Charitable Lead Trusts

As part of our firm’s continuing plan to provide educational information to clients and friends of McKinley Carter, the following article focuses on a Charitable Lead Trust. A Charitable Lead Trust must be carefully fashioned with experienced legal counsel.

For individuals with charitable inclinations, and either an estate tax issue, or income tax issue, a Charitable Lead Trust may offer a solution.

There are two types of Charitable Lead Trusts, a grantor and a non-grantor lead trust. In simple terms, the donor of a Charitable Lead Trust transfers assets to their favorite nonprofit organization, for a period of 10 to 20 years. The donor gives up the income from the asset transferred and designates the income to be given to the organization. At the termination of the trust, the assets are transferred back to the donor or the donor’s beneficiary.

A non-grantor lead trust has qualities that help individuals with gift tax and estate taxes, while a grantor lead trust helps individuals with annual income tax planning.  Therefore, if a donor were to structure the lead trust to ultimately benefit a son or daughter, then a non-grantor lead trust may be the most appropriate. Usually, a non-grantor lead trust will make payments to the organization for a specified period, and at the conclusion of the payment term, the remaining assets are distributed to the grantor’s children as an inheritance.

With a grantor lead trust, the individual who created the trust is also usually the individual who receives the trust proceeds at the end of the trust term. The trust income is taxed to the grantor every year. When the grantor contributes the assets to the trust, he receives an immediate charitable income tax deduction for the value “today” of all the future payments to be made to charities from the trust.

The donor would be entitled to a substantial charitable contribution deduction depending on whether the Charitable Lead Trust is a grantor or non-grantor, and whether it is a unitrust or annuity trust. The donor would be able to carry over the deduction for a period of five years but would be limited to 20% of the donor’s adjusted gross income. In other words, any deduction in excess of 20% of the adjusted gross income would be carried over for a period of five years.

Once it is determined which type of Charitable Lead Trust is best for the donor, there needs to be a decision made as to whether the investment of the funds is best in a unitrust or an annuity trust. The difference between a unitrust and an annuity trust is this:  A unitrust pays a fixed percentage of the income to the organization, while an annuity trust pays a fixed dollar amount to the organization.

The investment of the lead trust needs to be carefully considered, since the donor may need to declare the income on his/her tax return. To offset this, it may be best to invest the assets in tax free securities. However, this would produce a smaller return than other investments.

Just as drafting of an appropriate legal document for a Charitable Lead Trust is extremely important, the investing of the funds is also extremely important. For these reasons, McKinley Carter is uniquely positioned, to help organizations search for and cultivate donors, develop the planned giving instruments and invest the funds for maximum benefit to the donor and grow the organization’s endowment. Charitable Lead Trusts can have many variations and require legal counsel to draft and calculate the financial implications to the donor.