This summer in Deal there seemed to be more fund raising events than ever before. I couldn’t help but notice there were some people donating mega amounts of money to just about every worthwhile charity that came along (and there were lots of them).

Donating money is about the love of giving and, to a much lesser degree, about the tax breaks. Charitable contributions impact two of everyone’s favorite tax systems: income taxes and transfer taxes (gift and estate). In general, cash donations can be deducted from income taxes up to 50% of adjusted gross income (AGI), with any excess carried over for five years. There is, however, a 100% deduction against gift and estate taxes for contributions to qualified charities. For those not familiar with transfer taxes, it is basically a 50% gift or estate tax above exclusion amounts outlined through the year 2011.

A person of means could just keep giving out of their cash flow and get the current income and transfer tax benefit. While this is a plan, it is not really a well thought out one. Chances are that the assets that created the wealth for giving will be ultimately taxed at 50% at death in 120 years. There are lots of wonderful planning ideas that could be recommended to the wealthy, charitably-inclined individual. The following scenario looks at one particular strategy that works really well for the guy with lots of money to give and lots of assets to protect him from estate taxes.

The Charitable Lead Annuity Trust (CLAT) 
Take the case of our old friends SY LLC (Salim and Yosef). The last time we checked in with them (IMAGE, August, “Real Estate 101”) they bought their first building. Since then, they have gone on to accumulate an enormous real estate portfolio. Salim is a particularly generous person; he just can’t say no. In fact, last year he donated $100,000, roughly the net cash flow from one of his buildings. The building’s current value is $1,250,000. Salim is not concerned about cash flow for his wife and children, as he has other income assets for personal consumption. He is, however, concerned about losing half the value of the building to estate taxes.

Salim is now 50 years old. He transfers the building valued at $1,250,000 to a Charitable Lead Annuity Trust (CLAT). The trust provides that the charities of his choice will receive a $100,000 donation for the next 22 years. The IRS calculates that if $100,000 is given to charity for 22 years, the full amount of the building ($1,250,000) will be available for immediate income tax deduction. The rule states that an income tax deduction is available for charitable contributions of up to 50% of adjusted gross income (AGI). Any amounts that cannot be deducted immediately can then be carried forward for future deduction over the next five years. If Salim’s AGI is $420,000 a year for the next six years, he can deduct the full $1,250,000. Now that’s a substantial planned income tax deduction.

However that is just half the benefit. Due to the relationship between the cash flow, principal, length of term, and assumed interest rate, there will be no gift taxes to be paid at the outset of the trust. In other words, at the end of the trust, this asset will pass gift-tax-free to beneficiaries of Salim’s choice. In this case, he names his children as remainder-man beneficiaries of the trust. The value of the building however has been growing at 4% per year during the 22 years it has been in the trust. The building will be worth $3,000,000 at the end of the trust to the kids. This full value passes income- and gift-tax-free to his heirs. There is one catch though, since this is a trust for a term of years—Salim must survive the trust. In this case, $3,000,000 of life insurance is put into force on Salim’s life.

Instead of using a term of years, Salim’s life expectancy could be used with similarly favorable results. Salim gets an immediate income tax deduction of $1,190,000 (subject to the 50% of AGI with carry over rules). There would be a small gift tax due at the inception of $60,000 that would be covered by his $1,000,000 life time exemption. Salim would also buy a life insurance policy to protect the future cash flow of his favorite charity when the trust payments cease.

This is undoubtedly an exciting bit of charitable planning. An asset has yielded a maximum of income tax deductions while passing gift/estate-tax-free to heirs. All this has been accomplished while benefiting the main objective of donating to worthwhile charities. There are, however, numerous other advanced charitable concepts that can be employed with varying degrees of tax efficiency. In future articles, other charitable income/estate tax designs will be enumerated.
Happy giving!
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Morris is the principal owner of Morris J. Mizrahi LLC, an estate planning company.

This information should not be interpreted as specific legal advice. Individuals are directed to seek the guidance of personal legal and tax counsel, for it is only upon their advice that any final course of action should be based.