A CLT allows you to gift assets to heirs at a discounted gift value, and provide a consistent annual gift to a charity.
A Charitable Lead Trust (CLT) is an irrevocable split interest trust where one party (a charitable organization) receives an income stream from the trust and another party (typically the grantor’s children) receives the remaining trust assets at the end of the income period.
Mechanics of a CLT
There are two basic types of CLTs:
* Grantor CLT where the grantor (or spouse) receives the remaining trust assets after the income period.
* Non-Reversionary CLT where someone other than the grantor or spouse (typically children) receive the remainder assets after the income period. This type of CLT is considered a gift to the remainder recipient. However, the value of the gift for gift tax purposes is reduced by the present value of the income interest received by the charity.
The benefits and tax ramifications are slightly different for each type.
Advantages of a Grantor CLT
1. The grantor can claim an income tax deduction equal to the present value of the promised income stream to charity. This type of CLT is effective for people seeking income tax deductions rather than estate tax deductions.
2. A charitable organization receives a steady flow of funds for the specified period. For a Grantor CLT, the income period is for a specified term of years.
Advantages of a Non-Reversionary CLT
1. Value of the asset (and any future growth) is immediately removed from the grantor’s estate. This is especially advantageous if assets are contributed that are expected to appreciate rapidly. The potential estate tax savings can be significant.
2. The value of the gift to the grantor’s heirs is reduced for gift tax purposes by the present value of the income stream that goes to charity.
3. A charitable organization receives a steady flow of funds for the specified period. For a non-reversionary CLT, the income period can be for a specified term of years or for the life of the grantor.
Phil has $1 million worth of assets he expects to appreciate considerably in the future. He would like his children to inherit the asset. Phil estimates that if he holds onto the asset, it could be worth $4 million in 15 years and create about $2 million in estate taxes. He decides to gift the asset to his children now and avoid the estate tax bill.
To save even more taxes, Phil decides to use a CLT. He gifts the $1 million of assets into the CLT with a $70,000 annual payout for 15 years to his favorite charity. (Actual valuation would depend on the currently published IRS discount rate.) Because of the charity’s income interest, the IRS might value the gift to his children at $400,000. Phil’s unified credit covers the gift tax on $400,000. If the assets grow by more than 7%, Phil’s children may receive much more than $1 million in 15 years even though the gift only cost Phil tax on $400,000. The charity receives a significant gift, Phil’s children will ultimately receive the assets, and Phil paid gift tax on $400,000 rather than estate tax on potentially $4 million.