If you wish to include philanthropy in your broader estate plan, this structure can help you support meaningful causes while planning for the eventual transfer of wealth to your loved ones. At Evans & Davis, our estate planning attorneys can explain how CLTs work and how they are taxed so you can determine if one makes sense for your estate plan.
How a Charitable Lead Trust Works
A CLT is designed to benefit a charitable organization first and your chosen beneficiaries later. To accomplish this, assets are transferred to the trust and managed by a trustee, who makes the required charitable payments for a designated period. When that period ends, the remaining assets pass to your beneficiaries. This process generally unfolds in four steps.
Step 1: Fund the Trust
Creating a CLT begins by funding the trust with the assets you want it to hold. Because a CLT is generally irrevocable, transferring property into the trust is an important decision that should be coordinated with your broader estate, tax, and charitable-giving plans.
Depending on the trust’s design and your goals, assets with income or appreciation potential may be considered, such as publicly traded stocks, real estate, or certain business interests. Once transferred, those assets are held and administered by the trustee in accordance with the trust’s terms.
Step 2: Manage and Invest the Assets
During the charitable term, a trustee administers the assets held in the CLT. Depending on the terms of the trust, the trustee’s duties may include holding existing investments, selling assets, reinvesting proceeds, and managing the portfolio throughout the trust’s duration.
Those investment decisions matter because the trust must make its required charitable payments while preserving—and potentially growing—the assets that will eventually pass to the beneficiaries.
Step 3: Make Annual Payments to Charity
The trust makes payments to one or more qualifying charitable organizations in accordance with the terms of the CLT. Those payments may be structured as either a fixed annual amount or a percentage of the trust’s value, depending on whether the trust is a charitable lead annuity trust or a charitable lead unitrust.
- Charitable Lead Annuity Trust, or CLAT: A CLAT provides the charity with a determinable annuity amount established under the trust’s terms. Because the payment is determined when the trust is created, changes in the value of the trust’s assets generally do not change the amount the charity is entitled to receive each year.
- Charitable Lead Unitrust, or CLUT: A CLUT pays the charity a fixed percentage of the trust’s value, which is determined annually. As a result, the amount paid to charity may increase or decrease from year to year as the trust’s value changes.
“A charitable gift can be structured to benefit your family, a charity, or both over time.”
Step 4: Transfer the Remainder to Your Beneficiaries
When the charitable term ends, the remaining trust property passes to the beneficiaries identified in the trust, which may include children, grandchildren, or other loved ones.
The value ultimately available to those beneficiaries depends in part on how the trust’s assets perform during the charitable period. This creates an important relationship between the trust’s investment performance, required charitable payments, and the amount remaining for your family.
The Section 7520 rate is an IRS-prescribed interest rate used in valuing certain charitable and remainder interests when a CLT is established. For a CLAT, investment performance above the assumptions reflected in that valuation rate can result in additional value remaining for the beneficiaries at the end of the charitable term.
How Long Do CLT Payments Last?
A charitable lead trust can generally make payments for a specified term of years or for a period measured by the lifetime of an eligible individual. Unlike a charitable remainder trust, which is generally limited to a maximum 20-year fixed term, federal CLT rules do not impose the same 20-year cap on a term-of-years arrangement.
The right duration depends on your charitable goals, beneficiaries, assets, and the type of CLT you establish.
Lifetime Option
A CLT may structure its charitable interest around the lifetime of an individual who qualifies as a permissible measuring life under federal tax rules. A lifetime structure may appeal to someone whose charitable goals are closely connected to a particular person’s lifetime rather than a predetermined number of years.
Fixed Term Option
With a fixed-term CLT, you establish a set number of years for the charitable period. Depending on the trust’s design and applicable state law, that period could potentially extend for 20, 30, 40, or even 50 years.
The ability to choose the term length gives families another way to align charitable giving with their long-term estate plans. A fixed term may be especially appealing when you want greater certainty about when the remaining assets are expected to pass to your beneficiaries.
CLAT vs. CLUT
Charitable Lead Trusts have two main options for payment terms: a Charitable Lead Annuity Trust, or CLAT, and a Charitable Lead Unitrust, or CLUT. The primary difference between the two is how the annual payment to the charity is calculated. A CLAT establishes a determinable annuity payment for charity when the trust is created, whereas a CLUT calculates its charitable payment using a fixed percentage of the trust’s value, which is determined annually. As the value of the trust changes, the amount going to charity changes with it.
