1 the role of life insurance in grats, idgts, qprts, cruts, and other four-letter words presented...

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The Role of Life Insurance inGRATs, IDGTs, QPRTs, CRUTs,

and Other Four-Letter Words

Presented by:Julius H. Giarmarco, J.D., LL.M.

Giarmarco, Mullins & Horton, P.C.101 W. Big Beaver Road, 10th Floor

Troy, Michigan 48084(248) 457-7200

[email protected]

Sponsored by:

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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this presentation is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

IRS Circular 230 Disclosure

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Preface

The federal estate tax is only vulnerable to lifetime gifting.

And there are generally three types of gifts clients can make: Gifts of life insurance. Gifts that shift or reduce value. Gifts to charity.

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Estate, Gift, and GST Taxes

YearEstate Tax Exemption Basis Method

GST Tax Exemption

Top Estate/GST

Tax RateGift Tax

ExemptionTop Gift Tax

Rate

2009 $3,500,000 Step-up in basis $3,500,000 45% $1,000,000 45%

20101

- 0 - Modified carryover basis

- 0 - 0%

$1,000,000 35%

$5,000,000 Step-up in basis $5,000,000 35%

20112

$5,000,000 Step-up in basis $5,000,000 35% $5,000,000 35%20123

2013 $1,000,000 Step-up in basis $1,000,0004 55% $1,000,000 55%

1 The Tax Relief Act of 2010:• For individuals who died in 2010:

Tax the decedent’s assets at 35%, after estate tax exemption of $5 million and receive a “stepped up” income tax basis equal to fair market value at death.

Alternatively, elect out of the estate tax regime, no estate tax is assessed and modified carryover basis rules apply in determining recipients’ income tax basis in the assets.

2 Beginning in 2011, introduction of the portability of the estate tax exemption between married couples (Note: not applicable to GST tax exemption).

3 Estate, GST, and gift tax exemptions are indexed for inflation in 2012.4 Indexed for inflation ($1.4M estimate).

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Transfer of wealthexcluded from

any gift tax

Transfer of wealththrough GST, estate,

and gift tax exemptions

Transfer of wealthutilizing discount

strategies

Transfer of wealthutilizing freeze strategies(appreciation-only gifts)

Transfer of wealththrough

taxable gifts

AnnuallyOver Lifetime

• $13,000 per individual ($26,000 gift splitting with spouse) per donee

• Direct payments to educational institutions and health care providers1

• Irrevocable life insurance trusts (ILIT)2

Wealth Transfer Strategies

• Gift tax exemption of up to $5M per individual

• GST and estate tax exemptions of $5M per individual3

• Generation-skipping transfer trust (GST)

• Family limited partnership (FLP)

• Family limited liability company (FLLC)

• Non-voting shares in family corporation (C or S corporation)

• Grantor retained annuity trust (GRAT)

• Intentionally defective grantor trust (IDGT)

• Qualified personal residence trust (QPRT)

• Intra-family loan

• Statutory freeze partnership (FLP or FLLC)4

• Pay gift tax now rather than paying estate tax later

• Converting traditional IRA to Roth IRA5

Charitable planning:

1 To qualify for exclusion, gifts (a) of tuition must be made directly to the educational institution; and (b) for medical expenses must be made directly to the health care provider.

2 Often can be structured to use annual exclusion gifting.3 In 2011, an estate is taxed at a top rate of 35% with a $5 million estate tax exemption and a $5 million GST tax exemption.4 Can serve to both utilize discount and transfer wealth utilizing freeze strategies.5 Paying the income tax in converting a traditional IRA to a Roth IRA is essentially a gift tax-free gift.

CRTs and CLTs.

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Dynasty Trust – Overview of Technique

Dynasty Trust

Discretionary Distributionsto Children for Life

Discretionary Distributions to Grandchildren for Life

Discretionary Distributionsto Great-Grandchildren

for Life

Future Generations

Grantor

Advantages•Creditor protection•Divorce protection•Estate tax protection•Dispositive plan protection•Spendthrift protection•Consolidation of capital

Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion

No transfer tax paid.




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1. Value of estate is $10,000,000. 3. One generation = 30 years.2. After-tax growth rate of 4%. 4. Federal Estate Tax = 35%.

