How a CLT Can Pass Your Business Wealth to the Next Generation

Selling a business that you’ve spent years building is an emotional and complex transition; It requires balancing the pursuit of a fair price with the heavy reality of a looming tax bill. Long before the sales process begins, you need a team of experts assisting you and concrete thoughts on “what comes next.”

With the right strategic guidance, you can mitigate the tax impact and transform the sale of your company into a powerful engine for both future family wealth and community impact.

We have looked at what a charitable remainder trust can do in helping prioritize retirement income of a business owner. This article will look at how we can flip that model on its head with a charitable lead trust. You can build an “impact first” strategic legacy that allows you to support the causes you love in the present while providing for your heirs in the future. By structuring your CLT, you can also claim various tax advantages depending on what is most important to you.

Charitable Lead Trust (CLT)

A CLT is a split-interest trust just like a CRT. However, the process is reversed from the CRT. The benefits of the CLT are still split between the Income Beneficiary ( in this case, the charity) and the Remainder Beneficiary ( you or your heirs).

This allows the business owner to make a charitable impact ( the lead interest) for the causes important to them for a period of years( 5, 10, 15 years, etc.) At the conclusion of that term, the remainder interest goes back to the business owner or their heirs.

Just like a CRT, timing is key. The CLT must exist first before the sale occurs. If the IRS determines that the CLT was created after the sale was agreed to, the IRS can ignore the trust and tax you personally.

Two Types of CLT and Their Tax Advantages : Grantor vs. Non-Grantor

Which type of CLT you use determines which tax advantage is most powerful:

• Grantor CLT: The Income Tax Benefit

This is usually the best choice for a business owner who is faced with a large tax bill in the year of the sale and wants to offset it:

• You get a large income tax deduction in the year of the sale.

• However, you do pay income and capital gains tax generated inside the CLT personally during the years that the lead term exists, even though the CLT payments are going to charity.

• When the lead term ends, the assets return back to the business owner or their heirs.

• Non-Grantor CLT: The Estate Tax Benefit

This is usually the best choice for a business owner that is more interested in building a legacy and wants their assets to pass to their children.

• You get no personal income tax deduction when you fund the CLT.

• The CLT, as a distinct legal entity, pays the income tax that the investment returns of the CLT generate. However, since the CLT is giving money away to charity, it earns a deduction for every dollar given, so its tax liability is usually little to none.

• There is no estate or gift tax. The business owner has removed the assets from their taxable estate. Thanks to this “zeroing-out”, the business proceeds and future investment growth will go to your heirs, avoiding the feared 40%  federal estate “death tax”.

The Mechanics of a CLT and a Business Exit

The mechanics of a CLT and a business sale work as follows:

1. The Contribution: You transfer the business interest (i.e. stock) into the CLT before the business sale closes.

2. The Sale: Unlike a CRT, a CLT is a taxable trust. However, depending if it is a grantor or non-grantor CLT, will determine what sort of tax advantages may exist.

3. Reinvestment: The CLT invests 100% of the gross proceeds back into the trust.

4. Income Stream: The trust pays out  during a lead period ( a select number of years) to charities of your choice or a donor advised fund.

5. The Remainder: At the end of the lead period, the remaining sum goes back to the business owner or their heirs.

Final Thoughts

Determining if a CLT (and which type to choose) is a complicated process. It requires the necessary experts to determine what tax advantages may exist, and what sort of charitable and familial impact the business owner wants to make. At Generosity Nexus, we have a track record of helping donors navigate down a complex path to determine what is best for them.

Put our depth of expertise to work on your behalf. Don’t hesitate to schedule an appointment to learn more about how we can help you.