A CLAT, or charitable lead annuity trust, is an irrevocable trust that pays a fixed dollar amount to one or more charities every year for a set term, then hands whatever is left to family members or other non-charitable beneficiaries. Wealthy families use it because the IRS values the eventual gift to the family at a steep discount, so large amounts of wealth can move to the next generation with little or no gift or estate tax. With the federal estate and gift tax exemption at $15 million for 2026, the CLAT remains a central strategy for families whose wealth sits above that threshold and who also want to support causes they care about.
How the Mechanics Work
A CLAT is a split-interest trust. Two different kinds of beneficiaries share the same pool of assets. The charity holds the “lead” interest and collects a fixed annual payment for the full trust term. When the term ends, the remaining principal and any accumulated growth pass to the remainder beneficiaries, usually children or grandchildren.
The term can run for a fixed number of years, often 10, 15, or 20, or it can be measured by one or more lifetimes. The annual payment to charity is set when the trust is created, calculated as a percentage of the initial fair market value of the contributed assets, and expressed as a specific dollar amount. Fund a CLAT with $5 million at a 5% annuity rate and the charity receives exactly $250,000 every year, regardless of how the investments perform.
The gap between that fixed payment and what the trust actually earns is where the planning power sits. If the assets grow at 7% a year while the annuity consumes 5%, the extra 2% compounds inside the trust. All of that excess growth eventually belongs to the family remainder beneficiaries. The investment goal is simple to describe: beat the annuity rate, so more wealth survives to the end.
Why Families Use a CLAT: The Transfer Tax Math
Transfer tax savings are the main reason most CLATs exist. When you fund one, the IRS treats the contribution as a gift to the remainder beneficiaries, but it does not value that gift at the full amount you put in. The taxable gift equals the fair market value of the contributed assets minus the present value of the charity’s annuity stream. Because the charity will be collecting payments for years or decades, that present value is large, and the taxable gift shrinks accordingly.
The present value calculation runs off the Section 7520 rate, which the IRS publishes monthly and sets at 120% of the applicable federal midterm rate, rounded to the nearest two-tenths of a percent. A lower 7520 rate makes the charity’s annuity worth more on paper and shrinks the taxable gift. A higher rate does the opposite. In early 2026, the 7520 rate has hovered around 4.6%.1Internal Revenue Service. Section 7520 Interest Rates
The Zeroed-Out CLAT
The most aggressive version is the “zeroed-out” CLAT. The annuity rate and term are calibrated so the present value of the charitable payments exactly equals the fair market value of the assets contributed. On paper, the gift to the family is zero. No gift tax is owed, and none of the grantor’s lifetime exemption is used. If the trust’s investments then outperform the 7520 rate baked into the calculation, every dollar of that excess growth reaches the family free of gift and estate tax. This is standard practice for families whose main goal is wealth transfer rather than maximizing what the charity receives.
The entire leverage of the structure comes from the spread between actual investment returns and the 7520 rate assumed at funding. If the trust earns 8% while the assumed rate was 4.6%, that spread compounds across the whole term. Growth equities and interests in fast-growing private businesses are common funding choices for this reason.
Grantor vs. Non-Grantor: The One Decision Every Creator Has to Make
The single most important design choice is whether the CLAT is a grantor trust or a non-grantor trust. That choice controls who pays income tax on the trust’s earnings and whether the grantor gets an upfront income tax deduction. It is built into the trust document and cannot be changed later.
Grantor CLAT
In a grantor CLAT, the person who creates the trust is treated as the owner of the assets for income tax purposes under the grantor trust rules in Sections 671 through 679. One common trigger is retaining a reversionary interest worth more than 5% of the trust’s value at inception.2Office of the Law Revision Counsel. 26 U.S. Code 673 – Reversionary Interests The grantor gets an income tax charitable deduction in the funding year equal to the present value of the entire annuity stream the charity will receive over the term.