Dynasty Trusts

Children’s Inheritance$10,000,000

Dynasty Trust

Grandchildren’sInheritance$32,433,975

Great-Grandchildren’s Inheritance$105,196,274

Non-Dynasty Trust


Great-Grandchildren’sInheritance$44,445,424


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Dynasty Trust vs. 35% Estate Tax Every 30 Years

$1 MillionAfter-Tax Growth

Value of Dynasty Trust After 120 Years

Value of Property if No Trust

3.00% $34,710,987 $6,196,128

4.00% $110,662,561 $19,753,959

5.00% $348,911,561 $62,282,970

6.00% $1,088,187,748 $194,248,314

7.00% $3,357,788,383 $599,386,213

8.00% $10,252,992,943 $1,830,223,321

9.00% $30,987,015,749 $5,531,375,980

10.00% $92,709,068,818 $16,549,148,216

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ILITs

Life Insurance trusts remain a key planning tool.

Increased exemptions provide additional opportunities.

ILIT will typically be designed as both a grantor trust and a generation-skipping trust.

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ILITs

Large premium cases: ILIT may not have enough Crummey beneficiaries

to cover premiums. Grantor may not have any unused gift tax

exemption to cover premiums.

What is the exit strategy for: Split-dollar plans. Premium financing arrangements.

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1. Amount of life insurance is $20 million.

2. Total premiums paid = $2 million.

3. Grantor allocates $2 million of his/her $10 million GST exemption.

4. This leaves Grantor with $8 million of GST exemption remaining.

5. Growth rate after taxes is 4% annually.

6. One generation = 30 years.


Dynasty Trust


Great-Grandchildren’s Inheritance$294,549,567

Great-Great-Grandchildren’s Inheritance$955,341,332

ILITs: Leveraging the GST Exemption

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Family Limited Liability Company(“FLLC”)

FLLC

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FLLC

Donor can maintain control and management of investment assets (by retaining the voting membership interests).

Creates otherwise unavailable minority and marketability discounts for estate and gift tax purposes.

Protects investment assets from creditors or ex-spouses of members because “charging order” is sole remedy of creditors.

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ReceiveVoting Interests

&Non-Voting Interests

Contribute Assets

Parents

(Members & Managers)

FLLC

Governed by Operating Agreement

Gift/SellNon-Voting

Interests

ILIT(Member)

FLLC

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FLLC

FLLC’s assets protected from claims against individual members

Income retained in FLLC or allocated among members

based on percentage interests.

Gifts are easily made; reduce parent’s estate;

and may qualify for valuation discounts.

Parents/Managers ILIT

FLLC

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Grantor RetainedAnnuity Trust

(“GRAT”)

GRAT

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How Does a GRAT Work?

Grantor transfers assets to an irrevocable trust. Annual annuity paid to Grantor for a term of

years (in cash or in kind). With zeroed-out GRAT, the value of the

annuity = the value of the initial gift. Assets remaining at end of term pass –

tax free – to remainder beneficiary.

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What are the Advantages of a GRAT?

Statutory technique.

Suitable for persons with substantial estates and growth assets.

Remainder beneficiary can be an ILIT.

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What are the Advantages of a GRAT?

Permits tax-free gifts to beneficiaries. Tax-free gift of appreciation in excess of IRC

Section 7520 rate. Grantor’s payment of GRAT’s income taxes is

a tax-free gift to the beneficiaries. No risk of unintended gift tax.

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GRAT: 10-year term

Grantor (age 65): $5 million

Gift = $3.21

GRAT Value:$5 million

Children or ILIT

Remainder transferred to ILIT:

Assumptions:

12% return: $4,545,22410% return: $2,993,239 8% return: $1,727,268

Section 7520 Rate = 2.4%

Contribution of Assets

Annual Annuity Distributions (12.5%)

Remainder after10 years

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GRAT Drawbacks

Grantor must survive the GRAT term. Use an ILIT to “bullet proof” a GRAT.

Assets must outperform the IRC Section 7520 rate.

Cannot allocate GST exemption until end of GRAT term.

Congress may eliminate short-term GRATs. Practical downside is transaction costs only.

