During this economic decline, charitable lead trusts have become almost fashionable. Last year, the New York Times ran a story detailing the estate plans of Jacqueline Kennedy Onassis, praising her use of the charitable lead trust. Even with all its publicity, though, the charitable lead trust remains relatively unused, in part because it is so hard to understand.
If the charitable lead trust is Cinderella, the bargain sale is her ugly stepsister. It is perhaps one of the least used, and least known, estate planning techniques. That’s why the Cleveland estate planning firm, Bart Leonardi, LLC has written the following summary as a primer on the charitable lead trust and the bargain sale.
If you’ve read the article on charitable remainder unitrusts, then it may be helpful to think of the charitable lead trust as exactly the opposite. In a charitable lead trust, you transfer assets to a trust, which makes payments to a charity for a certain period of time, and upon the expiration of that period, the remaining assets are transferred to your heirs.
Like the CRUT, charitable lead trusts are irrevocable, which means that once you transfer the assets to the trust, there is no turning back.
There are a few reasons why a charitable lead trust may be desirable, one of which is because it may actually allow you to transfer more money to your heirs than you started with. This is due to the way the IRS calculates the amount that the trust pays to the charity. Every month, the IRS sets a rate by which it expects all charitable lead trusts to grow; this is known as the “hurdle rate.” For example, if the hurdle rate were set at 3.0%, your charitable lead trust would be expected to grow by 3.0% every year. If your trustee is able to invest the trust assets at a rate higher than 3.0% annually, the excess is transferred to your heirs at the end of the annuity period.
This hurdle rate never changes once your charitable lead trust has been formed. If the hurdle rate for the month your charitable lead trust was created was 2.3%, it will remain 2.3% even if the hurdle rate eventually increases to 9.7% or 11.4%.
This is why charitable lead trusts are popular in economic downturns. The low hurdle rate promises an opportunity to grow the amount ultimately transferred to your heirs tax free.
The charitable lead trust offers an important tax benefit as well. Assets transferred to the charitable lead trust are excluded from your estate for estate tax purposes, though the present value of the gift to your children will count against your gift tax exemption, and will therefore lower your unified credit.
A brief example may help illustrate.If you transfer assets worth $1 million to a charitable lead trust to pay a charity $50,000 a year for the next 20 years, that $1 million dollar asset is not included in your estate for estate tax purposes. However, the present value of the trust to the charity is only $623,111. That means you have made a gift to your heirs in the amount of $376,889.This amount will act to decrease the amount of your estate tax exemption (technically, your unified credit) from $5 million to roughly $4.4 million.
The benefit of a charitable lead trust comes from hoping the trust will grow at a high enough rate to pay the annuity to the charity and still accumulate additional income (e.g., a growth rate of 6.1% with a hurdle rate of 2.4%). This additional income passes to your heirs tax free.
A bargain sale is the purchase of property by a charity for less than fair market value. In this type of transaction, the IRS considers the seller of the property (you) to have made a gift equal to the difference between the selling price and the fair market value. This potentially allows the seller (you) to recoup your investment in the property, while also getting a charitable deduction. It does, however, require you to transfer the property to the charity; the property does not go to your heirs.
As you can see, deciding whether to use a bargain sale or a charitable lead trust—not to mention a CRUT or annuity trust—is a complicated decision to say the least. That’s why you need the help of an experienced estate planning and probate lawyer like Cleveland attorney, Bart Leonardi. Schedule a free consultation today to find out more.