As discussed in another article in this newsletter, a CLAT is an efficient option for charitable giving. An additional benefit of a CLAT is that it can greatly enhance a family’s charitable goals by using it to fund a Private Family Foundation.
A Private Family Foundation (“Family Foundation”) is a charitable foundation, organized as a nonprofit corporation or a charitable trust. The Family Foundation is called “private” because it is funded by one donor or a small number of donors, such as an individual or a family, as opposed to the general public. Using a CLAT to fund a Family Foundation can produce tremendous benefits for the family.
Family Foundations can serve as powerful vehicles for family philanthropy by allowing parents, children and future generations to work together to establish a family legacy of charitable giving. The process of investing the assets of the Family Foundation and making the required annual charitable distributions can bring the family together and provide an opportunity to transmit family values. In addition, Family Foundations may also provide excellent teaching opportunities for younger generations. And if the Family Foundation’s assets grow at a rate greater than the required annual distribution rate of 5%, the Family Foundation can provide opportunities for a family’s charitable giving for years to come. Perhaps most important, however, is that the family can retain control of the Family Foundation and direct its charitable distributions.
Such control, however, comes at a price. Family Foundations are subject to more stringent rules than public charities, so they must be carefully structured and managed. For instance, although the Family Foundation is exempt from income tax, it will be subject to an excise tax of 2% of its net investment income each year. Furthermore, a Family Foundation is required to make minimum distributions of 5% of its assets each year, and may not engage in certain transactions, such as self-dealing and excess business holdings.
When a Family Foundation is the beneficiary of a CLAT, another concern arises. CLATs that make payments to a Family Foundation in which the donor has too much control can result in an unpleasant surprise at the donor’s death. Unless the CLAT and the Family Foundation are carefully structured to limit the influence of the donor, the property transferred to the CLAT can be included in the donor’s estate at death. Estate tax inclusion results if a donor makes a transfer but retains the right, either alone or in conjunction with another person, to designate the persons who will possess or enjoy the income. So if a donor creates a CLAT and names, as the beneficiary, a Family Foundation in which he or she has the power to direct the disposition of its funds, the value of the property transferred to the CLAT may be included in the donor’s estate.
So how does a donor avoid this unfortunate result? The donor’s role in the CLAT and the Family Foundation should be limited. For instance, if the donor serves as a director or officer of the Family Foundation, the donor may be prohibited from voting on matters concerning the funds received from the CLAT. Perhaps the donor does not serve on the Family Foundation’s board of directors at all, but rather has his or her spouse or children serve on the board. In addition, the donor may be prohibited from serving as Trustee of the CLAT.
Having a Private Family Foundation as the charitable beneficiary of a CLAT can serve to enhance a family’s charitable and personal goals. Nonetheless, care must be taken to ensure the CLAT and Family Foundation are properly structured and operated so that the intended benefits are achieved.