A charitable lead trust (CLT) is a vehicle in which a donor funds a trust that makes fixed payments to charity over a specified period of time. The designated charity receives the benefits in the early years, while the donor’s heirs, or other non-charitable beneficiaries, receive the trust assets at the conclusion of the charitable term.
The beauty of the CLT is that the family gets a substantial share of the assets used to fund the trust when the charity’s term ends, while the donor gets a charitable income tax deduction in the year of the trust’s creation.
Today, the combination of low interest rates, increasing personal income tax rates on the wealthy and potentially increased Federal and Connecticut gift tax rates, as well as the potential lowering of the estate and gift tax exemptions, make the use of a CLT ideal. When interest rates are as low as they currently are, the value of the front end charitable gift, based upon government mandated tables, and the corresponding income tax deduction in the year of the gift, is substantially inflated, while the value ascribed to the deferred gift to family members for gift tax purposes is commensurately reduced.
When coupled with the current $11.7 million Federal gift tax exemption, a donor’s ability to remove significant wealth from his or her estate and pass it at a reduced valuation to heirs, while at the same time meeting their charitable goals, is very attractive. In fact, if properly structured, given today’s historically low government mandated rates for valuing deferred gifts, the trust assets going to the donor’s family at the end of the charitable term can be zeroed out for tax purposes; and, if appreciating assets are used to fund the charitable lead trust, a donor can transfer such growth to younger generation family members with very beneficial income, estate and gift tax consequences to the donor and his or her family.
For example, assume a moderately aggressive 6.5% growth rate, an initial gift of $5 million, a $366,222 annual payout to charity over fifteen years, and a government mandated rate of 1.2%. The donor can claim a charitable deduction of $5 million in the year of the gift, the charity will receive $5,500,000 over the fifteen-year term and although the value of the gift to the family will be zeroed out for gift tax purposes, the donor’s loved ones would actually receive $4 million plus at the conclusion of the 15- year charitable term. A more aggressive structure whereby the charity would receive an interest rate adjusted lump sum payment at the conclusion of the fifteen -year term instead of an annual distribution would yield an even greater amount passed to the family at the end of the term and also minimize the possible adverse impact of a poor investment return in the earlier years.
For openers, the donor has to be charitably inclined. For those who are, a CLT makes a lot of sense for donors with a gross estate of $11.7 million or more. But this vehicle would be most particularly attractive to those donors with very high income in the year of the potential transfer, for instance in a year when the donor has sold his or her business at a large capital gain, and most particularly if the Biden proposals to increase the capital gains rate for those with taxable income in excess of $1 million are enacted.
Think about this. Taking the previous example as a starting point, suppose a donor has sold his or her business, recognizes a $10 million capital gain, creates a charitable lead trust, takes a $5 million dollar charitable deduction by funding the trust with $5 million dollars of the sale proceeds, uses none of his or her gift tax credit equivalent and greatly benefits the Hartford Foundation for Public Giving, the donor’s favorite charity. If the Trust experiences a 6.5% annual return, the family ultimately receive more than $4 million dollars completely gift tax free, even under the current Administration’s revenue proposals.
*This article was originally written for the Hartford Foundation for Public Giving and has been republished with their permission.