When it comes to the intersection of estate planning, charity, and philanthropy, there are many things that must be considered. It may be estate tax concerns, leaving an inheritance to your family, or creating a lasting legacy of giving that can impact lives for many years. Often, what is not-so-obvious is the solution to accomplish the goals in question. And, some goals may not be equally met by all solutions considered. That can present a challenge to both the high-net-worth family, as well as the advisors that serve them.
In our experience, there are three types of entities that are most often considered when addressing these issues: charitable lead trusts (CLTs), charitable remainder trusts (CRTs), and private foundations. Let’s take a look at each of these in detail.
Charitable Lead Trust – According to Investopedia.com, a charitable lead trust, or CLT,
is a trust designed to reduce beneficiaries’ taxable income by first donating a portion of the trust’s income to charities and then, after a specified period of time, transferring the remainder of the trust to the beneficiaries.
A charitable lead trust, as the name implies, leads with charity. This type of entity is generally used by a high-net-worth individual or family to accomplish estate tax reduction, charitable distribution(s), and generational transfer through one entity. A trust is created and funded with one or more charities named as the lead beneficiary. Distributions to the charity may be lump sum, or for a number of payments over a specified period of months or years. The charitable distributions are typically calculated to continue until such time as the estate-tax consequence of the assets left in the trust have been sufficiently minimized. This is, of course, quite subjective and situational. While some may intend to reduce estate taxes to zero, others may not have this as a goal. Once charitable distributions are completed, the assets remaining in the trust are distributed to the individual beneficiaries (persons) deemed to be the recipients of the balance.
It is important to point out that a charitable lead trust is NOT a charitable organization and cannot apply for 501(c)(3) status.
Charitable Remainder Trust – Again quoting Investopedia.com, a charitable remainder trust, or CRT,
is a tax-exempt irrevocable trust designed to reduce the taxable income of individuals by first dispersing income to the beneficiaries of the trust for a specified period of time and then donating the remainder of the trust to the designated charity. This is a “split interest” giving vehicle that allows a trustor to make contributions, be eligible for a partial tax deduction, and donate remaining assets.
A charitable remainder trust can be thought of as being formed for a similar purpose as a CLT, but with the order of distribution reversed. A trust is formed and funded, with distributions made initially to non-charitable beneficiaries, e.g. children, grandchildren, the original trustor themselves, or others, for a set period of time. Once that distribution activity comes to an end, the remaining assets are donated exclusively for charitable purposes. This could include gifts to charities, or even setting up a private foundation with the remaining assets.
A notable difference between CLTs and CRTs is that assets placed into a CRT may be partially tax-deductible right away. The deductibility is based on a complex calculation that takes into account the remainder to be given to charity and the growth rate of the assets in the trust, plus other factors.
In the case of both CLTs and CRTs, a primary motivating factor for establishing them is tax-reduction. There may be scenarios where that isn’t the primary driver, but it is rarely not a significant factor. Which leads us to our final option:
Private Foundation – As we’ve established in many other articles, a private foundation is a 501(c)(3) organization (usually a nonprofit corporation) that is most often closely controlled or closely funded, or both. And while tax-reduction may be a factor in establishing a private foundation, it is rarely the driver of the decision. Philanthropy and desire to establish a family legacy and tradition of giving are much more often what motivates the creation of these entities.
Most private foundations are not meant to be used for short-term purposes, unlike many CLTs and CRTs. Private foundations can be established with initial gifts and continue to be funded for years to come, all immediately tax-deductible up to allowed limits (usually 20-30% of AGI). Governance can include all family members or related individuals, meaning multi-generational leadership can successively operate the foundation in perpetuity.
The decision of which charitable vehicle to use, among the charitable lead trust, the charitable remainder trust, and the private foundation depends on what the founder is trying to accomplish from a timing, tax consequence, and philanthropic perspective. For those seeking longer time horizons and a focus more on charity than on estate, the private foundation may be the better choice.