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1 TABLE OF CONTENTS Page I. PERIOD OF OPPORTUNITY... 1 A. Renewed Interest in Charitable Lead Trusts... 1 B. Opportunities for Charities... 2 II. CHARITABLE LEAD TRUSTS THE FUNDAMENTALS... 2 A. A Working Definition... 2 B. Cautionary Note... 4 C. Qualified CLTs... 4 D. Charitable Lead Annuity Trust... 5 E. Charitable Lead Unitrust... 6 F. Additional Considerations... 7 G. Reformation... 8 III. TAX CONSEQUENCES TO THE DONOR... 8 A. Lifetime Transfers... 8 B. Testamentary Transfers... 9 C. Valuing the Charitable Interest D. Generation-Skipping Transfer Tax IV. TAXATION OF TRUST AND ITS BENEFICIARIES A. The CLT B. The Charitable Beneficiary C. Income Taxation of the Non-charitable Beneficiary D. IRS Guidance V. ADVANCED CONSIDERATIONS - PRIVATE FOUNDATION RULES VI. A. Application of the Private Foundation Rules B. The Penalty Taxes C. The 60% Exception ADVANCED PLANNING CONSIDERATIONS VARIATIONS ON THE THEME A. The Qualified Grantor CLT B. The Non-Qualified Non-Grantor CLT VII. PLANNING OPPORTUNITIES i-

2 TABLE OF CONTENTS (continued) Page VIII. A. Some Preliminary Thoughts B. General Planning Considerations C. Illustrations of Advantageous Use of CLTs RECENT DEVELOPMENTS AND EMERGING OPPORTUNITIES, ISSUES AND PITFALLS A. Varying The Charitable Payout B. Funding Considerations C. Modification Of A Successful CLT Can Be Permissible IX. CONCLUSION APPENDIX APPENDIX ii-

3 CHARITABLE LEAD TRUSTS 1 by Edward Jay Beckwith 2 I. Period Of Opportunity A. Renewed Interest in Charitable Lead Trusts Many planners are familiar with the Charitable Lead Trust ("CLT") as a device for avoiding or reducing transfer taxes on large transfers. Currently, the device is useful to reduce or eliminate gift tax exposure for inter-vivos gifting and to reduce estate tax exposure for death time gifting. Similar advantages apply to the GST tax for both inter-vivos and death time transfers. Since the 2001 Tax Act, the ability to reduce gift taxes has become a greater focal point for many clients and, as a result, the utility of the CLT may well enjoy a renaissance. 1 This updated material was originally presented at the 37 th Heckerling Institute on Estate Planning, University of Miami, January, Edward Jay Beckwith, Esq.: Edward Jay Beckwith is a partner in the national law firm of Baker & Hostetler LLP residing in the firm s Washington office. He is head of that firm s Tax Exempt Team. He received a B.S. in Science from the Pennsylvania State University and a J.D. and LLM in Taxation from the Georgetown University Law Center. Mr. Beckwith is active in the American and the District of Columbia Bar Associations, as well as the American Law Institute. He is a Fellow of the American Bar Foundation and President of the ACTEC Foundation. He also is a Fellow and a former Regent of the American College of Trust and Estate Counsel where he has served as the State Chair in the District of Columbia as well as the Chair of the College's Philanthropy Study Committee and its Committee on Charitable Planning and Exempt Organizations. He lectures throughout the United States and has written extensively, including articles and speeches for the American Law Institute/American Bar Association Committee on Continuing Professional Education, the Council on Foundations and Tax Management. He founded and, for 18 years, chaired the Advanced Estate Planning Institute sponsored by The Georgetown University Law Center. In addition, Mr. Beckwith is an adjunct tax professor at the Georgetown University Law Center where he teaches graduate seminars in Advanced Estate Planning and Charitable Organizations and Planned Giving.

4 B. Opportunities for Charities Every charity runs the risk of missing an opportunity to present the non-tax case to its constituency at a time when virtually every person of means has or will review his or her estate plan and consider revisions to existing plans. In the long run, this may serve to refocus a charity's planned giving outreach on its mission rather than exclusively on its ability to provide tax benefits to the donor. II. Charitable Lead Trusts The Fundamentals A. A Working Definition 1. Conceptually, a CLT is the reverse of a Charitable Remainder Trust ( CRT ). With a CLT, a fixed or variable annuity is paid to charity for a determinable period which may be measured by a term of years or by reference to the life of one or more individuals; the remainder passes outright or in trust to one or more non-charitable beneficiaries. The charity should qualify under the applicable sections of the Code, sections 170, 2055 and 2522, which govern the type of deduction associated with the creation of the charitable lead trust. The remainder beneficiary can be one or more individuals, partnerships, corporations, estates or trusts. CLTs have been one of the more valuable planning structures available for wealthier individuals who wish to give to charity but also want to provide for the continued affluence of designated family members. Two separate gifts are made when the CLT is created: a gift of a - 2 -

5 current interest to one or more charitable beneficiaries; and a gift of the remainder interest to one or more non-charitable beneficiaries. The donor is liable for gift tax on the present value of the noncharitable remainder interest. 2. The principal tax advantage to a CLT lies in the transfer tax deduction for the present value of the charitable interest. The CLT has been used most appropriately in situations where the donor and his or her family have no immediate need for all of the income that they currently enjoy and are willing to forego some current benefit in exchange for the prospect of long-term capital appreciation. 3. Unless the donor retains any powers that could lead to its inclusion in his or her estate under sections 2036 or 2038 of the Code, the trust property and any appreciation on that property are removed from the donor s estate. 4. The donor must designate the charitable beneficiary when the trust is created (or provide a method for designating the charity that is beyond his or her legal control). Unless great care is taken with the wording and structure of the charitable benefit, a CLT donor should not designate a private foundation which he or she created as the charitable beneficiary of the CLT. 5. The term of the lead interest can be measured in a variety of ways: (i) in years; (ii) by the life or lives of individuals living when the CLT - 3 -