A Charitable Lead Trust (“CLT”) can be established during your life (“inter vivos”) or after your death (“testamentary”). In both types of CLTs, charitable gifts are made out of the trust for a period of years, then, at the end of that period, assets pass to designated family members or others.
A CLT with terms that provide for annuity payments (a fixed percentage of the fair market value of the property transferred to the trust as of the date of the transfer) is known as a charitable lead annuity trust (“CLAT”). A CLT with terms that provide for a unitrust amount (a fixed percentage of the fair market value of the trust property as that value is re-determined annually during the lead term) is known as a charitable lead unitrust (“CLUT”).
Charitable Lead Trusts established during lifetime
At the time the grantor transfers property to the CLT, the grantor is treated as having made a charitable gift equal to the present value of the stream of the annuity or unitrust payments to be paid to the charity. The present value of this stream is determined by applying a discount rate (equal to 120% of the federal AFR mid-term rate in effect for the month during which the grantor makes the transfer) to the aggregate payments to be made to the charity. The lower the AFR rate, the lower the discount rate, and the higher the present value of the revenue stream to be paid to charity. Additionally, at the time the grantor transfers property to the CLT, the grantor is treated also as having made a noncharitable gift to the remainder beneficiaries. The higher the present value of the revenue stream to be paid to charity, the lower the present value—and therefore the gift tax value—of the property transferred to the remainder beneficiaries.
If you establish an inter vivos CLT during your lifetime, you, as the grantor of the trust, are not entitled to a charitable income tax deduction for funding the trust unless it is treated as a grantor trust and therefore you are responsible for paying all of the CLT’s income taxes during the term of the trust. If the CLT is treated as a non-grantor trust, you are not entitled to a charitable income tax deduction but you are entitled to a gift tax charitable deduction for the value of the charitable lead interest.
Charitable Lead Trusts established at death
A testamentary CLAT, established at death, is typically used as a way of accomplishing not only a charitable giving goal but also the goal of passing assets on to next generation family members at a lower estate tax cost. The Grantor’s estate would be entitled to an estate tax charitable deduction for the value of the charitable lead interest. Since the property is included in the grantor’s estate, it would result in there being a stepped-up basis in the property contributed to the trust, which would eventually pass to the non-charitable beneficiaries. It is possible to establish a sufficiently long charitable lead interest so that the estate tax charitable deduction is equal to the full value of the trust corpus, thereby totally eliminating estate tax with respect to the trust corpus. This is called a “zeroed out” CLAT. In the case of a zeroed out CLAT, the remainder noncharitable beneficiaries receive is the upside of the economic performance of the trust assets over and above the AFR rate on an estate tax free basis. When interest rates are low, the likelihood that the trust assets will outperform the AFR rate and the remainder beneficiaries will receive excess trust property gift tax free at the end of the lead term increases. This is more difficult to accomplish when interest rates are higher.
A CLT with terms that provide for annuity payments (a fixed percentage of the fair market value of the property transferred to the trust as of the date of the transfer) is known as a charitable lead annuity trust (“CLAT”). A CLT with terms that provide for a unitrust amount (a fixed percentage of the fair market value of the trust property as that value is re-determined annually during the lead term) is known as a charitable lead unitrust (“CLUT”).
Charitable Lead Trusts established during lifetime
At the time the grantor transfers property to the CLT, the grantor is treated as having made a charitable gift equal to the present value of the stream of the annuity or unitrust payments to be paid to the charity. The present value of this stream is determined by applying a discount rate (equal to 120% of the federal AFR mid-term rate in effect for the month during which the grantor makes the transfer) to the aggregate payments to be made to the charity. The lower the AFR rate, the lower the discount rate, and the higher the present value of the revenue stream to be paid to charity. Additionally, at the time the grantor transfers property to the CLT, the grantor is treated also as having made a noncharitable gift to the remainder beneficiaries. The higher the present value of the revenue stream to be paid to charity, the lower the present value—and therefore the gift tax value—of the property transferred to the remainder beneficiaries.
If you establish an inter vivos CLT during your lifetime, you, as the grantor of the trust, are not entitled to a charitable income tax deduction for funding the trust unless it is treated as a grantor trust and therefore you are responsible for paying all of the CLT’s income taxes during the term of the trust. If the CLT is treated as a non-grantor trust, you are not entitled to a charitable income tax deduction but you are entitled to a gift tax charitable deduction for the value of the charitable lead interest.
Charitable Lead Trusts established at death
A testamentary CLAT, established at death, is typically used as a way of accomplishing not only a charitable giving goal but also the goal of passing assets on to next generation family members at a lower estate tax cost. The Grantor’s estate would be entitled to an estate tax charitable deduction for the value of the charitable lead interest. Since the property is included in the grantor’s estate, it would result in there being a stepped-up basis in the property contributed to the trust, which would eventually pass to the non-charitable beneficiaries. It is possible to establish a sufficiently long charitable lead interest so that the estate tax charitable deduction is equal to the full value of the trust corpus, thereby totally eliminating estate tax with respect to the trust corpus. This is called a “zeroed out” CLAT. In the case of a zeroed out CLAT, the remainder noncharitable beneficiaries receive is the upside of the economic performance of the trust assets over and above the AFR rate on an estate tax free basis. When interest rates are low, the likelihood that the trust assets will outperform the AFR rate and the remainder beneficiaries will receive excess trust property gift tax free at the end of the lead term increases. This is more difficult to accomplish when interest rates are higher.