CHARITABLE LEAD TRUSTS:
A STRATEGY WHICH DESERVES MORE ATTENTION

By Bertram L. Levy

Although there is much attention given in estate planning circles to the uses of charitable remainder trusts, there is relatively little attention given to its companion vehicle, the charitable lead trust.

What is a charitable lead trust? A charitable lead trust may be either a charitable lead unitrust or a charitable lead annuity trust. Each of these devices provides benefits at the beginning of the trust term to charity for a period of years (thus "charitable lead"), with remainder benefits to individuals. A charitable lead unitrust provides that a fixed percentage of the fair market value of the assets of the trust each year must be paid to charitable beneficiaries. A charitable lead annuity trust provides that a fixed payment, a kind of annuity, must be paid each year to charitable beneficiaries.

A charitable lead trust is analytically similar to a limited duration private foundation. Basically, the donor creates a charitable fund for a limited, designated term, with the remainder reverting to his or her family. A charitable lead trust is subject to many of the restrictions of a private foundation, and, like a private foundation, it may be used by the family as a fund for charitable giving. In some circumstances, almost as great a charitable benefit can be attained with the charitable lead trust as the private foundation, but with the additional benefit of ultimate distribution to family members. For example, if a donor creates under his Will a charitable lead trust with a duration of thirty years, designating that the trust be a charitable lead unitrust with a 6% payout per year, and the trust has an initial corpus of $5,000,000, the donor’s estate will receive a charitable deduction of $4,150,000. In contrast, a gift to a private foundation would bring a deduction of the full $5,000,000. However, as noted above, with the charitable lead trust, the principal of the trust will pass to family members at the end of the thirty-year trust term.

A charitable lead trust works especially well in coordination with generation-skipping planning. Federal estate tax laws currently allow a generation-skipping transfer tax exemption of $1,000,000. However, if a charitable lead unitrust is utilized, the generation-skipping transfer tax exemption may be leveraged. This is so because the transfer tax rules allow for this generation-skipping tax exemption to be allocated to the value of the remainder interest of the charitable lead trust at the inception of the trust term. Thus, if the initial value of the remainder interest is less than $1,000,000, the charitable lead trust principal may pass tax-free to grandchildren at the end of the charitable portion of the charitable lead trust. In the example in the previous paragraph, the non-charitable portion was $850,000. The generation-skipping tax exemption could be allocated fully to this amount, which would mean that all the assets of the charitable lead trust could pass tax-free to grandchildren at the end of the charitable term.

Who is an ideal candidate for a charitable lead trust? One ideal candidate would be a person with substantial assets, grown children, and a desire to benefit grandchildren. As indicated above, charitable lead trusts can work especially well over a longer term. If a 70-year old donor with married children and young grandchildren creates a charitable lead trust, at the end of the charitable lead term, the grandchildren will likely be in their 30’s or 40’s, an ideal time to receive property outright. On the other hand, were the children the remainder beneficiaries and their interests were to be postponed for thirty years, they would be at an age where the inheritance would do them little good. Therefore, one ideal candidate is an individual whose family has sufficient wealth to provide for children’s inheritances outside the lead trust, or who has children who are themselves independently wealthy. Additionally, another ideal candidate would be a person whose children have substantial charitable interests and are willing to postpone part of their inheritance. In such circumstances, a shorter term (e.g., eight years) charitable lead trust may be ideal, with remainder passing either outright or in trust for children.

It should be remembered too that the charitable lead trust can operate as a kind of bequest to the children. To explain this point further, the children can act as trustees of the charitable lead trust during its charitable portion and have control over the distribution of the charitable payments. Although the children may not receive the proceeds outright, their ability to make payments to charities to which they would have made donations from their own funds can be a substantial economic benefit to the children.

Charitable lead trusts can be created either during life or at death under a Will. However, there are fewer complications when the trust is created at death. This is so because when the charitable lead trust is created during life, the donated assets retain the basis of the donor. On the other hand, when assets pass at death, there is a step-up in basis. Since the charitable lead trust is not a tax-exempt vehicle for income tax purposes, the step-up in basis can be very

important in the management of the trust. In addition, the grantor of the trust during life gets no income tax deduction for the creation of the trust, unless it is a so-called "grantor trust" for income tax purposes. This "grantor trust" status is usually undesirable for other reasons.

The ultimate benefit of a charitable lead trust to the remainder individual beneficiaries thereof is very much affected by the investment performance of the trust. The investment performance also greatly affects the payments to the charitable beneficiaries with a charitable lead unitrust. See the example below for an illustration of this.

A charitable lead trust can provide enormous benefits, both to charity and to grandchildren, in appropriate circumstances. Although not for everyone, it should be considered in appropriate circumstances.

CHARITABLE LEAD TRUST EXAMPLE John Doe, age 65, and his wife, Janice, age 62, have three adult children, ages 39, 37 and 35. Each of their children has two children. John and Janice have a combined net worth of $30,000,000, consisting mostly of publicly traded stocks and bonds. Mr. and Mrs. Doe believe that their children can be provided for adequately without inheriting all of their assets, and wish to provide benefits to charity and to grandchildren. If Janice creates under her Will a $5,000,000 charitable lead trust, with a twenty-five year term and 7% unitrust interest payable to charities determined by the children as trustees and with the property passing at the end of the twenty-five year term to grandchildren then living, the creation of the trust will generate a charitable deduction for federal and estate tax purposes of approximately $4,100,000. The estate taxes from this bequest will be less than $500,000, as opposed to $2,750,000 if no charitable planning were included. Because the non-charitable remainder interest is approximately $900,000, the executor may allocate generation-skipping tax exemption to the remainder interest so that the trust will be exempt from the generation-skipping transfer tax. Thus, the property can pass tax-free to grandchildren at the end of the charitable lead term. Additionally, if the trust has an annual net return of 10% during the twenty-five year trust term, there will be approximately $10,500,000 left to pass to the grandchildren tax-free at the end of the trust term. The charitable beneficiaries will receive approximately $12,000,000. If the investments yield a net annual return of 12% during the twenty-five year term, the grandchildren would instead receive approximately $17,000,000, and if the trust yields 15% annually during the charitable trust term, the grandchildren would receive approximately $35,000,000.

 

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