Bear Markets Aren’t Always Bad News – Henry & Associates

Vaughn W. Henry

Has the stock market handed you lemons Make lemonade As it turns out, not all stock market gyrations are bad things Recent declines in equity portfolio values actually may present some excellent opportunities for tactical estate and gift planning.

Consider the charitable lead trust (CLT), an inverse of the better-known charitable remainder trust (CRT) How does a lead trust function A donor transfers cash or assets, preferably appreciating assets, into a trust with the intention of supporting a charity and then returning the asset to the family Commonly used to “zero out” an estate and popularized by Jackie O’s unfunded testamentary CLT, it’s a tool that helps preserve family wealth and control social capital.

The lead trust works best in a low interest environment when contributed assets are temporarily depressed in value, but are still liquid enough to make the required “lead” or income payments to charity on a regular schedule The donor has a choice about using either a fixed dollar contribution (CLAT) or a fixed percentage contribution (CLUT) in order to meet the requirements for a qualified lead trust Unfortunately, there is little IRS guidance and no prototype documents available to guide advisors Even with those hurdles, the bear market presents an ideal opportunity to gift assets that have intrinsic worth, but are temporarily at a lower value.

While the IRS and Congress have been trying to tighten restrictions on “estate compression tools” (legal structures that deflate an asset’s fair market value, like the family limited partnership or FLP), it’s darn hard to argue with a valuation that’s created by an active public market The IRS makes an argument that publicly traded stocks have an established value, are easily partitioned, and that aggressive FLP discounting taken for minority interests, lack of control, and lack of marketability in those limited partnership units may be abusive The lead trust offers a solution to passing family wealth A stock portfolio of $1 million that suffers a 35% – 40% decline due to erratic and emotional market behavior has presented the owner with a legal and timely way to reduce the family’s estate and gift tax bill.

Is there any risk to creating a charitable lead annuity trust If the CLT investments earn less than the government’s applicable federal mid-term rate (§7520 120% Annual “AFR”), then the trust will produce a remainder significantly less than what was originally contributed If the trust manager takes a long-term view and maintains a tax-efficiently managed portfolio, then the subsequent growth passes tax free to heirs Currently, with the government’s low AFR and the stock market decline, a charitable lead annuity trust is an excellent planning tool Create these trusts far enough ahead of time and inheritances pass with no tax cost at all. And since the assets placed into trust are (we hope) in a temporary decline because of market fluctuations, the family inherits a solid portfolio with the capacity to grow significantly.

Consider the charitable lead annuity trust if you are:

– already giving enough to charity to exceed schedule A deduction limits

– interested in supporting charity with pre-tax earnings

– living on modest income, but have an appreciating estate

– interested in preserving appreciated assets for heirs but may have already used up lifetime gifting exclusions (your applicable exclusion amount, $1 million in 2002 and 2003)

– trying to diversify and still discount estate values

– dealing with unforeseen income, don’t need it and would like to pass it on

– planning an estate for heirs as a “deferred inheritance trust” or “accelerated inheritance”

– selling a business and now that the contract is signed and found out that it’s too late for one of those “CRT things”, and would like to give the kids the proceeds

– willing to have your kids wait a bit in order to save tax on an inheritance