When a donor is considering a gift to Furman, one of the more sophisticated options is a charitable lead trust. Charitable lead trusts are an effective wealth transfer tool, and they fulfill a charitable goal as well. A charitable lead trust is an irrevocable trust which provides a current income payment to Furman for the life of the donor, the lives of the donor and his or her spouse, or a term of years.
The payments to Furman may be a fixed amount (charitable lead annuity trust) or a fixed percentage of the trust's value (charitable lead unitrust). At the end of the trust's term, the remaining principal is distributed to the remainder beneficiaries, typically the donor's family members. Charitable lead trusts are more viable in a low interest rate environment where the assets in the trust are more likely to appreciate above the IRS interest rates. A charitable lead trust can either be established during life (inter vivos trust) or upon death (testamentary trust). The donor receives a gift tax charitable deduction for the creation of an inter vivos charitable lead trust or an estate tax charitable deduction for a testamentary charitable lead trust based upon the calculated value to be distributed to Furman.
At the time of creation, the present value of the remainder interest in the charitable lead trust is treated as a taxable gift by the donor to the remainder beneficiaries if an inter vivos trust or is included in the donor's estate if a testamentary trust. The remainder interest is valued according to the valuation rules under the Internal Revenue Code and will depend on the payment amount to Furman, the length of the term, and the IRS discount rate, which changes monthly. The remainder interest may be valued with the IRS discount rate in effect during the month of the creation of the charitable lead trust or either of the two months preceding the transfer. The value of the remainder interest is frozen for transfer tax purposes, and any growth in the principal of the charitable lead trust will pass to the remainder beneficiaries free of estate and gift taxation.
One common technique is to have the remainder interest valued as close to zero as possible at the time of creation. Known as "zero-ing out" or a "zero-ed out" charitable lead trust, the donor will owe little or no gift or estate tax when the trust is created because the value of the remainder interest is close to zero or zero. This technique allows any principal remaining in the charitable lead trust at the end of the term to pass to the remainder beneficiaries without being subjected to the gift or estate tax.
Non-Grantor And Grantor Trusts
A charitable lead trust can be either a grantor trust or a non-grantor trust for income tax purposes. If the trust is structured as a grantor trust, then the donor is responsible for paying the income tax on the trust assets during the charitable lead term. Also, with a grantor trust, the donor receives an immediate income tax deduction at the time of the creation of the charitable lead trust equal to the value of the charitable lead interest. This deduction is subject to the charitable deduction limitations based on the donor's income and Furman's status as a qualified charity under the Internal Revenue Code.
With a non-grantor charitable lead trust, the trust must pay the income tax liability on the trust assets, but the trust receives a charitable distribution deduction equal to the amount distributed to Furman. There are no limits on the trust's charitable deduction. Therefore, if the charitable distribution is equal to or greater than the amount of income received by the trust, then no income tax will be due. The donor does not receive an income tax charitable deduction when the charitable lead trust is a non-grantor trust.
Charitable Lead Annuity Trusts And Charitable Lead Unitrusts
As previously noted, a charitable lead trust can be either an annuity trust or a unitrust. A charitable lead annuity trust, or "CLAT", pays a fixed dollar amount to Furman during the charitable term. This fixed dollar amount is typically expressed as a percentage of the initial trust value. A charitable lead unitrust, or "CLUT", pays a fixed percentage of the trust's value (as re-valued each year) to Furman during the trust term.
Flexibility exists in the drafting of a charitable lead trust such as the ability to change the charitable beneficiary during the term of the trust, so long as another qualified charitable beneficiary is selected. However, the donor's retention of this power will potentially cause inclusion of the trust assets in the donor's gross estate if the donor dies during the trust's term. Therefore, the right to change the charitable beneficiary should be held by someone other than the donor. The donor can also serve as the trustee, but care should be taken so that the donor does not retain any powers which would cause the trust to be included in the donor's estate at death.
There are many alternatives to structuring a charitable lead trust to accomplish the donor's objectives as well as many factors to consider in creating a charitable lead trust, such as the income, gift, estate, and generation-skipping transfer tax consequences. In the proper situation, charitable lead trusts can provide significant wealth transfer opportunities while also benefiting Furman.
Article originally published in Furman University's The Advisor newsletter, 2016 Issue and is posted with the permission of Furman University. Visit www.furman.edu.