Tax Incentives for a Charitable Remainder Trust

Consider a charitable trust when you are ready to make a large gift to a public charity or private foundation. Making a charitable gift can provide significant federal tax savings.

A charitable trust allows for tax-free charitable giving. It can provide a benefit to your favorite charity. It also offers tax benefits to you (the grantor) as a charitable deduction and annual income to you and your heirs. This trust income can avoid the gift tax. It is a multipurpose estate planning tool.

Your estate planning attorney will consider several factors when planning for a charitable trust. These include:

• Your life expectancy
• Market forces
• Income streams
• Your current amount of income
• The expected longevity of a particular charity over a term of years

Several different types of assets can fund charitable trusts. Real estate and life insurance are popular options. Charitable trusts are irrevocable trusts. That means once you start the trust and it comes into operation, you cannot take back what you have given as trust assets.

How a Charitable Remainder Trust Works

• A charitable remainder trust (CRT) is the most common type of charitable trust. To set up a charitable remainder trust, you must first set up a trust. Then you must transfer the property you want to donate to charity to the trust. The Internal Revenue Service must approve the charity. It must be exempt from taxes under the Internal Revenue Code.

The charity will serve as the trustee of the charitable remainder trust. It will invest, protect, and manage the trust funds.

The charity will pay you, or someone you have named, a portion of the trust fund's income. These payments will last for a set number of years, or the remainder of your life, depending on the terms of the trust. The trust will end at the time of your death, and the appreciated assets held in the trust will go to the charity.

Another option is a split-interest trust. The charitable trust provides a payout to a non-charitable beneficiary, such as a donor's family member. The remainder goes to the charity.

Three Tax Advantages for a Charitable Trust

In addition to assisting the charity, a charitable remainder trust provides tax benefits, including the following:

• Taxpayers can take a charitable income tax deduction spread over five years. The IRS calculates the allowable deduction as the fair market value of the assets in the trust minus what the income beneficiaries expect to receive as a payout over their lifetime. For example, if you give $200,000 but expect to get back $100,000 in interest throughout your life, your total tax deduction would be $100,000.
• The property you gave to the trust will go to the charity outright upon your death. Thus, the property is excluded from your estate to determine your estate tax.
• A charitable trust allows you to turn assets not functioning as income-producing assets into cash. This can occur without paying capital gains tax on any profits.

For example, Lee held appreciated property that he wanted to donate. Lee has 5,000 shares of stock that had appreciated from $10 per share to $100 per share. That is an increase of $450,000. If Lee sold his shares, he would pay capital gains tax on $450,000. If Lee donates the stock to a charitable trust, the trust can sell the stock and avoid the tax.

The charity can then take the cash they received from the sale to invest in a mutual fund. Their interest income from that investment allows them to pay Lee a yearly distribution for the rest of his life.

Two Types of Income From a Charitable Trust

When you first set up a charitable trust, you will have a choice between two different ways of receiving income from the trust fund.

Charitable Remainder Annuity Trust (CRAT)

Under this option, you receive a fixed dollar amount from the trust each year. This amount stays the same regardless of how interest rates change or how much the trust gains or loses in a year.

How do you determine how much the fixed annuity payments should be? You will need a trust attorney to help set up a trust and provide legal advice. Considerations include:

• If you set it too low, you will never receive the full benefit of setting up a charitable trust. Your income tax deduction will be more significant.
• If you set the annuity too high, you may end up depleting the principal of the trust, thus leaving the charity with nothing at your death. Also, your income tax deduction decreases as annuity distributions increase.
• A charity is less likely to agree to be the trustee of a trust if annuity payments are too high. In such a case, the charity may end up with nothing at the trust's termination.

Charitable Remainder Unitrust (CRUT)

A more common option is to set your payout rate as a percentage of the current value of the trust fund. This is called a "charitable remainder unitrust." You will receive the same percentage of the value of the trust each year. The IRS has ruled that a trust beneficiary must receive at least 5% of the value of the trust each year. At the end of the year, the trust will be re-appraised to find its current value and will pay 5% of that value.

This payment option is better suited for changing market conditions such as inflation. If the value of the dollar increases, your annual payments will reflect this change by also increasing.

Example of a Charitable Remainder Unitrust

Suppose Rita is trying to figure out what to do with stock she bought 10 years ago for $200,000. The stock is currently worth $4 million, but the dividends are small. One option for Rita would be to sell the stock and invest in something that would pay more interest. However, if Rita sold, she would owe $570,000 in capital gains tax.

Another option Rita has is to set up a charitable trust with her favorite museum. She would donate the stock to the trust, which would be able to sell the stock for a $3.8 million profit because of its tax-exempt status. The charity would be in charge of investing and managing the $3.8 million. Rita could claim an income tax deduction for her charitable donation over five years.

In addition, the trust document requires the trust to pay Rita 7% of the value of the trust annually for the remainder of Rita's life. During the first year, Rita would receive $266,000. This amount will change depending on how well the trust invests and manages the money. If the trust does well, Rita will receive more each year.

To Learn More, Contact an Attorney

If you want to start a charitable remainder trust, talk to someone familiar with the tax code. It's in your best interest to contact a qualified tax attorney who can help ensure that your trust is tailored to your particular needs.