What is a Charitable Trust?
The simple answer is that a charitable trust is a trust in which a charity is a beneficiary. The more complex answer is that there are two main types of charitable trusts: charitable remainder trust and charitable lead trust. This article primarily focuses on charitable remainder trusts as they are the most common form of charitable trusts.
Charitable Remainder Trust
A charitable remainder trust (CRT) benefits a beneficiary – or multiple beneficiaries – for life or for a fixed number of years, after which the trust property passes on to a charity. If the CRT owns assets that have appreciated in value, such as artwork which are not necessarily generating income, the CRT can sell the donated asset(s) without paying capital gains taxes as the CRT is a tax-exempt entity. The CRT may then invest the proceeds, which are unaffected by capital gains taxes, in other investments that may generate greater income for the beneficiaries.
There are two types of charitable remainder trusts: a charitable remainder annuity trust (CRAT) and a charitable remainder unitrust (CRUT). Regardless of which type of trust you create, there are a few things you must consider:
- The term of the trust;
- Whether the charity of your choosing is a qualifying charity according to the IRS; and;
- The payout amount.
The term of your CRAT or CRUT can either be for life or for a specified number of years. After this term passes, the donated property, cash or other asset(s) will pass to the charity. However, if you want to qualify for a charitable tax deduction, discussed in detail below, you must make sure that the charitable charity is in fact a “charity” according to the IRS. You can find the list of qualifying charities here: https://www.irs.gov/charities-non-profits/tax-exempt-organization-search-bulk-data-downloads
For both a CRAT and a CRUT, you must determine how much income the trust should pay out. In a CRAT, the annual payments are a fixed amount of income whereas in a CRUT, the annual amount is a fixed percentage. This fixed percentage must be equal to be at least 5% of the value of the trust’s corpus or total value.
What types of assets are typically transferred?
Common assets typically transferred to a CRT may include, but are not limited to:
- Publicly traded securities.
- Stock in some closely held corporations.
- Real estate.
- Art, jewelry, or other personal effects of value.
These assets, usually highly appreciated, may not be generating an income stream commensurate with asset’s value. As such, the CRT may choose, as noted above, to sell the asset and purchase another which may generate revenue for the trust.
Which Charitable Remainder Trust is Best?
So why choose one type of charitable remainder trust over another? Under a CRAT, payments are limited to a fixed annual amount whereas a CRUT is designed to pay out a percentage of the trust’s value. For example, if the initial corpus of your CRAT is worth $100,000, and it is being paid out at $10,000 a year, if the trust value increases over time, it will not pay out any more than the $10,000 annual amount. However, with a CRUT the annual payment is determined by a percentage. So, as the value of the trust increases with investment revenue, the dollar amount paid out from the trust would also increase. Finally, unlike a CRAT, a CRUT can receive additional contributions after its initial funding. There are strategic and tax related reasons for preferring one type of charitable remainder trust over another, and careful advance planning is a must.
Charitable Lead Trust
When you have a charitable lead trust, the charity receives the lead interest for a term of years or for the lifetime of an individual, after which the principal passes to noncharitable beneficiaries. The payments from the charitable lead trust must occur at least annually and it must be in the form of an annuity or a unitrust interest.
What are the Tax Benefits?
Creating a charitable trust not only fulfills a philanthropic purpose, but it may provide favorable tax benefits. For both main types of charitable trusts, you can receive a charitable deduction for your donation. Specifically, for a charitable remainder trust, you as the donor can take an income tax deduction for the value of the gift you gave to the charity that can be spread over five years. The charitable remainder trust also allows an income tax deduction for the year in which the assets are donated. The deduction amount is the present value of the remainder interest being donated to the beneficiary. Keep in mind, however, if you are also a beneficiary to the trust, the IRS will subtract the income you are likely to receive from the value of the gift. Additionally, the trust allows the donor to avoid paying capital gains on appreciated assets. For example, if you were to sell an appreciated property yourself, and then use that money to invest, you would have to pay tax on the amount realized from the sale of your property. However, if you transfer the property to a trust and that trust sells the property so it can use that money to invest in something that would produce income to you and other beneficiaries, you do not have to pay tax on the sale of the property. A charitable lead trust can also bring tax benefits as it could reduce the non-charitable beneficiaries’ tax obligations at the donor’s death.
What are my Next Steps?
While there are additional benefits to creating a charitable trust, there are also numerous rules and regulations the trust creator must consider and apply. To ensure you and your beneficiaries get the most out of a charitable trust careful planning and due diligence is required. The attorneys at RJS LAW are well versed in this area and stand ready to assist in the planning, formation, and administration processes involved in determining the best type of trust, its creation and subsequent management.
Authors: Lydia Tran and Aurora Gallardo