Charitable Lead Trust (CLT)

Charitable Lead Trust: Give to Charity First, Then Pass Wealth to Your Family

A Charitable Lead Trust puts charity first. It provides income to the charitable causes you care about for a defined period, then passes the remaining assets to your children, grandchildren, or other designated heirs. For families who want to transfer significant wealth to the next generation at reduced tax cost while also fulfilling a meaningful charitable purpose, a CLT is one of the most powerful tools available.

A Charitable Lead Trust (CLT) is an irrevocable trust that makes periodic payments to one or more qualifying charitable organizations for a specified term, after which the remaining trust assets, known as the remainder interest, pass to non-charitable beneficiaries designated by the grantor, typically children or grandchildren. The word “lead” refers to the fact that the charitable interest comes first; the family receives what remains after charity has been served.

A CLT is the structural mirror image of a Charitable Remainder Trust. In a CRT, the donor receives income first and charity receives the remainder. In a CLT, charity receives income first and the family receives the remainder. The two structures serve different planning goals and are suited to different family circumstances, but both integrate charitable giving with sophisticated tax planning.

The present value of the charitable income stream qualifies for a gift or estate tax deduction, reducing the taxable value of the transfer to family members. Any appreciation in the trust assets during the lead term passes to the family entirely free of gift and estate tax. In environments where asset appreciation is expected to outpace the IRS hurdle rate, a CLT can transfer substantially more wealth to the next generation than a direct gift or bequest, while simultaneously making a significant charitable impact during the lead term.

A Charitable Lead Trust is not simply a charitable gift. It is a wealth transfer strategy. Done well, it allows you to support the organizations you care about for a defined period while passing appreciating assets to your children or grandchildren at a fraction of the gift or estate tax cost of a direct transfer.

A Charitable Lead Trust can be structured as either a Charitable Lead Annuity Trust (CLAT) or a Charitable Lead Unitrust (CLUT). The choice determines how the charitable payments are calculated and how the trust responds to changes in asset value during the lead term.

Charitable Lead Annuity Trust (CLAT)

A CLAT pays a fixed dollar amount to the designated charitable organizations each year, calculated as a percentage of the initial fair market value of the trust assets at the time the trust is funded. The payment amount never changes during the lead term regardless of how the trust's assets perform. If the trust's investments outperform the IRS hurdle rate, the excess growth accumulates within the trust and passes to the family beneficiaries at the end of the term. If the trust underperforms the hurdle rate, the charitable payments may consume principal and reduce the remainder available for the family.

A CLAT is particularly effective in low-interest-rate environments, when the IRS hurdle rate is low and assets are expected to significantly outperform it. The excess return over the hurdle rate passes to family beneficiaries free of gift and estate tax. A CLAT also offers the possibility of a “zerod-out” structure, where the annuity payments are set so that the present value of the charitable lead interest equals the entire initial contribution, eliminating gift tax on the transfer to family beneficiaries if the trust outperforms the hurdle rate.

Charitable Lead Unitrust (CLUT)

A CLUT pays a fixed percentage of the trust's assets, revalued annually, to the designated charitable organizations. Because the payment is tied to the trust's current value, it fluctuates with investment performance. If the trust grows, the charitable payments increase and the remainder available for the family also grows. If the trust declines, the payments decrease proportionally.

A CLUT provides more certainty about the ultimate remainder for family beneficiaries in volatile markets because the charitable payment adjusts with asset values rather than consuming a fixed dollar amount regardless of performance. It is generally less effective than a CLAT for zeroing out gift tax because the fluctuating payment structure makes the present value calculation less predictable.

Gift and Estate Tax Deduction

When assets are transferred to a CLT, the present value of the charitable lead interest qualifies for a charitable deduction for gift and estate tax purposes. This deduction reduces the taxable value of the transfer to the family beneficiaries. In a properly structured CLT, particularly a CLAT with a zeroed-out annuity, the taxable gift to family members can be reduced to zero or near zero, allowing significant wealth to pass to the next generation at minimal transfer tax cost.

The present value of the charitable lead interest is calculated using the IRS Section 7520 rate at the time the trust is funded. When that rate is low, the present value of the charitable lead payments is higher, which produces a larger deduction and reduces the taxable gift to the family even further. CLTs are most tax-efficient when interest rates are low and the contributed assets are expected to appreciate significantly.

