8105 / Can a deduction be taken for a charitable contribution to a charitable lead trust of a right to payment to the charity?

Yes, if certain requirements are met. A charitable lead trust is essentially the reverse of a charitable remainder trust; the donor grants a right to payment to the charity, with the remainder reverting to the donor (or his named beneficiaries). Such trusts are commonly called charitable “lead” trusts because the first or leading interest is in the charitable donee. Even though a gift of such an interest in property is less than the entire interest of the donor, its value will be deductible if the interest is in the form of a “guaranteed annuity interest” or a “unitrust interest.”¹

A guaranteed annuity interest is an irrevocable right to receive payment of a determinable amount at least annually. A unitrust interest is an irrevocable right to receive payment at least annually of a fixed percentage of the fair market value of the trust assets, determined annually. In either case, payments may be made to the charity for a term of years or over the life of an individual (or lives of more than one individual) living at the date of the transfer to the trust.

Only one (or more) of the following individuals may be used as measuring lives: (1) the donor; (2) the donor’s spouse; (3) a lineal ancestor of all the remainder beneficiaries; or (4) the spouse of a lineal ancestor of all the remainder beneficiaries. A trust will satisfy the requirement that all noncharitable remainder beneficiaries be lineal descendants of the individual who is the measuring life (or that individual’s spouse) if there is less than a 15 percent probability that individuals who are not lineal descendants will receive any trust corpus. This probability must be computed at the time property is transferred to the trust taking into account the interests of all primary and contingent remainder beneficiaries who are living at that time. The computation must be based on the current applicable Life Table in Treasury Regulation Section 20.2031-7.²

A guaranteed annuity may be made to continue for the shorter of a term of years or lives in being plus a term of years.³ The IRS determined that an annuity met the requirements for a “guaranteed annuity” even though neither the term nor the amount was specifically stated; the term was ascertainable as of the death of the grantor, based on a formula described in the trust instrument.⁴ The annuity cannot be for the lesser of a designated amount or a fixed percentage of the fair market value of trust assets, determined annually.⁵ After termination of the charity’s right to payment, the remainder interest in the property is returned to the donor or his designated beneficiaries.

Example: Walter gives $1,000,000 to a charitable lead trust. The trust’s term is 21 years paying 5 percent each year to his favorite charity. At the end of the 21 year period, the assets in the trust will be distributed to Walter’s three children. The gift tax charitable deduction is $741,870 assuming annual trust payments and a 3.4 percent 7520 rate. Over the course of 21 years, the charity will receive $1,050,000. The children will receive the trust assets free of any further estate or gift taxes.

According to regulations, an income tax charitable deduction is allowable for a charitable annuity or unitrust interest that is preceded by a noncharitable annuity or unitrust interest. In other words, the regulations eliminate the requirement that the charitable interest start no later than the commencement of a noncharitable interest in the form of a guaranteed annuity or unitrust interest. However, the regulations continue to require that any amounts payable for a private purpose before the expiration of the charitable annuity or unitrust interest must be in the form of a guaranteed annuity or unitrust interest, or must be payable from a separate group of assets devoted exclusively to private purposes. The regulations conform the income tax regulations to the Tax Court’s decision in Estate of Boeshore.⁶

The IRS determined that the requirements for a charitable lead annuity trust were met even though the trust authorized the trustee, who was the grantor’s son, to choose among various charities to receive the annuity interest and apportion the payouts among them.⁷ The IRS has also found that the requirements for a CLAT were met when the taxpayer first established a revocable trust that would make payments to cover certain debts and expenses after his death, and then make payments to individual and trust beneficiaries, before eventually funding the CLAT. The IRS found that it would eventually be possible to calculate the payout term based upon the fair market value of the CLAT assets after the original revocable trust made the other payments.⁸

The Service ruled that so long as a donor was treated as the owner of a guaranteed annuity interest for purposes of the grantor trust rules, the income interest transferred in trust to a private foundation qualified as a “guaranteed annuity interest” under IRC Section 170(f)(2)(B). Even though the present value on the date of the transfer exceeded 60 percent of the aggregate fair market value of all the amounts in trust, the Service reasoned that this did not prevent the income interest from being a “guaranteed annuity interest” because the trust agreement provided that the acquisition and retention of assets that would give rise to an excise tax if the trustee had acquired the assets was prohibited, in accordance with Treasury Regulation Section 1.170A-6(c)(2)(i)(D).⁹

The partition of a charitable lead annuity trust into three separate trusts to address differences of opinion among trustees as to the choice of charitable beneficiaries and the investment of trust assets did not cause the original trust, the new trusts, or any of the trusts’ beneficiaries to realize income or gain.¹⁰

The Service has privately ruled that the sale of assets, which were pledged as collateral for a promissory note to the family’s charitable lead annuity trust, to a limited liability company would not constitute self-dealing so long as the value of the collateral remained as required under the terms of the note, and would not give rise to tax liability under IRC Section 4941 to the CLATs, related family members, the estate, or the marital trusts.¹¹

Sample Trusts. The IRS has released sample forms, annotations, and alternate provisions for inter vivos and testamentary charitable lead annuity trusts and unitrusts.¹²