A Good Time for Charitable Lead Trusts

Many estate planning techniques involve split interest gifts, gifts which have two components, (1) the current interest and (2) the remainder interest. A Charitable Lead Trust (“CLT”) is such a gift. The use of the CLT is particularly effective at this time because the Applicable Federal Rate (“AFR”) is particularly low. The AFR, which is an interest rate equal to 120% of the Federal midterm rate in effect for the month in which the gift is made, is used in the computation to determine the respective current interest and remainder interest of split interest gifts. A low AFR will reduce the value of the future interest, thus lowering the taxable gift.

The Charitable Lead Trust is one of the more valuable planning devices available for wealthy persons who wish to make gifts to charity and also want to ensure the continued affluence of family members. It is most appropriate when the Donor and Donor’s family do not require the income from the assets to be given to the CLT, or are willing to forego current income for the potential of realizing long-term capital appreciation for themselves or other family members at low gift or estate tax cost. Using a CLT lowers the amount of the taxable gift and transfers all appreciation to the beneficiary at no further gift tax cost at the termination of the CLT.

It is possible, by selecting an appropriate payout rate and trust term, to greatly reduce or even eliminate almost entirely the gift or estate taxes due upon the transfer to the CLT. Because of this, the lead trust is a significant means by which a donor may pass on assets to the next generation of family members at little or no tax cost. The CLT is a particularly advantageous means to transfer wealth when the AFR is low, as it has been in the last few months, because the lower the AFR, the smaller the remainder interest is deemed to be when the value of the remainder interest is computed upon creation and funding of the CLT. The effect is that the Donor will be deemed to be making a smaller taxable gift when the AFR is low.

For example, Donor owns a parcel of real estate worth $1,000,000 that he wishes to give to his children. If he gives it to them outright, the taxable gift is $1,000,000 and the tax is $345,000. There is no charitable gift component in this case.

If he gives the property to a CLT for a 20-year term with an annual gift to charity of $50,000, the taxable value of the gift when the AFR is 8% is $469,822 and the tax is $145,539. Under the same facts, if the AFR is 6.01%, as in the month of August, the taxable gift is reduced to $392,095 and the tax is reduced to $119,112.

If the Donor wishes to further reduce the taxable gift, an increase in the charitable gift component will have that result. For instance, an increase in the annual gift to the charity to $60,000 will reduce the taxable portion of the gift to only $270,514 and the tax is only $77,775.

The use of the CLT not only reduces tax, but also provides a charitable component to the transaction. Upon termination of the CLT, all the appreciation passes without further taxes to the children. If the appreciation is consideration, a significant tax savings would be realized.

The current low AFR makes the use of the Charitable Lead Trust an efficient vehicle to make larger charitable gifts with no adverse effect to the Donor or his family while allowing the family to enjoy the future appreciated value of the gifted property.