The Nuts and Bolts of Charitable Remainder and Charitable Lead Trusts

Continuing with our reports from the 2016 Heckerling Institute on Estate Planning

Michele A.W. McKinnon of McGuireWoods LLP and Richard L. Fox of Dilworth Paxson LLP led an in-depth discussion of the intricacies of charitable remainder trusts (“CRTs”) and charitable lead trusts (“CLTs”). Both of these planning techniques provide benefits to high-net-worth individuals that are seeking either income or estate tax planning, coupled with charitable intent. Both CRTs and CLTs can be structured as annuity trusts where the annual payments are based on a fixed percentage of the initial trust value or dollar amount, or as a unitrust where the annual payments are based on a percentage of the value of the trust principal (as valued each year).  

The basic function of a CRT is to enable a taxpayer to transfer property to an irrevocable trust, which in turn will return a stream of payments over a fixed period of time to a non-charitable beneficiary (either to the original settlor, or some other individual). At the end of the fixed term, the remainder of the trust property must pass to one or more qualified charitable organizations, or continue to be held in trust for those charities.  

A CRT is generally seen as an income tax planning technique ideal for individuals with highly appreciated capital gain property, since the sale of that property (once placed in the CRT) will escape capital gains tax and other associated taxes on investment income (including NII tax, state income tax, or even increased tax rates on collectibles). Although the payments to non-charitable beneficiaries will be subject to income tax on an annual basis, the ability to sell an appreciated asset without income tax at the trust level can provide for increased cash flow and asset diversification. If the CRT is established during the lifetime of the individual, the donor (or settlor of the CRT) will receive a current income tax and gift tax deduction based on the remainder interest passing to the charity. If the CRT is established at death, an estate will receive a charitable estate tax deduction instead.  

A CLT is used more frequently for estate tax planning purposes and is generally seen as the reverse of a CRT. In a CLT, income is paid to a charity for a specified term and upon the term end, the assets pass to non-charitable beneficiaries. If established during a donor’s life, a CLT is effective at removing appreciating assets from an estate, without limits on charitable deductions. If established upon death, the estate will be able to claim a charitable deduction for the income payable to the charity. Both inter-vivos and testamentary deductions are based on the present value of the income payments made to the charitable organization over the term of the CLT. The assets used to fund a CLT would ideally appreciate over the term of the trust, so as to provide sufficient income for annual charitable payments, and provide increased value in the remainder assets passing to the non-charitable beneficiaries.

As with CRTs, the rules surrounding qualified CLTs are intricate, and require a skilled advisor to help navigate both drafting and administration. Unlike a CRT, the charitable beneficiaries are often unnamed in the trust document, and trustees or other responsible parties are granted broad discretion for these distributions. The speakers cautioned against the grantor’s retained rights to participate in any of these decisions, as it could cause an unintended inclusion in the grantor’s estate under IRC § 2036.  

In each case, practitioners and clients are advised to give careful consideration to the establishment of a charitable trust. They should contemplate their own philanthropic intentions and family commitments, along with monetary concerns, such as cash flow needs, income tax, and estate tax in conjunction with their overall planning goals.