Are Gifts to Children Tax-Deductible? Introducing CLATs

Are Gifts to Children Tax-Deductible?

I am often asked if someone can take an income tax deduction for money they gift to their children. Unfor­tu­nately, gifts to individuals are not tax deductible: tax deduc­tions can only be taken for gifts to organi­za­tions on the IRS list of approved charities. In fact, the IRS limits the amount of gifts you can make to any one person. As of 2021, the maximum gift exclusion is $15,000 per child, per parent. That means your child could get as much as $30,000 in tax-free gifts from both parents, but neither you nor your spouse can take a deduction for the gifts you give. 

There is however, a way to get a partial deduction for money that will eventually go to your children. A chari­table lead annuity trust (CLAT) gifts money to a charity first, and then passes assets to your beneficiaries.

Assets gifted to a CLAT are used to make annual payments to a charity for a specified term. At the end of the term, money remaining in the trust can poten­tially go to the benefi­ciaries free of estate and gift taxes. The concept is to distribute the entire principal plus a minimum rate of return to the charities. The  return is defined by the applicable federal rate (AFR), which the IRS publishes monthly. The benefi­ciaries receive the growth of the trust that exceeds the AFR. The trust assets need to be invested in a manner that allows them to generate excess growth for the beneficiaries.

The donor receives a chari­table deduction equal to the present value of the chari­table payments based on the AFR. For example, a donor gifts $1 million into a CLAT that makes annual chari­table payments over 20 years. Assuming a hypothetical AFR of 2.76%, the donor would receive an immediate deduction of about $250,000.  The charity would receive more than $1 million in payments during the term of the CLAT, and the benefi­ciaries would receive the remaining principal. An average return of 7½% would allow the trust principle to maintain the $1 million original value for the beneficiaries.

There are drawbacks to using a CLAT. For one, the income earned in the CLAT during the term is taxed to the donor. You should seek the counsel of an experi­enced financial adviser or estate planner to determine if a CLAT is appro­priate for your goals.

Origi­nally published June 2018