Charitable Remainder Trust v Charitable Lead Trust


Charitable Remainder Trust is one of the most efficient estate planning tools available and is created for the purpose of converting appreciated, low-yielding property into higher-yielding property, while receiving an income tax deduction for the charitable contribution.  The IRS has produced model forms but they do not include all of the provisions which may be beneficial to taxpayers.  Charitable Remainder Trusts are subject to the anti-abuse, excise taxes which apply to private foundations.

Things to keep in mind: 1)  If a person other than the grantor (or grantor’s spouse) is a non-charitable beneficiary, then a taxable gift has been made and the value of the gift must be determined.  If the gift is for current income, then it qualifies for the annual gift exclusion.  2)  A life income interest must be created for the lives of one or more non-charitable beneficiaries with the remainder interest passing to the charitable organization.  The duration must be a definite term of years of the non-charitable beneficiaries.  Distributions are taxed as ordinary income.  Trust assets may be invested in tax-exempt securities to produce tax-free income to the non-charitable beneficiary.  3)  If a grantor has a binding legal obligation to sell the property when it is transferred to the charitable remainder trust then the IRS will treat the grantor as the seller of the property and assess the capital gain tax.

Charitable Lead Trust is designed to make a charitable contribution of the income generated by trust property while preserving trust principal for the grantor, the grantor’s family, or some other non-charitable beneficiary.  It may be used to make lifetime or testamentary gifts of the remainder interest with little or no gift/estate taxes.

Following is a table highlighting the differences between a Charitable Remainder Trust and a Charitable Lead Trust.  For more detailed information, please contact an estate planning attorney.

Charitable Remainder Trust Charitable Lead Trust
Tax-exempt trust unless it has unrelated business taxable income.  The trust is taxable on all of its income as a complex trust and may use the charitable deduction and income distribution deduction if it has unrelated business taxable income. Not tax-exempt unless it is a grantor-type lead trust it will receive an unlimited deduction for distributions to the charitable beneficiary.
Forms of Trusts
Charitable remainder annuity trust

  • Pays a fixed annuity to the non-charitable beneficiary as a fixed dollar amount or a fixed percentage of the initial value of the trust assets
  • Must pay out principal if income is not adequate to provide the annuity
  • Future additions are not permitted
  • No annual revaluations are required for properties such as real estate and closely held business stock which are difficult to value
  • Non-charitable beneficiary receives no benefit from appreciation in trust assets

Charitable remainder unitrust

  • Pays a variable annuity to the non-charitable beneficiary as a fixed percentage of the trust assets based on annual revaluations
  • Invasions of principal are not required to pay the annuity, annual distributions to the non-charitable beneficiary may be the lesser of fixed percentage or actual income
  • Annual revaluations are required
  • Non-charitable beneficiary receives increased income as the trust assets appreciate
Grantor type lead trust

  • If the remainder of the trust property will revert to the grantor, then it is a grantor trust and the grantor must report all trust income on his individual income tax return
  • Grantor receives an income tax charitable deduction for the actuarial value of the income interest given to charitable organizations, subject to the annual percentage limitations in the year the trust is created

Non-grantor type lead trust

  • If the remainder of the trust property will not revert to the grantor but passes to a non-charitable beneficiary, the trust is not a grantor type trust
  • Grantor does not receive an income tax deduction when the trust is created but does receive a gift/estate tax deduction for the actuarial value of the income interest given to the charitable organization
  • Taxed under the ordinary rule for fiduciary income taxation.
Advantages
  • Benefit to charitable organization
  • Current income tax charitable deduction
  • Converts appreciated, low-yielding property into higher-yielding property without recognizing capital gain upon the sale
  • Benefit to charitable organization
  • Income tax charitable deduction effectively available for persons who could not otherwise deduct charitable gifts because the income of the trust is never included in the taxable income of the donor
  • Significant charitable gifts are possible without transferring the principal beyond the control of the grantor’s family
  • The tax value of the remainder of the trust property is fixed at the time of the gift, rather than at the death of the grantor if the trust consists of appreciating property
  • For grantor type lead trusts, grantor receives a large income tax deduction in the first year which may offset larger income in that year
  • Non-grantor type lead trusts grantors receive a gift/estate tax deduction for the value of the income interest which is given to the charity and the grantor transfers the remainder of the trust property to the non-charitable beneficiaries at a low tax cost
Disadvantages
  • Difficult concept for clients
  • Client must forfeit use, possession, and control of property
  • Remainder interest is removed from the family’s inheritance

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