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Charitable Lead Trusts Can Save Transfer Taxes

A charitable lead trust (CLT) pays an annuity to one or more charities of your choice for a specified number of years or for the life of an individual. At the end of the term, the remaining assets in the trust (and any appreciation thereon) pass to one or more non-charitable beneficiaries, such as your children or other family members. The IRS anticipates that the property transferred to a CLT will grow at a rate equal to the prevailing interest rate dictated by the IRS when the trust is established. If the trust generates higher total returns over its term, the excess growth will pass to your family free of gift tax.

CLTs can be structured so that the gift tax on the remainder interest passing to family members will be small or even non-existent. The effectiveness of a CLT is determined in part by the interest rates that prevail at the time the trust is created. These trusts are particularly attractive right now because low interest rates increase the value of the charitable annuity, producing a greater tax deduction and reducing the gift tax on amounts passing to your family at the end of the CLT. Moreover, when markets are depressed, the potential for appreciation is that much greater.

Technical Rules Must Be Followed to Ensure Tax Deduction

An individual is deemed to make a charitable gift when he or she establishes a CLT. There are certain requirements under the Internal Revenue Code which must be met in order to qualify the charitable interest as deductible for estate and gift tax purposes. The interest must be either a "guaranteed" annuity with a fixed and determined annual payout based on the initial market value of the CLT, or a "unitrust" interest, in which the percentage is fixed, but is applied to the annually-revalued assets in the trust.

For example, if a transfer of $1,000,000 is made to a charitable lead annuity trust with a 
5 percent payout to charity, $50,000 will be paid to charity each year of the trust. In the case of a charitable lead unitrust, if the payout rate is 5 percent and the trust property increases to $2,000,000 in a subsequent year, the annual payment to charity for that year will increase to $100,000.        

A CLT created during your lifetime can be set up to produce tax benefits in the form of either a substantial income tax deduction in the year the trust is funded (for the present value of the charitable payments) or the exclusion of the trust's taxable income from your personal income tax return each year. If you choose the immediate income tax deduction, in each year of the trust term, you must report the trust's income on your tax return even though it is paid to charity. This option may be appropriate if you have an unusually large amount of income in a particular year so that the charitable deduction when the trust is established will more than offset the future income taxes on the trust income.

Trust Terms Can Be Tailored to Suit Your Needs

The amount of the charitable deduction is based on the size of the payments to charity, the length of the charitable term of the trust and the rate prescribed by the IRS to calculate the present value of the charitable payments (i.e., the rate set out in section 7520 of the Internal Revenue Code, or "7520 rate"). The 7520 rate changes monthly depending upon market interest rates and is presently near historic lows. If the payments to charity and the charitable term are structured to provide a tax deduction equal to the full amount transferred to the CLT, any growth of the trust assets in excess of the 7520 rate will pass to the non-charitable remainder beneficiaries (e.g., your family) free of gift tax. Given that the 7520 rate for August 2016 is only 1.4 percent, the potential exists for significant tax-free wealth transfers. (As a comparison, the 7520 rate for August 2000 was 7.6 percent.) 

Set forth below is a chart demonstrating the benefits of creating a charitable lead annuity trust in August 2016. The chart shows how much will pass tax-free to your family depending on the length of the charitable term and the rate of return achieved by the trust. In this scenario, $5,000,000 is transferred to a charitable lead annuity trust, which is structured to produce as small a taxable gift to the remainder beneficiaries as possible. The higher the rate of return, the more property remains to pass to your family free of gift tax at the end of the charitable term.

Amounts Passing To Beneficiaries Free Of Gift Tax At The End Of The Charitable Term (Assuming Various Growth Rates)

Charitable
Term

Beginning Principal

Annual Payment to Charity

5.00% Growth

7.50% Growth

10.00% Growth

15.00% Growth

10 Years

$5,000,000

$539,300

$1,361,216

$2,675,634

$4,373,659

$9,277,993

20 Years

$5,000,000

$288,350

$3,731,921

$8,752,351

$17,122,254

$52,293,080

30 Years

$5,000,000

$205,250

$7,973,138

$22,552,049

$53,484,613

$241,827,419

Tax Advantages of Charitable Lead Trusts

The tax benefit of a CLT is that it can reduce the amount subject to gift or estate tax to a significantly smaller amount than the value of the property ultimately transferred to the family beneficiaries. Furthermore, any future appreciation in the trust principal inures to the benefit of the family remaindermen, and that enhancement is not taxed in your estate upon your death.

 CLTs can be created during your lifetime (an "inter vivos" trust) or under your will or revocable trust (a "testamentary" trust). A testamentary charitable lead trust is included in your estate at the date of death value of its assets but the estate receives a deduction for the value of the interest passing to charity, determined as described above. The same principles apply with respect to gift tax if the trust is created during your life, but no gift tax is actually payable (if a gift is even deemed to be made) if a portion of your unified credit is still available (i.e., generally if you have not already made taxable gifts in excess of $5,450,000).

The opportunity for significant estate and gift tax savings which the CLT presents should not be overlooked if you have the desire to benefit a favorite charity (including your own family foundation) and the willingness to delay for a number of years the receipt by your family of property transferred to the trust.

 

© 2019 Proskauer Rose LLP.

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About this Author

Albert W Gortz, Proskauer Rose Law Firm, Personal Planning Attorney
Partner

Albert W. Gortz is a Partner in the Personal Planning Department and has been with the firm since 1970 and in the Florida office since he opened it in 1977.

561-995-4700
George D Karibjanian, Proskauer Rose Law Firm, Personal Planning Attorney
Senior Counsel

George D. Karibjanian is a Senior Counsel in the Personal Planning Department, resident in the Boca Raton office. George is Board Certified by the Florida Bar in Wills, Trusts & Estates and is a Fellow in the American College of Trust and Estate Counsel.

561-995-4780
David Pratt, Personal Planning Attorney, Proskauer Rose Law Firm,
Partner

David Pratt is a Partner in the Personal Planning Department and head of the Boca Raton office. His practice is dedicated exclusively to the areas of trusts and estates, estate, gift and generation-skipping transfer, fiduciary and individual income taxation and fiduciary litigation. He has extensive experience in estate planning and post-mortem tax planning. He has been asked to serve as an expert witness on several occasions, and has been referred to as a “seasoned trusts and estates lawyer” in a Florida Third District Court of Appeals Opinion

561-995-4777
Mitchell M Gaswirth, Proskauer Rose Law Firm, Tax Attorney
Partner

Mitchell M. Gaswirth is a Partner in the Tax Department. His practice focuses primarily on income, gift and estate tax and related business planning. Mitchell counsels individuals, entrepreneurs and business entities in connection with the various income and other tax issues which arise in sophisticated business transactions.

310-284-5693
Andrew M Katzenstein, Proskauer Law Firm, Personal Planning Attorney
Partner

Andrew M. Katzenstein is a Partner in the Personal Planning Department in the Los Angeles office where he assists high net worth individuals, companies and charitable organizations with all aspects of tax and estate planning. He focuses his practice on tax planning matters, which include estate, gift and generation-skipping tax planning, as well as income tax of trust planning, probate and trust administration matters, resolving disputes between fiduciaries and beneficiaries, and charitable planning

310-284-4553