Transfer of Appreciation Without Additional Transfer Tax

Any appreciation in the trust assets during the lead term passes to the family beneficiaries at the end of the term entirely free of additional gift or estate tax. Because the taxable gift was calculated and fixed at the time the trust was funded, subsequent growth in asset value is not subject to further transfer tax. This makes CLTs particularly effective for transferring assets with high growth potential: the gift tax cost is calculated at today's value, but the family receives the full appreciated value at the end of the term.

Income Tax Benefits for Grantor CLTs

A grantor CLT, in which the grantor is treated as the trust's owner for income tax purposes, generates an immediate income tax deduction for the present value of the charitable lead payments at the time the trust is funded. The grantor then pays income tax on the trust's earnings during the lead term, which effectively allows the grantor to make additional tax-free transfers to the trust's beneficiaries over time. This structure is sometimes called an “accelerating” CLT because the grantor takes the entire deduction upfront while paying tax on income year by year.

A non-grantor CLT does not generate an upfront income tax deduction for the grantor but is not subject to income tax at the grantor's level. The trust pays income tax on its earnings and takes annual charitable deductions for the payments made to charity. Non-grantor CLTs are more commonly used for estate tax planning purposes.

Vermont Estate Tax Reduction

Assets transferred to a CLT are removed from the grantor's taxable estate for Vermont and federal estate tax purposes. The present value of the charitable lead interest reduces the taxable value of the transfer further. For Vermont families with estates above the $5,000,000 Vermont exemption threshold, a CLT can meaningfully reduce Vermont estate tax exposure while transferring appreciating assets to the next generation.

A Vermont grantor funds a twenty-year CLAT with $2,000,000 in business stock expected to appreciate at 8% annually. The CLAT is structured to pay an annuity to a designated charitable organization each year for twenty years, with the annuity amount set so that the present value of those payments equals the full $2,000,000 contribution at the applicable Section 7520 rate. This “zerod-out” structure means the taxable gift to the grantor's children is $0 at the time of funding.

If the trust assets grow at 8% annually but the IRS hurdle rate is, for example, 4%, the excess 4% of growth accumulates within the trust. Over twenty years, that excess compounding produces a substantial remainder that passes to the grantor's children entirely free of gift and estate tax, having been transferred at a taxable gift value of zero.

This illustration is for conceptual purposes only. The actual results of a CLT depend on the specific assets contributed, the annuity or unitrust rate, the Section 7520 rate at funding, the trust's actual investment performance, and the applicable Vermont and federal tax laws. We will model the specific numbers for your situation as part of the planning process.

A CLT is most valuable in the following circumstances.

•      You want to transfer significant assets to your children or grandchildren at reduced gift or estate tax cost while also making a meaningful charitable contribution during your lifetime or for a defined period.

•      You hold appreciating assets, such as business interests, real estate, or investment portfolios, that you expect to significantly outperform the IRS hurdle rate over the trust term.

•      You are in a low-interest-rate environment, where the IRS Section 7520 rate is low and the CLT's gift tax reduction is most powerful.

•      You have a large enough estate that estate tax planning is a priority and you want to remove assets from the taxable estate while also serving charitable goals.

•      You have meaningful charitable intent and want your estate plan to reflect both your family values and your philanthropic priorities.

•      You want to use the current federal gift tax exemption while it is available, and a CLT structure allows you to maximize the amount transferred to family members within that exemption.

The CLT and the CRT are mirror images of each other, and understanding the difference is essential to choosing the right structure for your goals.

•      Who receives income first: In a CLT, charity receives income first and the family receives the remainder. In a CRT, the donor or family receives income first and charity receives the remainder.

•      Primary planning goal: A CLT is primarily a wealth transfer and estate tax planning tool, designed to pass assets to family members at reduced tax cost. A CRT is primarily an income and capital gains planning tool, designed to generate income for the donor and defer capital gains tax on appreciated assets.

•      Who benefits most: A CLT benefits families who want to pass appreciating assets to the next generation at reduced transfer tax cost and who have charitable intent but do not need income from the trust during the lead term. A CRT benefits donors who hold appreciated assets they want to convert into income without a capital gains tax burden and who want to make a charitable gift at the end of that income period.

•      Tax mechanism: A CLT generates a gift or estate tax deduction for the charitable lead interest, reducing the taxable value of the transfer to family members. A CRT generates an income tax deduction for the charitable remainder interest and eliminates immediate capital gains tax on the sale of contributed assets.

What is the difference between a CLAT and a CLUT?

