Charitable trusts can be important components of any estate planning program, permitting individuals to make substantial gifts to favorite charities without giving up all rights to their property. A current tax deduction can be claimed by making a limited or postponed gift. That’s right — through a charitable trust, an individual can make an irrevocable future gift to a charity and still claim a current income tax deduction. These trusts can allow taxpayers to reduce estate taxes, eliminate capital gains, claim an income tax deduction and benefit charities.
There are two basic types of charitable trusts: a charitable lead trust (CLT) and a charitable remainder trust (CRT). CLTs provide steady streams of income to the designated charity for a stated period of years, and when the period ends the property held in trust returns to the donor or the donor’s designated beneficiary. CRTs provide for the retention of a stream of income to the donor, either for a period of years or for life. After that period, the donor gifts the property to the charity.
A CRT may take either of two forms, depending on whether the income payments are determined based on the trust’s initial value or the value of the trust property on an annual basis. Under a charitable remainder annuity trust, the payments must be at least 5 percent of the trust’s initial value. A charitable remainder unitrust, on the other hand, must provide for payments equal to at least 5 percent of the annual value of the trust’s property. The payments under a charitable remainder annuity trust remain the same for the period of the trust, while the payments under a charitable remainder unitrust vary depending on the trust’s investment return.
If the income from the trust property under a CRT is insufficient to make the stipulated payment, the trustee of a charitable remainder annuity trust must sell enough property — and therefore invade principal — to make the payment. Invasion of the trust principal is permissible but not required by the tax laws for a charitable unitrust. This is why many charitable remainder unitrusts provide for the payment of the lesser of the trust income or 5 percent of the current value of the trust.
CRTs, though irrevocable, allow for changes in the charitable beneficiary at any time. You may even serve as a trustee and therefore maintain full investment control of the assets within. You don’t have to pay any capital gains taxes, making CRTs ideal for assets like stocks and property with a low cost basis but high appreciated value.
CRTs can be used to augment retirement planning. Let it grow during the early years, and then take payouts when you retire. Unlike IRAs or 401(k)s, there are no limits to how much you can contribute.
A CRT is considered “outside your estate” by the Internal Revenue Service. Because of this, you may end up saving as much as 46 cents of every dollar you move to the CRT. Plus, you are usually not limited in how much you can contribute by the annual gifting limit or the estate and gift tax credits.
CRTs, because they benefit a charity, also qualify you for an income tax deduction. The amount of your deduction is the present value of the remainder interest to the charity.
On the other hand, a CLT offers current income tax deductions and a reduction in capital gains taxes. As the reverse of CRTs, charities become the income beneficiaries, receiving a steady stream of income during the owner’s lifetime. At the owner’s death, named beneficiaries receive the bulk of the CLT’s assets. And just as with the CRT, CLTs receive preferential tax treatment.
These trusts help charities and nonprofits generate more revenue for their causes. And they’re popular because they produce income during a donor’s lifetime. Your personal goals and financial situation will determine which is most appropriate for you.
We welcome the opportunity to put our tax expertise to work for you. To learn more about how our firm can help advance your success, don’t hesitate to contact Kathy Corcoran at (302) 254-8240.
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