June 29, 2022
Are you inclined to donate assets to a charity for a period of time without ultimately giving up the property? Consider the benefits of a charitable lead trust (CLT). This type of trust is essentially the opposite of the charitable remainder trust (CRT), a better-known alternative.
With a CLT, the property eventually reverts to your family members — not the charity. At the same time, the CLT provides a stream of annual income to the charity for a term of years.
A CLT in action
A CLT may be funded during your lifetime, or a testamentary trust can be created through your will or other estate planning documents. In either case, the trust is irrevocable. You can incorporate this technique into your estate plan to accommodate charitable intentions.
The basic premise is relatively simple although the mechanics can be complicated. Generally, you contribute property to a trust drafted to last for a specific number of years. The charity (or group of charities) designated as the income beneficiary receives payouts during the trust term.
Depending on the CLT’s structure, payments are made as fixed annuity payments or a percentage of the trust. When the trust term expires, the remaining assets are distributed to the designated beneficiaries.
Charitable deduction implications
One of the main attractions of a CRT is that you can claim a current tax deduction for the value of the remainder interest. However, if you use a CLT, your deduction may be limited or nonexistent, depending on whether it’s a grantor or nongrantor trust.
With a grantor CLT, you can claim a current deduction for the present value of the future payments to the charitable beneficiary, subject to other applicable deduction limits. However, there’s a downside to this arrangement: The investment income generated by the trust is taxable to the grantor during the term.
Conversely, if the CLT is set up as a nongrantor trust, the trust itself — not the grantor — is treated as the owner of the assets. As a result, the trust is liable for the tax due on the undistributed income. Thus, the trust, but not the grantor, can claim the charitable deduction for distributions to the charitable organization. Each situation is different, but the resulting income tax liability for a grantor trust often outweighs the benefit of the current tax deduction.
Note that a properly structured CLT will produce a gift or estate tax deduction for the value of that portion of the trust designated for charity. This makes it possible to transfer a remainder interest to family members at a relatively low tax cost.
Ins and outs
The CLT must provide annual payments to at least one designated charity for a specific number of years, the life of one or more individuals, or a combination of the two. Unlike a CRT, there’s no mandatory timeframe of 20 years, nor does the trust have to impose maximum or minimum requirements each year. When the trust term finally expires, the remainder passes to the designated beneficiaries named at the outset.
Is a CLT right for you? It depends on your circumstances. Discuss this option with us.