A Charitable Lead Annuity Trust (CLAT) pays a fixed dollar amount to charity each year, calculated as a percentage of the initial trust value at funding. The payment never changes during the lead term. A CLAT is most effective when the trust outperforms the IRS hurdle rate, because the excess growth passes to family beneficiaries tax-free. A Charitable Lead Unitrust (CLUT) pays a fixed percentage of the trust's assets revalued annually. Payments fluctuate with performance, providing more predictability for the family's remainder in volatile markets. For most estate tax planning purposes, a CLAT is the more commonly used structure.

What does “zerod-out” mean in the context of a CLAT?

A zeroed-out CLAT is structured so that the present value of the annuity payments to charity, calculated at the applicable Section 7520 rate, equals the full value of the assets transferred into the trust. This means the taxable gift to family beneficiaries is calculated as zero at the time of funding. If the trust outperforms the hurdle rate during the lead term, the excess growth passes to the family entirely free of gift and estate tax. The zeroed-out CLAT is one of the most powerful wealth transfer strategies available when interest rates are low and assets are expected to appreciate significantly.

How long can the charitable lead term last?

The grantor specifies the duration of the CLT in the trust document. The lead term can be a fixed number of years, the lifetime of one or more individuals, or a combination of both. Most estate planning CLTs use a fixed term of years, commonly ten to twenty years, because a fixed term provides greater predictability for modeling the expected remainder and because a lifetime term introduces actuarial uncertainty. Vermont law does not restrict the permissible duration of a CLT lead term, but IRS rules impose requirements on how the charitable and remainder interests are valued.

Can I change the charitable beneficiary during the trust term?

It depends on how the trust is drafted. Some CLTs permit the grantor to designate or change the charitable beneficiaries during the lead term, provided the replacement organization is a qualifying charity under Section 501(c)(3). Others fix the charitable beneficiaries irrevocably at funding. If flexibility in directing the charitable payments is important to you, we can draft the trust to accommodate that, and in some cases naming a donor-advised fund as the charitable beneficiary achieves the greatest flexibility while preserving the trust's tax-qualified status.

Does the grantor pay income tax on a CLT's earnings?

It depends on whether the CLT is a grantor trust or a non-grantor trust. In a grantor CLT, the grantor is treated as the owner for income tax purposes, receives an upfront income tax deduction for the full present value of the charitable payments, and pays income tax on the trust's earnings throughout the lead term. In a non-grantor CLT, the trust pays income tax on its earnings and takes annual deductions for the charitable payments. Most estate planning CLTs are structured as non-grantor trusts to avoid the income tax burden on the grantor during the lead term.

What happens to a CLT if the grantor dies during the lead term?

If the grantor dies during the lead term, the trust continues to operate according to its terms. The charitable payments continue for the remainder of the lead term, and the assets ultimately pass to the designated remainder beneficiaries at the end of that term. If the CLT was structured as a grantor trust, the grantor's death terminates grantor trust status, which may have income tax consequences for the trust. We address these scenarios in the drafting process to ensure the trust operates as intended regardless of the grantor's longevity.

Does a Charitable Lead Trust reduce Vermont estate taxes?

Yes. Assets transferred to a CLT are removed from the grantor's taxable estate for both Vermont and federal estate tax purposes. The present value of the charitable lead interest further reduces the taxable value of the transfer to family members. For Vermont families with estates above the $5,000,000 Vermont exemption threshold, a properly structured CLT can meaningfully reduce Vermont estate tax exposure while transferring appreciating assets to the next generation at significantly reduced transfer tax cost.

A Charitable Lead Trust requires careful drafting and precise structuring to achieve its estate planning and charitable goals. The annuity or unitrust rate, the lead term, the Section 7520 rate at funding, and the nature of the contributed assets all interact to determine the trust's tax efficiency and the expected remainder for family beneficiaries. A CLT that is not carefully modeled before funding may fail to achieve its intended gift tax reduction or may produce a smaller remainder than anticipated.

At Will and Trust Planning, we begin every CLT engagement with a thorough analysis of your assets, your estate tax exposure, and your charitable goals. We model the specific numbers for your situation before the trust is funded, showing you exactly what the charitable payments will be, what gift tax deduction you will receive, and what remainder your family is expected to receive at the end of the lead term. We then draft the trust document, coordinate with your financial advisors on trustee selection and investment strategy, and ensure the trust is properly administered in compliance with Vermont and federal law.

Contact Will and Trust Planning Today

For personalized advice on estate planning, including strategies to minimize or avoid probate, contact Will and Trust Planning today. Our experienced estate planning attorneys can help you understand your options, draft essential documents, and create a plan that protects your assets and achieves your goals.