The details surrounding the taxation of charitable lead trusts, or CLTs, can get pretty hairy. However, you can get a quick feel for the different variations by understanding who owns the trust. A CLT contributes to charities for a certain period and might create tax breaks. What money remains after the contributions are complete is distributed back to the owner, the owner’s estate or to noncharitable beneficiaries. You will want to consult with a trust lawyer before setting up a CLT.
CLT Tax Deductions
Three different tax deductions come into play with CLTs. Depending on the trust type, deductions may be available on income, personal gifts and estates. Some trusts provide all three. The first step in figuring out who gets what deduction is to identify the trust owner. A grantor CLT belongs to the person who sets up the trust. The grantor can benefit from charitable gifts made by the trust but must treat trust income as his own. A nongrantor trust is a separate entity that pays taxes and takes deductions on its own.
A nongrantor CLT must pay income tax on its earnings. However, it can take a tax deduction for charitable contributions up to the amount it earns. It can’t deduct contributions in excess of income. The trustee has the option of applying the deduction retroactively to the previous tax year. In some states, capital gains are not considered income to which deductions can apply. In other words, trusts in certain states must pay taxes on all capital gains. Nongrantor trusts might also owe taxes for unrelated business income and debt-financed income.
The grantor adds the trust’s income to his taxable income and deducts the trust's charitable contributions. If the trust assets revert to the grantor after a set time, the trust provides no gift or estate tax deductions. The grantor can only deduct the trust’s charitable contributions if the amount is set when the trust is established. In a “qualified reversionary grantor CLT,” the grantor takes a tax deduction in the first year that's equal to the present value of the total charitable contributions the trust will make over its lifetime. But the grantor still has to pay the taxes on the trust’s annual income. A grantor can set up a CLT that comes into existence after his death and thereby dodge the trust income bullet.
Gift and Estate Taxes
While a nongrantor trust gives no income tax deductions to the grantor, she can still benefit by receiving a gift tax deduction for the net present value of the charitable contributions. As of 2013, an individual can exclude $5.25 million of personal gifts from gift tax. A gift tax deduction increases the total amount an individual can give without being taxed on the gift. Alternatively, the grantor can set up a nongrantor trust so that the net present value of the charitable contribution is deducted from estate tax after the grantor dies. Estates also receive $5.25 million in tax exclusions as of 2013.
- Planned Giving Design Center: Charitable Lead Trust
- Internal Revenue Service: What's New -- Estate and Gift Tax
- IRS.gov. "Basic Trust Law." Accessed Aug. 29, 2020.
- IRS. "Tax Forms and Instructions, Tax Rate Tables," Page 10. Accessed Aug. 30, 2020.
- IRS. "IRS provides tax inflation adjustments for tax year 2020." Accessed Aug. 30, 2020.
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