Creative Uses of Lifetime Charitable Lead Trusts

Increased federal income taxes, decreased income tax deductions and excessively high estate taxes makes one ponder the accuracy of the humorous slogan "the one who dies with the most toys wins." The IRS has clearly stated that they strongly disagree with this philosophy. Instead they want fifty-five percent (55%) of every dollar you have in excess of three million dollars (upon the later of the death of you and your spouse).

As estate planners we look under every rock to locate a creative solution to this excessive penalty tax which is imposed on successful savers. One extraordinary solution is the Charitable Lead Trust (CLT). This vehicle is a close relative to the Charitable Remainder Trust (CRT). It basically is an upside down CRT.

The CLT provides member(s) of the Settlor or Donor's family with the remainder of the CLT upon the expiration of the Trust term. The Settlor's favorite charity or charities, as the case may be, receive an income stream from the CLT until the expiration of the Trust term. This income stream is referred to as the Lead Interest (ergo, the CLT).

There are two types of commonly used charitable lead trusts; the charitable lead annuity trust (CLAT) and charitable lead unitrust (CLUT). These two types of CLTs have other characteristics as well. There are grantor trusts and non-grantor trusts. Finally, there are testamentary (taking place at death) and inter vivos (lifetime) CLTs. Jackie Onassis attempted to utilize and made famous the testamentary CLT.

If you wish to provide a substantial benefit to your favorite charity during your lifetime, then the inter vivos CLT is very attractive. The following example illustrates this point.

JOHN DOE places $1,000,000 in a trust. The trust provides that the charity will receive a six percent (6%) annuity based on the initial value of the trust for 15 years (i.e., $60,000/year) and JD's family members will receive the remaining balance of the trust at the end of the term of years ($1,000,000 plus or minus fluctuation in the portfolio). If the assets grow at a rate in excess of 6%, the remaining balance to JD's family will be far in excess of the original contribution (e.g., $1,500,000). Note, that the higher the stated annuity amount (i.e., the greater the amount passing to the charity), the higher the gift tax charitable deduction and visa versa.

The federal estate tax is substantially reduced based on the fact that the assets contributed to the CLT are no longer owned by you at the time of your death. Actually, the transfer to the CLT results in a gift tax charitable deduction which is based on the present value of the income stream passing to the charity (which is a substantial portion of the initial contribution). The longer the term of the trust (i.e., the Lead Interest) the greater the deduction. Current interest rate assumptions used by the IRS also have a direct impact on the size of the deduction. The higher the interest rate assumption the lower the deduction.

The most obvious negative of the CLT is the loss of the use of the income and principal for an extended period of time. The obvious advantage is the very low gift tax cost of transferring your wealth to younger generations. This attempts to maximize the use of your unified credit or discounts your gift and/or estate tax.

The creativity involves transferring assets to a CLT which have the greatest potential for future appreciation and/or assets that may be valued at a substantial discount. Examples of the first category include start-up businesses and investments that have not quite turned the positive corner, and the latter category includes such assets such as minority interests in closely held businesses (e.g., limited partnership units in a family limited partnership or minority stock in a C-corporation).

Another important consideration is the application of the generation-skipping tax to transfers made to charitable lead trusts. The federal government would like to tax wealth transfers at each generation. If you attempt to "skip" a generation and leave money or property to your grandchildren, the government will impose a 55% tax on that transfer above and beyond the 55% estate tax rate. However, each individual has a $1,000,000 exemption from this "generation?skipping transfer (GST)" tax. When a person transfers assets into a charitable lead trust in which the grantor's grandchildren will receive the trust assets at the end of the lead term, a generation-skipping tax may be imposed. Proper allocation of the generation-skipping tax exemption to these transfers is important.

A significant distinction can be made between the use of charitable lead annuity trusts (CLAT) and charitable lead unitrusts (CLUT) in this area. Section 2642(e) of the Internal Revenue Code was passed to limit leveraging of the generation-skipping tax exemption by taxpayers who used charitable lead annuity trusts to transfer assets to their grandchildren. Grantors of these trusts would transfer funds into the trust at the applicable 7520 rate and allocate their generation-skipping tax exemption based on the calculated remainder interest of the trust corpus. If the trust grew at a higher rate, then the amount passed on to their grandchildren would be higher, and the exemption was in effect leveraged.

Under the Section 2642(e), for transfers made to a CLAT, the applicable amount for the adjusted GST exemption is now based on the value of the assets remaining at the end of the charitable lead annuity term, but the adjusted GST exemption is still calculated using the applicable Section 7520 rate at the time of the initial transfer of the assets to the trust and the charitable lead annuity period. Therefore, any appreciation above the calculated annuity amount will trigger a generation-skipping tax. If the trust corpus appreciates at a rate that is less than the annuity interest rate factor, then to that extent the GST exemption is wasted.

Other options include the use of late allocations of the GST exemption and CLUTs. CLUTs do not have the same restrictions as the CLAT because the amount transferred to the charity is calculated based on the growth of the trust corpus.

In Summary, the inter vivos CLT provides a way to keep your assets in your family, provide your remainder beneficiaries with the use of the money much sooner than they would receive it under a testamentary CLT, benefits your favorite charities sooner than later, provides the Settlor with a great deal of control over the variables (interest rate fluctuation), allows the Settlor to leverage the unified credit and allows the Settlor to see their legacy plan unfold during their lifetime.

Edward E. Wollman is the Principal of Wollman, Gehrke & Solomon , P.A. and is a Board Certified Wills, Trusts and Estates attorney.