This article appears on Charlotte Business Journal.
A charitable lead trust (CLT) is an irrevocable trust designed to provide financial support to one or more charities for a period of time, with the remaining assets eventually going to family members or other beneficiaries. The trust operates for a fixed term, which could be the life of one or more individuals, and one or more designated charitable beneficiaries receive payments from the trust during that time. Depending on how the trust is structured, the donor enjoys a current income, gift, or estate tax deduction on the donated assets. After the end of the trust term, the remainder is distributed to the non-charitable beneficiaries, such as family members.
A CLT can be funded either during the lifetime of the individual creating the trust or by will. It can potentially provide benefits such as income tax deductions, estate tax reductions, and or gift tax savings on assets ultimately passed to the individuals designated as remainder beneficiaries.
Income Tax Deductions
While charitable lead trusts are not tax-exempt (investment earnings accrued are taxed to the grantor), a grantor may get a one-time tax deduction for the fair market value of their full donation to the trust at the time that it is set up. The grantor should make sure that the cumulative taxes on earnings don’t outweigh the initial tax deduction.
Each of the two types of CLTs offers different tax benefits:
- Grantor CLT—This is typically used for donors experiencing a significant income event. A grantor trust is one in which the donor is treated as the owner of the trust for income tax purposes. With this structure, the donor receives an immediate income tax deduction, with the trust assets distributed to the donor or to another non-charitable beneficiary after the trust term ends. The charitable deduction the donor received at the funding of the trust is recaptured over the trust term because the donor is taxed on the CLT income, including the payouts to charity. Tax-exempt investments in the trust help to minimize the donor’s tax liability.
- Non-Grantor CLT—This is used to reduce gift and/or estate tax. The lower the remainder value (the gift to the non-charitable beneficiary), the lower the potential gift tax cost. The remainder value can be zeroed out by adjusting the charitable lead payment amount and duration. If the CLT assets appreciate at a rate that exceeds the 7520 rate (the interest rate that is 120 percent of the applicable federal midterm rate for the month in which the valuation date falls), the value of the excess investment return will be distributed to remainder beneficiaries at the end of the term free of estate or gift tax.
Estate Tax Reductions
By transferring assets into a CLT, you may be able to reduce the size of your taxable estate. This can help minimize estate taxes, allowing you to pass more of your wealth to your chosen beneficiaries. Here are a few ways CLTs can help reduce estate taxes:
- Estate Tax Charitable Deduction – When you create a CLT, the present value of the income stream going to the charitable beneficiaries is eligible for an estate tax charitable deduction. This deduction can help reduce the taxable value of your estate. The amount of the deduction is calculated based on factors such as the value of the charitable lead interest, the length of the trust term, and the applicable federal and state tax laws.
- Removal of Assets from the Estate – When you transfer assets to a CLT, those assets are no longer considered part of your taxable estate. The income and appreciation generated by the trust are directed to the charitable beneficiaries, effectively reducing the taxable value of your estate. This can result in significant estate tax savings, especially if the assets in the trust experience substantial growth over time.
- Time-Limited Charitable Lead Trusts – A time-limited CLT, typically a grantor trust, allows for a fixed term during which the charitable beneficiaries receive income from the trust. Once the term ends, the remaining assets in the trust can pass to your non-charitable beneficiaries, such as family members, with little or no additional estate tax implications. This strategy can effectively transfer wealth to the next generation while benefiting charitable causes during the trust term.
Legacy Planning
CLTs can help you establish a lasting philanthropic legacy by supporting charitable causes beyond your lifetime. You can significantly impact the causes you care about and leave a charitable legacy for future generations.
- Continued Support for Charitable Causes – By establishing a CLT, you can provide ongoing financial support to charitable organizations or causes that are meaningful to you. The income generated by the trust is directed to the charitable beneficiaries during the trust term. This ensures that your philanthropic goals and values are honored beyond your lifetime.
- Multi-Generational Impact – CLTs can involve multiple generations in your philanthropic legacy. You can designate family members or other individuals as trustees or advisors for the trust, allowing them to participate in the charitable giving process and learn about philanthropy. This can instill a sense of giving back in future generations and create a lasting legacy of charitable involvement.
Because charitable lead trusts are irrevocable, we recommend careful planning to ensure the trust can make its required payments during the trust term. It’s important to consult with an experienced estate planning attorney or financial advisor to understand the benefits and considerations of charitable lead trusts, as the effectiveness and implications may vary depending on individual circumstances and applicable tax laws.
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