Here’s How to Delight Your Highest Income Clients (Including W2s!)

We usually focus these weekly emails on marketing topics and TaxCoach system news. But this week I want to introduce a little-known planning strategy for clients who want to avoid tax on a big slug of specific income.

For hedge fund managers, life is probably pretty good. They’re making a fortune – the top managers make literally billions in a single year. And as long as they can keep demonstrating their value to their clients, they’ll keep raking in that money, year after year.

Still, there’s a shadow on the horizon. On December 31, 2017, an eight-year-old loophole closes, and fund managers need to pay tax on performance fees they’ve parked offshore. Last month, Bloomberg ran an article on the dilemma, reporting that fund managers are scrambling to find ways to avoid tax on that gain, which they estimate at about $100 billion. That suggests that Uncle Sam may be looking at a $25 billion windfall.

The article presents one especially powerful strategy to ease the upcoming bill, at least for future generations. It’s a strategy that you can take to your clients, too. They don’t have to be hedge fund managers. They don’t even have to own their own businesses! This makes it that rare unicorn of a strategy that you can present to a high-income W2 client.

The strategy is a charitable lead annuity trust, and here’s how Bloomberg summarizes it:

“It works like this: Dump the money into a charitable lead annuity trust, CLAT for short, and have the trust purchase a private-placement life insurance policy. The U.S. allows the taxpayer to deduct up to 30 percent of adjusted gross income for contributions to the trust, so the [client] saves right off the bat. What’s in the trust can be invested…

The Internal Revenue Service adjusts the interest-rate threshold [that determines the net present value of the income stream going to charity]; right now gains over 1.8 percent stay in the life-insurance policy, where they grow, un-taxed, for later distribution.

Scott Sambur, a partner at Seward & Kissel in New York, figures the kids of a middle-aged manager with $100 million offshore who goes the CLAT-insurance policy route would end up pretty happy. Assuming an annualized rate of return on investments of 7 percent for 28 years, Sambur says the manager could leave more than $260 million to his heirs tax free.”

Most of us are familiar with charitable remainder trusts, where the grantor retains the income for life and the remainder goes to charity. The charitable lead trust, on the other hand, reverses this order, with the charity getting an income for a period of years or a grantor’s lifetime, and the grantor or heirs getting the remainder. Given today’s low interest rates, the lead trust generally produces a bigger deductible gift than the remainder trust.

A charitable lead trust is a “grantor” trust, which means its income is taxable to the grantor (donor). That’s why tax-advantaged life insurance is an appropriate strategy. Private placement life insurance offers lower fees than regular commercial coverage, which lets trust assets grow even faster. Using a private-placement policy is appropriate for clients with $500,000 or more in discretionary income. That’s because $500,000 is generally the minimum deposit for private-placement life insurance policies.

Want to put it to work for your clients? TaxCoach has several modules on charitable giving strategies, including one on charitable trusts for big-ticket asset sales. (You’ll find them all in the Tax Strategy Reference feature – just search on “Charitable” – as well as in the tax planning and tax reporting section of TaxCoach).

And we’re working to beef up our coverage of charitable strategies, too, in part to give you more material to present to high-income W2 clients. This new material will include a new seminar kit on charitable gifts, suitable for presenting to church congregations, nonprofit donors, and similar audiences.

Here’s the moral. (Can’t have a TaxCoach Briefs without a moral.) You can always find ways to help clients. We’re always looking for more ways to help you help clients. And for the right client, this one strategy can be a huge windfall. That means it can be huge for you too – not just in terms of fees, but in terms of referrals to other high-value prospects your client might know who would like a huge windfall because they face a huge tax bill. (I realize that’s a lot of “huge” in one paragraph. But this sort of strategy really justifies it.)

Tax never sleeps, so tax planning has to be an ongoing process.  Make sure to reach out to your most complex clients on a regular basis and review any major changes on the horizon – especially if you’ve got strategies like this for them.