That deduction is capped at 30% of adjusted gross income because the gift is treated as “for the use of” a charity, with any unused portion carrying forward for up to five years.3Office of the Law Revision Counsel. 26 U.S. Code 170 – Charitable, Etc., Contributions and Gifts The tradeoff is heavy. Because the grantor is treated as owning the trust, every year of trust income flows onto the grantor’s personal return for the full term. The charity collects the annuity, and the grantor owes tax on income that never reaches their pocket. Planners call this “phantom income,” and in years when trust taxable income exceeds the annuity, it creates real cash-flow pressure.
Non-Grantor CLAT
A non-grantor CLAT is its own taxpaying entity. The grantor gets no upfront deduction. Instead, the trust itself claims an unlimited charitable deduction under Section 642(c) for the annuity amounts it pays to charity each year.4Office of the Law Revision Counsel. 26 USC 642 – Special Rules for Credits and Deductions When trust income is roughly equal to or less than the annual payout, the deduction wipes out the tax bill entirely.
This structure avoids phantom income. For people who do not need a large upfront deduction, or whose income is too high for the 30% AGI cap to be useful, the non-grantor version is usually the better fit. Most CLATs built primarily for transfer-tax planning are non-grantor trusts.
Risks and Downsides
A CLAT is irrevocable. Once funded, the grantor cannot pull assets back, change the annuity, or swap beneficiaries. If personal circumstances shift, the money inside is out of reach.
The biggest planning risk is underperformance. The charity gets paid first, every year, no matter what. If investments earn less than the annuity rate, the shortfall comes out of principal. A long stretch of poor returns can shrink the remainder to a fraction of what was projected, or in bad cases leave nothing for the family at all. The grantor has transferred the assets permanently, the charity has collected its payments, and the intended heirs end up worse off than if the trust had never existed.
Payout flexibility is also absent. Unlike a charitable lead unitrust, which pays a percentage of annually revalued assets, the CLAT’s annuity is fixed at inception. In a down market, the trust still owes the same dollar amount to charity, which accelerates the drain on principal.
And for grantor CLATs, the phantom income problem is more than theoretical. If the trust holds assets throwing off substantial ordinary income, the grantor needs outside resources to cover the annual tax every year for the whole term. Failing to plan for that drain is one of the more common implementation mistakes.
Rules the Trust Must Follow
Under Section 4947(a)(2), CLATs are subject to several excise tax rules that normally govern private foundations. The self-dealing rules of Section 4941 and the taxable expenditure rules of Section 4945 apply to every CLAT. The excess business holdings and jeopardy investment rules can also apply depending on the trust’s structure.5Internal Revenue Service. IRC Section 4947 – General Explanation of Trusts
In practice, that means the grantor and other disqualified persons cannot buy, sell, or lease property to or from the trust, lend to or borrow from it, or use its assets for personal benefit.6Internal Revenue Service. IRC Section 4941(d)(2)(E) – Taxes on Self-Dealing, Special Rules The trustee also cannot invest in a way that jeopardizes the charitable purpose, and penalties for violations escalate if the problem is not corrected.7Office of the Law Revision Counsel. 26 U.S. Code 4944 – Taxes on Investments Which Jeopardize Charitable Purpose
Every CLAT files Form 5227, the Split-Interest Trust Information Return, by April 15 each year.8Internal Revenue Service. Return Due Dates – Other Returns and Reports Filed by Exempt Organizations A non-grantor CLAT also files its own Form 1041 income tax return and issues Schedule K-1s to beneficiaries who receive distributions.
How a CLAT Differs From a Charitable Remainder Trust
CLATs and charitable remainder trusts (CRTs) are often confused, and the names do not help. The two are mirror images. In a CRT, the non-charitable beneficiary, often the donor, receives income from the trust for a period of years or for life, and the charity gets what remains at the end. A CLAT reverses the order: charity first, family last.
The tax picture follows that structure. A CRT gives the donor a current charitable deduction based on the present value of what the charity will eventually receive, and the donor collects income during the term. A non-grantor CLAT gives the grantor no income tax deduction at all; its benefit sits on the transfer tax side, reducing or eliminating gift and estate tax on wealth passed to the next generation. Donors who want current income and an upfront deduction look at CRTs. Families focused on estate tax planning look at CLATs.