It may be advantageous for a donor to create a trust with an income interest payable to the ACR REF for a term of years. The donor may direct that the trust property be returned to the donor or distributed to another person at the end of the trust period.
This method is particularly suitable if the donor:
- Wants to give to the REF more than the donor can currently deduct
- Will have unusually high income in one year, and much lower income for a period thereafter
- Is willing to part with income-producing property for a time, but wants the property to revert to the donor or the donor’s family
- Can afford to dispense with part of current income and wants to make gifts to his or her children or others in a way that can save gift and estate tax
Typically charitable lead trusts are more attractive when the IRS discount rate, which can change monthly, is low. There are several varieties of charitable lead trusts, each type achieving different tax objections for the donor:
- Traditional Lead Trust—Assets returned to donor’s family
- Grantor Lead Trust—Assets returned back to donor
Example of a Traditional Lead Trust
Dr. Graham is in high income gift and estate tax brackets, and he has used none of his unified gift and estate tax credit for lifetime gifts. He would like to make a substantial income gift to the ref using assets that will eventually be given to his children. If he makes an outright gift to his children he will incur substantial gift tax. If he defers making his gift and the assets meanwhile appreciate in value, the eventual gift tax or estate tax could be even higher because the tax will be based upon the appreciated value of the assets at the time of the gift.
Instead of giving the assets directly to his children, Dr. Graham funds a charitable lead annuity trust with suitable assets currently valued at $1.5 million. The trust agreement provides for a term of twenty years and a 7.5%annual annuity payment to the REF. Thus, each year for the next twenty years, the REF will receive $112,500 from the trust. At the end of 20 years the trust will terminate and all of the assets in the trust will be distributed to the children. If the total return on the trust assets during the trust term exceeds the payments to the REF, the children will receive more than the original $1.5 million value of the trust.
The tax consequences of Dr. Graham‘s lead trust gift:
- Income Tax: Dr. Graham receives no income tax charitable deduction for this type of lead trust but he does remove otherwise taxable income from hi s income stream because he is not taxed on the income from the trust assets. The effect is analogous to the donor receiving an income tax charitable deduction of $112,500 each year for the annual payment to the REF without any limitations.
- Gift Tax: Dr. Graham receives a gift tax charitable deduction in the amount of $1,428,075 (assuming the discount rate is at 5%), leaving a balance of $71,925 as the taxable value of his gift to his children. Since the gift is under the applicable credit amount, he does not have to pay any tax at this time. Any appreciation in the assets in the trust will pass free of tax to the children upon the termination of the trust.
Estate Tax: Dr. Graham transfers the assets out of his estate, eliminating probate fees and death taxes on those assets.
Grantor Lead Trust—Assets returned back to donor
If a qualified charitable lead trust is created for a term of years with the trust assets to be returned to the donors when the trust ends, the donors will obtain an immediate income tax charitable deduction. The deduction is limited to 30% of adjusted gross income any excess deduction over the 30% limit can be carried over to each of the next five years. The trust income is taxable to the donors in the year earned.
A the end of the trust term, the donor’ heirs will receive all of the trust property, the value of which at the time may be substantially in excess of the value at which was included in the donor’s estate if the trust assets appreciate after the donor’s death.
