operated by the charity itself or by a community foundation, or a supporting organization. The following briefly describes these options.
Private family foundation. If you are interested in controlling your charitable gifts, then an appropriate option for your giving from the Dynasty Trust might be a private family foundation. A private foundation is required to distribute 5% of its assets annually to charities that are either named in the governing documents or selected by the foundation directors or trustees annually. In exchange for having this control, a private family foundation is subject to additional tax requirements, such as a 2% excise tax on net investment income. Additionally, donors are subject to certain limitations that are less favorable than limitations applicable to public charities. Finally, there are some other restrictions that apply to private family foundations, such as restrictions on self dealing and some additional filing and administrative requirements.
A private family foundation provides some important non-tax benefits that are often more favorable than those afforded by other charitable giving options. In this respect, private family foundations provide a forum for parents to teach children about finances, something that seems particularly important for those children who have not earned the family wealth. Private family foundations also serve as a forum for parents to teach children how to deal with current and anticipated affluence. Families who have established private family foundations often find that these entities promote family unity and serve as a focal point of family meetings for generations into the future. You will often find that families who have foundations will comment about how working together in the foundation has made the family closer, the parents often feel more involved in their children's lives and the family members learn things about each other that they may not have otherwise known. Private family foundations serve as a means for organizing the family's charitable efforts and for regularizing the annual charitable gifts.
Many charities may not discuss private family foundations with potential or existing donors because of concerns that the family's charitable dollars will be shifted to the foundation instead of the charity. Such charities may want to re-visit this approach because donors are likely to hear of foundations from others and they are more likely to name the charity as a foundation beneficiary if the charity provided the initial education. In this respect, private family foundations must distribute at least 5% of their value annually to charity, therefore, the donor might name the charity in the foundation agreement as a recipient of some or all of this distribution. Also, charities should recognize that donors creating private family foundations typically make other outright gifts to charities, and the charity could be a beneficiary of such gifts.
Advised fund. Community foundations and other public charities typically offer donors a giving option that compares to a private family foundation called a donor advised fund.
If you are the donor of an advised fund, you, or others named by you, have the privilege of suggesting charities that should be the recipients of the advised fund. You make these suggestions or recommendations to the entity with which you established the advised fund, i.e., the community foundation or public charity. Typically these entities may receive grant requests from those charities seeking distributions from your fund, and you may be able to suggest which grant requests should be honored. While you can make such suggestions or recommendations, you cannot make a binding directive. In other words, the fund is "advised" and not directed by you. With an advised fund you, as the donor, sacrifice control over the donations in order to use the advised fund.
For giving up this control you, as the donor, receive more liberal tax treatment than you do for a gift to a private family foundation. This is because the IRS treats gifts to advised funds like gifts directly to public charities. An advised fund may appeal to you if you want to obtain expert advice on grant making and administrative services. It may also appeal to you if you don't want ultimate control over your gifts, if you want to maximize your charitable income tax deductions, or if you want a more cost-effective way to make your charitable gifts than may be available with a private family foundation. Finally, this option may appeal to you if you do not have the funds necessary to start a private family foundation, which often requires about $250,000 to be cost effective.
While a donor advised fund has some advantages over a private family foundation, most believe the major disadvantage is the loss of ultimate control, and the fact that your family cannot receive a salary as is possible if they managed the private family foundation. Thus, in deciding between a private family foundation and an advised fund, you must balance these factors and select the entity that best meets your family's desires.
Supporting organization. A third option for the charitable beneficiary may be a supporting organization. A supporting organization is a type of public charity, and therefore, it is not a private foundation. Unlike an advised fund or a private foundation, a supporting organization is indirectly public. In that respect, it is public because it supports a public organization.
If you like the benefits of a private family foundation, but want a larger income tax charitable deduction than is permitted for gifts to a foundation, you may find the supporting organization an acceptable option.
