Charitable Lead Trusts: Not Just for the Super-Rich

Sometimes, in the world of charitable gift planning, we focus too closely on the tax consequences of potential gift plans. With charitable remainder trusts (CRTs) and charitable gift annuities (CGAs), it is not enough to know how much the income tax deductions will be – donors also want to know how much the vehicles will pay to themselves and/or other beneficiaries over time. And not just how much the payments will be, but also, how those payments likely will be treated for income tax purposes. Occasionally a donor comes along and says that the amount of the charitable deduction, or even the amount of the payments, is not important, but that type of donor tends to be the exception to the rule.

Charitable lead trusts (CLTs) are at times described as “upside-down” or “reverse” CRTs. While it is true that the charitable interest leads with a CLT (a stream of payments is made over time to one or more charitable organizations), and the remainder of the corpus at the end goes to one or more non-charitable interests (i.e., one or more persons), the simple comparison ends there. CLTs can be either “grantor” or “non-grantor.” The former means the remainder of the corpus reverts to the grantor, and the latter means the remainder of the corpus goes to other persons. In addition, there are a number of other significant differences between CRTs and CLTs.

Specifically with non-grantor CLTs – historically the more popular version – the trust does not earn an income tax deduction, but rather, it earns a gift tax deduction. Or an estate tax deduction, if the trust is funded upon the grantor’s death. Gift taxes and estate taxes are components of the mysterious realm of transfer taxes, with which most Americans are unfamiliar. Transfer taxes are levies on wealth that has been transferred, whereas income taxes are levies on income that has been earned.

Transfer taxes elude the concerns of most Americans because they affect only a very small segment of the population – the proverbial 1%, or more likely, just a small fraction of that 1%. For the very wealthy, charitable lead trusts can reduce or eliminate huge amounts of taxes on the transfers of wealth. Currently, individuals who have wealth in excess of about $14 million can structure CLTs that pay millions to charities, leave millions to their children, while escaping millions of dollars in gift or estate taxes.

It is frequently said that professional gift planners need not be concerned right now with charitable lead trusts because the threshold above which federal transfer taxes occur (a.k.a. the “lifetime exemption”) is $13,610,000 in 2024. This very high threshold is a result of the exemption threshold being doubled – and then some – with the passage of the 2017 Tax Cuts and Jobs Act (TCJA); the 2017 Tax Act raised the exemption threshold from $5,490,000 in 2017 to $11,180,000 in 2018. In addition, the number is indexed annually for inflation, so it goes up a little each year.
But timing is everything, and the clock is running out on the current schedule for the exemption threshold. Beware the so-called “Sunset Provision:” If Congress fails to take action before the end of 2025, the exemption threshold for 2026 and subsequent years will go back to the amount it would have been without the changes found in the 2017 Tax Act: without the doubling of the threshold, but still indexed for inflation. That amount would be approximately $7 million in 2026. Obviously, there are far more individuals who have total wealth of $7 million or more than there are individuals who have total wealth of $13.6 million or more. For this reason alone, we could be hearing – and engaging in – a lot more discussions about charitable lead trusts as we approach the end of 2025.

Another aspect of lead trusts and transfer taxes that is frequently overlooked is the existence of estate taxes at the state level or even the local level. The federal estate tax exclusion amount is $13,610,000 in 2024, but a number of states and other jurisdictions have much lower thresholds. In fact, the lowest threshold for estate taxes at the state level is $1,000,000 (Oregon), and the second-lowest threshold is $1,733,264 (Rhode Island). Four other states and Washington, DC have estate tax thresholds less than $5,000,000: Massachusetts at $2,000,000; Washington at $2,193,000; Minnesota at $3,000,000; Illinois at $4 million; and the District of Columbia at $4,528,000. When the values of comfortable homes are combined with other investments and retirement plans, the total wealth of upper-middle-class people can easily exceed these estate tax thresholds. So even though almost all Americans escape the federal estate tax in its current form, many more can be affected by the estate tax levied at the state or local level.

Our final point circles back to the issue of tax benefits and asks the question: in the big picture, do the tax benefits really matter that much? Or in some cases, do they matter at all? While it is true there can be significant tax benefits for certain donors in establishing charitable lead trusts, at its root the CLT is simply a split interest charitable gift arrangement. The primary objective of grantors is typically that they want to establish a meaningful charitable gift for their favorite organizations while simultaneously allowing for the possibility – or probability – of additional benefits for their family and loved ones. The charitable lead trust allows for significant payments to be made to the charity or charities of one’s choice, while also providing the opportunity for significant financial benefit to accrue to the grantors’ favorite people. The donor gets to have their cake and eat it too, so to speak, regardless of whether there are meaningful tax benefits. Perhaps we might try to attach less focus on the tax consequences of charitable lead trusts and allow donors to express what truly matters most to them.

Note: PG Calc will be offering its popular Lead Trust School on March 5 and 6, 2024 (3 hours each day). You may register for the online class here: www.pgcalc.com/class/lead-trust-school-online