Peer-reviewed income tax deduction strategy can deliver 3-5x wealth gains for CFPs, RIAs, and their clients

The Optimized CLAT (OCLAT) is a special version of a charitable lead annuity trust that has been designed to optimize the tax and economic benefits to the contributor. An OCLAT is ideal for persons seeking to create a “giving engine” for tax-favored philanthropy during their lifetime.

The OCLAT is unique among tax planning vehicles in its ability to:

• generate a dollar-for-dollar tax deduction in the year of funding (providing immediate tax savings);
• return an expected 1-5x of the initial contribution back to the contributor;
• immediately exempt the contributed assets from the 40% federal gift and estate tax; and
• exempt the transferred assets from the contributor’s personal creditors.

To achieve a tax deduction this year, the Optimized CLAT must be funded by December 31. The OCLAT may be funded every tax year with up to 30% of the contributor’s annual income (including capital gains from the sale of a business).

Specific benefits include the following:

Immediate Dollar-for-Dollar Tax Deduction, and Return of 1-5x Contributed Funds. Immediately upon transferring funds into the Optimized CLAT, the contributor enjoys a dollar-for-dollar charitable income tax deduction in that tax year. At the end of the “Lock-Up Period” (discussed below), the contributor can expect to receive back one to five times the amount of the initial contribution, assuming a reasonable 5-7% rate of return. (Custom financial projection model available upon request.)

Assets Immediately Exempt from Federal Gift and Estate Tax. For clients with large estates, the Optimized CLAT is designed so that:

• the contributed assets are immediately exempt from federal estate taxes (currently imposed at a 40% tax rate), and
• the contribution does not utilize any of the contributor’s lifetime gift exemption when transferred into the trust.

The Optimized CLAT assets can grow to an unlimited amount – when the assets are transferred to children or family members at the end of the Lock-Up Period, there are no gift tax or estate taxes paid on the transfer.

Assets Immediately Protected from Creditors, Bankruptcy and Divorce. Finally, upon funding the Optimized CLAT, the assets are also protected from the contributor’s creditors, bankruptcy, and, if single when trust is funded, divorce.

OPTIMIZED CLAT VS. TRADITIONAL INVESTMENT ACCOUNTS

The Optimized CLAT operates much like any other “traditional” investment account, with two main differences:

Charitable Lock-Up Period (No Withdrawals or Loans). The Optimized CLAT has a Lock-Up Period selected by the contributor (typically 15-30 years). There is no minimum or maximum term, but the longer the Lock-Up Period, the greater the expected return. During this time, the contributor:

• may invest the assets but not withdraw (or borrow) from the account; and
• must pay taxes on the CLAT’s income using funds outside of the Optimized CLAT.

Payments to Charity In Lieu of Taxes. During the Lock-Up Period, a portion of the assets must be paid from the Optimized CLAT to charities of the contributor’s choosing (including the contributor’s donor advised fund). The amount required to be paid to charities is determined at the outset based on the IRS Section 7520 “benchmark rate” in effect at the time of funding.

The IRS benchmark rate is currently near an all-time low (approximately 4%), minimizing the required payments to charity (which are fixed at the outset and not subject to interest rate changes) and maximizing the amount returned to the contributor at the end of the Lock-Up Period (any asset performance above approximately 4%).

Moreover, the IRS has approved the deferral (back-loading) of the bulk of the charitable payments until the final years of the Lock-Up Period, allowing the assets to potentially triple (or quadruple) before large charitable payments become due. Put simply, taxes are avoided this year in exchange for making donations to charity far off in the future.

30-Year Example: In August 2023, your client, Mr. Smith moved $1 million of stocks into an Optimized CLAT and elected a 20-year Lock-Up Period. He enjoyed a $1 million deduction on his 2023 tax return and will receive back $500,000 as a tax refund in April 2024 (assuming he withheld 50% federal and estate tax on $1 million ordinary income).

Based on the lowest available IRS benchmark for August 2023 (4.2%), which sets the charitable amounts, Mr. Smith must pay 2.75 times the contributed amount ($2.75 million) to charities over the 30-year Lock-Up Period (with approximately 70% of the charitable gifts paid in the final five years).

In year 30, assuming a 7.5% rate of return, 4.5x ($4.5 million) would be returned to Mr. Smith (or could be paid to his children or family members, free of the 40% gift/estate tax – an additional tax savings of approximately $1,800,000).

Conclusion. Reading this article has probably triggered the names of high-net-worth clients who would be interested in, and benefit from, this compelling opportunity to achieve substantial tax savings.

In implementing over 150 Optimized CLATs as of the end of 2022 (without a single known IRS audit), Jonathon Morrison has created collaborative relationships with dozens of tax accountants and other financial professionals, resulting in an effective team devoted to maximizing the client’s wealth, philanthropic legacy, and tax savings.