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If you are considering establishing a private foundation or already have one in place, then you probably understand the range of benefits offered. Opportunity for family involvement, ability to support multiple organizations, and a structure that will allow your philanthropic dreams to outlive you, are just a few. In addition, how you fund your foundation can be just as far-reaching. Nevertheless, you might be looking for a method to provide for your descendants' futures while continuing your charitable giving.
A charitable lead trust (CLT) allows you to achieve both goals. The trust will provide an income to your private foundation for a fixed period or the remainder of your life. Ongoing payments may be a set dollar amount, or a percentage of the CLT's assets. After the term ends, money left in the trust passes to your beneficiaries, which may include a trust.
Your contributions to a CLT are considered taxable gifts to your beneficiaries. However, the value subject to gift tax is discounted to account for the charitable income that will be paid out over the trust's term. Thus, you will leverage the amount that will eventually go to your heirs by reducing the gift tax payable and the asset will not be included in your estate.
The anticipated future value of the trust depends on the interest rates when you set up the CLT. The IRS uses the Section 7520 Valuation Rate to value the remainder interest in a gift. A higher rate means that more of the trust's principal will be available to your heirs, whereas a lower rate will reduce the estimated future bequest.
Therefore, in a low interest rate environment, you will realize a larger present charitable interest, a greater gift-tax charitable deduction, and a smaller taxable gift to your beneficiaries. If the assets in the trust grow at a higher rate than the IRS's assumption, your beneficiaries should end up with an amount greater than your original charitable gift. In addition, the principal, as well as the accumulated growth, may pass free of income, gift, estate, and generation-skipping transfer taxes.
If the CLT is structured as a unitrust, to ensure that your foundation benefits from the growth in the assets throughout the charitable term, you are allowed to allocate the generation-skipping transfer tax exemption to the original transfer, at the gift tax value. At the end of the charitable term, the assets may pass to a long-term trust for your heirs, free of tax.
Your foundation will also see an extra benefit since the payment from a CLT is not considered a foundation asset in the year received. Thus, it is not taken into account when calculating that year's mandatory 5% distribution. This undistributed income could add substantially to your foundation's gift-giving ability over the years.
You will want to ensure that the transfer of assets to the CLT is complete for gift tax purposes, so that the assets are not includable in your gross estate at death. The IRS has ruled that the donor's control of a private foundation meant that the gift to his CLT was incomplete. Therefore, as the donor of a CLT, you may not make grant recommendations, be involved in the grant-making decisions in any way, or change the charitable beneficiary. Although you may not serve on the foundation's board, or be a trustee, other family members may be active with the foundation.
Your private foundation will allow your good deeds to outlive you, and if you include a charitable lead trust, you may fulfill your charitable objectives today, while replenishing the wealth available to your heirs.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.