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Henry Smith is a hedge fund manager at ABC Asset Management LLC (ABC). ABC is a $1.5 billion hedge fund and splits its assets between onshore and offshore funds. Because of Sec. 457, Henry is required to repatriate the $14 million in pre-2009 management and incentive fees that he is currently holding offshore before the end of 2017. Between federal and state taxes, Henry will be facing a tax of 50% and will have to report the entire $14 million on his 2017 income tax return. Unless he finds a way to offset this tax, he will have to hand over approximately $7 million to the government.
Henry meets with his advisor, Mick, about the upcoming December 31 deadline to recognize income from his offshore fees. Mick suggests making a charitable donation to offset the $7 million that he will have to recognize this year from his deferred offshore funds in addition to the $1 million he will have to report from other income sources. After reviewing his current assets, Mick suggests that Henry consider making a charitable gift of his highly appreciated real estate. By making a charitable gift of the land, he will be able to avoid tax on the gain and also offset his tax bill with the charitable income tax deduction. The real estate's fair market value is $4 million. By gifting the property before the end of 2017, Henry will receive a $4 million charitable income tax deduction to help offset the tax on his deferred overseas income. Note that, because the real estate is an appreciated property gift, he can use the charitable deduction up to 30% of his adjusted gross income in 2017. Therefore, he can deduct $2.4 million this year and carry forward the remaining $1.6 million to use for up to five additional years.
Henry knows that the December 31 deadline is looming and he wants to find a way to reduce his 2017 tax bill. Henry likes the idea of setting up a private foundation and wants to encourage his kids to live philanthropic lives. However, he realizes that the time, effort and cost of setting up a private foundation simply does not align with his planning goals this year. His advisor, Mick, suggests creating a donor advised fund with the local community foundation instead. Mick explains that Henry could transfer cash and appreciated property to the DAF and then recommend grants to different organizations without having to go through the lengthy and expensive process of setting up a private foundation. He will receive a charitable income tax deduction for the full value of the assets transferred to the DAF and will be able to avoid capital gains tax on the appreciated property used to fund the DAF. Henry not only likes the tax benefits of this plan, but also sees this as a great way to plant a philanthropic seed in the hearts of his children by naming them successor advisors to the fund.
Henry knows that he needs an income tax deduction this year to offset the taxes that will be due on his deferred offshore fees. However, he has also been looking into ways to support his favorite charity and receive a stream of income later in life. His advisor, Mick, discussed the possibility of funding a NIMCRUT for the lives of Henry and his wife Sally with some highly appreciated tech stock that Henry purchased many years ago. The stock is currently valued at approximately $5 million. By transferring the stock to the NIMCRUT, Henry and Sally will receive a $1,690,500 income tax deduction and will be able to avoid paying tax on the gain when the trust sells the stock. Because Henry and Sally are both in their mid-60s and are not in need of an income stream at this moment, they plan on investing the trust in growth assets until they reach age 80. At that time, the value of the trust will have increased and their 5% trust payments will be approximately $625,000 with estimated lifetime income from the trust of $9,264,000 over their joint lives.
Henry and his advisor Mick have been discussing various charitable strategies to ease the tax burden he will be facing this year. Henry knows that one of his primary long-term goals is to provide financial security for his two children and asks Mick if there is a charitable plan that would generate an income tax deduction and also enable him to transfer a substantial amount of wealth to his children in the future. Mick suggests that Henry consider funding a super CLAT. If Henry were to transfer the $4 million real estate along with $1 million cash to a CLAT that will make a fixed 5% or $250,000 payment to his favorite charities for a 15-year term, he will receive a $3,164,775 deduction and be able to pass the trust's remainder to his children at reduced gift and estate tax costs. Between the tax savings and the trust's estimated remainder value of $6,163,798, Henry will receive the deduction that he is looking for this year and also meet his goal of transferring valuable assets to his children.
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