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Installment Sale toIntentionally-Defective

Grantor Trust(“IDGT”)

IDGT

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IDGT

An IDGT is a type of trust where all income earned by the trust is taxed to the grantor because the trust is considered “defective” for income tax purposes, but “effective” for estate and gift tax purposes.

Defective nature of trust also allows for a “tax-free” gift to the trust’s beneficiaries when grantor pays income taxes otherwise attributable to the trust or its beneficiaries.

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Installment Sale to an IDGT – Summary of Technique

Grantor sells an appreciating asset to an IDGT in exchange for an installment note.

For estate tax purposes the grantor should make an initial gift (at least 10% of the total transfer value) to the trust.

To the extent that the growth rate on the assets sold to the IDGT is greater than the interest rate on the installment note, the “excess” is passed on to the trust beneficiaries free of any gift, estate and/or GST tax.

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Installment Sale to an IDGT – Summary of Technique

No capital gains tax is due on the installment sale to the trust because the trust is “defective” for income tax purposes.

IDGT’s basis in the assets is Grantor’s carry-over basis.

Interest income on installment note is not taxable to the grantor because the trust is “defective” for income tax purposes.

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Sale to an IDGT

Grantor/Insured

IDGTLife

Insurance Company

1. Gifts $5M of LLC Non-Voting Interests

2. Sells $45M of LLC Non-Voting Interests (No Capital Gain Tax)

5. Excess Cash Flow / Premiums

6. Death Proceeds (Income and Estate Tax Free / Leverages GST Exemption)

3. $45M Note to Grantor Balloon Payment in 9 Years

4. $1,098,000 annual interest (Interest Rate 2.44%)

Advantages:

• Value of assets sold frozen at 2.44% for nine years (assumed mid-term AFR).

• Grantor’s estate further reduced by the income taxes paid on behalf of the trust.

• The trust property escapes estate taxation for as long as permitted under state law.

• Possible valuation discounts for non-voting interests.

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Low Interest Rate Loan to IDGT

Grantor/Insured

IDGTLife

Insurance Company

1. Gifts $5M

2. Loans $45M

5. Excess Cash Flow / Premiums

6. Death Proceeds (Income and Estate Tax Free / Leverages GST Exemption)

3. $45M Note to Grantor Balloon Payment in 9 Years

4. $1,098,000annual interest (Interest Rate 2.44%)

Advantages:

• Value of loan proceeds frozen at 2.44% for nine years (assumed mid-term AFR).

• Grantor’s estate further reduced by the income taxes paid on behalf of the trust.

• The trust property escapes estate taxation for as long as permitted under state law.

• Possible valuation discounts for promissory note in grantor’s estate.

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Grantor Trust vs. Non-Grantor Trust

NON-GRANTOR TRUST GRANTOR TRUST

YearBeginning Balance

Taxable Income

7%

Less: Taxes at

40%Ending Balance Year

Beginning Balance

Taxable Income

7%

Less: Taxes at

40%Ending Balance

1 $10,000,000 $700,000 $(280,000) $10,420,000 1 $10,000,000 $700,000 $ - $10,700,000

2 10,420,000 729,400 (291,760) 10,857,640 2 10,700,000 749,000 - 11,449,000

3 10,857,640 760,035 (304,014) 11,313,661 3 11,449,000 801,430 - 12,250,430

4 11,313,661 791,956 (316,783) 11,788,835 4 12,250,430 857,530 - 13,107,960

5 11,788,835 825,218 (330,087) 12,283,966 5 13,107,960 917,557 - 14,025,517

6 12,283,966 859,878 (343,951) 12,799,892 6 14,025,517 981,786 - 15,007,304

7 12,799,892 895,992 (358,397) 13,337,488 7 15,007,304 1,050,511 - 16,057,815

8 13,337,488 933,624 (373,450) 13,897,662 8 16,057,815 1,124,047 - 17,181,862

9 13,897,662 972,836 (389,135) 14,481,364 9 17,181,862 1,202,730 - 18,384,592

10 14,481,364 1,013,695 (405,478) 15,089,581 10 18,384,592 1,286,921 - 19,671,514

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Installment Sales to an IDGT - Example

