For New York families with significant wealth, philanthropic goals and a desire to pass assets to the next generation tax-efficiently, the charitable lead trust (CLT) is one of the most powerful planning tools available. Structured correctly under New York and federal law, a charitable lead trust can sharply reduce gift and estate taxes, support causes that matter to you for years or decades, and ultimately pass the remaining assets to your heirs at a fraction of their original transfer cost. This page explains how charitable lead trusts work, when they make sense and what has to be done to implement one properly.
What Is a Charitable Lead Trust?
A charitable lead trust is an irrevocable trust that pays a stream of income to one or more qualified charities for a specified term of years or for the life of one or more individuals. At the end of the term, the remaining assets, which often have grown substantially, pass to non-charitable beneficiaries, typically the grantor’s children, grandchildren or a continuing family trust.
A CLT reverses the structure of a charitable remainder trust. Rather than the donor receiving income with charity getting the remainder, charity receives the income (the “lead” interest) and the family receives the remainder. That structure lets a New York donor make a meaningful charitable commitment while using favorable IRS valuation rules to transfer wealth to heirs at a discounted gift or estate tax value.
Types of Charitable Lead Trusts
Choosing the right CLT structure is one of the most important decisions in the planning process. There are two principal forms, and a second distinction cuts across both of them.
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Charitable Lead Annuity Trust (CLAT)
A CLAT pays a fixed dollar amount, or a fixed percentage of the trust’s initial value, to charity each year. Because the payment is fixed, any investment growth above the IRS Section 7520 rate accrues for the benefit of the remainder beneficiaries. CLATs are particularly attractive in low interest rate environments because the “hurdle rate” the trust must beat to deliver value to the heirs is correspondingly low.
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Charitable Lead Unitrust (CLUT)
A CLUT pays charity a fixed percentage of the trust’s assets, revalued annually. As the trust grows, the charitable distributions grow with it. CLUTs are used when a donor wants the charitable payments to keep pace with inflation and asset appreciation.
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Grantor and non-grantor CLTs
Equally important is whether the CLT is structured as a grantor trust or a non-grantor trust, because that decides who gets the income tax deduction and who pays tax on the trust’s income during the term.
Feature Grantor CLT Non-grantor CLT Income tax deduction The donor takes an immediate charitable deduction equal to the present value of the charitable interest. No upfront deduction for the donor; the trust deducts each year’s distributions to charity. Who pays tax on trust income The donor, every year of the term. The trust itself is the taxpayer. Best suited to A donor with a high-income year, such as a large bonus, an IPO or a business sale. A donor whose primary goal is wealth transfer to heirs; this is the more common structure.
Tax Benefits Under New York and Federal Law
Charitable lead trusts deliver several layers of tax benefit, and they matter most for New York residents, who face both federal and state estate tax exposure.
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Federal gift and estate tax
When you fund a CLT, the IRS values the remainder interest passing to your heirs using the Section 7520 rate in effect at the time of funding. The longer the trust term and the higher the charitable payout, the smaller the taxable gift. In a properly structured “zeroed-out” CLAT, the present value of the charitable interest equals the value of the contribution, reducing the taxable gift to zero or near zero. Any growth above the 7520 rate then passes to the heirs free of additional gift or estate tax.
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New York estate tax
New York imposes its own estate tax with a significantly lower exemption than the federal exemption, and a notorious “cliff” that can subject the entire estate to New York estate tax if it exceeds 105% of the basic exclusion amount. Lifetime gifts to a CLT remove the assets and their future appreciation from the New York taxable estate. When the CLT is testamentary, the charitable distributions during the term qualify for the unlimited charitable deduction for New York estate tax purposes. And CLT planning can be coordinated with other strategies to keep an estate beneath the cliff; our New York estate tax cliff calculator shows where the line falls.
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Income tax
For a grantor CLT, the donor may claim a sizable charitable deduction in the year of funding, subject to AGI limitations. New York largely conforms to the federal charitable deduction rules, so a high-income New York donor also saves state income tax.
