Charitably inclined high-net-worth individuals often want to provide for their philanthropic goals while reducing their tax liability. While there are many different ways to do this, there are some lesser-used options that can create unique opportunities for charitable giving.
An often underutilized but valuable tool in estate planning is the Charitable Lead Trust.
What is a Charitable Lead Trust?
A Charitable Lead Trust (CLT) is a split-interest irrevocable trust with two or more beneficiaries.
The lead income beneficiary is the charity(ies) named in the CLT, and the remainder beneficiary(ies) is either the Grantor (known as a Grantor CLT) or the Grantor’s heirs (a Non-Grantor CLT).
There are several sub-categories of CLTs. They are defined by how the payments to charity are determined (e.g., unitrust, annuity, step):
- In a Charitable Lead Unitrust, the payments to charity are based on a percentage of that year’s trust value.
- In a Charitable Lead Annuity Trust, the payments to charity are a fixed amount from the beginning.
- In a Charitable Step Lead Trust, the payments to charity increase by a certain percentage (e.g., 10%, 20%) every year until the trust term ends.
- A Shark-fin Charitable Lead Trust is a form of Charitable Step Lead trust where the payments to charity are small at the beginning (1%-5%) and grow as time goes on. Then, they can either escalate dramatically toward the end of the trust term or have one final balloon payment made at term-end.
We will explore the Grantor CLT and the Non-Grantor CLT in this post.
Grantor Charitable Lead Trust (GCLT)
A Grantor Charitable Leads Trust (GCLT) is a split-interest irrevocable trust with two (2) or more beneficiaries: The “lead” income beneficiary is the charity named in the GCLT, and the “remainder” beneficiary is the Grantor or the Grantor’s estate. In addition, the donor/grantor contributes property to the trust.
The trust provides an annual payment to a qualified charity, and the remainder passes back to the Grantor or the Grantor’s estate. There is no minimum or maximum charitable payment requirement.
The trust may last for a person’s lifetime or a person’s lifetime plus a term of years. The principal must be used to pay the charitable lead interest if income is insufficient.
There are two common types of Grantor Charitable Lead Trusts:
- Grantor Charitable Lead Annuity Trust (GCLAT) – The charitable income beneficiary receives annual payments/annuity, and the remainder passes to the Grantor or Grantor’s estate.
- Grantor Charitable Lead Unitrust (GCLUT) – The charitable income beneficiary receives a fixed percentage of the trust principal over the trust term.
The fixed percentage is based on the fair market value of the trust, which is calculated on the first day of the tax year. At the end of the trust term, the remaining assets revert to the Grantor or the Grantor’s estate.
Non-Grantor Charitable Lead Trust (NGCLT)
A Non-Grantor Charitable Lead Trust (NGCLT) is a split-interest irrevocable trust with two or more beneficiaries. The “lead” income beneficiary is the charity(ies) named in the CLT, and the “remainder” beneficiaries are the Grantor’s heirs.
The trust provides an annual payment to a qualified charity(ies), and the remainder passes to the Grantor’s heirs (outright or in trust). Unlike a Charitable Remainder Trust, there is no minimum or maximum percentage payout to the charity required from an NGCLT.
An NGCLT is an “estate freeze” technique in which the gift-tax value of the assets contributed is determined on the date the trust is funded. All future growth will be outside of the Grantor’s taxable estate.
The trust may last for a person’s lifetime or a person’s lifetime plus a term of years. The principal must be used to pay the charitable lead interest if income is insufficient. An NGCLT is not income tax-exempt and cannot be used to avoid or defer tax on the sale of low-basis assets.
In an NGCLT, the Grantor does not receive an upfront charitable income tax deduction, but the Grantor is also not taxed on trust net income or recognized gains. Instead, the trust pays its own income tax and claims an unlimited charitable income-tax deduction for its distributions to charity.
There are various types of Non-Grantor Charitable Leads Trusts, including:
- Non-Grantor Charitable Leads Annuity Trust (NGCLAT): The payout is fixed (set) based on the fair market value of the trust on the date that the trust is established. The payout can be set as either a percentage or a set number.
- Non-Grantor Charitable Leads Unitrust (NGCLUT): The payout to charity is based on a percentage of the fair market value of the trust. This is typically calculated on the first day of the tax year.
- Non-Grantor Charitable Leads Step Trust (NGCLST): A standard CLAT makes payments of the same amount every year to the charitable lead beneficiary(es). A CSLT makes payments to a charity that increase in “Steps” during the trust term, i.e., 10% per year.
CLT Income Taxation
As a Charitable Lead Trust is not income tax-exempt, avoiding tax on the sale of low-basis assets does not exist the way it does with a Charitable Remainder Trust (CRT).
A Grantor may either take a charitable income tax deduction for contributing to the CLT (a Grantor CLT) and become the trust’s taxpayer and remainderman or forego a charitable income tax deduction. If the charitable deduction is not taken, the trust becomes its own taxpayer (Non-Grantor CLT), with another person(s) becoming the remainderman.
Income Tax on a Grantor CLT
GCLTs are often used for income tax planning purposes. They are usually considered in years when a Grantor has unusually high adjusted gross income (AGI).
The Grantor is considered the “owner” of the trust and receives an income tax deduction for the present value of the payments that will be made to charity.
If the Grantor dies during the trust term, the Grantor’s estate must recapture a portion of the prior charitable income tax deduction taken. Trust income is taxed to the Grantor, but the Grantor does not receive an income tax deduction for the periodic payments made to charity.
The Grantor takes a charitable income tax deduction for donating the property to the trust and becomes the trust’s taxpayer for all future net income and recognized gain.
Income Tax on a Non-Grantor CLT
The Grantor does not receive an income tax deduction when the trust is established. Trust income is taxed to the CLT itself, and the trust gets an unlimited charitable deduction for its periodic distributions to charity.
If there is a sale within two years of the trust’s creation, any “built-in” gains will be taxed to the trust at the Grantor’s tax rates.
CLT Estate Taxation:
The timing of the trust creation determines what the basis of the assets will be in the hands of the remainderman.
- Grantor CLT created during life – A Grantor CLT created during the Grantor’s life will include the reversionary interest in the Grantor’s estate. The closer the Grantor’s death is to the end of the trust term, the greater the amount of the reversionary interest to the trust.
- Non-Grantor CLT created during life – A Non-Grantor CLT created during the Grantor’s lifetime will cause the entire trust value to be excluded from the Grantor’s estate since the Grantor has no reversionary interest.
The Grantor has gifted the remainder of interest in the trust to the trust beneficiaries. The remainder beneficiary(ies) then inherits both the assets and the cost basis that the assets had in the hands of the Grantor.
- Charitable Leads Trust created by testamentary instrument (at death) – A Testamentary CLT funded at the Grantor’s death means the assets get a stepped-up basis equal to the estate tax value.
Charitable Lead Trusts with Alliance Trust Company
Alliance Trust Company of Nevada works with individuals across the globe to help them manage their Charitable Lead Trusts. We value each of our clients and support their charitable and philanthropic inclinations.
Alliance is based in Reno, Nevada, with representatives in multiple states and countries. With some of the most favorable trust laws in the United States, Nevada leads the nation in both domestic and global asset protection and wealth management.
To learn more about Charitable Lead Trusts and discover which option may be the best choice for you and your situation, call Alliance Trust Company at (775) 297-4000 or email Alliance today.
This article is informational only and should not be taken as legal or tax advice. Each individual’s legal and tax situation is unique and should be reviewed by licensed professionals. Laws and regulations are subject to change, and Alliance cannot be held responsible for reliance on the information contained herein.