Assumptions

FMV of Assets Sold to IDGT $ 1,111,100

Gift to Trust $111,100

Interest Rate (Mid-Term AFR) 2.33%

Terms (Years) 9

Payment Structure $111,100 Down Payment with Gift, Balance Interest-Only w/Balloon Payment

Payment Period Annually

Timing of Payments End of Period

Year Beginning Balance

Income10.00%

Installment Payment

Ending Balance

1 $1,000,000 $100,000 $ (23,300) $1,076,700

2 $1,076,700 $107,670 $ (23,300) $1,161,070

3 $1,161,070 $116,107 $ (23,300) $1,253,877

4 $1,253,877 $125,388 $ (23,300) $1,355,965

5 $1,355,965 $135,596 $ (23,300) $1,468,261

6 $1,468,261 $146,826 $ (23,300) $1,591,787

7 $1,591,787 $159,179 $ (23,300) $1,727,666

8 $1,727,666 $172,767 $ (23,300) $1,877,133

9 $1,877,133 $187,713 $ (1,023,300) $1,041,546

Amount passing to beneficiaries free of estate and gift tax

And income tax on trust income is paid by grantor as additional “gift” without gift tax

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IDGT vs. GRAT

No mortality risk with IDGT. Can allocate GST exemption to seed gift. Mid-term AFR is less than Section 7520 rate. Back-loading (i.e., interest only with balloon

payment vs. level annuity payment). Not a statutory technique. Possibility of unintended gift tax, which may be

mitigated by using a “defined value” clause.

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Qualified PersonalResidence Trust

(“QPRT”)

QPRT

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QPRTs

Increased popularity in light of enhanced gift tax exemption and reduced fair market value of residential real estate.

Potential for large estate tax savings. Very low tax risk: statutory technique. Relatively easy to implement and administer.

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QPRT: Personal Residence

Primary residence. Vacation residence. Fractional interest in a residence. No more than 2 residences at a time. Rental property or commercial use not

permitted. Mortgaged property complicates the planning. Some surrounding land permitted, but not too

much.

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How Does a QPRT Work?

Grantor makes a gift of the residence to a trust.

Grantor retains right to occupy the residence during the QPRT term.

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Grantor is entitled to 2 key discounts to current FMV: Cost of waiting: Beneficiaries must wait to receive

the residence (when the QPRT term expires). Possibility of reversion: Grantor retains the “right to

get the residence back if he/she dies before the QPRT term ends.

These discounts can result in substantial reductions to current FMV.

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Grantor can continue to occupy the residence following the QPRT term, though the Grantor will have to pay FMV rent.

Grantor continues to receive tax deductions for property taxes and remains eligible for exclusion from gains tax on resale (if primary residence).

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QPRT: Tax Benefits

No gift tax consequences unless Grantor has already used up his/her $5 million lifetime gift tax exemption.

All appreciation is out of the Grantor’s estate for estate tax purposes.

Any rent the Grantor pays after the QPRT term is out of his/her estate for estate tax purposes.

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QPRT: Tax Benefits

If residence in a grantor trust at end of term, the rent payments will not be subject to income taxes.

There could be property transfer tax consequences at end of QPRT term.

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QPRT: Drawbacks

Grantor must survive the QPRT term. Use an ILIT to “bullet proof” a QPRT.

The QPRT is an irrevocable trust – there may be no commutation.

May use some or all of Grantor’s lifetime gift tax exemption.

Grantor may have to rent the property back at end of QPRT term.

Cannot allocate GST exemption until end of QPRT term

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Grantor QPRT

Residence

Rent Free Right of Use of Residence for 15 Years

Childrenor ILIT

After Expiration of Selected

Term of YearsGrantor’s Age 70FMV of Residence $1,000,000FMV in 15 years at 5% growth $2,079,000Term of QPRT 15 Years

Initial Gift $295,820FET Savings (35%) $624,088§7520 Rate 3%

QPRT

ASSUMPTIONS:

RESULTS:Grantor

Pays

Rent

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Charitable Remainder Unitrusts(“CRUTs”)

CRUTs

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CRUTs: Common Features

Grantor transfers assets to an irrevocable trust.

No capital gains tax on the sale of appreciated assets by the trust.

Grantor and spouse are lifetime beneficiaries of the trust.