That distinction also affects how investment gains and losses influence the charitable payments and the assets available for transfer to your beneficiaries. The following chart breaks down the differences:
Feature | Charitable Lead Annuity Trust (CLAT) | Charitable Lead Unitrust (CLUT) |
Annual Payout | Provides a determinable annuity amount established under the trust. | Pays a fixed percentage of the trust assets’ annually determined value. |
Market Volatility Impact | The required charitable payment generally does not change with annual market performance, leaving investment performance to affect the remainder. | The charitable payment rises or falls as the trust’s annually determined value changes. |
Inflation Defense | Limited because the payment does not automatically rise with portfolio value. | Greater potential because the charitable payment can increase as the portfolio grows. |
Future Contributions | The standard IRS safe-harbor CLAT prohibits additional contributions after initial funding. | Additional contributions may be permitted with appropriate structuring. |
Best Suited For | Donors focused on transferring potential future appreciation to beneficiaries. | Donors who want charitable payments to respond to changes in portfolio value. |
The Top 3 Tax Benefits of a CLT
Tax planning is often an important reason families consider a charitable lead trust, but the benefits depend heavily on how the trust is structured. A CLT may reduce the taxable value of assets transferred to beneficiaries, provide an upfront charitable income tax deduction in certain circumstances, or reduce taxable income at the trust level.
Benefit #1: Reduce the Taxable Value of a Gift to Your Beneficiaries
A CLT can reduce the value of a taxable gift when you transfer assets to the trust and designate beneficiaries to receive the remainder. For gift tax purposes, the value of the charitable interest is taken into account when determining the value of the remainder passing to your beneficiaries.
For example, suppose you transfer $2 million to a CLT that will make payments to charity for 20 years, with the remaining assets passing to your children. For taxation purposes, this is not treated as making a $2 million gift to your children. Instead, the value of the charity’s interest reduces the value of the remainder.
If the trust’s assets appreciate during the charitable term, that growth may also increase the amount ultimately passing to your beneficiaries without increasing the value of the original remainder gift.
Benefit #2: Claim a Potential Upfront Income Tax Deduction With a Grantor CLT
When a CLT is structured as a grantor trust, you may be able to claim a charitable income tax deduction in the year you fund it. Rather than waiting to claim deductions as the trust makes charitable payments over time, the potential deduction is based on the present value of the charitable interest at the time the trust is created, subject to applicable tax rules and limitations.
The tradeoff is that you must report the trust’s income during the charitable term, even though the trust is making payments to charity. You generally do not receive another charitable deduction for those annual payments.
This structure may be worth considering if you have an unusually high-income year and want to make a long-term charitable commitment while potentially receiving a charitable deduction sooner.
Benefit #3: Offset Trust Income With Charitable Payments in a Nongrantor CLT
A nongrantor CLT approaches income taxes differently. Because the trust is generally treated as its own taxpayer, you do not typically claim an upfront federal income tax charitable deduction when you fund it. Instead, the trust may deduct qualifying amounts of gross income that it pays to charity.
For example, suppose a nongrantor CLT holds investments that generate $100,000 of qualifying gross income during the year and uses part of that income to make its required charitable payment. Subject to the applicable tax rules, the trust may be able to deduct the qualifying amount paid for charitable purposes when calculating its own taxable income.
This structure can allow the charitable payments and the taxation of the trust’s income to work together throughout the charitable term.
Who Benefits the Most From a Charitable Lead Trust?
CLTs are sophisticated planning tools and will not be the right fit for every estate. Determining whether you need a trust like a CLT starts with understanding what you want your estate plan to accomplish. These trusts tend to be most useful when a meaningful commitment to charity is combined with long-term family wealth-transfer or tax-planning goals.
People who commonly consider a CLT include the following :
- High-net-worth individuals and families: A CLT may provide a way to combine substantial charitable giving with a long-term strategy for transferring wealth to children or other beneficiaries.
- Business founders and entrepreneurs: Owners holding interests with meaningful appreciation potential may consider whether those assets fit into a broader charitable and succession strategy.
- Real estate investors and families: Appreciating or income-producing real estate may create planning opportunities, although valuation, liquidity, management, and tax considerations require careful review.
- Philanthropists: Individuals already committed to sustained charitable giving may use a CLT to formalize that support while coordinating philanthropy with their estate plan.
- High-income executives and business owners: A CLT may be worth evaluating when an individual has a particularly high-income year and wants to pair long-term charitable commitments with potential current income-tax planning.
Ready To Create a Charitable Lead Trust?
Supporting the organizations you care about does not necessarily mean choosing between your charitable legacy and the people you want to provide for. A charitable lead trust can create a structured path for pursuing both goals at different stages of the same plan.
Evans & Davis is here to guide you regarding charitable trusts and help you evaluate how a CLT may fit alongside the other pieces of your estate plan. Whether you are considering a charitable lead trust, a charitable remainder trust, or another giving strategy, our attorneys can explain your options and devise an approach that reflects both your generosity and the legacy you want to leave behind.
Call 866-708-2335 or contact us through our online form to discuss whether a charitable lead trust is right for your estate plan.
