How to Save Money on Your Taxes with Charitable Lead Trusts
Chris Peden, CPA, CMA, CFM
I help small business owners grow their profits and cash flow and reduce their taxes by finding the holes in their financials and creating an action plan to plug them to create the business that funds their ideal life.
If you're looking for a way to support your favorite charities while also gaining significant tax benefits, a Charitable Lead Trust (CLT) might be the perfect solution. As a CPA, I've helped many clients navigate the complexities of CLTs to maximize their tax savings. Let's explore how a CLT can work for you.
Understanding Charitable Lead Trusts
A Charitable Lead Trust is a type of "split interest" trust. This means the trust assets are divided into two parts. One part provides an income stream to a charity for a specified period, and the other part reverts back to the donor or other non-charitable beneficiaries at the end of that period. There are various ways to structure a CLT, each with different tax consequences.
How a CLT Works
A CLT essentially splits the trust assets into two pieces:
1. Income Interest: This part is payable to the charity for a fixed number of years or the lifetime of one or more individuals. It can be set as a fixed dollar amount (an "annuitrust") or a percentage of the trust assets (a "unitrust"). The income interest can be designed to grow over time or include a balloon payment at the end.
2. Remainder Interest: Once the income interest period ends, the trust assets revert back to the donor or another non-charitable beneficiary.
Benefits of a Grantor CLT
One popular variety of CLT is the "grantor" CLT. This type allows you to deduct the full net present value of the interest donated to the charity in the year you establish the trust. The value of your deduction depends on several factors, including the IRS discount rate at the time of the gift, the amount of income reserved for the charity, and the duration of the charity's interest.
For example, if you set up a CLT with $1 million and the IRS discount rate is 1.4%, and you give the charity a 5% annuitrust income interest for 20 years while keeping the remainder interest for yourself, your deduction would be $636,271. If you increase the annuitrust to 5.77%, you could deduct the full $1 million transferred into the trust.
Tax Considerations
Income generated by a grantor CLT is taxable to you, the grantor. Therefore, it is crucial to invest the trust assets in a tax-efficient manner to minimize the tax impact. You can fund a CLT with various types of assets, including cash, securities, and real estate.
Potential Pitfalls
There are a few potential pitfalls to be aware of when setting up a CLT. If you designate someone other than yourself as the remainder beneficiary, it may be considered a taxable gift to that beneficiary. This could reduce your gift tax annual exclusion and eat into your gift/estate tax unified credit.
Implementation Tips
1. Plan Your CLT Carefully: Work with a CPA or financial advisor to structure your CLT in a way that maximizes your tax benefits while aligning with your charitable goals.
2. Choose the Right Assets: Consider funding your CLT with appreciated assets to avoid capital gains taxes. Ensure the assets are suitable for generating income efficiently.
3. Monitor IRS Discount Rates: The IRS discount rate can significantly impact the value of your charitable deduction. Timing your gift when rates are favorable can enhance your tax savings.
4. Understand Gift Tax Implications: Be aware of the gift tax implications if you designate someone other than yourself as the remainder beneficiary. Plan accordingly to minimize potential tax liabilities.
5. Invest Trust Assets Wisely: Since the income from a grantor CLT is taxable to you, invest the trust assets in a tax-efficient manner to minimize the overall tax impact.
Action Items
To make the most of your charitable lead trust and maximize your tax savings, consider these action items:
1. Consult a Professional: Work with a CPA or financial advisor to design a CLT that meets your financial and charitable goals.
2. Select the Right Assets: Choose appropriate assets to fund your CLT, considering the tax implications and potential for income generation.
3. Monitor IRS Discount Rates: Keep an eye on the IRS discount rates to time your gift for maximum tax benefits.
4. Plan for Gift Tax Implications: Understand the potential gift tax implications if you designate a non-charitable beneficiary and plan accordingly.
5. Invest Tax-Efficiently: Invest the trust assets in a tax-efficient manner to minimize the tax impact on the income generated by the CLT.
By understanding and utilizing these strategies, you can significantly reduce your tax burden while supporting the charities you care about. Over the years, I've helped many clients navigate the complexities of charitable lead trusts and achieve substantial tax savings, and I'm confident you can too. Take these steps, stay informed, and don't hesitate to seek professional advice when needed.
If you would like some help with your tax situation, you can set up a call with me here:? https://calendly.com/pedenaccounting/30min
Navigating the complexities of taxes can be a daunting task for small business owners. Check out my tax guide designed to demystify the tax process and provide actionable insights to help entrepreneurs manage their tax obligations effectively: https://businesstax.pedenaccountingservices.com/