The inflation adjustment of the unified gift and estate tax
exemption to $5.43 million, coupled with a low interest rate environment, opens
the door to yet another year for creating a qualified charitable lead trust
(CLT) to transfer wealth to family and charities. For existing CLTs, the
continued strong performance of the capital markets should compel trustees to
evaluate the usefulness of commuting the charitable interest. Not only do CLTs
continue meriting serious consideration, but also there may be planning
opportunities for nonqualified CLTs benefiting non-lineal heirs, especially for
owners of highly appreciating assets generating no immediate or small
income.
Opportunities With
Qualified CLTs
The qualified CLT offers philanthropic clients a way to do
good and transfer assets to family members with reduced transfer tax cost. In
designing a qualified CLT, the planning goal is to zero-out so that there’s no
taxable gift to the remaindermen. Because the gift and estate exemption is near
historic highs, a donor may be willing to incur a taxable gift to the
remaindermen. The amount of the taxable gift likely generates no immediate gift
tax but will draw down the exemption.
The payment to the charity must be expressed as a fixed
percentage of the initial amount of trust (annuity amount) or as a fixed
percentage of its annual value (unitrust amount). The duration of the payments
may be for a fixed term of years or permitted measuring lives. The amount of
the taxable gift from the remainder interest is determined by a combination of
the duration and amount of the charitable payments, as well as the Internal
Revenue Code Section 7520 rate.
Opportunities With
Nonqualified CLTs
Income tax
consequences. A nonqualifying non-
grantor CLT provides for payment of
the net income from the trust. Because the payment to the charitable
beneficiaries is neither a unitrust nor annuity trust amount, the trust isn’t
qualified. The donor to the charitable income trust receives neither an
income tax nor a transfer tax deduction. Notwithstanding these tax
disincentives, such a nonqualified trust has a powerful income tax-related
advantage. Because the
nonqualifying CLT can be non-grantor for federal income
tax purposes, the donor isn’t taxed on the income earned from it. The net
effect to the donor is as if he received a full charitable deduction, even if
he previously exceeded his adjusted gross income (AGI) limits. That could be
the case if the donor has contributed cash or appreciated property to a private
foundation whose limits are respectively 30 percent and 20 percent of AGI.
Its other advantage arises from the flexibility in the
choice of funding asset. The ability to fund a CLT with a highly appreciated
asset with additional growth potential but insufficient income is possible.
Because the charitable income trust isn’t required to pay out an annuity or
unitrust amount, the trust isn’t compelled to sell all or a portion of such an
asset.
Estate and gift tax
consequences. Because the charitable lead income trust is
nonqualified, there’s no gift or estate tax deduction for the charitable
interest at the time of funding. To avoid consuming the unified exemption, the
donor should retain the power to determine annually the charitable beneficiary.
Because the charitable lead income trust is likely to be
funded with illiquid assets, it’s critical that the charitable income
beneficiary still have a “degree of beneficial enjoyment” within the meaning of
the regulations under Section 7520.
Appeal of Lead
Trusts: Even a doubling of the Section 7520 rate from 2 percent to 4
percent in the near future won’t dramatically diminish the utility of qualified
CLTs. While Congress can always reduce the gift and estate exemption as part of
a revenue-raising bill or even a revenue-neutral tax reform, CLTs remain
attractive. The nonqualified, non-grantor charitable income trust merits study
to benefit heirs, such as nieces and nephews who aren’t family members within
the meaning of IRC Section 2702(c)(2).
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