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 or estate or gift tax savings on assets ultimately passed to the individuals designated as remainder beneficiaries.
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.
Because charitable lead trusts are irrevocable, we recommend careful planning to ensure the trust can make its required payments during the trust term. Please contact your SignatureFD advisor to learn more about establishing a charitable lead trust.
Source: Fidelity Charitable