In episode 37 of How Tax Works, Matt Foreman discusses the various tax things you should consider when you win the lottery, right after you throw a party in the Whale Room of the American Museum of Natural History.

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How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

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Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matthew Foreman [00:00:00]:
Hello and welcome to the 37th episode of How Tax Works.

Matthew Foreman [00:00:13]:
I’m Matt Foreman. In this episode, I’ll discuss, and to be honest, I’m not sure how to name this episode. I guess I’ll have to figure out ’cause it does get named, but it tries to respond to the prompt, if you win the lottery, The first thing you should do is call a tax attorney. So we’ll see how that goes. How Tax Works is meant for informational and entertainment purposes only. It may be attorney advertising and it is not legal advice. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make.

Matthew Foreman [00:00:49]:
Before we get started, a few administrative things. First, new episodes every 2 weeks, obviously. Next episode’s going to talk about updates to Section 1202, Qualified Small Business Stock, and 174, Research and Experimentation Expenses, Section 174, under OB Thrice. That’s what I’m calling it. I don’t, I don’t care. That’s, that’s what I’m calling it. If you have any questions, comments, or constructive criticism, you can email me at my FRB email address. Upcoming webinars, I have a bunch that we’re putting on as a firm, FRB is doing, called the Advanced Tax Strategy Series.

Matthew Foreman [00:01:23]:
I didn’t name it, So we’re rolling with it. They’re all Thursdays at 1 PM Eastern time. I’m in New York, so that’s Eastern. So that’s when we’re doing it. They’re free. November 6th is 704(c) allocations. November 20th is succession planning using profits, interest. December 4th, stock sales and asset sales, talking about FRIORGS, 338(h)(10)s, etc.

Matthew Foreman [00:01:42]:
And December 18th, QSBS common mistakes and misconceptions. All right, let’s talk about the 37th episode. You know, where did the title come from? Where did that prompt come from? The question is, I was at a birthday, family birthday party, and I was talking to a cousin. And one thing that happens as you get further and further from your 20s is the things that get discussed change somewhat, right? You still talk about sports and, and other stupid things. But also, my cousin, also very much not in his 20s anymore, um, said, you know, I have a question for you. And this is when the lottery was around $900 million. It later went to $1.8 billion, which is a lot of where sort of this you know, the, the somewhat, at least the impetus for this episode came from. And he said, you know, people always say if you ever win the lottery, right, your first call should be to a tax attorney.

Matthew Foreman [00:02:36]:
Why is that? And I had no answer. I was somewhat dumbfounded. And anyone who knows me knows that I’m rarely dumbfounded, or I should say often dumbfounded, rarely without words. So I didn’t really have an answer. And I said, you know, I don’t know if that’s true. I actually think it’s if you win the lottery, the first thing you should do is call an estate planner and a wealth manager, which I think is correct. I’ll get to later. But also, when the lottery was $1.8 million, you know, I work with someone in our office asked me, you know, should you take the lump sum or over the years? And which I said, well, you take the lump sum.

Matthew Foreman [00:03:11]:
And she said, yeah, yeah, that’s what everyone says. But why? And I thought about it. And I ran some math. And I’ll come up, I’ll discuss the answer later. But before I go there, I’m going to tell one of my favorite stories that I really don’t tell very often because it really does not come up often at all. My dad had— it was either his assistant. My dad was a dentist. It was either his assistant or his office manager/receptionist who won the lottery.

Matthew Foreman [00:03:35]:
It was back in the late ’80s. We lived in upstate New York at the time. And my dad got a call on a Sunday night. And I remember this. It was either the Sunday between Christmas and New Year’s, you know, when schools are closed. Or it was right when school ended. I don’t remember which, and there’s a reason I don’t remember which one it is, which I’ll get to in a second. And she called and said, I won the lottery, it’s $2.5 million, which at the time in New York State was the amount that it reset to after someone won, and I quit, I’m never working for you again.

Matthew Foreman [00:04:03]:
What gets sort of amazing about it, she took the lump sum, so you figure $1.5 million, subtract some tax, she probably got about $1 million, $900,000, I’ll get into how the math works in a second. And what she did was she went out and she, she burned it. She just spent on dumb things. She never bought a house. And the reason why I don’t know whether it’s around Christmas or when school lets out— for those who don’t live in New York, school in New York gets out the end of June, 20th, 24th, somewhere in that range. So it’s later. So the reason I don’t remember is because the other one of the two, right, late June or late December, 6 months later, she called and she had gone through every single penny. And what was sort of amazing is thinking about this is she spent basically 30 years of her salary, maybe more, maybe less.

