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Please Click Links to the Left to Read about the Phase 2 Benefits
The deductions from gifts to an SO will not zero-out all income taxes of the donor, but the assets can grow inside the SO with zero capital gains or income taxes. The tax advantages of an SO remain attractive even after the Pension Protection Act of 2006 put new and sometimes strict limitations on the control given to SO boards. SO trustees still have great flexibility when funding public charities but Congress has further limited the ability of SOs to benefit donors and their family members.
Possibly the most popular charitable tool is the CRT. The CRT provides four significant tax benefits. First, a donor can receive a large tax deduction when funding the CRT. Second, low basis assets sold inside a CRT will not be subject to any current income tax. Third, assets can grow tax-free inside a CRT. Fourth, a donor can take tax-favored or tax-free distributions from a CRT.
Although the CRT provides substantial income tax benefits, clients may hesitate to use the CRT because all assets will pass to charity upon death, thereby reducing the inheritance for the client’s heirs. To overcome this problem, wise advisers often combine the CRT with a TCLAT. The TCLAT and CRT are in many ways opposites of each other and therefore fully complementary. Whereas the CRT provides large income tax benefits, it will not zero-out transfer taxes. Alternatively, the TCLAT can eliminate all transfer taxes but it will not typically impact income taxes. An adviser combining these tools can show how the client can improve her current plan by reducing income taxes, eliminating estate taxes, and transferring more wealth to heirs. To help insure that heirs will receive a larger inheritance, the client establishing a CRT may use a portion of the tax savings to fund an insurance policy in an ILIT.
One of the most intriguing zero-tax planning tools is the Inter Vivos Grantor Lead Annuity Trust. This trust can minimize both transfer taxes and income taxes. Because of this tremendous tax avoidance potential, tax planners have long referred to the Inter Vivos Grantor Lead Annuity Trust as the Super CLAT.
The Super CLAT has one large drawback that has limited its use. Although the trust can generate large income and transfer tax deductions, the tax savings are often offset by the taxes that the grantor must pay on the income generated by the trust. To minimize or avoid this tax on the income, the grantor must fund the Super CLAT with assets that generate tax free income. Suitable assets include high yield municipal bonds, derivative securities, private placement variable universal life insurance, and leveraged real estate with tax sheltered rental income. Pools of such assets can be designed to pay income to charity for a period of years while still offering enough appreciation potential that heirs can receive a substantial benefit tax-free at the end of the trust term.
Advisers Should Integrate Tax Planning Tools Using a Wealth Optimization Process
To optimize the basic, leveraged, and total wealth control plans described above, the adviser can use portfolio optimization software and estate optimization software to create a wealth optimization plan. As the adviser moves the client through the planning process, the client should see progressively greater cash flow and/or wealth transfer benefits attendant to upgrading from the basic plan to the leveraged plan and then to the total wealth control plan or, ideally, a wealth optimization plan.
Although a taxpayer could significantly reduce taxes using just one of the tax planning tools discussed in this article, great synergy develops as the adviser combines planning instruments. For example, high cash flow from some planning tools may offset low cash flow on other tools or large tax write-offs from some growth-oriented investments may offset taxable income on liquidating assets. As the adviser combines complementary legal and financial tools and analyzes how the combined tools impact financial statements, the client typically sees much more capital accumulating for family and favorite causes. Clients see that they should pursue fully-integrated wealth optimization planning because the whole is greater than the sum of the parts.
The performance of the ten legal tools discussed above depends greatly on how each is designed. A planner cannot know how to establish the duration, payout, and other variables for a particular tool without taking into account design terms for all tools in a client’s plan. This process of developing interrelated design specifications is known as estate optimization.
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Voorhees Family Office Services, Inc.
650 Town Center Drive, Suite 890, Costa Mesa, CA 92626
Phone: (800) 447-7090 • Fax: (866) 447-7090
©Tim Voorhees, 2002-2017 |
