Updated June 24, 2024
Charitable Lead Trusts (CLTs) can be a good way to do three very beneficial things: (1) support your favorite charities over many years; (2) possibly obtain a tax break; and (3) leave any remaining trust assets to family members. Recent tax law changes and historically low interest rates make CLTs worth considering if you’re a high-net-worth family or individual.Jacqueline Kennedy Onassis, for one, had arranged that upon her death (1994) her estate would be transferred to a CLT set up to last 24 years, all that time distributing money to charity annually. In 2018, whatever was left in that CLT was distributed to her grandchildren.
Major Benefits of a Charitable Lead Trust (CLT)
There are no specific minimum or maximum payout rates to charity. Payouts must occur annually but the amount can be determined by the grantor (see CLAT or CLUT below).
Some or most of the CLT assets can eventually pass to your heirs free of estate tax. That’s because the IRS sets a “hurdle rate” at which the CLT assets are expected to grow. Any growth above this rate can usually pass estate-tax-free to heirs after the trust expires. The hurdle rate for July 2024 was 5.4% and it is adjusted monthly to reflect changes in U.S interest rates.
CLTs are definitely not for every wealthy household; they’re complex vehicles that must be set up properly for all the intended benefits to be realized. So you can get an idea of how they work, below is a general overview.
Types of Charitable Lead Trusts
You can set up a Charitable Lead Trust (CLT) during your lifetime. Or the CLT can be created upon your death, as specified in your will or another estate-planning document.
The tax treatment depends on whether you have a Grantor or Non-Grantor CLT.
Grantor CLT: You, as grantor, are considered the owner of the trust. For assets transferred to your CLT, you get a charitable income tax deduction up to 30% of your adjustable gross income (AGI) and up to 20% of AGI for appreciated property (amounts in excess can be carried forward for five straight years). However, this deduction is re-captured if you die before the trust expires. In addition, you will be taxed annually on all trust income.
Non-grantor CLT (can be set up upon death or during lifetime of grantor). If you as grantor retain no personal financial interest in the CLT, you do not get the upfront charitable income-tax deduction. But you’re not taxed on the trust income. Another plus: the assets in the trust will not be considered part of your taxable estate.
CLAT or CLUT?
CLTs are defined by their payout structure:
— A Charitable Lead Annuity Trust (CLAT) pays out a fixed annual amount to charity, based on a specified percentage of the initial trust assets, just like an annuity. CLATs are the most common types of charitable lead trusts, mainly because both the charity and the trust administrator know what to expect in terms of payout.
— A Charitable Lead Unitrust (CLUT) pays out a variable annual amount, based on a specified percentage of trust assets at the time.
Dotting the I’s and Crossing the T’s
Regardless of whether you opt for a CLAT or CLUT, certain requirements apply:
— The trust must be irrevocable – once established, it cannot be changed.
— The life of the trust must be for a fixed number of years or for the life of the grantor.
— To get the tax deductions, at least one annual payment must be made to a qualifying charity, either a fixed dollar amount or a fixed percentage of the value of the assets.
— The charity must be an IRS-qualified charity, per IRS Section 170(c).
— If a private foundation is the receiving charity (including your own family foundation), you as the grantor cannot be involved in the grant-making decisions in any way, or change the charitable beneficiary.
Other Considerations
Tax situation when the CLT expires. It is unlikely that the initial gift to the CLT will generate a gift tax (the current estate tax exemption is $13.6 million per person). Note, however, that the portion of the CLT that will eventually pass to heirs is considered a taxable gift. And the generation-skipping tax may apply should the grantor choose grandchildren as the remainder beneficiaries.
Get clued in to CLATs and CLUTs. As you can see, there are many moving parts to CLATs and CLUTs. So we always work closely with clients’ attorney(s) and accountant(s) to analyze the benefits and pitfalls of a CLT for their specific situation before taking any action.