Matthew Foreman [00:04:47]:
I don’t know. I have to work through the math on it in 6 months, which is sort of amazing. And again, did not buy a house, which is really pretty. It’s special. So she called my dad and asked for her job back. My dad’s like, well, no, we hired someone else. Can’t really hire extra people. But there was a pause.

Matthew Foreman [00:05:07]:
I remember I was in the kitchen and my dad said something along the lines of, but we do need a babysitter for Saturday. You know, parents were going out, whatever. I don’t remember whether she ended up babysitting me. Maybe she did. Maybe she didn’t. It’s a funny story about it. So when people talk about, you know, you don’t want to win the lottery, it leads to problems. It really leads to problems of the fact that people have unrealistic expectations and don’t properly budget.

Matthew Foreman [00:05:29]:
It’s really a budgeting issue than anything else. Same as, you know, professional athletes who suddenly have huge amounts of money, you know, you have hangers-on, you’re buying stupid things. And that’s why I talk about the need for estate planning and wealth management assistance. That’s really the key, which we’ll get to later. So what, you know, people talk about, like, what can you do? You know, what can I actually do to save on taxes? And I don’t really think there’s anything you can do from an income tax perspective. Again, estate planning, you know, gift tax, wealth management, wealth preservation. Maybe that’s what he meant, right? A lot of people, when they say a tax attorney, You know, they, they include trust and estates attorneys and trust and estates attorneys really come in a variety of flavors, I guess, for lack of a better word, where some are very tax focused. Others are not, you know, most, most people don’t need to worry about taxes.

Matthew Foreman [00:06:14]:
The vast majority of the world, right, of people in the US, anywhere really, don’t need to worry about estate taxes, not a major concern, etc. So, so really don’t have to worry about it. But, you know, there are a lot of estate planners who do really complex tax work, really interesting stuff. I’ll talk about a bunch of it. during this episode. So, you know, the first question is lump sum or annuity, and the answer is lump sum. Um, I went on the website and I went through the mechanics of how it’s paid and how the lump sum’s done, etc., etc. And for the $1.8 billion, um, you get about $800 million, you get $826 million based on sort of what, you know, how their, how their math works out.

Matthew Foreman [00:06:54]:
Um, the $1.8 $1 billion is over a total of 30 payments, one the first year, then 29 years thereafter. And what you do is you take the amount you get the first year, $100 for example, and the next year you get $105, and so on and so forth. You add 5% each year, 5% compounded. Anyone who knows anything about investing or money management knows that 5% is not a tremendous rate. Some people would even go so far as to use the word poor rate. It’s not really a good one. You can get that more or less with munis with no taxes. So you’d almost be better off actually taking the lump and then putting the money into munis and you end up better.

Matthew Foreman [00:07:29]:
Neither here nor there. So you take the lump sum and then I, I wondered, you know, what is better, right? Take the lump sum tax now, basically $826 million, 45% tax rates, about $450 million. If you take the full $1.8 billion over 30 years, time value of money, 45% rate, right? You end up with somewhere in the neighborhood of $990 million. They might say, well, yeah, $454 million is less than $990 million. That’s true. But then if you were to have a 30% tax rate, which we’re probably going to have less on, um, on the $454 million, you’d end up with somewhere in the neighborhood of $1.4 billion. Or again, if you were to take the, the $454 million post-tax, uh, on the lump sum, put it into munis earning 5%, you’re going to be almost at $1.9 billion. You’d actually end up better off.

Matthew Foreman [00:08:15]:
Right? As I point out to people, $454 million is an amount of money you probably can’t spend unless you’re trying to spend it. Spending for spending’s sake, so to speak. And so I’m not really super worried about it. You know, go out, have fun. You can do a lot of stuff, fun stuff, right? Can you delay it or gift it? As a way, you know, I was thinking about like, how could people from an income tax perspective, you know, do some stuff on this, right? And do some planning. And the answer is, can you delay or gift it? No. Actual or constructive receipt. When you get that ticket and the lottery happens, that’s when you have the money, even if you don’t actually claim it for some extended period of time, right? You think back to Oprah, you get a car, you get a car.