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Charities named by grantor are remainder beneficiaries of trust.

Grantor and/or grantor’s spouse can be the trustees of the trust.

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Trustee can control timing and amount of income distributions to grantor and grantor’s spouse.

Trust assets are protected from creditors. Grantor receives a charitable income tax

deduction (of at least 10%) based on the present value of the remainder interest.

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Assets in trust are excluded from grantor’s and grantor’s spouse’s gross estates.

Life insurance “replaces” the assets passing to charity with premiums paid for out of the tax savings.

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CRUTs: Common Uses

To diversify low basis/low yield investments.

To sell an asset without a capital gains tax.

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CRUT Diagram

Donor (Age 70)

CRUT2% growth / 6% income

Charity

$1,000,000 Property$100,000 Cost Basis

Income tax deduction

$529,380

Gain not taxed

$900,000

First year payment

$50,000

Total Payments (14 yrs)

$854,600

IRC Section 7520 Rate

3.4%

At Donor’s Death (14 years)

Remainder to Charity

$1,513,600

5% Unitrust

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GRANTOR

Life Insurance /

Dynasty Trust for

benefit of heirs

Tax savings from income tax deduction; and increased cash flow from not paying capital gains taxes.

Annual Gifts

CRUTWealth Replacement with Insurance

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NIM-CRUTs

A Net Income with Makeup Charitable Remainder Trust or NIM-CRUT is a type of CRUT where a fixed percentage (minimum of 5%) of the annual value of trust assets is credited to the income beneficiary.

If the net income is less than the fixed percentage, then any deficiencies are "made up" in later years when trust income exceeds the required set percentage amounts for such years.

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NIM-CRUTs

If there is insufficient income to meet the payout, the income beneficiary must wait until sufficient income exists.

Until such time however, the income beneficiary's "make-up account" will continue to build.

Once income is sufficient, the income beneficiary will be entitled to the entire buildup in the "make-up account."

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FLIP-CRUTs

In its initial phase, a FLIP-CRUT acts like a NIMCRUT and only distributes the trust's accounting income to the income beneficiaries.

In the second phase, following the occurrence of a predetermined triggering event, the trust switches, or "flips," to a standard CRUT and pays out a fixed percentage of the trust's annual fair market value.

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FLIP-CRUTs

The triggering event must be defined in the trust document. For example, the triggering event may be a date specified in the trust, or (most commonly) the sale of an unmarketable asset.

NIMCRUTs and FLIP-CRUTs can solve the problem of funding a CRUT with a non-income producing asset by limiting the requirement for income distributions to times when the trustee has the capacity to make them.

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FLIP-CRUTs

Further, NIMCRUTs and FLIP-CRUTs provide planning opportunities for those income recipients who wish to defer income distributions.

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i-CRUTs

The “i-CRUT” is a “Flip-CRUT” that is funded with a life insurance policy on the life of the donor(s).

In the iCRUT context, a “flip” is never used unless there is an emergency need for funds.

The flip would occur upon the sale of the policy.

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i-CRUT Advantages

Life InsuranceStrategy

Tax Deductible Premiums?

Access to Cash

Value?

Ability to Change Charity?

Protection from

Personal Creditors?

Protection from

Charity’s Creditors?

Personal-Owned

No Yes Yes No Yes

Charity-Owned

Yes No No Yes No

Foundation-Owned

Yes No Yes Yes Yes*

iCRUT Yes Yes Yes Yes Yes*

*While assets remain undistributed.

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i-CRUT Support: PLR 1999-15045

Husband acquired a single premium life insurance policy on his wife’s life and then transferred the policy to a bank as trustee of a one-life NIM-CRUT for his stepdaughter. The policy was the sole asset of the trust. The trust “passed” as a non grantor trust because

all contributions to and distributions from the policy were to be allocated to trust principal.

Important because CRTs cannot be grantor trusts.

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Husband transferred a life insurance policy on his life and other assets to a two-life NIM-CRUT for himself and his wife. The NIM-CRUT “passed” as a non grantor trust for the same reason as in PLR 1999-15045.

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The trustee of a two-life NIM-CRUT proposed to sell appreciated real estate held by the trust and to reinvest the sale proceeds in a life insurance policy on the lives of the donors.

