Charitable Lead Unitrust (CLUT)

Charitable Lead Unitrust (CLUT)

When a term-of-years CLUT is established, a donor transfers cash or other assets to an irrevocable trust. A charity you select receives variable annuity payments from the trust for the term of years you have specified. That means each year the value of the trust’s assets is re-determined. Although the charity will continue to receive the same percentage of the trust’s assets each year, as the total value increases, the charity receives more. If the value of the trust’s assets fall, the charity will receive less. For example, if the trust is worth $1,000,000 when you create it and you’ve given the charity a 6% annuity, it will receive $60,000 in the first year. If the trust doubles in value in the second year, the charity will still receive 6% – but of $2,000,000, i.e., $120,000. Of course, if the value of the trust in the third year falls to only $500,000, the charity receives 6% of $500,000, $30,000.

When the trust ends, assets in the trust will pass to the non-charitable remainderperson or persons you have specified. Although this party is usually a child or grandchild, it can be any person you select – including someone who is not legally related to you.

You can set up a CLUT during your lifetime or at death as a form of bequest. Both corporations and individuals may establish lead trusts.

You can set up a CLUT so that you will receive an immediate and sizeable income tax deduction. In the second and following years, you must report the income earned by the trust even though it is actually paid to the charity in the form of an annuity.

What is the advantage of a trust that produces a high deduction in the first year but requires you to report income you don’t receive in later years? One advantage is the acceleration of the deduction. For example, suppose you have just won the lottery, closed an incredibly large case, or sold a very highly appreciated asset. Perhaps you reasonably expect that in future years, your income will drop considerably. It’s good planning to have a very high deduction in a high bracket year even if you have to report that income in lower bracket years. You are spreading out the income (and the tax) over many years.

Another advantage of the CLUT is that it allows a discounted gift to family members. Under the present law, the value of a gift is determined at the time the gift is made. The family member remainderman must wait for the charity’s term to expire; therefore, the value of that remainderman’s interest is discounted for the time cost of waiting. In other words, the cost of making a gift is lowered because the value of the gift is decreased by the value of the annuity interest donated to charity.

When the assets in the trust are transferred to the remainderman, any appreciation on the value of the assets is free of either gift or estate taxation in your estate.

Many people of wealth set up CLUTs at death through their living trusts. The present value of the charity’s annuity stream is deductible for estate tax purposes. Since your heirs don’t pay estate taxes on the charity’s portion, the money that otherwise would have been paid in estate taxes can instead be invested. During the term of that trust, increased investment income can help pay for the fixed annuity promised to the charity – and if there is any surplus, that extra income can be compounded for your heirs and pass to them – gift tax free – when the trust ends.

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