Choosing the Right Charitable Trust: CLT vs. CRT
Charitable Lead Trusts and Charitable Remainder Trusts: Maximizing Tax Benefits
The critical distinction between a Charitable Remainder Trust (CRT) and a Charitable Lead Trust (CLT) is the order of payments: a CRT pays an income stream to the non-charitable beneficiary (the donor or heirs) first, with the remainder going to a qualified charity, while a CLT pays an income stream to the charity first, with the remainder ultimately passing to the non-charitable beneficiaries. Both irrevocable trusts offer sophisticated ways to combine philanthropic giving with estate and tax planning, but the choice depends entirely on the donor’s primary financial goal: securing current income or achieving tax-efficient wealth transfer.
Key Takeaways
What is the primary purpose of a Charitable Remainder Trust?
The primary purpose of a Charitable Remainder Trust is to provide a fixed income stream to the donor or their heirs for a specified period, with the remainder going to charity.
What is the main tax benefit of funding a Charitable Remainder Trust with appreciated assets?
Funding a Charitable Remainder Trust with highly appreciated assets allows the trust to sell them without incurring immediate capital gains tax, thus maximizing the amount available for investment and income generation.
Which charitable trust is better for reducing estate and gift taxes for my heirs?
A Charitable Lead Trust is generally better for reducing estate and gift taxes because the value of the payments made to charity discounts the taxable value of the assets passing to the non-charitable heirs.
Understanding Charitable Remainder Trusts (CRTs)
A Charitable Remainder Trust (CRT) is designed to provide an income stream to the donor or other designated non-charitable beneficiaries for a term of years (up to 20) or for life. When the term ends, the remaining principal of the trust is distributed outright to one or more qualified charities.
CRTs are particularly popular because of their immediate and long-term tax advantages. Upon funding the trust, the donor is eligible for an immediate income tax deduction. This deduction is calculated based on the present value of the projected remainder interest that the charity will ultimately receive. Furthermore, since the CRT is a tax-exempt entity, it can sell highly appreciated, low-basis assets—such as real estate or concentrated stock positions—without incurring immediate capital gains tax. This allows the trustee to reinvest the full proceeds into a diversified portfolio, maximizing the amount available to generate the income stream for the non-charitable beneficiaries and potentially increasing the eventual charitable gift.
The income stream paid out by the CRT is classified into tiers for tax purposes, often consisting of ordinary income, capital gains, and finally, tax-exempt income, but the ability to defer the capital gains tax at the trust level makes the CRT an unparalleled tool for converting appreciated assets into diversified income.
“The choice between a CLT (tax-efficient inheritance) and a CRT (tax-efficient income) depends on the donor’s primary financial goal.”
How Charitable Lead Trusts (CLTs) Operate
The Charitable Lead Trust (CLT) is the mirror image of the CRT, focusing on wealth transfer rather than income generation for the donor. With a CLT, the trust makes regular payments to the designated charity for a set period. Once the term expires, the remaining assets in the trust revert back to the grantor or are transferred to non-charitable heirs, such as children or grandchildren.
The primary benefit of a CLT is the reduction of gift and estate taxes when passing wealth to the next generation. When the trust is created, the taxable gift made to the heirs is valued by subtracting the present value of the charitable payments from the total value of the assets contributed. This “discounting” of the gift can significantly reduce or even eliminate the gift tax liability on the assets that ultimately pass to the heirs.
CLTs are most effective when the trust assets are expected to appreciate significantly over the term. If the actual investment return of the trust exceeds the IRS-assumed rate (the Section 7520 rate), all of that excess growth passes to the non-charitable beneficiaries entirely free of gift or estate tax. There are two main types of CLTs: grantor CLTs, which give the donor an immediate income tax deduction but require the donor to pay tax on the trust’s income, and non-grantor CLTs, which offer the superior estate and gift tax deduction but no upfront income tax break.
The Strategic Choice: CRTs vs. CLTs
The decision between a CRT and a CLT is driven by the donor’s current financial priorities and legacy goals.
If the donor’s priority is current income and capital gains avoidance, the CRT is the superior tool. It converts highly appreciated, low-basis assets into a diversified, life-long, or term-limited income stream while bypassing the immediate capital gains tax hit and providing an immediate income tax deduction. CRTs are ideal for individuals nearing retirement who need to diversify a concentrated, appreciated portfolio to secure a stable income.
If the donor’s priority is tax-efficient wealth transfer to heirs and they are willing to forego current personal income from the assets for a period, the CLT is the better choice. It is a powerful estate-freezing tool that leverages the charitable payments to dramatically reduce the taxable value of the future gift to heirs. CLTs are generally used by high-net-worth individuals focused on minimizing estate and gift taxes to maximize the inheritance for the next generation.
Both structures provide an immediate tax deduction based on the present value of the charity’s future interest, demonstrating how these trusts allow donors to align their philanthropy with powerful tax benefits. While both trusts are irrevocable and require professional administration, they stand as two of the most effective vehicles for charitable giving and long-term wealth planning.
Disclaimer: This article provides general information and should not be considered professional financial or tax advice. Please consult with a qualified CPA or financial advisor for guidance specific to your individual business needs.
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Estate, Trust, and Succession Planning Services
Mark’s background in tax enables him to provide extensive services to the firm’s clients in the areas of estate and retirement planning, and business succession consulting.