Charitable Lead Trusts

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Charitable Trust Lawyer in Reston, VA

Serving Northern VA, DC, and MD

What Are My Options for Creating a Charitable Trust?

There are two basic types of charitable trusts: charitable lead trusts and charitable remainder trusts.

Charitable Lead Trusts

When you establish a charitable lead trust, you would transfer cash or other assets to a trust, and a charity receives payments from the trust for a period of time. After that period, assets in the trust transfer to a non-charitable remainderman (usually a child or grandchild).

You may receive an immediate income tax deduction if you elect to recognize income from the trust in later years (otherwise, the initial gift is not deductible). You also would receive a lower gift tax for transferring the trust assets to the children or grandchildren or trusts for their benefit. A lead trust may also be established at death as a form of bequest. Both corporations and individuals may establish lead trusts.

A lead annuity trust pays a specified percentage of the initial trust value to one or more charities.

Income, gift, and estate tax deductions are only permitted for transfers to lead trusts if one of the following requirements is met:

  • The income interest is paid out in the form of a guaranteed annuity.
  • The income interest is a fixed percentage of the fair market value of the trust’s assets (calculated annually) and is paid at least annually.

Income tax rules also require the donor to be the owner of the income earned by the trust to claim the charitable income tax deduction. In other words, you receive an immediate, large income tax deduction, but in later years, must report the income of the trust as it is received by the trust. Consequently, the typical lead trust produces little if any net income tax deductions since future income taxes are likely to counterbalance the initial deduction.

Despite future tax obligations, however, the charitable lead trust can be beneficial. For example, if you are in a high-income year, but in future years you are expecting a drop in income, your tax bracket will most likely also drop. Consequently, deductions are received in a high bracket year, and taxes are paid in low bracket years. This premise also applies if a drop in income tax rates is expected.

Another advantage of the charitable lead trust is that it allows a discounted gift to family members. Under present law, the value of a gift is set at the time the gift is complete. The family member remainderman must wait for the charity’s term to expire; therefore, the value of that remainderman interest is discounted for the cost of waiting. In other words, the cost of making a gift is lowered because the value of the gift is decreased by the value of the income interest donated to charity.

When the assets in the trust transfer to the children or grandchildren (or their trusts), any appreciation on the value of the assets is free of estate taxation in the client’s estate.

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