Soon after Jacqueline Kennedy Onassis died, reporters lined up in the Surrogate’s Court in lower Manhattan to purchase a copy of her will, which was a public document. But to estate planning lawyers the will is of interest because Mrs. Onassis made use of a charitable lead trust, a device which is not well known. For the owner of a family business, the charitable lead trust can be a powerful planning tool.
Mrs. Onassis did not own a family business, but her plan could protect a family business from having to be sold or liquidated to pay estate taxes after the owner’s death. Creating a charitable lead trust creates a tax deduction, and the family business stays in the family in the end.
Here’s how it works. In her will, Mrs. Onassis created a trust. It requires the trustees to pay a fixed amount annually to charity. If Mrs. Onassis’s estate was, say, $100 million, the amount to be paid annually to charity is $8 million (8 percent of the initial value of the trust fund). The charitable payments are to continue for 24 years. After that time, whatever is left is to be held in trust for Mrs. Onassis’s (as yet unborn) grandchildren.
The family and employees of the owner of a family business face a potential crisis nine months after the owner’s death. There is a tax of up to 55 percent of the value of the business due at that time. If the business is worth $100 million, someone has to come up with $55 million. The payment date can be extended with various interest and principal payments, but that is a form of borrowing which may not help much for long.
If the owner is married, the stock in the company can pass tax-free to the spouse. But when the spouse dies the stock is taxed at 55 percent (due within nine months of the spouse’s death). Life insurance is one possible solution.
Another solution is the charitable lead trust. The owner’s will or trust can put the stock into a charitable lead trust. In this setup, charity receives distributions for a certain number of years (any number is possible), and then the family or heirs receive the remainder. The result is a charitable deduction on the estate tax return. This tax break could save the business from having to be sold or liquidated, and the delay in receiving the stock may not matter much to the family. Also, the trust enables the business owner to carry out his or her plan for charitable giving.
While the charitable lead trust is making distributions to charity (during the 24 years of Mrs. Onassis’s trust, for example) the trustees can be business executives, including family members, and they can vote the stock.
Reducing tax payments
The way a charitable lead trust works can best be explained with an example. Let’s pick an estate consisting of $100 million of family business stock all subject to the maximum 55 percent rate, with no surviving spouse. Now let’s put the $100 million of company stock into a charitable lead trust. If the trust pays charity 8 percent of the value of the stock, appraised every year, for 24 years, the estate gets a tax deduction of $86.5 million. The tax due in nine months would be about $7.4 million instead of $55 million. That’s an improvement which could save the business.
Instead of paying 8 percent of the value, appraised every year (which is a hassle), the trust could pay a fixed $8 million a year (as in Mrs. Onassis’s will). In that case, the deduction is a little less and the tax bill is $10 million (instead of $7.4 million), still a lot less than $55 million.
The annual $8 million charitable payments create a problem. The company must produce dividends or redeem stock or find some other way to get money to the trustees (or the trustees could distribute shares of stock to charity). This is a significant problem, but not as bad as the problem of coming up with $55 million. There is no way a dividend or redemption would generate that much cash without destroying the company.
The family or heirs must wait to get the company stock. That may make no practical difference to them. If the estate consisted of cash or marketable securities, instead of a family business, however, it would make a big difference to have to wait, say, 24 years to get the money. The charitable lead trust can’t be justified, in that case, unless the donor wants to make charitable gifts. In the case of a family business, however, the tax break avoids a crisis.
There’s a catch: If the charitable deduction is more than 60 percent of the amount in the lead trust, the trust must get rid of the company stock within five years. In a lead trust of $100 million, if the figures (for the periodic charitable distributions, the number of years, and the IRS interest rate) work out to a charitable deduction of over $60 million, the trust cannot hold the stock more than five years. If that is not acceptable, then the number of years or the size of the payment must be juggled so that the 60 percent limit is not reached.
Helping Grandchildren
Mrs. Onassis’s estate is not being given to her children after the charitable lead. We can assume the children have other resources (we know they get the remainder of their father’s trust, and they may have gotten something from grandparents). After 24 years, the remainder of Mrs. Onassis’s charitable lead trust will pass to her grandchildren in trust. This arrangement can achieve some of the benefits that generation-skipping trusts offered years ago, before Congress cracked down on them.
Generation-skipping trusts were commonly used to save taxes. The trust would say, more or less, “Pay the income to my child for life; and when my child dies turn the principal over to my grandchildren at age 21.” This trust skipped a generation, because there was no estate tax payable at the child’s death. Applying the current 55 percent rate, if the estate was left outright, the tax on $100 million at the first generation would be $55 million, and the tax on the remaining $45 million at the second generation would be $24.75 million, leaving only $20.25 million for the grandchildren. With a generation-skipping trust, on the other hand, the amount left for the grandchildren would be $45 million instead of $20.25 million.
The two taxes combine for nearly an 80 percent tax on inheritance by grandchildren, which comes pretty close to the abolition of inheritances in wealthy families. Nevertheless, generation-skipping was considered a “loophole” and it was closed in the 1976 tax legislation, which was scrapped in 1986 and replaced by the current “tax on generation-skipping transfers.” Now, even with a trust exactly like the old generation-skipping trust, there is a 55 percent tax when the child dies and the grandchildren get only 20.25 million after all. While 20.25 percent of a sum of money is one thing, 20.25 percent of a family business is no family business at all.
Mrs. Onassis did something which, to some extent, reinstates the old generation-skipping plan. If Mrs. Onassis had simply left $100 million to her grandchildren, they would get $20.25 million after taxes. By using the charitable lead trust, they will get about $41 million (24 years later, disregarding the time value of money and any investment returns). The $41 million is pretty close to the $45 million left under the old generation-skipping trust setup.
The time value of money makes the charitable lead trust look less attractive, in a case like Mrs. Onassis’s, unless there is a significant desire to benefit charity. A sum of $20.25 million invested at 9 percent for 24 years grows to about $160 million. A sum of $100 million invested at 9 percent for 24 years, paying $8 million a year to charity, grows to $177 million, which is then taxed at 55 percent, leaving $70.65 million. In the case of stock in a family business, on the other hand, the time value of money may not be a consideration because keeping the business alive and in the family may provide good salaries and personal satisfaction.
The charitable lead trust, in Mrs. Onassis’s case, does not end with the money being turned over to the grandchildren outright. It is held in trust. There can be a number of reasons for this, but from a tax planning point of view keeping the money in trust is advantageous in a smaller estate, because there is an exemption of $1 million dollars (per grandparent) which is allocated to the trust, and continues as long as the trust continues. For example, if the trust is $3 million the exemption of $1 million means that only two-thirds of the trust is subject to the generation-skipping transfers tax. That tax shelter could go on forever in a few states (Idaho, South Dakota, and Wisconsin). In most states, however, trusts can continue only for “lives in being plus 21 years,” which is about 100 years.
To no one’s surprise, Mrs. Onassis had good estate planning advice from which we can all learn. It has special application to family business owners.
Louis H. Hamel Jr. is chair of the trusts and estates department at Hale and Dorr, a Boston law firm.