Tansey Estate Planning

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Charitable Lead Trust

A Charitable Lead Trust (“CLT”) is a Split-Interest Trust developed under the tax rules in which (1) an Annuity Interest or Unitrust interest is paid to a charity for a Term of Years or the Settlor’s lifetime (the “Income Period”) and (2) at the end of the Income Period, the remaining property in the trust is transferred to non-charitable beneficiaries (normally the Settlor’s children). A CLT is the mirror of a Charitable Remainder Trust.

The value of the taxable gift is the value of the Remainder Interest following the Income Period. There are three factors that the IRS uses to determine the value of the Remainder interest: (1) the length of the Income Period; (2) the percentage rate chosen by the Settlor to measure the amount to be paid to the charity each year during the Income Period; and (3) AFR at the time money or other assets are contributed to the CLT. The first two factors are in the Settlor’s total control, and the AFR is set by the IRS each month (based on interest-rate market conditions). A longer Income Period and/or a higher percentage rate during the Income Period makes it easier to reduce the amount deemed to be a taxable gift. On the other hand, a lower AFR makes it easier to reduce the amount deemed to be a taxable gift.

A Charitable Lead Annuity Trust (“CLAT”) pays the charity an Annuity Amount during the income period, which is based on upon a percentage of property contributed to the CLAT. Normally, most Settlors create a CLAT, because any increase of the underlying principal will go to the Settlor’s children. However, a CLAT is not useful for Generation Skipping Transfer Tax (“GST Tax”) planning, because under IRS rules, one cannot allocate the GST Exemption until the end of the Income Period.

If the Settlor wants to use a CLT for GST planning, the Settlor must create a Charitable Lead Unitrust (“CLUT”) where it pays a Unitrust Amount during the Income Period. The Unitrust Amount is adjusted each year to a fixed percentage of the trust’s property valued each year. In a CLUT an increase in the trust’s principal is shared with the charitable beneficiary during the Income Period. However, the IRS allows the GST Exemption to be allocated upon the creation of the CLUT.

Lifetime CLTs are Irrevocable Trusts. There are two types of lifetime CLTs: 1) a grantor CLT; and 2) a non-grantor CLT. A grantor CLT is a Grantor Trust, where the CLT is ignored for income tax purposes. The settlor of a grantor CLT, is allowed to take an immediate charitable income deduction of the present value of the charitable lead interest; however, the Settlor must report the income of the CLT each year during the Income Period. A non-grantor CLT is a separate taxpayer for income tax purposes. The Settlor is unable to take any charitable deduction; however. the trust is allowed to take a charitable income tax deduction for payments made to charity during the Income Period. Non-grantor CLT’s are used when the Settlor is unable to fully use his or her charitable income tax deduction. However, non-grantor CLT’s cannot be an owner of S-Corporation Stock.

Unlike Charitable Remainder Trusts, CLT’s are not tax-exempt entities. CLTs are taxed as normal trusts. In addition, they are allowed a charitable income tax deduction for payments they make to charities during the Income Period. However, the Settlor must not contribute property that creates unrelated taxable business income, because such income will reduce or even eliminate the charitable deduction for the CLT.

CLTs work best when: 1) the property contributed to the CLT earns income to make the payment to the charity during the Income Period; and 2) the property should increase in value during the Income Period of the CLT. If the property contributed to the CLT does not pay out income for any year during the Initial Term, some of the CLT’s assets will have to be distributed “in-kind,” which would reduce the amount of property distributed to the Remainder Beneficiary after the Initial Term.

For more information about CLT’s created at death, see Testamentary Charitable Lead Annuity Trusts.