Before we explain the value of charitable lead trusts, we should provide some information about the federal estate tax parameters, because these trusts can be useful for people who are exposed to the death tax.
There is an unlimited marital deduction that allows you to transfer unlimited assets to your spouse tax-free, presuming your spouse is an American citizen. Transfers to others are potentially taxable, but you can use your available transfer tax exclusion to transfer a certain amount tax-free. For the rest of 2015, the exact amount of this exclusion is $5.43 million.
Each year there can be inflation adjustments, so the figure is likely to be a little bit higher next year.
You cannot simply give gifts to avoid the estate tax, because there is also a federal gift tax. The two taxes are unified, so the $5.43 million exclusion is a unified exclusion, encompassing lifetime gifts along with postmortem bequests.
Charitable Lead Trusts
Now that we have set the stage, we can look at the value of charitable lead trusts. With this type of trust, you name a charitable beneficiary, and you also name non-charitable beneficiaries.
You convey assets into the trust, and you arrange for the trustee to distribute assets to the charitable beneficiary throughout the term of the trust. Because this will be done incrementally over time, the assets are likely to grow. To account for appreciation, the IRS adds anticipated interest using the discount rate, which is 120 percent of the federal midterm rate.
The idea is to allow the charitable beneficiary to eventually assume ownership of the entire taxable value of the assets that have been conveyed into the charitable lead trust.
At the present time, experts are saying that the federal interest rate will be rising in the near future, but the rate has been low for numerous years. If the assets in the charitable lead trust performed better than the anticipated interest that was applied by the Internal Revenue Service, there will be a remainder left in the trust after the expiration of the term.
If this scenario comes to fruition, the non-charitable beneficiary would inherit this remainder free of taxation.
Tax Efficiency Strategies
A charitable lead trust can be part of a comprehensive tax efficiency strategy if your estate is going to be exposed to the death tax. If you would like to learn more about the tax and the strategies that you can employ to preserve your wealth, download our special report.
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