by Brian Mahany
When I was in Maui last January, several of the beaches had warning signs for sharks. Surfers were advised to enter the water at their own risk. This post discusses so-called shark finned CLATs or “Charitable Lead Annuity Trusts”. Investors are advised to invest at their own risk.
CLATs have become a popular tool among the sophisticated estate planners as a vehicle to help clients transfer wealth to another generation while also providing funds to charitable causes. Despite their popularity – and apparent IRS blessing – we remain quite concerned that the IRS could disallow the tax benefits associated with their use.
If you are eyes aren’ glazed over by now, your probably have a CLAT or are considering one. The so-called “shark finned” CLATs are a derivative of this popular estate planning tool. To understand the risks, it is first necessary to understand how these tools work. (One of our biggest peeves is the frequent inability of both the experts and their clients to explain how CLATs work – if you can’t explain it, you probably should not invest in one!)
In the typical CLAT, the donor creates a trust that pays an annuity to a charity. The annuity can be for a fixed number of years or can be for the life of a specified individual. At the end of the term, the assets in the trust pass to the named beneficiary.
In a shark finned CLAT, the annuity payment increases over time. If one were to graph such an annuity stream, the latter year(s) would appear as a big spike, hence the graphical reference to a shark fin. This particular structure allows funds to build up in the trust and provides for a big balloon payment to the charity near the end of the trust.
Two 2007 IRS Revenue Procedures appear to allow this type of CLAT. Of course, aggressive promoters have jumped on the bandwagon and sold many plans that we feel do not pass IRS muster.
We are particularly concerned about plans funded with a single premium life insurance policy. All or most of the money in the trust is used to purchase a life insurance policy. The plan is set up so when the settlor dies, the CLAT ends and a portion of the insurance is used to make a balloon payment to the designated charity.The remainder, of course, passes to the designated beneficiary.
It is probably no coincidence that some of the same promoters that offered life insurance funded 419 and 412 plans also offered the so-called shark finned CLATs. That the 419 and 412 plans are frequently disallowed as abusive tax shelters does not bode well for the balloon payment CLAT.
Although CLATs are a valuable estate planning tool, having too much of a deviation year to year in the annuity payout is an invitation to trouble. We know that some advisers disagree and have been actively selling these devices. While we are certainly not ready to declare all such devices are illegal and abusive tax shelters, we do feel some are.
If you find yourself under audit because of a bogus 419 welfare benefit plan, 412 plan or shark finned CLAT, give us a call. We have helped other taxpayers unwind their abusive tax shelters and avoid significant penalties.
For more information, contact attorney Bethany Kroes at or by telephone at (414) 223-0464. All inquiries are protected by the attorney – client privilege and kept in strict confidence.
Mahany & Ertl – America’s Tax Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine; Minneapolis, Minnesota and coming soon San Francisco, California. Services available worldwide.
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