A grantor charitable lead trust (Grantor CLT) is a grantor trust that provides a fixed annuity payment to a Section 501(c)(3) charitable organization for a term of years. Once the term expires, the trust distributes the remaining trust assets to the grantor or another noncharitable beneficiary.
In the year the grantor funds the CLT, the grantor receives a charitable tax deduction for the present value of the total annuity payments the trust will distribute to the charitable organization.
Example Grantor CLT Arrangement
John Doe, a resident of Orlando, FL, is a wealthy individual and wants to form a Grantor CLT for the benefit of a local charitable organization. On January 15, 2022, John contributed $5,000,000 cash to a Grantor CLT. The CLT will pay the local charity $250,000 annually for five years, a total contribution of $1,250,000.
In 2022, John Doe can claim a charitable contribution tax deduction for the present value of the annuity payments. The Section 7520 interest rate for January 2022 was 1.6%. John references Table B of Publication 1457 actuarial tables and finds the relevant annuity factor for a 5-year term at 1.6% is 4.7687.
John calculates the present value of the annuity as $1,192,175 (i.e., $250,000 times 4.7687). On John’s 2022 income tax return, he can deduct a charitable income tax deduction of $1,192,175 on his Form 1040 Schedule A (Itemized Deductions).
The trustee takes the $5,000,000 cash and invests the cash into stocks, corporate bonds, and treasury bills. Each year, the trustee must distribute $250,000 to the charity. Each year, the investment income earned inside the trust is reported on John’s personal income tax return, and John pays the income tax on those earnings.
Federal Income Tax Consequences
A Grantor CLT is either a grantor or nongrantor trust for federal income tax purposes. Under most circumstances, the grantor prefers the Grantor CLT to be a grantor trust.
As a grantor trust, the grantor is responsible for reporting the trust’s income on his federal tax return and paying federal income taxes on the earnings. The grantor pays the income taxes using funds not inside the trust, which helps to reduce his taxable estate further while preserving the assets within the trust.