If you are considering engaging in estate planning or you may be inheriting assets, it is important to understand what the step-up in basis is and how it may affect you.
A charitable lead annuity trust (CLAT) is an estate planning tool whereby a person (grantor) creates a trust that initially benefits a charitable organization, foundation, or other qualifying entity for a defined period.
After this time ends, the CLAT’s remaining assets are distributed to non-charitable beneficiaries, usually a grantor’s loved ones or family members. Depending on how it is structured, a CLAT may be able to reduce a person’s estate and gift taxes.
Characteristics of CLATs
CLATs are irrevocable trusts and can be created and funded during a grantor’s lifetime or through that grantor’s will. The grantor can fund the CLAT with cash or other assets. A trustee manages the CLAT according to the terms outlined in the trust document for a designated period.
CLATs are usually set up in one of two ways: as a charitable lead annuity trust or unitrust. If it is set up as the former, the charity typically receives a set amount from the CLAT per year. If established as the latter, the charity gets a percentage of the trust assets annually, which may cause the amount to vary yearly as distributions depend on trust asset values.
Whether a CLAT is an annuity trust or a unitrust may have different tax implications for the remaining trust principal once the terms of the CLAT come to an end.
What Assets Can Be Transferred to a CLAT?
A person can transfer various assets to a CLAT, including but not limited to cash, stocks, real estate, and other assets that may first need to be converted to cash to be transferrable.
Who Takes the Charitable Tax Deduction?
The person or entity that receives a charitable tax deduction from a CLAT depends on whether a CLAT is a grantor or non-grantor trust.
In a grantor trust, the grantor can take an immediate tax deduction for the present value of the future payments that will be made to the charity, subject to certain limits and rules. However, the grantor will also have to pay taxes on investment income earned from the trust’s assets during the CLAT’s term.
Where a CLAT is a non-grantor trust, the CLAT itself is the party that can take an income tax deduction for the distributions made to the charity. The trust will also be responsible for any taxes owed on its undistributed net income. Depending on a person’s situation and estate planning goals, a non-grantor trust structure may offer greater benefits for transfer tax purposes.
Speak With a Professional
When evaluating if a CLAT is an appropriate estate planning tool for you or your family, there are many other details to consider. These include other tax implications that may arise depending on whom the assets of a CLAT revert to at the end of its term. A CLAT usually requires the advice of multiple professionals to be properly effectuated. Furthermore, a CLAT must be structured carefully to make sure it can fulfill its required payments during the CLAT’s term and avoid other potential problems.
If you have questions about whether a CLAT is suitable for you, contact your estate planning attorney.