Using Charitable Trusts with Stock Options


The numbers don’t lie: Americans are very charitably inclined people. The U.S. has ranked at the top for charitable giving over every country for the last 10 years. So, it should come as no surprise that a number of our clients have participated or plan on participating in philanthropy. For those with pre-IPO stock, the possibilities are even more profound.

The type of charitable vehicle to use varies with a person’s goals and how much they are looking to set aside for their preferred causes. For those looking to give a million dollars or more, a private foundation can make a lot of sense. For those who want to donate a few thousand dollars, a donor-advised fund (DAF) will do the trick. But for those who are looking to do something in-between, a charitable trust may be the best choice.

Charitable trusts come in all shapes and sizes, but there is value in bifurcating the category into two: charitable remainder trusts (CRTs) and charitable lead trusts (CLTs). In this article, we are going to focus on CLTs. A CLT gives the charity an annual gift over a term of years, and then the corpus of the trust transfers to a person.


Charitable Lead Trusts (CLTs)

There are two types of CLTs: grantor and non-grantor. The grantor CLT allows for the person making the gift to get a big tax deduction up front, and then get the assets back at the end. Sound too good to be true? Well, there is a catch. The grantor must pay income taxes on the interest, dividends, and capital gains generated from the trust despite the fact that they are not actually receiving any cash. This may seem like a deal breaker, but it can be bent in the taxpayer’s favor.

In addition to the capital gains being distributed, the capital losses are also distributed. So, if the grantor has other gains they are trying to deal with from long-term stock positions, incentive stock options (ISOs), or gains from real estate, they can generate losses inside of the trust and use them in the current year. Depending on the state, this loss may be worth 36% in after-tax dollars. On the other hand, if a stock portfolio pays around 2.5% as dividends, that will show up on the grantor’s tax return, as well.

Besides the tax losses that can be harvested, there is also a lump sum tax benefit. A grantor CLT allows for a massive tax deduction up front based on the present value that the charity will receive. The deduction is calculated by figuring out the expected amount that will go to charity via the income stream.

The value of the income stream is derived from a formula based on IRS regulations, which calculates the deduction. The formula has three main components: the term of years of the trust, the amount put into the trust, and the expected rate of return. The only thing the taxpayer doesn’t have control over is the expected rate.

All expected rates of returns are set by the Applicable Federal Rate (AFR). The AFR is published by the IRS every month. For a CLT, if the rate of the return is expected to be high, that means the grantor is likely going to receive a bigger sum when the trust terminates. The result is a lower deduction in the current year. The opposite is true for when interest rates are lower; the lower the rate, the higher the expected amount to charity, and the greater the deduction.


A Closer Look at CLTs

As an example, let’s take a CLT that is going to run for 10 years. It starts with $1,000,000 and pays the qualified charity 5% per year on a quarterly basis. The current AFR (May 2020) is 0.8%. Per IRS regulations, the present value of the donation is $470,633, which will go as an itemized deduction on the grantor’s tax return in year one. Of course, there are plenty of limitations, so you’ll want to check with your tax counsel before making any decisions.

If the assets in the trust outperform the low 0.8% rate, the IRS doesn’t take your deduction back. The taxpayer keeps whatever is left over. Add that to the deduction and the couple hundred thousand of capital losses over the next two years, and the tax benefits of the CLT look pretty amazing—and they are.

If you need help analyzing a gift for a charity and you have stock options, it’s important to work with competent professionals who can navigate the complex tax and planning landscape. For more information about your financial management options, explore the rest of our blog. 

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