New estate-planning and charitable-giving instruments can make resources available to community development groups and other nonprofits immediately. Have your donors heard?Investments ; Community development

John H. Clymer

Sarah T. Connolly

English

Research Papers in Economics

Winter  2006 10
by John H. Clymer and 
Sarah T. Connolly, Nixon Peabody LLP
oday’s most knowledgeable nonprofits are alerting supporters to new estate-planning and charitable-giv-
ing tools, some of which make resources available to the charity immediately. Even small nonprofits are
telling potential donors about instruments that simultaneously enable larger gifts and generate significant tax
benefits for donors and their heirs. The charitable lead trust is one such instrument. T
Benefiting Both 
Nonprofits and Donors:
Charitable Lead Trusts&Banking Communities 11
Two Types of 
Charitable Lead Trust
A charitable lead trust is a trust that
gives an “income” interest (the “lead
interest”) to one or more charities for a set
number of years (three-, five-, 10-, and
20-year terms are all common). It pro-
vides that the principal (the “remainder
interest”) will ultimately go back to the
donor—or to designated beneficiaries.
There are two types of charitable
lead trust: annuity trusts and unitrusts.
Both are irrevocable.
Annuity Trust 
At least once a year, a charitable lead
annuity trust gives a nonprofit organiza-
tion either a fixed percentage of the ini-
tial net asset value of the trust or else a
fixed dollar amount. The amount that
must be distributed each year remains
the same no matter what happens to the
value of the trust’s assets.
Unitrust 
A charitable lead unitrust differs in
that the donor specifies from the outset
the  percentage of the trust’s net asset
value that is to be distributed annually
to a charity. The net asset value is deter-
mined anew in each taxable year on the
same day. Because the percentage is
fixed—but the value upon which it is
based varies—unitrust payments
increase or decrease with the value of
the assets. Thus for the recipient organ-
ization, the income is less predictable.
How Is a Charitable Lead
Trust Created?
A charitable lead trust is created by a
written trust agreement between the
donor and one or more trustees. The
trust document will indicate whether
the trust is to be an annuity trust or uni-
trust, will state the amount to be dis-
tributed, and will name the charity or
charities to be benefited. 
The trust instrument also will con-
tain terms providing for the disposition
of the trust assets when the period of
payments to the charitable organiza-
tions ends. The property may pass to
named beneficiaries, return to the
donor, or continue in trust for family
members or others. The trust instru-
ment also will contain provisions com-
mon to all trusts, such as those related
to the trustees’ investment powers and
duties. Usually the trustees receive
investment assets at the time the trust
instrument is signed. Also, a trustee is
entitled to receive a trustee’s fee, and a
separate management fee may also be
charged if the trustee is not actively
managing the investments.
Federal Tax Consequences
Charitable lead trusts give the
donor particular tax benefits.
Income Tax
Taxable income and capital gains
realized by a charitable lead trust are
taxed to the trust. The trust is allowed
an unlimited charitable income-tax
deduction each year for the distribu-
tions made to charity. The donor does
not receive a federal income-tax deduc-
tion, either for the initial contribution
to the trust or for the distributions
made annually to charity, but there are
advantages to reducing taxable income
this way, as described below.
Gift, Estate, and Generation-
Skipping Taxes
A donor may receive a federal gift-
tax charitable deduction for the present
value of the income interest given to
charity. If the property is to pass to the
donor at the end of the term, the prop-
erty returning to the donor will be
included in the donor’s estate at death,
but there will be no liability for gift tax
at the time the trust is created. If the
property is to pass to others at the end
of the term, it will not be included in
the donor’s estate, but it will be subject
to gift tax at the time the trust is fund-
ed, based upon the discounted value of
the beneficiaries’ right to receive the
property in the future. The gift will not
qualify for the annual exclusion from
gift tax (currently $11,000 per donee),
because it is a future interest. If those
receiving the remainder of the lead trust
are grandchildren, there may be a gener-
ation-skipping transfer tax imposed
when they receive distributions.
Example 
Let’s say a donor transfers $100,000
in appreciated securities to a charitable
lead annuity trust in November 2005.
The trust has a 15-year term, and at
the end of that period, the property
remaining in trust will pass to the
donor’s children. To value any gift of
this sort for tax purposes, the Internal
Revenue Service promulgates regula-
tions that contain actuarial and finan-
cial-return assumptions. 
For November 2005, for example,
the assumption was that returns would
be 5 percent per year. The donor sets
the annual annuity rate at slightly in
excess of 9.6 percent. This produces an
annual annuity payment to charity of
$9,640 a year on a $100,000 initial
value. Under the applicable Internal
Revenue tables, an annuity of that
amount, given a return assumption of 5
percent, will reduce the annuity trust
value to zero at the end of the 15-year
term. Therefore, there will be no taxable
gift to the donor’s children. However, if
the average annual return on the trust’s
assets is actually 8 percent a year for the
15-year term (rather than the 5 percent
assumption), then when the trust ends,
the children will receive $55,606 free of
estate or gift tax. During the 15-year
term, payments to charity will have
been $144,600. The donor has achieved
the objective of passing more than
$140,000 to charity, reducing the chil-
dren’s anticipated inheritance by only
$55,000 while removing $200,000
from the estate, free of income, estate,
and gift taxes. 
Why Establish a Charitable
Lead Trust?
Charitable lead trusts are created
by donors who have a commitment to
charity and who also wish to benefit
their families or others.
Donors with a history of generous
charitable giving may find that they
have hit the ceiling of the income-tax
charitable deduction of 50 percent of
adjusted gross income for cash gifts (or
30 percent for gifts of “appreciated
property,” such as securities). 
Placing property in a lead trust
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eWinter  2006 12
enables them to increase an income-tax
charitable deduction by removing from
their own tax returns the income from
the property placed in the lead trust.
Donors thus lower taxable income while
still having income go to charity.
Another reason a donor with signifi-
cant assets and strong charitable interests
may wish to take this path is the ability to
benefit a favorite charity today without
giving away assets forever. A lead trust
can meet the donor’s own future needs if
it is tailored to end on an expected occa-
sion, such as a retirement or the termina-
tion of another trust from which the
donor or a family member has been
receiving income. If the lead interest is
designed to end when the specified event
occurs, the donor or family member will
then receive the trust’s assets.
In short, a charitable lead trust can
offer significant tax benefits to donors
and their families while providing a
stream of funds to serve favored charities. 
John H. Clymer and Sarah T. Connolly
are partners in the Private Clients’ Group
in the Boston Office of Nixon Peabody
LLP. 
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Benefitting both nonprofits and donors: charitable lead trusts

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Benefitting both nonprofits and donors: charitable lead trusts

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Research Papers in Economics