Many individuals have charitable intentions and want to ensure that their values are expressed through their giving. There are several ways to express this intent. We believe the simplest method is directly donating cash to the charity of one’s choice, which is typically the most frequently used method.
However, there are other ways to give to charitable organizations. Many charities also accept property donations. These can range widely from financial assets like stocks to personal assets like art and used cars. In addition to current property, individuals can donate future interests in property. Different types of trusts are eligible to make charitable gifts of future interest.
The most common are Charitable Remainder Trusts (CRT) and Charitable Lead Trusts (CLT). These trusts can act as powerful planning tools to help maximize the gift’s impact on the donor and charity. There are specific IRS guidelines that, when followed, can provide opportunities for donors to be eligible for both income and estate tax benefits.
Charitable Trusts
A charitable trust is a tool to hold assets for the benefit of a charitable organization. These trusts are irrevocable gifts designed for the benefit of the named charity. However, these trusts are created as “split-interest” trusts that have both charitable and non-charitable beneficiaries. These trusts can be established with two primary forms: The Charitable Remainder Trust (CRT) and the Charitable Lead Trust (CLT). Each form of trust has different parameters that define how the charity receives the gift.
With a CRT, the charity receives the remainder of the assets in the trust after the non-charitable beneficiary receives a stream of income for a designated period. The CLT is the mirror image with the charity receiving a stream of income for a designated period and the non-charitable beneficiary receiving the remainder of the interest. There are benefits and drawbacks of each form. The primary focus of a Charitable Trust is to create a structure that will benefit the named charity. In addition, IRS guidelines provide opportunities for personal tax benefits, including a potential income tax deduction and reducing transfer taxes, like estate and gift taxes.
Charitable Remainder Trusts
CRTs can be powerful tools to facilitate the transfer of assets to a charity. The gift to the CRT is an irrevocable transfer that establishes an income stream paid to a non-charitable beneficiary for a set period of time, with the remainder of the balance passed to the named charity. The income stream can be designated as a Charitable Remainder Unitrust (CRUT), which pays a fixed percentage of trust value, i.e., 5%, which is recalculated annually. Alternatively, the income stream can be a Charitable Remainder Annuity Trust (CRAT) that pays a fixed annual income regardless of trust value fluctuations. The term of the payment can be for a specific number of years or the lifetime of an individual. When the payment period is over, the remaining balance is passed to the named charity, hence the name remainder trust.
CRTs may provide significant tax benefits to grantors when appropriately structured, but proper planning is key. The most common tax benefits generated include a charitable income tax deduction and the potential to avoid tax on highly appreciated assets. Many gifts to charity can be funded with cash, but grantors often choose to use appreciated property. This type of property often faces onerous tax liabilities if sold by the grantor.
When a 501c3 Charity receives this property, they often can liquidate the property without a tax liability as a tax-free entity. Gifts to a CRT benefit from this tax-free status as well, though there are differences in the amount available as an income tax deduction. When assets are granted to the CRT, a calculation of the balance remaining after the income period is exhausted is used to determine what amount is available for a charitable deduction.
The IRS guidelines state, “The remainder donated to charity must be at least 10% of the initial net fair market value of all property placed in the trust.” This amount can be adjusted to fit the needs of the grantor. Individuals may focus on total charitable deduction or choose to maximize the income provided to the non-charitable beneficiary. It is important to note that the income received by the non-charitable beneficiary is taxable income that is reported by the beneficiary.
Potential benefits of a CRT
- An immediate charitable tax deduction
- Can create a stream of income for a defined period of time
- Avoid tax on donated assets that have embedded gains
- Reduce the grantor’s taxable estate
Issues to be aware of with CRTs
- Complexity – Complying with IRS regulations requires careful planning, legal documentation, and ongoing administration.
- Costs – Establishing and maintaining a CRT involves legal, accounting, and administrative fees, which can be substantial.
- Irrevocable Transfer
- Market and investment risk – Poor investment performance may affect the income stream and remainder balance.
