The Charitable Lead Trust is a type of charitable trust that can reduce or virtually eliminate all estate tax on wealth passing to heirs. In order to accomplish this goal, you create a trust that grants to a charity or charities, for a set number of years, the first or “lead” right to receive a payment from the trust. At the end of the term of years, your children or grandchildren receive the balance of the trust property—which often is greater than the amount contributed—free of estate tax in most instances. Although the Charitable Lead Trust is a complex estate planning strategy, the steps to implement it are few and simple from your perspective. Here is how one of the most frequently used Charitable Lead Trusts, the Charitable Lead Annuity Trust, operates:
You, as grantors, create a Charitable Lead Trust as part of your revocable living trust planning. Upon the death of the survivor of the two of you, a substantial amount of property will pass to the Charitable Lead Trust. The income beneficiary of the Charitable Lead Trust will be a qualified charitable organization, chosen by the two of you or by the survivor of you, named in your revocable living trust. The charitable income beneficiary receives a fixed, guaranteed amount from the trust for a certain number of years (determined by you with the assistance of your legal and financial advisors). Generally, any charity that has received tax-exempt status through an IRS determination qualifies, but this is not always the case. It is possible for you to name a private foundation established by you as the charitable beneficiary. If so, you must have very limited authority over which charity is to receive money from the foundation. Too much control while you are alive will result in adverse tax consequences.
At the end of the Charitable Lead Trust’s term, the remaining assets in the trust pass to non-charitable trust beneficiaries such as children and grandchildren, free of estate and gift tax. These assets can pass outright to the beneficiaries, or can continue to be held in trust, either in new trusts or in trusts previously established for the benefit and protection of beneficiaries.
The charity will receive the same dollar amount each year, no matter how its investments perform. The remainder interest ultimately passing to the heirs, however, will be affected by the performance of the trust’s investments.
This is know as a Testamentary Charitable Lead Trust. This technique can use a Charitable Lead Annuity Trust, a Charitable Lead Unitrust, or both. Charitable Lead Annuity Trusts are particularly suited for hard-to-value assets (such as real estate or family limited liability company interests) and assets which are expected to grow rapidly in value.
It is also possible to create a Charitable Lead Trust during your life. If created as a grantor trust, this technique can help with your income tax planning by creating current income tax deductions.