A supporting organization is organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more public charities. Alternatively, it can be established to be operated, supervised, controlled by, or in connection with, one or more public charities. A supporting organization is tied to the charities it supports. As the donor to the supporting organization, you will have less control over a supporting organization than you will with a private foundation, but in exchange you retain some control and receive a larger income tax charitable deduction for your gifts to the supporting organization than you would receive for your gifts to a private foundation. These entities provide you with more control over distributions than you would have with an advised fund.
Public charities do not seem to advertise the opportunity to establish supporting organizations. Thus, they may be missing many gifts that could otherwise support their entities.
Making charitable distributions from the Dynasty Trust may impact charities more in future years than today. Therefore, the non-tax benefits to your heirs who are trust beneficiaries may be very valuable and meaningful.
We frequently hear that the government is reducing its philanthropic support from social services to the arts and education. This shifts the burden to make up this reduction to private citizens. However, this burden may not be met if we continue our present charitable giving habits. In this respect, current studies show that bequests are minimal and that people have the financial ability to give significantly more during life than they are presently giving.
If you and your family wish to help make up this reduction, and support charities of your choice in the future, you may do so by having your Dynasty Trust distribute some of its "excess" assets to charity in amounts and at intervals that you desire. When you consider that your family is saving a maximum of 55% in transfer taxes every 25-30 years with a Dynasty Trust, you may find that sharing some of this savings with charities of your choice is acceptable. Such sharing provides your family with the necessities and luxuries you desire, while giving them a wonderful opportunity to be involved with each other and have a meaningful experience in creating a better society.
In summary, you have many options for the recipient of your charitable gifts. You should explore these with your advisor before making a selection so that you and your family maximize the tax and non-tax benefits that you desire to obtain.
Combining The Dynasty Trust With A Charitable Lead Trust
If you are interested in providing for you heirs while shifting money that would otherwise be paid in transfer taxes to charity, you may want to create a Charitable Lead Trust (CLT) that is connected with your Dynasty Trust.
A CLT is a trust that pays an annual amount to charity for a term that you select, with the trust principal then passing to a non-charitable beneficiary when the charitable term ends. In this situation, the Dynasty Trust would be the non-charitable beneficiary.
Using a CLT with a Dynasty Trust provides a great leveraging opportunity and gives you the ability to further shift assets that would otherwise be paid in transfer taxes to charity.
A popular use for a CLT is as a means to provide for the economic future of your heirs, in particular to provide them with a retirement fund. In this case, by using a CLT with a Dynasty Trust, you can give immediately to charity the assets that you would have otherwise paid in transfer taxes, while providing for the retirement of your descendants, thereby assuring that your descendants will eventually receive significant assets at a time when they may most need them.
How a CLT works. When you establish a CLT, you transfer cash or other assets to the CLT. A charity that you designate in the CLT agreement receives payments from the CLT annually for a term that you select. The payments to the charity must be a stated percentage of the CLT assets valued annually. When the term of the charitable payments ends, the remaining CLT assets are distributed to a non-charitable beneficiary that you select, in this case a Dynasty Trust that benefits your heirs in perpetuity.
When you establish the CLT, you do not receive an income tax deduction like you do with a charitable remainder trust, unless the CLT is drafted as a grantor trust. Rarely is the CLT drafted as a grantor trust because in such case the trade-off for the income tax deduction in the year the trust is established is that the grantor must report all the CLT income on his or her personal tax return in subsequent years. Therefore, the CLT is typically drafted as a non-grantor trust. The advantage with a non-grantor CLT is that you can minimize the transfer taxes on the gift your heirs will ultimately receive. This is because when you create the CLT, you are entitled to a gift tax deduction for the present value of the charity's lead interest. This value is subtracted from the value of the gift to the trust, resulting in a leveraged gift of the remainder interest to your heirs. A CLT may also be established at your death as a form of bequest, and in such case, the estate receives a similar type of estate tax charitable deduction as described for gifts.