The IRS approved but warned that: income earned on money borrowed from the policy

would be debt-financed income;

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the transaction would not be a violation of the “trustee must be able to invest to realize income” rule of regulation 1.664-1(a)(3);

the payment of premiums is not a violation of the “no other payee” rule of regulation 1.664-3(a)(4), if for full and adequate consideration; and

the policy will not be a jeopardy investment under section 4944, if the death benefit will be greater than the cumulative premiums.

No analysis of the grantor trust question was made.

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Husband funded a 1-life NIM-CRUT for his wife with a life insurance policy on his life. Husband paid the premiums directly to the insurance company. The IRS approved, even allowing an income tax deduction for the present value of the remainder interest portion of the premiums paid directly to the insurance company. No analysis of the grantor trust question was made.

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i-CRUT Variation

An iCRUT need not be for the life of the donor(s) alone.

Consider adding the next generation as successor beneficiaries to make a “stretch-iCRUT”.

A substantial gift to charity is still made, but not before all members of the next generation have first passed away.

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Charitable Lead Annuity Trusts (“CLATs”)

CLATs

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CLATs

The grantor transfers property to a trust for a term of years.

The grantor receives an up front income and gift tax deduction (but must include income in later years).

The trust pays an annuity interest to a charity for the term.

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CLATs

The remainder interest will go to the grantor’s heirs or to an ILIT.

If asset growth rate exceeds the Section 7520 rate, the trust may receive a significant interest.

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CLATs

CLATGrantor

Grantor’sFoundation

and/orSelected Charities

$5,862,000

Under different growth assumptions, the heirs or ILIT may receive the following:

12% $5,242,00010% $3,626,000 8% $2,303,000

Heirsor

ILIT

$5,000,000 of Assets to Lead Trust

Year 10: Assets pass to heirs or ILIT

Value of Remainder Interest = $-0-

Charitable Deduction = $5MNo taxable gift.

11.724% Annuity streamto selected charities

§7520 rate =3%

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The Shark Fin Charitable Lead Annuity Trust

The Shark Fin CLAT is a CLAT that guarantees a charitable gift through purchase of a life insurance policy.

Donor receives charitable income tax deduction.

Charity receives: During donor’s lifetime – annual income stream. At donor’s death – large lump-sum payment.

At donor’s death – heirs receive remaining trust assets.

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How Does a Shark Fin CLAT Work?

Donor has an income recognition event (i.e., a Roth conversion).

Donor gifts an asset to the trust. Donor receives a substantial charitable income

tax deduction (usually 50% - 80%). 30% adjusted gross income (AGI) limit. 20% AGI limit for private charity or gift of capital

gain property. 5-year carry-forward.

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Donor’s gift to the trust is taxable gift that is reduced by the amount of the charitable deduction (same value as the income tax deduction.

The taxable gift can be offset by applying Donor’s lifetime gift tax exemption ($5 million per individual in 2011 and 2012).

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A portion of the Shark Fin CLAT’s assets are used to purchase a municipal bond to provide an annual payout to charity. Generally, 10%-15% of the donated assets go

towards the purchase of an income-producing asset.

Municipal bonds make a viable option for annual payment to charity due to their federal income tax-free nature.

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For maximum leverage, the majority of the CLAT’s assets are used to purchase a single premium life insurance policy on the grantor’s life. The CLAT is the owner, premium payer and

beneficiary of the life insurance policy. Upon the death of the insured, the CLAT pays out

the final charitable contributions. Remainder of death benefit and other trust assets

are paid to the remainder beneficiaries and the CLAT terminates.

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Why Life Insurance?

Life insurance inside a Shark Fin CLAT offers multiple advantages. Provides a guaranteed amount for the charity and

the donor’s family. Gives the donor’s family tax-free insurance policy

benefits. Provides charity with final payout that is liquid.

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Summary

Benefits to the grantor: Current income tax deduction. Leverage assets to pass on wealth to heirs through

purchase of life insurance. Minimize estate taxes. Benefit charity of choice.

Benefits to the charity: Annual income. Large, liquid lump-sum gift at death of insured.

