Which Charitable Trust Is Right for You?

For families who want to prioritize philanthropy in their estate plans, charitable lead trusts (CLTs) and charitable remainder trusts (CRTs) can be attractive options because of their potential tax benefits. These trusts are commonly thought of as inverses of each other, and their potential usefulness depends on your goals.

Let's explore how each of these trusts works and how to evaluate them against your needs.

What it is: A CLT is an irrevocable trust that pays an income stream to a charity of your choice for a period of years or your lifetime, after which any remaining assets pass to a noncharitable beneficiary—typically children, grandchildren, or a spouse—potentially without incurring taxes on the transfer. Note, however, that because it is irrevocable, the trust can't be changed once it's established; if the trust's assets don't perform, there may not be anything to pass to noncharitable beneficiaries at the end of the term.

A CLT may be formed as a grantor or a nongrantor trust. When structured as a grantor trust, you 
as the grantor receive an upfront tax deduction for the present value of the charitable income stream, but you also owe taxes on the trust's earnings going forward. (If you were to create a CLT nongrantor trust, the trust would be its own tax-paying entity, but you would not get an income tax deduction.) To determine the value of the tax deduction:

• First, find the IRS' Section 7520 interest rate for the month and year of the trust's creation.
• Next, use the 7520 rate and the duration of the trust to find the present value factor using IRS Publication 1457, Table B.

For example, let's say you create a 10-year, $1 million CLT that will distribute $100,000 annually to a charity of your choosing. Using May's 7520 rate of 5.4%, your present value factor for a 10-year term is 7.5739. Your tax deduction for the present value of the charitable income is therefore $757,390 ($100,000 × 7.5739), and the remainder interest— the amount potentially subject to gift taxes—is $242,610 ($1 million – $757,390). Typically, this amount reduces your lifetime estate and gift tax exemption ($13.61 million in 2024), and gift taxes are imposed only if the exemption amount has been exhausted. At the end of the term, any appreciation of the trust's assets beyond your initial gift tax determination transfers to your noncharitable beneficiaries without incurring additional gift taxes.

When to use it: Creating a CLT might make sense in a year in which you have unusually high income—such as a large Roth conversion or the sale of a business—that you'd like to offset with a charitable deduction. The lower the 7520 rate, the higher your upfront tax deduction. But even at higher rates, a CLT can be attractive, depending on your needs.

Note that the charitable deduction is generally limited to 30% of your adjusted gross income (AGI) in the year of transfer. However, you can carry over and deduct any excess amount for up to five additional years, so long as the deduction in any single tax year doesn't exceed the annual limit.

What it is: With a CRT, you (and potentially your spouse) receive an income stream for a period of years—though not more than 20 years—or your lifetime, after which a charity or charities of your choice receive any remaining assets at the end of the term. When you fund the CRT, you get an immediate charitable deduction based on the present value of the assets estimated to pass to charity at termination. As with a CLT, a CRT is irrevocable and cannot be changed after its creation.

While all CRTs must make a minimum annual payment to the grantor of no less than 5% but no more than 50% of the value of the trust assets, the type of CRT determines whether the payouts are fixed or variable:

• A charitable remainder annuity trust (CRAT) gives the noncharitable beneficiary a fixed amount annually—either a percentage of the CRAT or a fixed dollar amount based on the initial gift. Consequently, you cannot make additional contributions to a CRAT once it has been established.
• A charitable remainder unitrust (CRUT) gives the noncharitable beneficiary a percentage of the fair market value of the assets, which are revalued at the end of each year. This allows donors to make additional contributions but also means the payout amounts may change from one year to the next.

Note that when the assets are contributed to a CRT, there should be a calculation to ensure that at least 10% of its assets will pass to charity. If it fails this 10% test, the trust is no longer considered a valid CRT under the law.

When to use it: Investors who may want to defer taxes on highly appreciated assets can transfer them into a CRT, which will then sell the assets, paying no capital gains, and reinvest the proceeds. You'll owe income taxes on the annual distributions, but you can offset part, or all, of those taxes with the charitable deduction.

For example, say you're looking to liquidate a long-term investment property with a fair market value of $2 million and a cost basis of $200,000. Because you're in the top capital gains tax bracket, you'll owe $428,400 in taxes ($1,800,000 × 23.8%) if you sell the property outright.

If you transfer the property to a CRAT that then sells it, on the other hand, you could receive a $100,000 annuity for 20 years and—using the same assumptions as above—receive an income tax deduction of $794,980 for the charitable portion of the trust, which can be used to offset tax on the trust's annuity income for up to five consecutive tax years.

In addition to the costs of setup and maintenance, trusts are complicated vehicles that must be structured properly to realize the benefits you're looking for, so make sure to outline your specific goals with your estate-planning attorney and tax advisor before determining which approach, if either, is right for you.