Charitable Trust Plans

All about Giving… and Managing Tax Liability

If the current market value of your assets exceeds $11,000,000 with low basis, a straight sale incurs a 40% tax obligation. The alternative is one of several charitable trust plans.

When you create, execute and fund a charitable trust, you can suspend tax liability while maintaining your ability to receive income off the principal for a set period of time. And, like other trusts, the assets in the charitable trust are safe from future creditor claims.

These tax-free trusts offer you savings from sizeable income tax liabilities on highly appreciated stock, bonds, and real estate investments. By contributing capital assets to these ‘exempt’ organizations your deductions are not based upon depreciated book value, they’re based upon current market value.

Once you fund one of these trusts, you can still have full control as trustee over the investments even to the point of liquidation. And unless you distribute the income or assets, future growth of principal compounds tax free inside the trust. You only pay taxes on the distributions.

A stock market or real estate investor might want to convert equity to cash flow without paying capital gains. All they need do is setup any one of four different charitable trusts and act as the trustee.

Charitable trusts originated in England early in the 17th century and centered on the religious activities of the noble class. They were another creative method of retaining control over family wealth for the benefit of the living as much as they were about redistribution to philanthropic causes.

How Charitable Trusts Work

When you create a charitable trust there are no capital gains tax, no gift tax, and no estate tax. This is because the assets are removed from your estate and personal tax return. All charitable trusts are irrevocable because of the tax consequences – you can’t revoke or ‘undo’ them.

Over time, the donor can either:

1. Receive a tax deduction for the gift to the trust (based on the appreciated fair market value of the assets donated minus the total income stream.
2. Or, receive an income stream for a specified number of years until the death of named heirs who can be up to two generations after you, e.g., grandchildren.

Variations

Lead Trusts – ideal for assets that produce significant steady income, e.g., rental property or a business. Escapes tax on future appreciation of assets returned to you/heirs.

Remainder Trusts – ideal for assets with nominal income but highly appreciated, e.g., stocks, farm or ranch land. More robust tax relief.

The difference between Lead and Remainder is how the income is distributed. You “fund the trust” with your assets. And you may change heirs (beneficiaries).

Both are irrevocable non-grantor trusts with EIN as a separate taxpayer.

1.- Charitable Lead Annuity Trust – pays a fixed dollar amount (or percentage) of the initial value of the trust assets to the charity for the charitable term. Afterwards the remaining assets are distributed to you or your heirs.

Your charity of choice gets the present income stream from the assets. They might use it to fund a legacy building project. You or your heirs get those assets after your death or a maximum of 20 years.

One Example:

(Tax deduction is based upon the present value ‘PV’ of the income annuity to the charity per treasury tables. Estate tax is discounted future value ‘FV’ of the property to heirs.)

One example is Jackie Kennedy. She funded a Charitable Lead Trust with nearly $200,000,000 years ago. It was designed to last 24 years and earn 8% compounded interest. The qualified charity she named was a Foundation to be run by her two children, Carolyn and John. They would have made all investment decisions, set their own salaries, and make donations equal to 5% of the trust assets annually. Once the term expired, all the assets with compounded appreciation would have reverted to the kids as beneficiaries.

This strategy not only removed most of her assets from estate taxes but also tax deductions that reduced the portfolio value to about 8% of pre-gift appraisal. She really did her homework and certainly had smart advisers. However, it was not to be.

After her death in 1994, Carolyn and John exercised their right to get the principal assets. Consequently there was a heavy tax burden which also led to an auction of their mother’s personal possessions.

2.- Charitable Lead Unitrust – pays a variable dollar amount based upon the total value of assets determined annually to a charity for the charitable term. Afterwards the remaining assets are distributed to you or your heirs.

The 5% minimum distribution is based upon the value of the assets each year – which may increase by virtue of accruing compound interest or appreciation.

You may add more assets to a unit trust over time. Alternatively, the trust agreement can specify minimum distribution plus any additional income (but not capital gains) is paid to your heirs each year. Ultimately the asset reverts to charity upon death of the last heir.

NOTE: One benefit of the lead trust is that appreciated assets are NOT subject to estate or gift tax when the assets are distributed to the beneficiaries.

Your estate can take deductions from federal estate and gift tax in the amount of total payments to the charity.

Lead Trusts make sense when a charity intends to use a specific asset without selling it, e.g. real estate, artwork, etc.

3.- Charitable Remainer Annuity Trust – pays a fixed dollar amount (or percentage) of the initial value of the trust assets to the you or your heirs for a life term or a maximum of 20 years. Afterwards, the remaining assets are distributed to the charity.

You or your heirs receive a fixed dollar amount (at least 5%) annually of the initial fair market value. This income expires upon death of you/heirs or 20 years maximum. The ‘remainder’ interest goes to the charity.

The income is based on a single funding of the annuity. Unlike the unitrust, no additional contributions can be made to the annuity after it is established.

Example:

(Tax deduction based upon the present value ‘PV’ of reversionary interest per Treasury tables)

4.-Charitable Remainer Unitrust (aka NIMCRUT) – pays a variable amount based upon value of its assets, determined annually to the you or your heirs for a term not to exceed 20 years. Afterwards, the remaining assets are distributed to the charity.

The trust must pay a minimum of at least 5% of the original investment each year as income. The term is limited to 20 years or the lifetime of the beneficiary. At the end of the term, remaining assets are distributed to the charity.

This unitrust is similar to the annunity trust with a few exceptions. The income to the donor isn’t specified as a percentage of the initial funding amount but a percentage of the assets valued annually. As the assets grow in value the income to the donor increases as well.

Often the main reason for using this type of trust is to get a deduction and avoid capital gains taxes. Income is secondary. You also get a deduction up to 30% of the adjusted gross income at fair market value.

Contributions to the trust can qualify for a charitable deduction – limited to the present value ‘PV’ of the charitable organization’s remainder interest.

You may add more assets to a unitrust anytime. Alternatively, the trust agreement can specify minimum distribution plus any additional income (but not capital gains) is paid to your heirs each year. Ultimately the asset reverts to charity upon death of the last heir.

NIMCRUT – net income with makeup provisions, charitable remainder unit trust

This variation of a CRUT only distributed a percentage of its actual ‘net’ income after all expenses are deducted. No matter how much net income it produces, distributions can not exceed the maximum percentage of gross assets specified in the original trust declaration by the donor.

You might think a NIMCRUT a great way to avoid taxes and increase the principal. But many donors are in high income tax brackets and don’t want any more income.

Wealthy famous people such as Warren Buffet and Bill Gates use these charitable trusts.

STRATEGY: Low Tax Profile

Charitable trusts can make assets disappear from your personal 1040 tax return. Meanwhile it can provide you and the family with steady pension. Upon the death of your last surviving beneficiary the assets revert to the charity named in your will – maybe a private family foundation. Meanwhile you control trust’s investments and indirectly the income.

Each year the charitable trust distributes a portion of its income to you as retirement income. This is reported via K-1 form and listed on your 1040 personal return. There is no disclosure about the assets. Even if they were discovered the law protects these assets because the charity holds a remainder interest.

STRATEGY: Compounding Rules

No debt leveraged assets to produce income nor engage in any business activity that would result in UBI – unrelated business income.
No self-dealing with any disqualified party – Custodians, Trustees, Beneficiaries or any related parties (family or controlled entity).
Trustees must observe ‘prudent investor’ standards. This requires the plan to diversify its investments.

Summary

Charitable trust plans can solve many tax and legacy issues for high value estates.