Gifts to charity are one of the best opportunities to save on your taxes. Aside from the personal benefit many people experience through the spirit of giving, it is always nice to know that you saved on your tax bill while doing so. Most people are aware that all or part of their charitable contributions can be deducted from the income they report to the government. Since the more you earn, the more you tax you owe, taxpayers can and should take every legal opportunity the government gives them to reduce the amount of income they report to the government and, in doing so, lower the amount of tax owed at the end of the year.

A deeper dive into the tax laws, however, will turn up often overlooked strategies to maximize tax savings through charitable contributions. A skilled and knowledgeable attorney will be up to date on these laws and know how to leverage them to save his or her client’s hard-earned money.

One such law is buried deep in sections 170 and 172 of the Internal Revenue Code. Together, these provisions allow taxpayers who intend to make charitable contributions to significantly lower their tax bill on their next tax return. The specific vehicle a taxpayer can use to do this is called a Grantor Charitable Lead Annuity Trust, or “CLAT” for short. By structuring his or her charitable contributions into a CLAT, a US-citizen taxpayer can reap immediate and substantial tax savings.

What is a CLAT and how does it work?

A CLAT is a trust funded entirely in year one, which will then make distributions to charity from those funds each year over a specified term of years. The individual that establishes the CLAT is called the Grantor. The Grantor is then able to take a deduction equal to nearly the entire amount of his or her initial funding of the trust the same year that he or she establishes the CLAT.

A Grantor may deduct up to 95 percent of the present value of the annuity interest. Section 7520 of the Internal Revenue Code requires that an annuity interest must be valued using tables with interest rates published by the IRS and updated with varying rates each month. Presently, those rates are 1.0 percent as of October 2021, which is notably low. By way of example, this would mean that a Grantor that established a CLAT in November of 2021 with an Initial Contribution Amount of $150,000 to be distributed over ten years at $15,000 per year could take an immediate deduction of $141,359 dollars. Of course, a CLAT can be for a longer term of years or a greater amount, the latter of which would result in a higher deduction in the year the CLAT is established.

Assets in the trust are invested by the Grantor or an external manager and each year the CLAT makes a fixed payment to charity for a preset number of years. At the end of the term, the remaining principal amount returns back to the Grantor. Over the period the CLAT exists, the Grantor is responsible for paying capital gains taxes when any assets are liquidated, whether to fund charitable contributions or for any other reason.

Who benefits most from using a CLAT?

For these reasons, a CLAT is ideal for an already-charitably-inclined individual who has higher-than-expected income in a given year, and is seeking to leverage their contribution to the maximum degree of savings that year.