Payment of annuity with appreciated property by grantor charitable lead annuity trust.

• Author: Fairbanks, Greg A.

Taxpayers often are interested in using excess assets to benefit their own philanthropic interests as well as those of their family members. Split-interest trusts, in which charitable and noncharitable beneficiaries have interests, can accomplish both purposes. Three types of split-interest trusts are sanctioned by the Internal Revenue Code, so the interest passing to the charitable organizations qualifies for the charitable deduction for income, gift, and/or estate tax purposes--charitable remainder trusts, pooled income funds, and charitable lead trusts. With charitable remainder trusts and pooled income funds, the noncharitable beneficiaries receive the lead interests and the charities receive the remainder interests. Charitable lead trusts (CLTs) are the reverse of these trusts because the charities receive the lead interests and the noncharitable beneficiaries receive the remainder interests.

In a CLT, an annuity or unitrust payment is made annually to charity for the term of the trust. At the end of the trust term, the assets in the trust pass to individuals designated by the grantor. The remainder beneficiaries are usually the grantor's family members or trusts established for the benefit of family members.

Most frequently taxpayers who set up CLTs provide that the charity will receive an annuity rather than a unitrust amount. The amount of the annuity, which must be established in the governing instrument, is usually either a stated sum of money or based on a stated percentage of the fair market value of the trust assets as of the date they are transferred to the trust. As a result, the amount required to be paid does not fluctuate with the value of the trust corpus or the amount of income generated by the trust. In contrast, the unitrust amount is a fixed percentage of the fair market value of the trust assets determined annually, so the amount paid each year fluctuates with the value of the trust assets. By using an annuity amount, the grantor is able to know exactly what will be paid to charity, and any appreciation in the value of the assets in excess of the discount rate used to determine the present value of the charitable interest will inure solely to the benefit of the named noncharitable beneficiaries.

A charitable lead annuity trust (CLAT) may be established as an inter vivos trust during the grantor's life or as a testamentary trust that is created upon the grantor's death. A CLAT set up during the grantor's life can be established as either a grantor trust (grantor CLAT) or a nongrantor trust (nongrantor CLAT). Whether the trust is a grantor or nongrantor trust affects whether the grantor is entitled to an income tax charitable deduction upon the creation of the trust, but for both types of trusts the grantor is entitled to a gift tax charitable deduction for the present value of the annuity interest payable to charity. A testamentary...