As we approach the end of the year, we have been discussing the topic of charitable lead trusts (“CLT”) with several of our clients as a way to leverage a charitable deduction to save on income taxes. A CLT is an excellent strategy for someone who has incurred a significant amount of income in a given year, such as large amount of capital gains related to the sale of a business or of appreciated stock or real estate. However, it can also be used to provide an income tax deduction in other years when income might be unusually high.
The benefit of a CLT is that the client can receive a large income tax deduction for a charitable contribution by transferring money into the irrevocable charitable lead trust for a certain number of years. The trust states that a charity will receive a specific amount of money, based on a percentage of the initial value transferred to the trust, each year during the term of the trust. At the end of the trust term, the client receives back the money transferred to the trust, plus any growth during the trust term, less the amounts paid out to the charity each year. The benefit is that the client receives an income tax deduction for the present value of the total amounts paid to the charity over the full term of the trust all in the year that the trust is created.
For example, let’s assume that a client is willing to give $5,000 per year for five years to their favorite charity. This client also sold some stock during the year for $100,000, creating a significant amount of capital gains, which will be subject to tax this year. The client could create a CLT by transferring the $100,000 to a trust that is required to pay $5,000 (5% of the $100,000 transferred to the trust) each year to the charity for a total of five years. The charity will receive a total of $25,000 over the life of the trust. Because the trust is irrevocable, the IRS will allow the client to take an upfront charitable deduction of approximately $23,500 in the year the trust is created, which can be used to offset the capital gains taxes from the sale of the stock. Additionally, let’s say the $100,000 is invested in such a way as to generate 8% growth each year. Even after paying the charity $5,000 each year, at the end of the five-year period, the client would get back over $117,500 from the trust. Thus, at the cost of setting aside the $100,000 for five years, the client got a large, upfront income tax deduction and received back more than he put into the trust at the end of the five years.
A CLT can be a very powerful tool to provide a large income tax deduction when a client is willing to set aside some money for a couple of years. The trust must be properly drafted, however, to make sure that the client is receiving all of the benefits that can come from such a trust. This is a perfect time, before the end of the year, to consider creating a CLT. Give the Dana Law Firm a call to discuss this strategy with one of our qualified attorneys.