DATELINE: February 11, 2009, Chicago
Yesterday’s Wall Street Journal has an article extolling the benefits of charitable lead trusts, an estate planning device that balances charitable motivations, family wealth transfers, and reductions in estate and gift taxes. Mike Spector, Giving Smarter While Helping Your Estate: Bear Market Provides Boost to Little-Known Strategy (Feb. 10, 2009). It is a great planning device when fully understood and used properly. Structurally, the donor makes a gift to a trust. The charitable beneficiary receives payments during the term of the trust. On termination of the trust, whatever remains is paid to the donor, her chidlren, or other named beneficiaries. It derives its name based on the charity’s relative position to the beneficiaries who receive the trust's assets upon termination. The charity is in the lead--it receives the first payments. A charitable remainder trust is just the opposite. The charity receives what is left following termination of the trust, with the children or other named beneficiaries receiving the annual payments. Charitable lead trusts can be created during an individual's lifetime (inter vivos) time or following an individual's death as part of the estate plan (testamentary).
There are two basic types of charitable lead trusts. The first pays the charity a fixed annual amount (a charitable annuity trust). The second pays the charity an annual amount based on a percentage of asset value (a charitable unitrust). It is worth noting that the payments to the charity can be made at shorter intervals (e.g., semi-annually or quarterly), with the calculations adjusted to reflect that fact. The more popular form is the annuity trust, in part because it avoids the need to value the assets annually.
Lead trusts can be further divided between grantor or non-grantor trusts. If the trust is structured as a grantor trust, the grantor receives an immediate income tax deduction, but must include the income from the trust assets in her annual income. Because the grantor will be paying tax on income that is paid to the charity, the trust is often funded with assets that produce income that is tax-advantaged such as tax-exempt bonds. The grantor is typically the recipient of the assets when the trust terminates, but it is possible to have someone other than the grantor receive the remainder interest--referred to as a nonreversionary grantor charitable lead trust. See Private Letter Rulings 9224029 and 9247024. These trusts look a lot like nonreversionary non-grantor lead trusts, but achieve grantor trust status through a drafting trick that takes advantage of the grantor trust rules. The grantor retains the right to require the trust's property by substituting property with an equivalent value.
The trust also can be structured as a non-grantor trust, in which case the person funding the trust does not receive an income tax deduction at the time of funding, but she does not have to pay include the trust's annual income in her income for tax purposes. Instead, the trust files its own tax return, pays the tax on the income, and receives a charitable contribution deduction. The decision whether the trust is structured as a grantor or non-grantor trust often turns on the funder’s income tax rates at the time the trust is funded. If the funder is in a high marginal tax rate in the year of funding, but expects to be in a lower bracket in later years, the funder may opt for a charitable lead grantor trust. The overall goal with the more popular non-grantor trusts is to...