CLTs are particularly attractive when the rate used to determine the value of the gift is low. This rate is called the IRC §7520 rate. The lower the rate, the greater the deduction for the charitable gift, and the lower the value of the remainder taxable gift to your heirs via the Dynasty Trust.
Creating a CLT is not only a way to save taxes, but is also a way to provide an immediate benefit for charity, a way to endow the charity, and permanently benefit the family.
Kiplinger's magazine (May 1999, page 20) discussed the popularity of CLTs in an article entitled "Estate Planning, The gift that keeps on giving." This article discussed that grandparents use CLTs to teach philanthropy to succeeding generations. It stated, "As teenagers or young adults, grandchildren help choose charities that will benefit from the trust. Then, when the children are in, say, their thirties, they inherit the money." The article did not discuss the benefits of combining CLTs with Dynasty Trusts, but doing so is another way to further benefit your heirs and charity.
CLTs became popular when Jackie Kennedy Onassis created one in her will. By now, most people know that the bulk of Jackie Kennedy Onassis' estate was to fund a charitable lead annuity trust. In her will, she made some specific bequests and then provided that the residue would fund the CLT. This CLT was to pay 8% annually to charity for 24 years. After 24 years, the CLT was to terminate and the balance was to pass to Mrs. Onassis' grandchildren. Under the then IRS tables used for valuing such transfers, the CLT would have permitted her to protect between 93-97% of her assets from transfer taxes. Assuming her estate was $100 million and the CLT's net return was 12% annually, this planning would have reduced her estate taxes from about $55 million to $5 million, charities would receive about $192 million, and the grandchildren would receive about $110 million.
For various reasons, this plan was not implemented. However, it continues to serve as a model of the tax benefits of a CLT. In Mrs. Onassis case, the CLT was created under her will to be effective upon her death, showing that a person who chooses not to give up assets in life can do so and still obtain significant tax deductions in a fairly simple manner.
It works just as well for the smaller estates. If you don't have a $100 million estate this technique still provides tremendous tax benefits. You can have more benefits if you use a Dynasty Trust as a remainder beneficiary instead of passing the remainder outright to your heirs, as did Mrs. Onassis. Had Mrs. Onassis named a Dynasty Trust as the ultimate beneficiary of her CLT, she may have been able to protect the assets from transfer taxes and creditors for years to come.
Whether to draft the CLT as an annuity or unitrust depends on many factors, including various growth rates. The benefits to both the family and charity can be substantially different depending on the growth rate and type of CLT used. Therefore, your attorney must do a careful analysis before making a decision. Additionally, if the CLT distributions are made to a private family foundation, the heirs may be able to manage that foundation long after the CLT terminates. This is because by law the foundation is only required to distribute a small percent of its assets annually, letting the balance significantly accumulate. Therefore, by using a private family foundation, when the CLT terminates, your heirs can continue to manage the foundation well into the future, providing a significant benefit to charities.
The Specifics of a CLT
Because you may want to use a CLT in your estate planning, the following provides some basic information about CLTs:
Payments. Unlike a charitable remainder trust, there is no requirement that the CLT pay a certain percentage of its assets to charities annually. However, the larger the amount paid to the charity and the longer the term of payment, the lower the gift tax will be on the remainder gift to your Dynasty Trust.
Additional contributions. You may make additional contributions to a charitable lead unitrust but not to a charitable lead annuity trust.
Completed gift. Properly drafted, the transfer of assets to a CLT will result in a completed gift. Your gift to the remainder beneficiary is subject to gift tax, but you will reduce that gift by the value of the payments to charity. If your gift is complete, you allocate your unified credit to this gift when you create the CLT. If you use a charitable lead unitrust, then you may allocate your generation-skipping transfer tax exemption (GST) to the remainder beneficiary at the time you fund the CLT, provided the remainder beneficiary is a Dynasty Trust or other skip person. If the CLT is an annuity trust, the GST allocation must be adjusted at the end of the CLT term.
