A Charitable Lead Trust (CLT) is an irrevocable trust created by the donor, who contributes assets such as cash or marketable securities to the CLT.  The CLT gives a charity the right to receive funds for a fixed number of years, after which the funds pass to family members.  The charity can be a private family foundation, donor-advised fund, or another charity of the donor's choice.  The amount payable to charity can be either a fixed dollar amount each year (charitable lead annuity trust or CLAT), or a percentage of the value of the assets as re-determined each year (charitable lead unitrust or CLUT).  Usually, a CLT is used to pass assets to family members at a reduced gift tax cost, while benefitting a charity.

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A CLT can provide either income or estate and gift tax benefits to individuals with a desire to fund charitable organizations.

 

INCOME TAX BENEFITS 

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A CLT can be set up during the donor's lifetime, or on the donor's death.  If the CLT is set up during the donor's life as a grantor trust for income tax purposes (so the donor is taxed on the income earned by the trust each year), then the donor can claim an income tax deduction when the trust is funded, but the donor will not get an income tax deduction as distributions are made to charity.  If the trust is not set up as a grantor trust for income tax purposes, then the donor gets no income tax deduction when the trust is funded, but distributions to charity from the trust will be deductible against the trust's income.

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ESTATE TAX BENEFITS

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If the donor's primary goals is to transfer assets to family members while potentially using little or none of the donor's lifetime federal estate and gift tax exemption, a nongrantor trust is typically recommended.  There is no initial income tax deduction when the donor makes the initial gift to the CLT, but the donor gets a charitable deduction against the value of the assets that will pass to family members when the CLT term ends.

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In addition, the donor doesn’t pay income tax on the CLAT income.  The tax is paid by the trust, which receives a charitable deduction each year for the amount paid to charity from the CLAT.

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An Example:

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A donor contributes $2 million of marketable securities to a CLAT with a 10-year term.  Based on a 7520 interest rate of .4% (current for the month of November 2020), if the donor wanted the remaining assets at the end of the term to pass to family members without using any of the donor's estate or gift tax exemption, the CLAT would pay out approximately $204,000 annually for 10 years (total of $2,044,000) to charity.  Assuming a conservative 2.5% growth rate per year on the contributed assets, a remainder of approximately $270,000 will pass free from gift and estate tax to the donor’s heirs.

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The donor can adjust to allow a larger amount to pass to heirs and a lesser amount to charity.  In that case, the donor would use up some lifetime estate or gift tax exemption, but it would be a fraction of the amount ultimately passing to the heirs.  The trustee can be given flexibility to pick charities each year or the donor can select the charities for the entire term.

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A nongrantor CLAT also allows the donor to effectively fund charitable gifts with pretax income by contributing income-producing property.  The income is excluded from the donor’s taxable income, and therefore the individual doesn’t need to offset it with a deduction, which is subject to various charitable deduction limitations.   

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CREATING CLT AT DEATH

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A CLT may also be set up under a revocable living trust or Will.  The decedent's estate gets an estate tax deduction for a portion of the assets going into the trust.  The amount of the deduction will depend on what kind of CLT (unitrust or annuity trust) is used, the payout rate, interest rates when the trust is funded and the length of the charitable term.  

 

A CLT works well if the donor has assets which are likely to increase in value far faster than the IRS assumed rate of interest, or if valuation discounts can be claimed to reduce the value of the assets going into the CLT.