Is there a limit to the number of non-charitable beneficiaries?
YES. You may assign more than one non-charitable beneficiary. Just make sure that it is clearly indicated in the trust document how the trust assets would be split among them.
Are there income tax incentives for establishing CLT?
As per the IRS rules, only the owner of the trust is eligible to receive an income tax deduction for the present value of the charity’s lead interest. But it is a one-time event only and is merely allowed in the year of the trust’s creation. And the easiest way to meet the owner criteria is to keep an interest in the trust as a non-charitable beneficiary which is also called as a reversionary interest since it reverts to you (it should be at least 5% of the total trust assets). The computation should be made at the start of the trust using the actuarial tables of the IRS. Under the rule of the 5% reversionary interest, you will be considered as the owner of the trust if your spouse has more than 5% interest in the trust assets, you would be considered as the trust’s owner. But in this case, the deduction on your income tax comes at a price. You will be taxed every year on the income earned by the trust (under the grantor trust provisions of the IRS). This applies even if it is the charity who receives the trust income (and not you).
This means that while you are eligible for an income tax deduction, you should still pay income tax on the trust income yearly. Offsetting any amount of trust income paid to charity is not allowed by the IRS. But one way to avoid paying taxes on trust income is to have the trust hold only the assets that create tax-exempt income like tax-exempt municipal bonds (though the income that can be produced from these may not be enough to make the required payment to charity).
Most of the time, there is a 30% (of your adjusted gross income) limit to your deduction because the IRS regards your gift as “for the use of” and not “to” the charity. But if a long-term capital gain property is used to find the trust, then it is not considered as a public charity and the 20% limit applies. In case that you cannot take the full deduction in the applicable year, the difference can then be carried over to the next years (up to five succeeding years if you will still itemize deductions in those years.
The deduction amount is computer using IRS’ special interest rate tables. At present, the rule requires that the value of a remainder interest be calculated using an interest rate that is 120% of the federal midterm rate then in effect of appraising specific federal government debt instruments of the month that you made the gift. Additionally, the computation uses the most current mortality table obtainable to establish the mortality factor.
When the time comes that you are no longer taxed on the yearly income that is earned by the trust (i.e. due to death), there will be a fractional recapture by the IRS of your prior one-time deduction for the value of the charity’s lead interest. Assuming you set-up a charitable lead trust for a term of five years with you as the non-charitable beneficiary also, your entitlement for an income tax deduction for the present value of the charity’s interest would be on the first year. In case you die on the third year, the recapture rules will take effect. As a result, your income on the third year must include a recaptured portion of the deduction that you took on the first year.
Can the charity be paid any excess amount from the required annuity or unitrust payment?
Normally, the non-charitable beneficiary of a charitable lead trust holds a residue interest only, which means it is second in line to the charity’s interest. Nevertheless, in certain situations, the IRS permits a non-charitable beneficiary to obtain an income interest that runs at the same time as with the charity’s interest. The income interest is allowed only if it is paid from trust assets that are separated from the assets used to pay the charity. The provision for this should be drafted accurately in the trust document and executed according to the regulations of the IRS. Or else, the IRS may rule that the total charitable lead trust is invalid.
When do you consider a CLT?
NEED FOR LIQUIDITY: A CLT is considered if for instance, you are selling your business and you want to recognize substantial capital gains and you are not willing to part with your sudden riches permanently. Transferring to a CLT that is a grantor trust after any sale of assets like closely-held stock will create a generous deduction while guaranteeing the return of the assets eventually to the donor or your spouse. In cases of unwillingness to part with the principal, this method is very practical. A grantor CLT permits you to offset the gains with an income tax deduction on the year of sale and pay the tax on your gains over a number of years. This efficiently allows income averaging as an alternative to an enormous tax bill in the year of the sale. You will then get the property back once the trust terminates.
INITIAL PUBLIC OFFERING (IPO): Some clients are sometimes advised by their planners to take on an IPO to put some of their shares in a charitable remainder trust. But this is an anathema to the shareholder who only has paper wealth and questions why the need to give it away when he would only be having the income and none of the principal. Some of the closely-held stock amount might be placed in a grantor CLT with a reversion to the donor. This produces a lump sum deduction in the same year that the shareholder had gain on the closely-held stock. Selling a few of the new stock may be essential to meet the payout commitment of the CLT, but eventually receiving back the remainder interested after a period of years would be the selling point of this approach.
BENEFIT TO YOUNGER GENERATIONS IN THE FUTURE: If you have children and you want to provide them with funds when they are all in the age wherein they can responsibly manage finances, a non-grantor charitable lead annuity trust will allow you to pass assets down a generation at minimum or no gift tax cost. A non-grantor lead unitrust will also you to pass assets down to your grandchildren at a minimum generatio-skipping transfer tax cost.
CHARITABLE DEDUCTIONS ARE ALREADY MAXED OUT: If you have contributed some substantial amounts to charity already and you cannot fully deduct your gifts due to the percentage limitations on income tax charitable deductions, CLT can be considered as it pays to your private foundation or to a donor fund that can, in turn, make grants to your chosen charities. The distributions from the CLT are deductible by the CLT and are not subject to the percentage limitation.
Grantor Versus Non-Grantor Trust Status
GRANTOR CLTs: A grantor CLT offers the settlor with an instant charitable income tax deduction for the current value of the annuity or unitrust amounts to be paid to charity. The grantor CLT is not allowed to claim a charitable deduction under IRC Section 642(c) for its distributions to charity.
NON-GRANTOR CLTs. A non-grantor CLT provides no income tax deduction to the settlor but can present substantial gift or estate tax savings.
The Charitable Beneficiaries
Types of Charities that Can Benefit: Private foundations, support foundations, community foundations and other charitable receptacles such as donor advised funds can receive the CLT distributions.
Power to Change the Charities: The charities to receive the lead interest may be named permanently in the trust document or may be modifiable by the settlor, the trustee or another.
Application of Private Foundation Rules
Excise Tax Provisions: The excise tax provisions suitable to private foundations under IRC Sections 4941 to 4945 also apply to CLTs. Therefore, the trust document should include specific prohibitions against their violation as required by IRC Sections 4947(a)(c) and 508(e).
Excess Business Holdings: If the value of the charitable interest goes beyond 60% of the value of the trust at inception, IRC Sections 4943 (excess business holdings) and 4944 (jeopardizing investments) may apply.