Judy
Potter (40) played the lottery every week.
For her, it was harmless fun and she enjoyed fantasizing about winning about
the “big one”. Then lightning struck and
her numbers were the lucky picks played giving her $15 million dollars in a
lump sum. Like many lottery players,
Judy had no professional advisor relationships and she took her
brother-in-law’s (an insurance sales representative) ill-conceived advice that
if she would just contribute her lottery ticket to a charitable remainder
trust, she could avoid taxation on her winnings and receive a tax deduction to
boot.
Too bad, it did not work out as he
described – there was no deduction and no avoidance of tax.
In fact, by locking her winnings inside an
irrevocable trust that could not provide the liquidity to pay taxes on her personal
income, she wound up owing more money in taxes than she will receive from her
CRT for years.
Assignment
of income, no tax deduction.
Since her lottery jackpot was untaxed ordinary income, funding
her CRT with a winning ticket meant that there was no charitable income tax
deduction available. Given that her
federal income tax bill was $5.834 million on the $15 million of winnings, even
if there had been a charitable deduction, it would have put only a small dent
in her tax bill, and once the cash was locked inside the CRT there was no way
to pay the tax liabilities Judy owed.
Instead, if she had taken the lump sum settlement, paid the
tax, and contributed the remaining $9 million in cash to her CRT, she would
have generated an income tax deduction of $1.128 million on a 5% two-life CRUT.
Why so low? Since she and her 42-year-old husband set up
a two-life CRT, the probability that the charity would receive anything soon
was remote. The IRS life expectancy tables
used to calculate the present value of her future gift produced a deduction of just
12.5% of the transferred amount. However,
given her adjusted gross income (AGI) for that year, Judy could use the
deduction limit of 50% for her cash contribution and help offset some of the
prior taxes withheld. If Judy could have
postponed collecting some of her winnings without sacrificing lifestyle, other
charitable tools might have been worth using.
For example, a grantor charitable lead annuity trust (CLAT) could have been
coordinated with her CRT to set aside money in an account that would pay
charities for a few years and then return her money, plus growth, back to Judy
after she’d had a little time to get her personal life back on course. This technique would have generated another
income tax deduction and ultimately given her more control over her newfound
wealth. Why give up the flexibility of
just keeping the money and enjoying it? There
is no reason Judy could not have done so, except that, statistically, few
lottery winners actually enjoy the fruits of their lottery winnings for very
long. Remarkably, it is common for big
winners to blow throw their winnings and actually have to declare bankruptcy,
some in as few as three to five years. While
the CRT cannot properly be viewed as an asset protection
vehicle, it does restrict the availability of the assets and protects them from
being squandered unnecessarily. If a lottery
winner has some interest in doing philanthropic works, a CRT might help impose
the discipline needed to make it to a point where the winner has a chance to go
on and live a life that has not been turned upside
down. After all, Judy had choices. Her money could be
squandered, and that which was left unspent would be available to
children, charity, or Congress or she could have decided that cutting the IRS
out of her life as much as possible and controlling her wealth made more
sense. Judy is not alone facing these
ethical planning dilemmas; some of these strategies might have practical uses
for recipients of salary bonuses, large inheritances, litigation awards, and
structured settlements. Anytime people
fall into unearned or unanticipated wealth, taking time to get it right makes
good sense.
Counting on lottery winnings isn't a reliable way to build wealth, however, some people do win and need advice. Seek competent counsel with experienced advisors who can help guide the process to include both values and financial planning solutions.
© 2002 -- Vaughn W. Henry
Gift and Estate Planning Services
217.529.1958 -- 217.529.1959 fax