Matthew Foreman [00:08:52]:
As soon as you get that car, that’s yours. It’s not earned income, so it’s ordinary income, but there’s no payroll taxes, which is good. Unlikely to be creditable from a state tax perspective. So if you were in the lottery, or same rules for gambling, actually, for the most part. Is if you were winning the lottery when you’re in California and you live in New York, you actually pay state taxes in both. Just kind of brutal. Not great, suboptimal, but, you know, take the money. Look, it’s found money.

Matthew Foreman [00:09:16]:
It’s the lottery, whatever. One idea that I had, I think about is buy the lottery like a year out because you can buy it, you know, some amount in the future, put it into a trust, right? Then gift the trust. What’s it worth? $2 after you paid for the ticket. I think it’s worth $2. I don’t really buy lottery tickets. It’s just not my jam. So let’s say $2, that’s the gift amount, right? If it wins, you’ve gifted it out of your estate. Now the trust is paying the taxes, but taxes get paid anyway.

Matthew Foreman [00:09:39]:
So I’m not really sure that works. But anyway, so let’s talk about estate planning. Like, what would you do, right? What should be done? What can you do? Let’s set up some trusts, right? Trusts are big in this aspect, because you want to take the money out of your hands, you want to make it so you are no longer in control of the money, so that you have a more set income, you don’t have the ability to access it, you’re not going to burn through through it. Like nothing else, an acronym soup. CRT, CLT, GRT, ASAP, MTA, whatever you want. What won’t work, right? Grantor, same taxpayer. So grantor trust would do nothing but make estate administration easier. A QTIP trust, Qualified Terminable Interest Property trust.

Matthew Foreman [00:10:18]:
Basically, the QTIP is the first spouse dies, second spouse has the lifetime use of the property. The first dying spouse still controls who gets the asset, after the second spouse dies, works under 2056, Section 2056 of the Internal Revenue Code. But, you know, it’s in the estate of the second spouse, so it really doesn’t do anything. You know, I guess it does defer it until the second spouse dies for state tax purposes, and that’s great, but it doesn’t really matter. Intentionally defective grantor trust, IDGT, it may sort of work, but you won the lottery, so it’s likely too big to avoid triggering some level of gift tax. So, you know, or using your entire lifetime exclusion, although it’s cash. So using the lifetime exclusion is kind of pointless. If you have $1 billion in cash, you basically retain the income, but it’s out of your estate.

Matthew Foreman [00:11:03]:
Maybe you could do it. Doesn’t really do anything. There are a number of things that I would put into the bucket of things that may work, but probably not. But if you’re super wealthy, there are things you should consider. Before we get there, let’s, let’s take a quick break, get some music in, get going, and I’ll be back in just a moment.

Matthew Foreman [00:11:21]:
Welcome back to the 37th episode of How Tax Works.

Matthew Foreman [00:11:32]:
Kind of crazy we hit this long, right? So things to consider, charitable remainder trusts, CRTs. There’s two basic flavors, right? Many subflavors, especially within one of them, but one basic idea. The charitable remainder annuity trust, CRAT, is a flat annuity. Well, the basic, I’ll say what the biggest basic idea is that you give income to someone and the remainder goes to charity. All right. So CRAT, Charitable Remainder Annuity Trust. I’m going to flub these. I’m going to mess them up, but not mess them up.

Matthew Foreman [00:12:02]:
I’m going to stumble over words just because they’re just too detailed in that way. Basically, a flat or even annuity payment during the term goes to the beneficiary, the remainder to charity. The charitable deduction is taken when the trust is funded. So it’s great for assets that have largely appreciated, not the lottery. Charitable remainder unitrust, CRUT, a variable annual payment based on the fair market value of assets. You can’t really use it for lottery because there’s already a constructive receipt. You need to have income after you put it in the trust. If the lottery draw, if before the lottery drawing, maybe, you know, it’s one where you do it a year before, maybe, but you’re only getting a deduction of $2, you know, it’s the value of the ticket.

