Charitable Remainder or Lead Trust … Which One is Right for You?

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Charitable giving and financial planning often go hand in hand. Charitable remainder trusts (CRTs) and charitable lead trusts (CLTs) allow individuals to support causes they care about while achieving meaningful tax benefits and wealth preservation. Understanding the differences between CRTs and CLTs can help determine which best fits your personal financial objectives and the current economic climate.

Charitable Remainder Trusts: Income Now, Charity Later

1. The donor irrevocably transfers property into the trust.
2. The trust pays the named non-charitable beneficiary(ies) an income stream each year, either for life or for a specified term not to exceed 20 years.
3. When the trust terminates, the remaining trust assets are transferred to the designated charity.

Tax advantages include:

• The donor receives an immediate income tax deduction for the present value of the charity’s remainder interest, as determined under IRS Section 7520 actuarial tables.
• Because a CRT is generally tax exempt under IRC Section 664, the trust can sell the appreciated assets without recognizing capital gains, allowing for the full value of the assets to be reinvested for greater growth.
• The assets placed in the trust are removed from the donor’s estate, which can help reduce estate tax liability.

There are two main types of CRTs:

1. A charitable remainder annuity trust (CRAT) pays a fixed dollar amount at least annually. The annuity amount must be at least 5%, but cannot exceed 50% of the initial fair market value (FMV), subject to the further requirement that the remainder interest in the trust (measured at the time property is transferred to the trust) must have a value of at least 10% of the FMV of the initial trust corpus. CRATs provide a predictable, steady income stream but do not allow for additional contributions once established.
2. A charitable remainder unitrust (CRUT) is similar in many respects to a CRAT except that the amount payable (the unitrust amount) is a fixed percentage, not less than 5% but not more than 50%, of the net FMV of the trust’s assets, subject further to the requirement that the remainder interest must have a value of at least 10% of the value of the initial trust corpus, determined at the time property is transferred to the trust. Because the unitrust amount is calculated annually based upon the FMV of trust corpus and isn’t a fixed amount determined upon the creation of the trust, the trustee must determine the FMV of the assets of the trust annually. In contrast to CRATs, CRUT payments can vary depending on investment performance and additional contributions can be made over time.

Charitable Lead Trusts: Charity First, Family Later

A CLT effectively reverses the structure of a CRT: the charity benefits first receiving income for a set term and the remaining trust assets ultimately pass to the designated non-charitable individual beneficiaries. Unlike a CRT, a CLT is not a tax-exempt entity. Its income is taxable either to the donor (in a grantor CLT) or to the trust itself (in a non-grantor CLT).

How it works:

1. The donor irrevocably transfers property into the trust.
2. The trust makes annual or periodic payments to a qualified charity for a specific term of years or for the life/lives of one or more individuals.
3. When the charitable term ends, the remaining trust assets are transferred to the designated non-charitable beneficiaries.

Tax advantages include:

• The present value of the charitable payments reduces the taxable value of the remainder gift to heirs for gift and estate tax purposes. This enables the donor to transfer more wealth while using less lifetime gift and estate tax exemption.
• If the trust’s investment performance exceeds the IRS Section 7520 rate, that excess growth passes to heirs free of additional transfer tax.
• In a grantor CLT, the donor receives an immediate income tax deduction for the present value of the charitable interest, but must report the trust’s income annually on their own tax return.
• In a non-grantor CLT, the donor receives no upfront deduction, but the trust deducts the charitable payments each year and pays tax on any retained income.

There are also two main types of charitable lead trusts:

1. A Charitable Lead Annuity Trust (CLAT) pays a fixed dollar amount to the charity each year. This structure provides predictable payments regardless of investment performance.
2. In contrast, a charitable lead unitrust (CLUT) pays a fixed percentage of the trust’s assets, recalculated annually. Payments rise or fall depending on the trust’s value, providing flexibility but less predictability.

Either one of these options can be drafted to be treated as grantor or non-grantor for income tax purposes.

Economic Climate and Strategic Timing

CRTs generally perform better when interest rates are high. To determine the size of a donor’s immediate tax deduction, the IRS uses a special interest rate calculated on a monthly basis, the Section 7520 rate, to calculate the present value of the future gift to the charity. When the Section 7520 rate is high, it increases the value of the remainder interest, allowing for a larger upfront charitable deduction. On the other hand, CLTs tend to perform better when interest rates are low. A low Section 7520 rate reduces the calculated present value of the remainder interest for your heirs, which means that less of the total gift is considered taxable.

Choosing the Right Approach

Both charitable remainder and lead trusts can create powerful legacies and significant tax benefits. A CRT may be best suited for those seeking current income, diversification of appreciated assets and an immediate charitable deduction. A CLT may appeal to those focused on legacy planning, reducing transfer taxes and providing for family after a period of charitable support. The ideal choice depends on your income needs, estate planning goals and charitable intentions.

Contact Us

We’re here to help you determine what works best for your individual needs. If you have any questions, contact your PKF O’Connor Davies client service team or:

Bhakti Shah, JD, CPA
Partner
bshah@pkfod.com | 908.956.0464

Claire Snow, CPA, CFE
Supervisor
csnow@pkfod.com