Income taxation of CLTs. The CLT is subject to income tax, with some offsetting income tax deductions for distributions made to charity.
Non-grantor versus grantor CLT. For a purpose of this discussion, the CLT is drafted as a non-grantor trust, therefore, the trust and not the grantor is taxed on the trust income annually.
Creating a CLT. You can create a CLT to be effective during life or at death. Some factors that should be considered in deciding when to create the CLT include: 1) Do you want control of your assets until death? 2) Do you need the assets until death? 3) Do you want or need an estate tax charitable deduction? 4) Would you benefit from a lifetime gift that minimizes your gift tax?
Creating a CLT at death, rather than during life, might be appropriate if you do not want to pay estate taxes, but want control of your assets during your life.
Funding a CLT with various assets. CLTs are subject to many of the private foundation provisions contained in IRC §4940-4948. These provisions include rules regarding excess business holdings and jeopardy investments. It is important to work with these rules to maximize the benefits of a CLT. Many business owners may want to use a CLT to pass assets at a minimal transfer tax cost to heirs, and the rules must be carefully followed. Therefore, when funding a CLT with assets like the following, be sure to pay particular attention to these rules: 1) family limited partnership units; 2) publicly traded stocks; (3) privately held stocks; and 4) real estate.
A properly structured CLT will permit you to shift assets that would have been paid in transfer taxes to your heirs and/or charity. A CLT can help you transfer many assets, including a business, to your heirs at a minimal transfer tax cost. The CLT can help you provide for your heir's retirement, and if combined with a Dynasty Trust can permit you to benefit your heirs and charity for years into the future, free of transfer taxes. And, all this is permitted under our present tax system.
If your goals are to minimize transfer taxes and maximize the opportunities for your heirs, or if your goals are primarily family and charitable, then one way to wisely accomplish your goals is to include a Dynasty Trust in your estate plan. With a Dynasty Trust you can:
- Provide long-term security for your family for generations to come.
- Minimize the impact of taxes on your estate.
- Maximize what your heirs receive.
- Eliminate potential loss of assets because of a beneficiary's mismanagement or misfortune.
- Protect your assets from your beneficiaries' creditors in the years ahead.
A CLT may be an attractive feature to combine with your Dynasty Trust. This combination of estate planning tools may permit you to meet your charitable needs today, provide for your heirs in the future at a minimal transfer tax cost, and shift assets that would otherwise be paid in transfer taxes to charity.
If you want to help your heirs gain fiscal responsibility, understand how to deal with their current and anticipated affluence, and develop feelings of self-worth, permitting the Dynasty Trust to make periodic charitable distributions might accomplish these objectives.
Not only will this type of planning permit you to favor charities of your choice over the IRS, but it will let you increase your heir's social awareness, their community involvement, and help build the family relationship in perpetuity.
Congress provides you with these benefits whether your plan is effective during your life or at your death. Using a Dynasty Trust in combination with the charitable techniques discussed in this article should be viewed as a family strategy that focuses on sustaining successful wealth and charitable management, as well as personal growth over generations in perpetuity.
This article represents our understanding of current federal and state tax laws. Any changes to the laws after publication could affect its accuracy and have an impact on current Dynasty Trusts or other trust strategies. Use of the Dynasty Trust strategy should only be undertaken after independent counsel has examined the impact of all applicable laws. This article is not intended to be legal advice and should not be interpreted as such. Your attorney must provide you with legal advice on the Dynasty Trust and its benefits in your situation.
"Presto, You're a Dynasty," Hochberg, R. Mark, Financial World, January 1997.back
This is illustrative only. The drafting attorney would need to provide the correct language.back
Each day more states attempt to join the growing ranks of states that permit perpetual Dynasty Trusts.back
If you exercise this option the distributions must be carefully drafted so that they do not jeopardize any potential tax savings.back