A charitable lead trust (“CLT”) is an irrevocable trust that pays a fixed amount or percentage of trust assets to one or more charities of the settlor’s choosing for a term of years, with the remaining assets eventually going to family members, trusts, or other beneficiaries. The income tax advantages of a CLT will vary depending on its particular form, but generally settlors will recognize estate and gift tax benefit through the use of this technique.
There are two general types of CLTs – a grantor CLT and a nongrantor CLT. Each can be in the form of a unitrust or an annuity trust. A grantor CLT provides an income tax deduction on its creation to the settlor, however the settlor is then taxed on all income that will be paid to the charity. While there are limited uses for grantor CLTs, a majority of our clients use nongrantor CLTs.
A nongrantor CLT is primarily used in conjunction with other estate planning vehicles to provide a way to not only reduce gift and estate tax on transfers of high growth assets to heirs, but also provide a transfer of future growth tax-free. Not only is the income of the trust paid to charity and not taxed to the settlor, but it may also replace or enhance outright charitable gifts the settlor would otherwise wish to make.
BENEFITS OF THE CLT
A properly structured CLT will result in several benefits to the settlor. Upon funding, the settlor receives a gift and estate tax deduction based on the value of the income stream given to charity, while at the same time recognizing a substantially reduced gift tax value on the gift of the remainder interest to heirs. The selected assets (and their future growth) are immediately removed from the settlor’s estate and thus reduce his or her federal estate tax liability. The settlor may continue to manage the trust assets during the trust term, affording continuity in management. In a low interest rate environment, any excess earnings and growth above the payout rate or amount will add to the value of the trust corpus. At the end of the successful CLT’s term, all assets in the trust, including any growth, are transferred to the settlor’s named beneficiaries without further gift or estate tax.
CLTs do not have the mortality risk or valuation risk that can be present in other estate tax planning strategies. However, CLTs are only appropriate for settlors who have strong charitable intentions and those who are comfortable delaying the transfer of assets to their heirs until the end of the trust term. Because the trust is irrevocable, the charitable commitment cannot be changed and payments must be made each year, regardless of whether there is sufficient trust income available. Additionally, there is no guarantee that the trust assets will appreciate.
HOW PERSPECTA CAN HELP
Perspecta helps our clients determine if CLTs should be incorporated into their wealth transfer plan. Through careful asset selection and trust design, we assist clients in their efforts to shift appreciating assets out of their taxable estate. Contact us to see how we can help structure a wealth transfer strategy that accomplishes your families’ objectives.
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