Technical - Charitable Lead Trusts (Part 2)
    CLUT v CLAT
    Inter Vivos v Testamentary CLT
    Ghoul CLT

Charity Advisor Resource Newsletter - Volume 1.2 (2009)

BY JONATHAN D. ACKERMAN

CLAT v CLUT (& GSTT) - A charitable lead annuity trust (CLAT) pays out an annuity amount to the charitable lead beneficiary. Thus, a specific dollar amount or a percentage of the net fair market value of the assets contributed to the CLAT determined on the date of contribution may represent the amount paid out to the charity. The annuity amount will be fixed on the date of creation and not change, But See, the "Getting More Sophisticated" portion of the Fundamentals Article.

A charitable lead unitrust (CLUT) pays out a unitrust amount to the charitable lead beneficiary. Thus, a percentage of the net fair market value of the assets contributed to the CLT determined on the date of contribution and revalued each year will represent the amount paid out to the charity. The unitrust amount is similar to the unitrust payout from a standard charitable remainder unitrust. The net income only payout (available to NIMCRUTs, for instance) is not available to CLTs. As a general rule, the CLUT will likely be used where a CLT is created with generation skipping planning in mind, i.e., where a grandchild will be the recipient of the remainder interest at the termination of the CLT. This is so because under Code Section 2642, the amount of the GST tax imposed on distributions from a CLT is determined by the application of an ãinclusion ratioä which takes into account the amount of the property transferred, the amount of the GST exemption allocated to the transfer, the death taxes paid, and any estate or gift tax charitable deduction allowed. The inclusion ratio is determined by subtracting the applicable fraction from 1. To prevent the avoidance of the GST tax by using a CLAT to zero out all gift tax and GST tax, Congress enacted Code Section 2642(e), which forces the applicable fraction to be determined at the end of the charitable term using the value of the assets then in the trust. Treasury Regulation Section 26.2642-3(a) further delineates that, in determining the applicable fraction with respect to a CLAT, the numerator is the adjusted GST exemption and the denominator is the value of the trust property immediately after the termination of the charitable lead interest. The adjusted GST exemption is the allocated GST exemption, increased by an amount equal to the interest that would accrue at the rate used to value the estate or gift tax charitable deduction, compounded annually, for the trust term. Under current law, it is impossible to have any assurance that a timely allocation of GST exemption at the creation of the CLAT will prevent the imposition of the GST tax. If the trust assets grow at a rate faster than is assumed in computing the value of the remainder interest, GST distributions from the trust will be subject to GST tax; if the trust assets grow at a slower rate, a portion of the GST exemption will be wasted. Suffice it to say, this area is very complex, and although there may be some saving actions that can be taken (like, make a late allocation of the GST exemption), a CLUT should be used where generation skipping planning is involved. A CLUT is not subject to Code Section 2642(e), and a GST exemption allocation made at the time of funding will be effective for the date of funding values.

Testamentary v Inter Vivos - A CLT may be created at the death of the donor or during the donorâs life. A testamentary CLT is created upon the death of the donor; therefore, it is hard to advise the donor what the payout and the term of the trust should be to maximize the estate tax charitable deduction. The IRS has liberally permitted donors to provide flexibility in the establishment of the different terms of the CLT when the donor passes. For instance, various private letter rulings indicate the flexibility that donors have to establish, based upon a formula, the charitable mid-term federal rate, term, amount to be contributed and payout of a CLT at death, See, PLRs 9118040, 9128051 and 9631021. In addition, if the assets remain a part of the donorâs gross estate, they will be includable in his or her gross estate and subject to estate tax; however, those assets will receive a stepped-up basis at death and the appreciation during the donorâs life will cause a larger estate tax charitable deduction. A CLT may also be created during the donorâs life, which is an inter vivos CLT. In that regard, the donor can experience the benefit of watching the charitable dollars at work during his or her life and take advantage of either estate tax planning and/or income tax planning (by the use of a grantor CLT). In the case of an inter vivos nongrantor CLT, these assets will be removed from the donorâs gross estate, if properly structured, at the price of a potential gift tax for the present value of the remainder interest at the creation of the CLT.

Ghoul CLT ö Donât Try This At Home!
Several years back, the IRS informed us that a promoter was touting a CLT based upon the life of an individual who was seriously ill, but not ãterminally illä under the Section 7520 rules. Even worse, this sick individual would receive some type of payment in return for using his or her life as the measuring life in a CLT. A ãterminally illä person, under the technical rules, has a 50% probability of dying within one year, and if such person lives beyond 18 months, he or she is presumed not terminally ill. The potential for abuse was clear. If a CLT is created using the life expectancy (letâs say 15 years) of someone who is very sick, but not ãterminally illä, and the calculation of the lead interest for income, gift or estate tax charitable deduction purposes is based upon annual payments being made to charity for 15 years. But in reality, the individual lives for only 5 years ö charity is only receiving 5 payments - and the balance is being distributed to the non-charitable remainder prematurely. The charitable deductions have been artificially inflated. Although there is no account of anyone actually creating such a CLT, Treasury heard about the abuse and reacted by amending the Regulations (for example, see Regulation Section 20.2055-2(e)(2)(vi)(a)). Basically, only one or more of the donor, the donorâs spouse and lineal ancestors of all remainder beneficiaries may be used as the measuring life in a CLT. In other words, the distribution from a CLT should be, in essence, a substitute for a testamentary disposition. Thanks to a promoter of a ghoulish application of a legitimate planned giving vehicle, a donor cannot create a CLT for the benefit of a step daughter, a partner in a common law marriage or a life partner, without violating these rules, which have been effective since April, 2000.

The CLT is a sophisticated gift planning vehicle, and as with all such vehicles, professional counsel should be retained to fully analyze the effectiveness of a particular vehicle given a particular set of circumstances.