Gift Planning

Getting Started: Charitable Lead Trusts

When people think about providing an inheritance to children and making a significant charitable gift through their estates, a vehicle known as the "charitable lead trust" is an excellent method to accomplish both objectives.

A charitable lead trust is a trust that the estate owner establishes either during life (an inter vivos trust) or at death (a testamentary trust). The income from the trust flows to a charitable organization, like Hood College, typically for a stated number of years. After that period, the assets inside the trust are then distributed. The fact that the assets will one day be transferred to another person means that this trust has one further distinction: it is a "nongrantor" trust, as opposed to a grantor trust. "Nongrantor" means the trust assets are not owned by the person who established the trust, and the assets are not going to be returned to him or her someday. (A "grantor" trust is one in which the assets will eventually be distributed back to the donor. As a result, the donor is subject to tax on the assets.)

The Tax Benefits
Of all the charitable vehicles available to donors, the charitable lead trust is among the most complex. However, a nongrantor lead trust does offer the advantage of providing excellent tax benefits to the estate owner.

Let's take a look at an example of how the trust works: A person transfers $1 million to the trust. The donor does not receive an income tax deduction. And, Hood College receives an income for 20 years. That income is either a fixed dollar amount or a percentage of the trust value as it is determined each year. For our purposes, let's assume that Hood is to receive $50,000 each year. This means that we will receive $1 million over a 20-year period, a wonderful gift for Hood. At the end of that time, the assets in the trust, which may or may not have grown in value, are then distributed (in our example) to a child or even a grandchild with extra planning.

How does this gift impact the donor? As mentioned earlier, the donor receives no income tax deduction. This fact makes it difficult for many people, including attorneys, to understand the benefit to the donor. In fact, the donor may have to pay a gift tax for the privilege of establishing a charitable lead trust.

A Look at the Issues
When the gift is established, the IRS requires a calculation to be made to determine the present value of the amount going to the child someday; in our case, in 20 years. Let's say that value, based on the data we have assumed, is $400,000. This means that the value to Hood over the years, as calculated by the IRS, is $600,000. If the donor is subject to tax and he or she is at a 35 percent level in 2010, the gift tax due on establishing the gift could be nearly $136,000. Not a good deal. Or is it?

When the gift is established, the tax paid is the only tax that will ever be due on that transfer. As far as the IRS is concerned, the transfer is being made on the day of the gift, not in 20 years. Now, consider the possibility that the trust has grown over the years, which is highly likely. And, let's say the value is ultimately $3 million. This means that the child will receive $3 million and no tax is due. If that asset were transferred outright at that time, the estate tax¹ at a hypothetical 55 percent rate assigned to that asset would be $1.65 million, far more than the $136,000 (even in inflation-adjusted terms) paid 20 years earlier. Further, during that time, Hood has an annual income from the trust of $50,000.

Calculate how a charitable lead annuity trust can benefit you.

Calculate how a charitable lead unitrust can benefit you.

Clearly, there are many issues to consider, both legal and personal, when considering the establishment of a charitable lead trust. In the end, you may find that such a trust represents one of the best ways to help Hood College while planning a deferred transfer of assets to children.

Please contact Nancy Gillece at 301-696-3702, or via e-mail at gillece@hood.edu, for more information.

Click the icon to request a FREE guide to charitable lead trusts.

¹Currently federal estate taxes are repealed for all deaths that occur in the calendar year 2010. In 2011, estate taxes are scheduled to be reinstated for estates worth more than $1 million at rates up to 55 percent. Congress, however, is likely to address reinstating estate taxes sooner than 2011. What the final legislation will look like and when it might become effective is unknown at this point. Check back later for updates.

The information in this Web site is not intended as legal advice. For legal advice, please consult an attorney. Figures cited in examples are for hypothetical purposes only and are subject to change. References to income tax apply to federal taxes only. Federal estate tax, state income/estate taxes or state law may impact your results.