There aren’t that many charitable lead trusts (CLTs) in the United States (fewer than 7,000, compared to almost 110,000 charitable remainder trusts (CRTs)).1 Perhaps their usefulness has been somewhat overlooked by the estate-planning and charitable-gift-planning professions. CLTs are hybrid tools that accomplish both estate-planning and charitable-planning goals. Obviously, not every client has both types of goals, but for clients who do, a closer look at the CLT is warranted. The Internal Revenue Service has provided annotated model documents for all types of CLTs, which will usually ease the process of drafting them.2
For the uninitiated, a CLT pays either a fixed amount (charitable lead annuity trust (CLAT)) or a fixed percent of value (charitable lead unitrust (CLUT)) annually to one or more charities over a term of years. At the end of the term, any remaining assets pass to non-charitable beneficiaries, typically in further trust. Like the familiar estate-planning trust, the grantor-retained annuity trust (GRAT),3 the more the assets appreciate during the term, the more there’s left for the family at the end. Like GRATs, CLTs generally produce better economic results in low interest rate environments—yet another reason to consider one now. Unlike a GRAT, however, a properly designed CLT won’t be included in the settlor’s taxable estate, even if she should die before the end of the trust term.
The term may be a specified number of years, or it may be measured by certain permissible measuring lives.4 Unlike term-of-years CRTs, which are limited to 20 or fewer years, CLTs may be for any number of years. There’s also no minimum or maximum annual percentage payout (unlike CRTs, which have a minimum of 5 percent and a maximum of 50 percent annual payout). This flexibility in design allows donors to consider funding CLTs with assets they expect to grow over time, even if the timing or pattern of that growth may be unpredictable.
Non-Grantor vs. Grantor
Most CLTs are non-grantor trusts and are, therefore, treated as complex trusts for income tax filing purposes. The trust is allowed a deduction for the amount of its taxable income distributed to charity each year. A trust may elect to “set aside” current year income for payment in the following year, up to the amount of the payment due to the charity in that subsequent year.5 Unlike the charitable income tax deduction for individuals, the charitable income tax deduction for a trust isn’t limited to a percentage of the trust’s income—it’s often possible for a trustee to manage the trust investments to reduce the net taxable income of the trust to zero. This deduction not only reduces the regular taxable income, but also, under the proposed net investment income regulations, reduces the income subject to the net investment income tax, which is imposed on trusts for 2013 and later years.6 In contrast, the charitable income tax deduction isn’t allowed to offset income subject to the net investment income tax for individuals.7 So, for the charitably inclined donor, a CLT may reduce the overall income tax burden, leaving more for family and charity.
A few CLTs are established as grantor trusts. A donor establishing a grantor CLT is allowed a deduction for the present value of the charitable payment stream in the year the CLT is established. Of course, the grantor must pick up the trust income throughout the term. Grantor CLTs, like other grantor trusts, are eligible Subchapter S shareholders.8 Therefore, an S shareholder with both charitable and estate-planning intent might find the grantor version of a CLT to be a good fit. Should grantor status be lost, including due to death of the grantor, some or all of the tax benefit of the large charitable income tax deduction allowed at the inception of the trust will be recaptured in the grantor’s final income tax return.9
Inter Vivos vs. Testamentary
An inter vivos CLT will be excluded from a settlor’s taxable estate (unless he’s retained a reversionary interest in it), thus allowing the assets in excess of the charitable payments to pass to the beneficiaries without estate taxes. A testamentary CLT may reduce the estate tax and defer the receipt of trust funds until the next generation is ready. Generation-skipping taxes may also be reduced, but only through the use of a CLUT, not an annuity trust.10
Calculating Taxable Gift or Estate
When calculating the taxable gift or taxable estate when a CLT is funded, an estate or gift tax charitable deduction is allowed for the present value of the payment stream to charity. For CLATs, this formula may result in a zero taxable gift or bequest: A useful thought for donors who used their lifetime exemptions in 2012 in anticipation of going off the fiscal cliff.
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1. This statistic refers to 2011 filed returns, Statistics of Income Bulletin Winter 2013, www.irs.gov.
2. See Revenue Procedures 2007-45 and -46 (Internal Revenue Service 2007), for charitable lead annuity trusts and Rev. Procs. 2008-45 and -46 (IRS 2008), for charitable lead unitrusts.
3. Grantor-retained annuity trust under Internal Revenue Code Section 2702(b)(1).
4. Treasury Regulations Section 1.170A-6(c)(2)(i)(A).
5. Treas. Regs. Section 1.642(c)-1(b).
6. Proposed Regulations Section 1.1411-3(e)(4).
7. Prop. Regs. Section 1.1411-4(f).
8. Private Letter Ruling 200747001 (Aug. 3, 2007).
9. Treas. Regs. Section 1.170A-6(c)(4).
10. Treas. Regs. Section 26.2642-3.