Charitable Lead Trusts: Leveraging Generosity

By Margaret Gibson, Katz Teller

A Charitable Lead Trust (CLT) is a valuable estate planning tool (under current law) for charitably inclined business owners who may also benefit from an income tax deduction to offset earnings from a sale of their business or from a successful year. 

A CLT allows the grantor to make annual gifts to charity while effectively transferring wealth to heirs largely free of estate and gift taxation. This irrevocable trust is designed to distribute an annual income interest (the lead interest) to at least one qualified charity for a period measured by a fixed term of years or the lives of one or more individuals. At the end of the term, the balance of the trust assets (the remainder interest) is distributed to non-charitable beneficiaries, such as the family members of the grantor (or typically a trust for their benefit).

Due to the value of the lead interest passing to charity, the length of the term of the trust, and low applicable federal interest rates, the CLT can be structured so that the value of the gift to the grantor’s family at the end of the CLT’s term may be close to zero for transfer tax purposes. The grantor may transfer assets to the remainder beneficiaries of the CLT with minimal or no gift tax consequence, and the transferred assets are excluded from the grantor’s estate. The grantor may simultaneously meet his or her personal charitable giving goals.

The income tax benefits of a CLT vary depending on its precise form. For example, a CLT may be designed so that its income is taxed to the grantor, making the grantor eligible for an upfront charitable income tax deduction when the CLT is created, subject to applicable percentage limitations. Alternatively, the income may be taxable to the trust as it is earned, and the trust may take the charitable deduction for amounts passing to the charitable beneficiaries.

Before establishing a CLT, John gives $56,000 to charities annually and also owns $1 million worth of marketable securities which would be includible in his estate upon his death. John decides to create a CLT and contributes the $1 million in marketable securities to a grantor CLT which will pay $56,000 to designated charities (or to a donor advised fund) each year for a term of 20 years. At the end of 20 years, any assets remaining in the CLT will pass to a trust for the benefit of John’s children that is outside the estate tax system. 

If the IRS § 7520 rate is 1.2% at the time of the contribution, then the IRS values the amount passing to charity at approximately $991,000 and values the gift to John’s children at approximately $10,000. John receives an immediate income tax deduction for approx. $991,000 in the year he makes the contribution to the CLT (subject to applicable limitations).

The amount that will actually pass to the trust for John’s children at the end of the CLT will depend on the rate at which the assets in the CLT grow. If the CLT assets grow by 6.3% annually, then there will be approximately $1.2 million dollars at the end of 20 years passing to John’s children. If the CLT assets instead grow by 8% annually, approximately $2.1 million will pass to John’s children.

For more information, please contact Margaret Gibson at mgibson@katzteller.com or 513-977-3410.

Katz Teller is a Goering Center sponsor, and the Goering Center is sharing this content as part of its monthly newsletter, which features member and sponsor articles.