What is a Charitable Lead Trust?
A Charitable Lead Trust (CLT) is a type of “split-interest” trust that provides a tax-efficient way to transfer wealth to your heirs while supporting your favorite charities.
Charitable lead trusts are designed to contribute to one or more charities over a defined period of time. After this period, the remaining assets are distributed to family or other non-charitable beneficiaries.
When properly structured, charitable lead trusts can help reduce income, estate, or gift taxes for you and your beneficiaries.
Is a Charitable Lead Trust Right for Me?
Charitable Lead Trusts are a powerful planning tool for anyone with significant assets.
That said, CLTs may be worthy of consideration for those who:
- Have a sizeable taxable estate and have already used their lifetime exemptions
- Wish to make a meaningful impact on their favorite causes
- Wish to transfer money to heirs without paying gift (or estate), OR
- Seek a deduction to lower income taxes in a high-earning year.
What are the Benefits of a Charitable Lead Trust?
There are several compelling reasons to choose a CLT for your charitable giving strategy.
Tax Savings
CLTs can help you achieve wealth transfer tax savings by reducing your taxable estate and passing more wealth to heirs at a minimal or nominal wealth transfer tax cost. CLTs may be structured to provide the Settlor an income tax deduction (discussed below).
Family Philanthropy
CLTs can help you leave a lasting philanthropic impact whether it’s for your favorite charitable causes or your own family foundation.
Family Legacy
Even if you have used all of your lifetime gift exemption, the CLT strategy can be designed to potentially pass more to heirs at a minimal or nominal gift tax cost.
How Does a Charitable Lead Trust Work?
When setting up a CLT, the Settlor (the creator of the trust, usually the donor) contributes assets to a trust over a defined term, such as 10 years or upon the death of an identifiable person or persons.
During this period, assets are managed within the CLT and payments are required to be made annually to designated charities, either as fixed annuity amounts or as a percentage of the trust’s value each year (unitrust). At the end of the CLT term, any remaining assets may be passed to family members or trusts for their benefit.
CLTs can be funded during your lifetime or at death. Only CLTs established during life may be created as a Grantor CLT. In both cases, the Settlor must feel comfortable with having large sums of family assets locked up for the duration of the lead term, which in most cases can be a very long time.
Therefore, this planning is typically done when you have more than enough to meet your personal lifestyle needs and perhaps have also done some substantial gifting to your children.
What Can You Contribute to a Charitable Lead Trust?
Charitable Lead Trusts can be funded with a wide variety of assets, allowing for significant flexibility in planning your charitable donations and estate.
- Cash
- Publicly traded securities
- Real estate
- Other complex assets
Understanding what assets you can contribute to a CLT is crucial for maximizing its benefits.
It’s important to evaluate the appropriateness of each type of asset with a financial advisor, ensuring they align with your overall estate strategy and the specific requirements of the CRT.
Types of Charitable Lead Trusts
CLTs can be structured as Grantor Trusts or Non-Grantor Trusts, each with its own tax rules.
Grantor CLT
- Settlor Pays Taxes: The Settlor reports the CLT’s income, deductions, and credits on his or her personal tax return, effectively picking up the CLT income during the lead term.
- Immediate Deduction: The Settlor receives an immediate income tax deduction in the year of the transfer equal to the actuarial value of the lead interest the charity will receive, calculated using the IRS 7520 rate.
- Ongoing Tax Liability: The Settlor must pick up the CLT’s income over time on their personal tax return.
Non-Grantor CLT
- Trust Pays Taxes: The CLT reports and pays the trust income taxes (and receives a charitable deduction for the annuity or unitrust payment made to charity each year).
- No Immediate Deduction: There is no income tax deduction for the Settlor.
CLATs vs. CLUTs
A Charitable Lead Annuity Trust (CLAT) and a Charitable Lead Unitrust (CLUT) are types of Charitable Lead Trusts (CLTs) that require annual distributions to charities. The key difference lies in how the payment to charity is calculated.
Charitable Lead Annuity Trust (CLAT)
- Fixed Payments: The charity receives a set dollar amount annually, based on the initial value of the trust assets.
- Predictability: This structure offers predictable and stable payments to the charity.
Charitable Lead Unitrust (CLUT)
- Variable Payments: Payments are a fixed percentage of the trust’s assets value, which must be recalculated each year.
- Flexibility: This allows the payments to adjust with the value of the trust’s investments.
Maximizing the Benefits
Zero-Out CLTs
Zero-out CLTs are designed to eliminate the taxable gift by matching the present value of the charitable lead interest to the initial contribution.
Example: If you donate $100 to a zero-out CLAT with a 10-year term, the annuity payments are structured so that the present value of the charitable interest equals $100. If the trust outperforms the IRS 7520 rate, any remaining assets pass to the non-charitable beneficiaries tax-free.
Testamentary CLTs
Testamentary CLTs are established upon the grantor’s death through their will or living trust
Use Case: These are ideal for those who have already provided for their children’s needs during their lifetime but wish to leave a charitable legacy. If the trust outperforms the IRS 7520 rate, the remainder beneficiaries inherit the excess tax-free.
Wrapping It Up
CLTs offer a powerful way to balance philanthropy and family wealth transfer tax planning. By understanding how they work and how to maximize their benefits, you can create a legacy that reflects your values and supports your loved ones.
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If you’re considering a charitable lead trust or just exploring your options, we are standing by and happy to be a resource.