Applicable Fraction for a Lead Unitrust
In contrast to a lead annuity trust, a lead unitrust is permitted to calculate the applicable fraction as of the testator's date of death. This enables the trust to use a formula or other allocation method that zeros out the GSTT. With a lead unitrust, the applicable fraction equals the allocated exemption divided by the fair market value of the property minus the charitable deduction. If the allocated exemption is equal to the present value of the taxable gift, the applicable fraction equals 1-1. Since the inclusion ratio equals one minus one or zero, the lead unitrust is exempt from GSTT.
The applicable formula is:
allocated GSTT exemption
fair market value of property - charitable deduction
Zero Inclusion Ratio
Because the value of the trust at date of death may be determined, it is quite common to use a testamentary charitable lead unitrust (CLUT) for estates in which the value of the taxable transfer is equal to or less than the exemption amount. The CLUT may be created and the funding or the payout adjusted so that the available exemption is fully utilized in a trust with a zero inclusion ratio and an exemption from the GSTT.
Multiple Layer Lead Trusts for Children and Grandchildren
A strategy to minimize total taxation is to create a multi-layer lead trust. The first two layers could be CLUTs with distributions to children, which would not be subject to GSTT. However, layers three and four could be trusts for a longer duration with remainders to grandchildren or great-grandchildren. Through formula clauses or careful planning for trust funding levels, the CLUTs for grandchildren would be designed to be exempt from the GSTT. It is even possible that the CLUT remainders could be distributed to a dynasty trust in a state without a rule against perpetuities.
