01 March 2017

Using a Charitable Lead Annuity Trust to Transfer Wealth to Children

A non-grantor charitable lead annuity trust (CLAT) is an irrevocable trust created during life or at death which provides charity with the lead interest in the trust and the remainder interest passes to or continues in trust for others, such as the donor’s children.  The donor can either specify the charity or charities that will receive payments from the trust or leave the selection up to the trustee each year.  The payments to charity are typically made for a term of years.  The charities receiving the lead interest payment must be qualified under IRC Sec. 2055 for estate tax purposes and IRC Sec. 2522 for gift tax purposes.

The gift and estate tax laws allow for a deduction for the present value of the lead interest in the trust which is committed to charity.  Therefore, the person who creates a charitable lead annuity trust will be deemed to have made a taxable gift or bequest equal only to the value of the remainder which will pass to the non-charitable beneficiaries after the lead interest terminates.  The value of that remainder will be subject, as a general rule, to gift or estate tax at the time the non-grantor lead trust is created.  The value of the remainder constituting a taxable gift or bequest is determined by subtracting from the fair market value of the property transferred to the charitable lead trust the present value of the annuity interest committed to charity.

With appropriate assets, such as real property or securities which may rapidly appreciate, a non-grantor charitable lead annuity trust can produce significant wealth transfer tax savings.  To the extent the CLAT assets outperform the Applicable Federal Rate (AFR), wealth is shifted free of gift or estate tax to the remainder beneficiaries.  With a CLAT, a low AFR will produce a smaller taxable gift to the remainder beneficiaries.  From a wealth transfer perspective, the ideal time to implement a CLAT is during a period of low interest rates and when favorable returns on equities and real estate held in the trust will take place.  With the current Section 7520 rates at historic lows, it is possible to leverage the lifetime gift tax exclusion and transfer significant wealth to children.