Matthew Foreman [00:12:43]:
So maybe Maybe not. A CRT is the way this, the reason this works is because CRTs, CRUTs and CRUTs, are not taxpayers. They’re, they’re, they’re nonprofits basically. So that it’s ordinary income for the payments when they receive. So it’s not capital gains. So it’s great for appreciated assets, stock, real estate that throw off cash or maybe can be sold in a few years to have cash in order to pay the beneficiary. There’s a couple flavors of CRUTs beyond that. There’s the NICRUT, net income CRUT.

Matthew Foreman [00:13:09]:
Distributions are limited to the income, often no distributions, good for non-income-producing assets. Why not just donate the asset to charity? Same thing. Then there’s the NIMCRUT, net income makeup CRUT, like a NICRUT, but in later use you may make up amounts that were not distributed for net income makeup CRUT. Then there’s the FLIPCRUT or flip NIMCRUT, which is absolutely way too many acronyms and things going on. That one, it’s a lot like, it starts as a NICRUT or a NIMCRUT and it converts to a standard CRUT upon some triggering event, which you can define. The next thought process I had is the charitable lead trusts, which is the flip of a CRT. CLTs and CRTs are the opposite. With a CRT, the money goes to beneficiary now and then the donation is at the end.

Matthew Foreman [00:13:56]:
Obviously you still get the deduction for the donation at the time you fund the trust. A CLT is the opposite, which is the charity gets for some period of time. And then the beneficiary gets it at the end of it. Two flavors, one idea. Charitable Lead Annuity Trust, CLAT, and Charitable Lead Unitary Trust is the CLUT. So, so far we’ve gone to CRATs, CRUTs, CLATs, and CLUTs, which sounds like someone walking on a marble floor wearing tap shoes. Like CRATs and CRUTs, like I said, charity gets to use now. The basic idea is that the charitable portion decreases the fair market value sufficiently to use less of the annual or lifetime exclusion.

Matthew Foreman [00:14:33]:
Basically, there’s an interest rate that you have to exceed for it to work. So if you have an asset that goes above it, what happens is the charity gets some level, you know, especially with stocks, and they get to throw off some dividends. And then at the end of it, it goes to the person you want. The value of the donation is sufficiently high over a sufficiently long period where you get the donation and then the value is zero because what’s happening is The content, the beneficiary has a value of zero. They’re receiving an interest in something that’s valuable at zero, even though what the idea is that when they get it after the trust terminates, when they get it, when they, I’d say when they become the beneficiary of the trust, the current beneficiary of the trust after a certain period, when the charity is no longer, they’ll have an asset that still has some level of value, right? It’s an interesting idea for sure. Like the key is again, and I already sort of said this, you know, the federal deduct— why do people use CRTs, CRTs? The answer is federal deductions limit to 50% of AGI. States may limit to, you know, New York, for example, does limit as well. The idea is to contribute far before the capital event, not 3 months before.

Matthew Foreman [00:15:38]:
I get questions all the time. I want to do this. Oh, when are you selling? Oh, in like 2 weeks. No, don’t. Doesn’t work. Not how it works. You’ve constructively sold it already. Ideally, a couple years at least.

Matthew Foreman [00:15:48]:
CRTs and CLTs, as I said before, are not taxpayers. They can have large amounts of income, such as the sale from the sale of a real estate or a business. And the trust is not taxed. It’s only taxed on distributions in the CRT. Distributions in the CLT are not taxed because the recipient’s a charity. But watch out for unrelated business taxable income. Every so often I’ll run into someone who has a great idea, put a business into one, and, you know, look, it’s a nonprofit, it’s a charity. So if it has UBTI, it’s at the corporate rates.

Matthew Foreman [00:16:14]:
So pretty unhelpful. CLTs are less effective in low interest rate environments, right? Because you don’t have much Of the gain of the asset value. Just for fun, because I like slacking on S-corps, you have an S-corp, CLTs and CRTs are ineligible shareholders, so they’ll blow the S-election, so don’t use them. Before we get to GRTs, grantor retained trust, let’s have some more music. They really rock out for a couple minutes and then I’ll bring it on home.

Matthew Foreman [00:16:48]:
All right, we’re back. Let’s talk about GRTs.