When Does a Charitable Lead Trust Make Sense?
A charitable lead trust is not right for every estate plan. We usually recommend exploring one when a client meets several of these conditions: a New York taxable estate likely to exceed the federal or state exemption; a genuine, ongoing commitment to charitable giving, whether to a public charity, a donor advised fund or a private foundation; assets expected to appreciate significantly, such as private company stock, investment real estate or a concentrated public equity position; a desire to transfer wealth to children or grandchildren at a reduced gift tax cost; and, for the grantor-trust version, an anticipated high-income event for which a large charitable deduction would be valuable.
Funding Assets and Practical Considerations
The choice of funding asset has a large effect on whether a CLT succeeds.
| Funding asset | Consideration |
|---|---|
| Closely held business interests | Often eligible for valuation discounts, which increase the leverage. |
| Marketable securities | Easy to value and to liquidate to fund the annual annuity payments. |
| New York commercial or investment real estate | Particularly appreciated property where the donor wants to defer or eliminate transfer taxes. |
| Hedge fund and private equity interests | Require careful unrelated business taxable income (UBTI) and liquidity analysis. |
We coordinate with your accountant and appraiser to make sure the funding asset is appropriate, properly valued and compliant with the special rules that apply to CLTs, including the private foundation rules of Internal Revenue Code Sections 4941, 4943, 4944 and 4945, applied to split-interest trusts by Section 4947(a)(2), which generally apply to CLTs and prohibit self-dealing and certain other transactions.
Choosing the Charitable Beneficiary and the Trustee
New York donors have wide latitude in choosing the charitable beneficiary: a public charity such as a university, hospital or cultural institution, a donor advised fund sponsored by a community foundation, or the donor’s own private foundation, which allows multi-generational philanthropic involvement. Where the donor or family members sit on the board of a private foundation that receives the CLT distributions, careful drafting and ongoing administration are essential to avoid self-dealing penalties.
Because CLTs are irrevocable and often run for 10, 20 or more years, trustee selection is critical. Donors frequently choose a New York-based corporate trustee or trust company for institutional continuity and investment expertise, a family member or trusted advisor as co-trustee to make sure the donor’s intent is honored, or a private trust company for very large family wealth structures. The trustee’s administrative responsibilities include annual valuations (for a CLUT), timely charitable distributions, fiduciary income tax filings (Form 1041 and the New York equivalent) and Form 5227 information returns, and we assist trustees with that compliance throughout the life of the trust.
Common Mistakes to Avoid
Charitable lead trusts are technical instruments, and small drafting errors can have large tax consequences. The problems we most often correct, or help clients avoid, are leaving out the governing instrument provisions required for private foundation rule compliance; funding the trust with assets that generate unrelated business taxable income without analyzing the impact; choosing a term or payout rate that produces an unintended taxable gift; overlooking generation-skipping transfer (GST) tax issues, which are particularly complex for CLATs; and failing to coordinate the CLT with the rest of the donor’s New York estate plan, including the will, revocable trust and beneficiary designations.
What the Work Involves
Designing a charitable lead trust requires familiarity with the Internal Revenue Code, the Treasury Regulations, New York estate and trust law and the donor’s own financial picture. In a typical engagement we model CLAT and CLUT structures at different terms and payout rates to find the right design, coordinate with the financial advisor, accountant and appraiser to project the outcomes for family and charity, draft a trust agreement that satisfies every federal and New York requirement and reflects the donor’s philanthropic intent, advise on trustee selection and prepare trustee instructions, prepare the gift tax return (Form 709) and assist with ongoing fiduciary tax compliance, and integrate the CLT with the wills, revocable trust and other irrevocable trusts in the plan, such as a dynasty trust.
Speak With Us
A charitable lead trust sits at the intersection of philanthropy and family wealth transfer. If you are a New York resident considering one, or you have an existing CLT that needs review or administration, we will analyze your goals, explain the options in plain language and help you decide whether a CLT belongs in your estate tax plan. Call 212-233-1233 or email [email protected].
