Charitable lead trusts are a type of irrevocable trust that provides income and financial support to charities before reducing the tax liability for designated beneficiaries.
Most users of charitable lead trusts have charitable intentions or wish to make use of estate tax planning purposes. For example, income tax deductions or estate or gift tax savings may apply, when the assets are later passed to the designated beneficiary.
How Do Charitable Lead Trusts Work?
- In simple terms, a charitable lead trust operates via a grantor (the trust creator) creating and funding a trust that has a fixed operating term. This could be a number of years or a lifetime of a select person.
- The trust then distributes the funds to the pre-selected charity or charities. Depending on the trust’s structuring, this could be a fixed annuity or a percentage.
- Once the trust’s operating term has expired, the remaining assets and funds are distributed to the pre-selected non-charitable beneficiaries.
- Charitable trusts must follow IRS rules and laws, which are complicated.
- If you’re considering creating a charitable lead trust, you should contact an estate planning lawyer for professional advice.
Charitable Lead Trusts vs. Charitable Remainder Trusts
Charitable lead trusts are effectively the opposite of ‘charitable remainder trusts’. Charitable remainder trusts provide a consistent income for family members for a fixed term, before sharing the remaining value with the charities.
Charitable lead trusts also don’t have a mandatory time limit of 20 years for fixed-term options, like charitable remainder trusts have.
Types of Charitable Lead Trusts
There are two main types of charitable lead trusts. Each has its own pros and cons and should be discussed with an estate planning lawyer before a decision is made over which to use.
Grantor Charitable Lead Trust
A grantor charitable lead trust allows a grantor to immediately take income tax charitable deductions. This deduction is the present value of future payments that are set to be made to the charities of choice. Deductions limits will be determined by whether the charity is a public charity or a private foundation.
The trust’s investment income is taxable to the grantor.
Non-Grantor Charitable Lead Trust
Non-grantor charitable lead trusts see the trust as the owner of the assets, and not the grantor.
Therefore, the grantor does not qualify to take an income tax deduction. The trust pays tax on its undistributed net income and can qualify for unlimited income tax charitable deductions.
However, non-grantor charitable lead trusts are considered far more useful for transfer tax benefits.
Read a Guide to Different Types of Trusts in Estate Planning
Assets Placed in a Charitable Lead Trust
Charitable lead trusts can be funded with the following assets:
- Cash
- Real Estate
- Publicly traded securities
- Closely held stocks (certain types)
- Other complex assets
Some of these assets may need to be sold or combined with cash donations in order to provide enough resources for the trust. They may face taxes.
How Are Charitable Lead Trusts Funded?
Charitable lead trusts are funded by the individual creating the trust during their lifetime or upon their death via a will.
The Benefits of Charitable Lead Trusts
Estate Tax Reductions
Charitable lead trusts can potentially reduce estate taxes. If the trust assets pass to heirs, then the assets will be considered part of the donor’s estate and the donor’s estate will be eligible for estate tax charitable deductions. This can considerably impact preserving your family’s wealth, as it reduces the amount of estate taxes required to be paid upon your death.
Gift Tax Reductions
Charitable lead trust contributions can qualify you for a gift tax charitable deduction. However, the remaining beneficiaries must be someone other than yourself. Otherwise, you may be subject to gift tax on the value of the remainder interest.
With the help of a Florida estate planning attorney, you can structure the charitable lead trust to potentially eliminate gift taxes on the remaining value that will be passed to the final beneficiary.
As you can see, these routes are complicated and should always be assisted by an estate planning lawyer.
The Cons of Charitable Lead Trusts
- Charitable lead trusts are not tax-exempt and income is taxed like the income of a grantor trust.
- Legal support is required to set up due to the complexity.
- They are likely to require ongoing costs.
- The trust is irrevocable.
- Planning is essential to ensure the trust can meet its payments during the term,
How to Operate a Charitable Lead Trust
Charitable lead trusts can be created and successfully operated through the following steps:
Fund the Trust
First, you will need to draft the trust documents with the help of an estate planning lawyer. Then, you need to make a contribution to the fund the charitable lead trust. Some types of charitable lead trusts may qualify you for immediate partial tax deductions with cash contributions.
The deduction amount is calculated by factoring in the trust term, projected payments and IRS interest rates.
Assets such as real estate, stocks and private business interests can also be added to the trust, but have their own tax considerations.
Pay the Charity
Charitable lead trusts require that payments are made to the selected charity or charities on at least an annual basis, a fixed number of years or for the life of an individual or individuals. Alternatively, you can combine these criteria.
There is no minimum or maximum payment, as long as these payments are annual.
Distribute Remaining Assets
After the trust’s term is complete, the remaining funds and assets will be distributed to the designated beneficiaries.
The principal will also be returned to you or shared with the other beneficiaries, allowing you to reduce or avoid transfer taxes.
Contact an Estate Planning Attorney for Dynasty Trusts Today
If you’re interested in creating a charitable lead trust to help minimize the tax impact on your family or to support your favorite charities, then our Florida estate planning attorneys can help.
These trusts are complex from start to finish due to their legal requirements and structuring. We regularly help families and individuals create and maintain them smoothly.
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Battaglia, Ross, Dicus & McQuaid, P.A. is U.S. News and World Reports Tier 1 law firm in Florida, specializing in Estate Planning & Probate since 1958. With award-winning experienced estate planning attorneys, they can help you create a charitable lead trust that is suitable for decades to come.
