The ‘Zero-Out’ CLAT Strategy: Wiping Out a Huge Tax Bill While Keeping Your Principal
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Result: You ended up with MORE personal wealth (~$400k extra) AND gave $1.6M to charity. The tax savings subsidized the gift.
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The ‘Zero-Out’ CLAT Strategy: Wiping Out a Huge Tax Bill While Keeping Your Principal
COACHING POINTS
- The Scenario: You had a windfall year (e.g., $1M bonus, crypto exit) and face a 37% tax bracket. You want to donate to charity, but you don’t want to lose your capital forever.
- The Strategy: A Grantor CLAT (Charitable Lead Annuity Trust) creates a massive upfront tax deduction (up to 100% of the contribution) that offsets your income spike. The trust pays charity over time, then returns the remaining assets to you.
- The Arbitrage: If the trust’s investment returns exceed the IRS “Hurdle Rate” (Section 7520 Rate), the excess growth returns to your pocket tax-free. It’s a “Heads I Win, Tails Charity Wins” structure.
Most people think giving to charity means the money is gone. With a CLAT, that is false. A CLAT is effectively a loan to a charity that pays you back in tax savings. By “Zeroing Out” the trust (setting the charitable payments to equal the initial gift + IRS interest), you get a tax deduction equal to your entire contribution today, yet you retain the right to the investment upside.
The “Hurdle Rate” Math
Success depends on beating the IRS Section 7520 Rate (e.g., 5.0%).
- Contribution: $1,000,000. Authority: IRS Reg 1.170A
- Term: 20 Years.
- Charity Gets: Fixed annuity payments (e.g., $80k/yr).
- You Get: Any asset value remaining in the trust after 20 years.
- The Bet: If portfolio grows at 8% and IRS rate is 5%, the 3% spread compounds for 20 years and comes back to you.
What-If Scenario: $1M Income Offset (40% Tax Rate)
Assumptions: $1M Contribution, 8% Returns, 5% IRS Rate, 20-Year Term.
| Action | Year 1 Tax Savings | Value Returned to You (Yr 20) | Total Benefit |
|---|---|---|---|
| Pay Tax (No CLAT) | $0 | $600k (Invested after tax) -> ~$2.8M | ~$2.8M |
| Zero-Out CLAT | $400,000 | ~$1,500,000 (Principal Recovery) | ~$3.2M + Charity gets $1.6M |
Visualizing the Principal Recovery
*Figure 1: Trust Value over Time. The Green area is the amount returning to the Donor after satisfying the charitable obligation.*
Execution Protocol
1
Confirm “Grantor” Status
To get the deduction now, the trust must be a “Grantor Trust.” This means you pay income tax on the trust’s earnings during the 20 years. (Strategy: Use municipal bonds or growth stocks to minimize this ongoing tax).
To get the deduction now, the trust must be a “Grantor Trust.” This means you pay income tax on the trust’s earnings during the 20 years. (Strategy: Use municipal bonds or growth stocks to minimize this ongoing tax).
2
Backload the Payments
Structure the payments to charity to start low and increase annually (e.g., +20% per year). This keeps more money in the trust longer to compound, increasing the final payout to you. Authority: IRS Rev. Proc. 2007-45
Structure the payments to charity to start low and increase annually (e.g., +20% per year). This keeps more money in the trust longer to compound, increasing the final payout to you. Authority: IRS Rev. Proc. 2007-45
3
Fund with Cash/Public Stock
Do not fund with private stock or real estate unless necessary (valuation issues). Liquid assets work best to meet the annual payout requirement without liquidity stress.
Do not fund with private stock or real estate unless necessary (valuation issues). Liquid assets work best to meet the annual payout requirement without liquidity stress.
COACHING DIRECTIVE
- Do This: If you have a massive one-time income event (e.g., $500k+) and want to erase the tax bill while keeping the option to get the money back later.
- Avoid This: If you need the money within 10 years. The CLAT is a long-term lockbox. Also avoid if you think market returns will be lower than the current IRS 7520 rate.
Frequently Asked Questions
What is a Grantor CLAT?
It is an irrevocable trust where you donate assets to fund annual payments to a charity for a fixed term. Because it is a ‘Grantor’ trust, you get an immediate income tax deduction for the present value of all future charitable payments.
How does the ‘Zero-Out’ math work?
By precisely calculating the annual payments based on the IRS Section 7520 rate, you can make the ‘Present Value’ of the charitable gift equal to 100% of the initial contribution. This creates a tax deduction equal to the full amount you put in.
What is the catch?
You must pay income tax on the trust’s earnings during the term. Also, the charity *must* get paid first. If the investments perform poorly, the charity gets everything and you get back nothing.
Disclaimer: CLATs are complex. If the trust underperforms the hurdle rate, you lose the principal. You are liable for taxes on trust income annually. Consult a CPA.
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