Charitable Lead Trusts

Charitable lead trusts are useful income, gift and estate tax planning tools for charitably inclined taxpayers. These irrevocable trusts offer benefits worthy of consideration by many, including a possible income tax deduction, charitable good feelings, removing assets from an estate and providing a future sum for a chosen beneficiary.

The easiest way to understand a charitable lead trust is to compare it to its "kissin' cousin," the charitable remainder trust. Simply stated, in a charitable remainder trust the grantor donates an asset to the trust. The trust pays a distribution, computed according to a pre-set formula, to the grantor (or some other non-charitable beneficiary selected by the grantor). The cash distributions continue for a specified period of time or for the life of the grantor (or other non-charitable beneficiary) after which whatever is left in the trust goes to the charity.

Charitable lead trusts are a mirror image of this structure. In a charitable lead trust (also sometimes called a “charitable income trust” or a “front trust”) the grantor donates cash or an income producing asset. The trust pays a distribution, according to a formula spelled out in the trust, to the charity for a specified period of time. After that period of time the principal of the trust is paid to the non-charitable "remainder beneficiary" designated by the grantor. Typically, the remainder beneficiary is a member of the grantor's family, other than the grantor or his spouse.

Charitable remainder trusts involve a gift and income tax deduction for the gift to the charity. The deduction is equal to the present value, computed per Internal Revenue Service (IRS) tables, of the charity's future interest. Although there is always a gift tax deduction involved in a charitable lead trust, there may or may not be an income tax deduction. An income tax deduction is available only if the grantor is taxed on the income of the trust (according to the so-called "grantor trust rules") and the distribution to the charity is in the form of a guaranteed annuity interest or a unitrust interest.

The annuity and unitrust interests are substantially the same concepts as are involved in the two types of charitable remainder trusts. The gift tax (and income tax, if applicable) deduction is computed based on the present value, again per IRS tables, of the charity's income interest. Investors should note that for any trust (either lead or remainder) established after May 1, 1989 the interest rate used to calculate the present values is adjusted each month. The rate equals 120 percent of the federal midterm rate ( the same rate applied to a number of other IRS computations). This rate is published monthly by the IRS.

With a charitable remainder trust, unless the grantor’s insurable, the donation to the charity must come at the expense of the heirs. If the principal is going to the charity, then it can't go to the children, too. With a charitable lead trust, if the grantor can afford to give up the income, he or she can pass an income producing (and potentially appreciating) asset on to heirs and satisfy charitable desires. Charitable lead trusts can solve financial planning problems for many individuals and should only be used with the aid of a qualified professional.