The charitable lead trust is an arrangement that provides a stream of income to Southwestern, usually for a number of years. At the end of the term, the trust assets either return to you (known as a grantor lead trust) or transfer to your beneficiaries, most often children or grandchildren (known as a nongrantor lead trust). The nongrantor version is by far more popular and is designed to transfer assets to heirs at substantially reduced transfer (gift and/or estate) tax costs. We will examine the benefits of each type of lead trust in the upcoming weeks, beginning with the nongrantor lead trust.

Take the Guesswork Out of Transfer Taxes

A nongrantor lead trust (made famous by Mrs. Jacqueline Kennedy Onassis) created during life does not provide the donor with a charitable income-tax deduction, but neither is he or she taxed on any of the income earned by the trust.

However, individuals with major charitable goals have discovered they can transfer substantial assets to intended beneficiaries at minimal or no transfer-tax cost by using a nongrantor lead trust.

The key to this strategy is twofold:

First, for purposes of determining potential transfer-tax liability, the present value of the payments to Southwestern is deducted from the total amount transferred to the trust and only the difference-if any-is subject to transfer tax. For instance, if you put $1,000,000 into a trust that pays Southwestern $75,000 annually for 20 years, then distributes the remainder to your children, the present value of the charitable interest is $950,720. The remaining taxable portion of $49,280 can be offset by using your exemption of $1,000,000 for gift-tax or $1,500,000 for estate-tax purposes.

Second, and potentially more significant, is that if the trust appreciates in value at more than the required 7.5% distribution to Southwestern, such excess accumulations over the 20-year term of the trust will pass completely transfer tax-free to your children.

Meaning: If the trust is able to achieve returns that approximate the historical market average of 10% a year, your children would receive a total of nearly $2,412,000 free of any transfer taxes.

Planning pointers:

1. The current low interest rate environment is a propitious time to establish a nongrantor lead trust. Decline in interest rates increase the present value of the distributions to Southwestern, thereby sheltering a larger portion of your trust's value from transfer tax.
2. Assets with the potential for substantial appreciation are ideal for this arrangement.
3. You can direct the lead trust to make either fixed payments or variable payments to Southwestern. Most often fixed payments are elected.
4. The lead trust permits you to delay the receipt of an inheritance by a child or grandchild until they reach an appropriate age.
5. You can increase the value of the gift-tax deduction by increasing the payout to charity or extending the term of the trust. Here, an 8% payout would increase the present value of Southwestern's payment to $1,000,000.
6. You can name a charitable remainder trust as the beneficiary of the lead trust so that income distributions are continued for children and then the assets pass to Southwestern.
7. If the lead trust is funded during life, the beneficiaries will inherit the donor's basis in the property for capital-gain tax purposes.

Watch for our upcoming analysis of the grantor lead trust. As always, if you would like to discuss this or any other charitable giving options with a member of our staff, please contact us.

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