Matthew Foreman [00:16:57]:
Let’s talk about grantor retained trusts. Similarly, there’s two flavors: grantor retained annuity trust, grantor retained unitrust. That’s in gruts. So we have crats and cruts, flats and klutz, grats and gruts, right? Wonderful. Sort of, so, so enunciated. To tell people what they want by using words, right? Not just the acronym, because much like me, you know, I mumble a bit. So want to make sure don’t get that. Sort of like CRTs, but the grantor themselves retains the interest that the charity received in the CRT.

Matthew Foreman [00:17:29]:
So basically the grantor retains the current income and then the future income, the future asset is sent to someone else, right? Someone you like, your niece, your nephew, whatever. Except the appreciation goes to the remainderman. There’s what’s called a zeroed-out grant. Sounds like whacked-out mural. Congrats to the single listener who got that reference. Zeroed-out grant is what many wealthy families do when they have income-producing assets. Baltans use them pretty heavily. Not throwing shade, not, you know, doing anything bad.

Matthew Foreman [00:17:57]:
There’s litigation that is public record on these, so they use zeroed-out grants. Anyway, the idea is the asset, such as public company stock like Walmart stock, right, appreciates enough that it exceeds the discount rate under 7520. So the gift is made now, the future value of the gift is zero, but it appreciates above the 7520 rate, the discount rate under Section 7520. And so the fair market value of your remainderman’s interest at the time of the transfer is zero. So there’s no estate tax, no gift tax, and the asset is out of the estate. Some people don’t like them because you don’t get the estate step-up under 1014. However, if you have a billion dollars, you are generally speaking, such as I think Walton’s, you’re generally speaking less concerned about state step-up as you are as transferring without incurring tax. So that’s the key.

Matthew Foreman [00:18:44]:
The key, you know, the grantor must outlive the term of it to get the estate. Technically it’s a grantor trust, so it’s no gift. There’s also GRITs, grantor retained income trusts. Same basic idea as a GRT, but the beneficiary cannot be a close relative. I just kind of like the name. I’ve never actually seen them used in my life. I’ve seen all these other ones, but never GRIT, a bit gritty, you know. If you’re a big fan of really weird mascots, Gritty, that’s a good one.

Matthew Foreman [00:19:11]:
You’ve already figured this out, I’ve already said it, but this episode is not really about winning the lottery. Winning the lottery is really about estate planning, wealth management, preservation, asset protection. From an income tax perspective, winning the lottery is not terribly interesting. I mean, beyond like we should hang out because I got some ideas and we could have a lot of fun, but it’s really not that interesting from an income tax or really an estate tax planning perspective. Interesting is what you can do with it, what you do with the assets and how it works out. If you win the lottery, what should you do? First, you know, don’t overthink it. If you’re charity inclined, QATs, CROTs are great. No increase in value, income tax on distribution, so you can control how much money you get.

Matthew Foreman [00:19:50]:
But don’t feel like you need to do one thing. Definitely mix and match. If you’re not charity inclined, zeroed out GRATs are great. Get to the next generation. Remember, CRTs are less beneficial in a low-income in low interest rate environment, uh, basic function of time value of money. And GRATs are better in low interest rate environments because it’s easier for the assets to appreciate sufficiently to exceed the hurdle. Um, just, you know, it’s a lot of tax and a lot of estate planning math. In conclusion, right, I don’t usually say this, but in conclusion, if you win the lottery, please let me know because I have some ideas for some things I’ve always wanted to do.

Matthew Foreman [00:20:20]:
Number 1 on my list is have a party in the Whale Room at the American Museum of Natural History on the Upper West Side of Manhattan. I’ve always wanted to do this. And for enough money, you can do it. There are weddings there, you know, all kinds of stuff happens there. And I just think that’d be really fun. Let’s be honest here. Life is short, as we all know, and far too often reminded. So let’s have some fun.

Matthew Foreman [00:20:43]:
Let’s have a party the way we’re on the Upper West Side. And that’s a cool thing to do. And so I think that’s something we should do. All right. So that was episode 37 of How Tax Works. I hope you enjoyed it. I’ll be back in 2 weeks with the 38th episode where I’ll be discussing, you know, updates to Section 1202 and 174 under OB Thrice. I’ll explain why I call it that in the next episode.

Matthew Foreman [00:21:05]:
So you got to come back for that. But hope you enjoyed. I hope you learned something.

Matthew Foreman [00:21:08]:
Now for some really good music. Mm-hmm.