Charitable Lead Trust (CLT)
CLTs are charitable trusts that are also designed as split-interest trusts. The key difference with a CLT is that the charity receives the stream on payments, and the non-charitable beneficiary receives the remainder interest after the specified term expires. CLTs are often used to help manage potential estate transfer taxes. CLTs are structured as irrevocable trusts whose terms cannot be changed. There are a few key elements that govern the impact of CLT for a donor.
First, the trust may be set up as either reversionary or non-reversionary. This term refers to who will receive the remainder interest at the end of the income term. The remainder of a reversionary trust will pass back to the original donor of the asset. In contrast to a non-reversionary trust where the remainder interest will pass to someone else besides the original donor, frequently a family member.
CLTs must be structured according to strict IRS guidelines to maximize the tax benefit to the donor. Again, planning is key to success with these instruments. There are two basic types of CLTs: grantor and non-grantor trusts. Each has different tax implications for the donor, which must be evaluated.
Grantor CLT
The Grantor CLT allows the donor to claim an immediate charitable income tax deduction. The deduction amount is calculated as the present value of the stream of income payments the charity will receive during the trust term. This is subject to restrictions depending on whether the charitable beneficiary is a public charity or structured as a private foundation. Perhaps most importantly, the donor is responsible for the trust’s tax liability. The potential tax liability must be considered when evaluating the upfront charitable deduction, as it is possible to significantly reduce the benefit of the upfront deduction with future tax owed.
Non-Grantor CLT
A non-grantor trust is designed such that the trust is the owner of the assets, not the original donor. This key difference creates significant tax changes compared to a grantor trust. First, as the donor is not the owner, the donor is not eligible for an upfront charitable tax deduction for the present value of the future income stream distributed to the charity. However, the donor is also not responsible for the tax liability generated by the trust. The trust is also able to deduct the payments it makes each year to qualified charities. The deduction is limited to the trust’s gross income for the year. Excess charitable contributions cannot be carried forward. CLTs can be structured to help increase the efficiency of asset transfer and are often used as an estate planning tool. Generation-skipping taxes may apply in certain situations, so proper planning is needed to mitigate this potential liability. The IRS defined 7520 rate is a key factor when determining the viability of a CLT for a specific situation.
Key Potential Benefits
- Support for Charitable Causes
- Gift/Estate Tax Benefits
- Income Tax Deduction (Grantor CLT only)
- Tax-Advantaged Growth: The trust’s assets can grow tax-free (or tax-deferred) while charitable distributions are made.
- Wealth Transfer: Allows the transfer of significant assets to heirs at a reduced gift/estate tax cost, especially if the trust’s assets appreciate during the trust term.
- Flexibility in Structuring:
- A Charitable Lead Annuity Trust (CLAT) for fixed annual payments to charity.
- A Charitable Lead Unitrust (CLUT) for variable payments based on the trust’s annual asset value.
Issues to be Aware Of
- Complexity – Complying with IRS regulations requires careful planning, legal documentation, and ongoing administration.
- Costs – Establishing and maintaining a CLT involves legal, accounting, and administrative fees, which can be substantial.
- Irrevocable Transfer
- Market Risk – Investments can fluctuate in value. Poor investment performance may reduce the remainder value
- No Immediate Tax Deduction for Non-Grantor CLTs
- Interest Rate Sensitivity—The IRS 7520 rate can impact the benefits. Low rates generally increase the benefits of a CLT, while high rates may reduce their efficiency for wealth transfer.
Charitable trusts can be powerful planning tools when properly developed. These trusts should be established with charitable intent but may also provide significant tax and transfer benefits for donors.
About the Author
William (Bill) Connor, CFA, CFP is a Partner and Wealth Advisor at SAX Wealth Advisors with over two decades of investment management and financial planning experience. Bill has a diversified skill set that focuses on risk management, investment analysis, and portfolio management. He works to develop comprehensive goal-based financial plans, including retirement, estate, tax, and concentrated equity planning. Bill has experience with private alternative investments, including hedge funds, private equity and real estate. Bill works in SAX’s New York office, serving the needs of domestic and international families.
For a complimentary consultation, Bill can be contacted at