CRTs and CLTs offer philanthropic and family benefits. For many people, a significant part of the estate planning process is deciding how (and how much) they want to leave to charity. Charitable remainder trusts (CRTs) and charitable lead trusts (CLTs) can offer particularly effective ways to achieve such goals and benefit family members. For this reason, they’re known as split-interest trusts.
CRTs provide no charitable beneficiaries with exclusive rights to specific distributions until their interests have terminated. At that time, charitable beneficiaries receive the remainder — the assets left over in the trust. This tool can be particularly useful if you want to divest yourself of a highly appreciated asset to diversify your portfolio but are concerned about the capital gains tax.
Here’s how it typically works: You create a CRT, name yourself the non-charitable beneficiary and transfer the appreciated asset to the trust. Then, the CRT can sell the asset (tax-free to the trust as a tax-exempt entity) and use the proceeds to purchase diverse, income-producing assets. You can receive annual payments from the trust for a specified period of up to 20 years or for your lifetime, increasing your cash flow.
A portion of each payment may be taxable to you based on the income earned or capital gains recognized by the trust. You might, for instance, have capital gains income attributable to the sale of the highly appreciated shares you transferred to the trust. But the gain you report will be spread out and taxed to you only as you receive payments. Plus, you’ll enjoy a partial but immediate income tax charitable deduction when you create the trust, calculated as the present value of the charity’s remain-der interest.
If you’re worried that there won’t be enough assets in your estate for your heirs to receive the inheritances you intended, should you die early in the CRT’s existence, there are two potential solutions:
- Set the CRT term for a specific number of years (rather than your lifetime) and name your heirs as contingent beneficiaries, or
- Purchase a life insurance policy to make up for the shortfall your heirs might experience. Finally, keep in mind that you can name someone other than yourself as no charitable beneficiary or set up the trust to be funded at your death. However, the tax consequences will be different.
CLTs reverse the timing of when charitable and no charitable beneficiaries receive distributions. The charitable beneficiaries receive the initial distributions and the no charitable beneficiaries receive the remainder.
A CLT can be useful when an asset generates substantial income every year, you don’t need the income and you wish to eventually pass the asset to your heirs. the CLT generates an income stream for the charity during the trust term, and at your death — or the end of the CLT term if you’ve set it for a specific number of years — the asset passes to your family. If structured as a grantor trust, the trust is essentially disregarded for income tax purposes, and a CLT then works similarly to a CRT in that you receive an immediate income tax deduction on the transfer of assets into the trust. But in subsequent years, the income generated by the CLT will be taxable to you. If you don’t structure it as a grantor trust, the CLT income won’t be tax-able to you, but you also won’t get an income tax deduction when you fund the trust. Unlike a CRT with you as the no charitable beneficiary, a CLT has a gift tax component, which is calculated based on the present value of the no charitable beneficiary’s remainder interest. As with CRTs, CLTs can also be funded at your death, with different tax consequences.
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