Charitable Lead Trust (CLT)

What is a charitable lead trust (CLT)?

A charitable lead trust (CLT) is a type of trust established by an individual to provide regular payments to one or more charities for a specified period. At the end of that period, the remaining assets in the trust either revert to the settlor (also referred to as the donor in this article) or pass to non-charitable beneficiaries, such as family members or other individuals named by the donor. 

In a charitable lead trust, the charity has a primary or “lead” interest in the trust assets before anything is passed down to other beneficiaries. The charity either receives fixed payments throughout the trust term (charitable lead annuity trust or a CLAT) or a fixed percentage of the trust assets valued annually (charitable lead unitrust or a CLUT).

If, at the end of the trust term, the remainder of the assets go back to the donor, this makes the trust a “reversionary” trust and creates certain implications for tax purposes. If the assets go to someone other than the donor, then the charitable lead trust is a “non-reversionary” trust.

Charitable lead trust vs charitable remainder trust (CLT vs CRT)

While there are many different types of trusts that can be used for effective estate planning, those who have a charitable intent and wish to reduce taxes often opt for either a charitable lead trust (CLT) or a charitable remainder trust (CRT). 

A charitable remainder trust stands as the reverse of a charitable lead trust. Rather than the income from the trust assets going to a designated charity first, a charitable remainder trust gives the income to a non-charitable beneficiary first and then leaves the remainder to a charity.

How does a charitable lead trust (CLT) work?

As one of many estate planning strategies to help individuals achieve their legacy goals and save on estate and gift taxes, a CLT starts with a legal document being drafted that names the settlor, the beneficiaries, and the trustee(s) of the trust along with specifically outlining the settlor’s wishes. The trust document also includes provisions for how long payments will be made to the charity. The settlor can indicate that payments last for a set number of years or throughout a specific individual’s lifetime. These payments should be made at least annually and can either be structured as a fixed annuity payment (charitable lead annuity trust or CLAT) or as a payment of a fixed percentage of the trust assets (charitable lead unitrust or CLUT). 

The settlor then funds the CLT with either cash, securities, real estate, business interests, or other assets that may be likely to appreciate.

After the end of the specified trust period during which assets go to a charitable beneficiary, any remaining assets in the trust will be distributed either back to the donor or to the beneficiaries as outlined in the terms of the trust.

If the remainder beneficiary of the CLT is someone other than the donor, the donor is making a taxable gift of the remainder interest. Because this would be considered a gift of future interest, the donor can’t offset this gift amount with the annual exclusion. As such, the value of the remainder interest being gifted would use up some of the donor’s lifetime gift and estate exemption.

Can a charitable lead trust provide an income tax deduction?

Upon contributing assets to a charitable lead trust, an individual may be able to take an income tax deduction. This is determined by the present value of the charitable interest and also depends on whether the trust is structured as a grantor trust or a non-grantor trust. 

The calculation of the income tax deduction is influenced by the payout rate of payments to the charitable beneficiary, the term of the charitable trust, and the applicable federal rate (AFR) at the time of funding.

Grantor vs. non grantor charitable lead trust

There are two ways to structure a charitable lead trust: as a grantor charitable lead trust or a non grantor charitable lead trust. The choice between these two affects the income tax treatment for the donor.

In a grantor charitable lead trust, the donor is treated as owner of the trust assets for income tax purposes, allowing them to qualify for an immediate income tax charitable deduction equal to the present value of the payments directed to the charitable beneficiary. Depending on whether the assets are benefitting a private foundation or a public charity, there may be limits to the deduction. 

It’s important to keep in mind, however, that a grantor charitable lead trust is not tax-exempt. The investment income from the trust is still taxable to the grantor throughout the duration of the trust.

In a non grantor charitable lead trust, the donor is not entitled to a charitable income tax deduction. Instead, the trust itself is treated as a separate taxpayer so the trust gets to claim an income tax deduction for the payments made to the beneficiary. Unlike in a grantor charitable trust, the income tax deduction is unlimited.

Charitable lead trust example

Emily is a recently retired executive who’s been a long-time supporter of the ABC Foundation. She wants to continue supporting them with annual contributions for the next 10 years. She’d also like the ability to receive an income tax deduction to reduce her income taxes. 

With the help of her estate planning attorney, she creates a grantor charitable lead annuity trust with a 10-year term. Emily sets up the trust to make fixed payments of $100,000 to the ABC Foundation every year. Because she structures the trust as a grantor charitable lead trust, she’s able to take a charitable income tax deduction for the present value of the fixed payments that ABC Foundation receives. Emily is taxed on all income as it is earned by the trusts. At the end of the 10 years, any assets remaining in the trust are designated to pass to Emily’s children, Alex and Bailey. 

This structure allows Emily to support the ABC Foundation while receiving an income tax deduction and providing for her children after the trust term passes. 

What are the advantages and disadvantages of a charitable lead trust?

The major benefit of using a charitable lead trust is that it can potentially reduce one’s estate and gift taxes while letting them fulfill their charitable goals. This is because whatever assets are gifted into the trust are removed from the donor’s estate. An additional advantage is that – if structured as a grantor charitable lead trust – it can also serve to reduce the donor’s income tax liability on account of the income tax charitable deduction in the year the trust is created. 

Amongst the disadvantages of a charitable lead trust is that it can be more complex to set up than other trusts, requiring higher legal and maintenance costs. In addition, because the assets are used to contribute to charity first, the donor or the donor’s beneficiaries will not have access to the assets or the income from the trust until the end of the trust term. 

Anyone considering a charitable lead trust should consult with an estate planning attorney as well as a financial advisor to ensure that the trust is set up properly to achieve its specified goals while also meeting the required payments.