A CLT Can Benefit Charity, Reduce Taxes & Transfer Assets to Heirs

shutterstock_147289640A common goal of estate planning to avoid estate and gift taxes. A charitable lead trust (CLT) is one tool that can accomplish this objective. Although less familiar than charitable remainder trusts, CLTs can meet many of a donor’s tax, financial, and non-financial goalsall in the context of making a charitable gift. For example, a CLT may be used to accomplish one or more of the following:

    • Make charitable gifts
    • Reduce gift, estate, and/or generation skipping transfer taxes
    • Create an income tax deduction
    • Transfer money, stock, and/or illiquid assets to heirs

In this blog post we will introduce some basics on CLTs. In the next blog post we will explore common CLT formats.

Charitable Lead Trust Defined

A CLT is an irrevocable trust that is not tax-exempt. Each year CLTs pay an income stream to one or more charities for a specified period of time. At end of the CLT term, any remaining assets are either returned to the donor or paid to the donor’s children or other non-charitable beneficiaries. Although a CLT is not tax-exempt, a CLT may create an income tax deduction, a transfer (i.e., estate or gift) tax deduction, or in some cases, both. Because a CLT is not tax-exempt, contributing appreciated assets is generally not recommended.

Donors may choose to create a CLT during their lifetime or elect to include a CLT in their testamentary plan.

Income Stream Options

To qualify as a CLT, the payments to the charitable beneficiaries must be defined as either a fixed amount or a fixed percentage of the trust assets revalued annually. A trust that uses the fixed amount format is called a charitable lead annuity trust (CLAT). A trust that uses the fixed percentage format is called a charitable lead unitrust (CLUT).

Duration of a CLT

The charitable term of a CLT may be for a fixed number of years or for the lives of certain named individuals, or for many combinations of the two. The maximum term of a CLT is a function of state law. Because of the mathematical dynamics of computing the charitable deduction for CLTs, almost all CLTs utilize a fixed term of years.

Effect of Applicable Federal Rate

The amount of the charitable deduction allowed when creating a CLAT is highly sensitive to the applicable federal rate (AFR, IRC section 7520 rate) the IRS publishes each month. The lower this rate is, the greater the charitable deduction will be for any given combination of payout rate and term of years.

Application of the Private Foundation Rules

CLTs are subject to several rules originally created for private foundations. Chief among these is the prohibition on acts of self-dealing. A CLT may not purchase from, sell to, lease from or to, lend money to or borrow money from, a disqualified person. Further, a CLT trustee may not permit a disqualified person to use the income or assets of a CLT. Disqualified persons include the trustee, the donor, the donor’s spouse, many of the donor’s family members, and certain entities these people directly or indirectly control. In addition to the rule against self-dealing, a CLT may not make payments to anyone other than the charitable beneficiaries or as payment to non-disqualified persons (with limited exceptions) for needed services.

Where the amount of the charitable deduction is greater than 60% of the value of the assets transferred to the CLT, additional private foundation rules apply that require the timely divestment of closely-held business interests and the avoidance of certain risky investments.

Generation Skipping Transfer Tax

Where grandchildren or other skip persons are named as remainder beneficiaries of a CLT, the generation skipping transfer tax will apply. The GST ramifications of a CLUT can be quantified upon funding; however, the GST ramifications of a CLAT cannot be known until the expiration of the CLT’s term. Because of this, if a skip person is a remainder beneficiary, then a CLUT is generally recommended.

In the next blog post we will explore common formats of CLTs.