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IRA or 401(k) orRoth Conversion

$1 million Withdrawal

Income Tax Liability $350,000

The Shark Fin CLAT

The figures above are for illustrative purposes only and not guarantees.

Grantor/InsuredAge 68

L-CLAT$100,000 in muni-bonds

$900,000 premium for a $4.2 million life insurance policy.

Charity Heirs

Charitable Deduction = $847,000Taxable Gift = $153,000

$1 million Contribution

$1.5 million at end of trust term

$5,000 per year

$2.7 million from life insurance.Plus balance of muni-bond account at end of trust term.

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Technical Support for Shark Fin CLATs

The Shark-Fin CLAT dates back to July 16, 2007, when the IRS indicated in its safe harbor CLAT forms (Rev. Proc. 2007-45) that the CLAT annuity need not be fixed, nor limited in its annual increase, but merely ascertainable.

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Shark Fin CLAT Issues

Charitable Split Dollar Violation?

Yes, because read literally, the statute disallowing charitable split dollar applies to the Shark Fin CLAT with no explicit exceptions as are made for CRTs (170(f)(10)(C) & (E)) and for CGAs (170(f)(10)(D)).

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Charitable Split Dollar Violation?No, because read literally, the statute disallowing charitable split dollar would also apply to ILITs with charities as beneficiaries, and because the legislative history (and informal IRS comments) suggest that the IRS did not have CLATs in mind since, unlike charitable split dollar, the sole owner and beneficiary of the policy is the CLAT and, also unlike charitable split dollar, charity is guaranteed to benefit, potentially at the complete expense of the grantor’s family.

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Charitable Split Dollar Violation?

Planning idea: Avoid the question by transferring a paid-up policy to the CLAT (subject to the 3-year rule).

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Increasing CLAT annuity allowed?

No, because analogous GRAT regulations (1992) allow no more than a 20% annual increase in the annuity per year; because the CLAT regulations do not explicitly allow it; and because the Code (1969) allows no variation in CRAT annuities.

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Increasing CLAT annuity allowed?

Yes, because the GRAT regulations apply only to GRATs; because the CLAT regulations do not explicitly disallow it; because the Code provision applies only to CRATs; and because Rev. Proc. 2007-45, the IRS’s latest pronouncement specifically on CLATs (2007), does allow it.

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Minimal annuity allowed?

No, because CRATs are not allowed de minimis payments (rather 5% minimum); and because the preamble to the analogous GRAT regulations explicitly prohibits balloon payments for GRATs.

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Minimal annuity allowed? Yes, because CLATs (taxable trusts) have never been subject to a minimum payment requirement like CRATs (tax-exempt trusts); because the GRAT preamble came at a time when the IRS thought that zeroed-out GRATs were not possible; because GRATs differ in that GRAT failure returns all the assets to the grantor, while CLAT failure returns none of the assets to the grantor or his family; because the GRAT regulations do not apply to CLATs; and because if the IRS wanted to restrict in this way, it could have done so in Rev. Proc. 2007-45.

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Shark Fin CLAT Critics

Richard Fox, J.D., Head of Philanthropic and Nonprofit practice at Dilworth, Paxson, LLP, Philadelphia, PA, and author of Thomson Reuters/Warren, Gorham & Lamont treatise, Charitable Giving: Taxation, Planning and Strategies.*

Mark Teitelbaum, Vice President of advanced markets for AXA and Assistant Editor of the Journal of the American Society of Financial Service Professionals.*

*Co-authors of Validity of “Shark-Fin CLATs” Remains in Doubt Despite IRS Guidance, Steve Leimberg’s Charitable Planning Email Newsletter – Archive Message #162, September 21, 2010.

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Shark Fin CLAT Supporters

Transamerica Life Insurance Co. (Enhanced Charitable Lead Trust or “ECLAT”).

David Pratt, Partner, Proskauer, Boca Raton, FL** Scott Goldberger, Member, Proskauer, Boca Raton,

FL** Paul S. Lee, National Managing Director, Bernstein

Global Wealth Management

**Co-authors of Defense of iCLAT: Biting Back: Responding to the Attack on Shark-fin CLATS, Steve Leimberg’s Charitable Planning Email Newsletter – Archive Message #163, October 5, 2010.

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