Charitable Trusts: Choosing the Right Giving Plan

Charitable remainder trusts allow individuals to further noble causes, look after beneficiaries and avoid taxes. Whether they're set up inter vivos while a donor is still alive or following their death as testamentary vehicles, these trusts are associated with a number of unique benefits. This basic guide should make it easier to understand the nuances of different giving plan options. 

According to the IRS, charitable trusts are those that satisfy the following conditions:

• The trust is not tax exempt,
• The unexpired interests of the trust are devoted to at least one charitable purpose, and
• The Internal Revenue Code permits a charitable contribution deduction for the trust.

Charitable trusts that don't meet the requirements for public charity exclusions are regarded as private foundations. This means that their investment income is subject to excise taxes.

It's important to remember that most private trusts don't qualify for charitable organization exemptions unless they specifically seek such treatment and satisfy an organizational test. The IRS and different states also impose unique laws governing the registration and management of charitable trusts.

Not all charitable remainder trusts, or CRTs, are equivalent. While they're unvaryingly irrevocable, the IRS recognizes unique forms, and each has its pros and cons. Here are the two most common types of CRTs used by investors and estate planners:

The charitable remainder unitrust, or CRUT, is a trust that meets the following definitions:

1. It distributes between 5 and 50 percent of its assets' net fair market value at least annually to at least one non-charitable
2. Although the asset value is reevaluated annually, the percentage is fixed, and distribution continues for no more than 20 years or the remaining length of the beneficiary's
3. When the distribution period is complete , the CRUT's remaining balance goes to a predetermined charity.

CRUT beneficiaries can include multiple parties, but at least one must not be an organization. You should also bear in mind that the assets in these trusts can't be used for purposes other than making the percentage payments and final transfers to the charitable organization. Finally, the amount projected to go to the charitable organization needs to equal at least 10 percent of the value of the assets contributed to the trust at the time of their contribution.

The Charitable Remainder Annuity Trust, or CRAT, shares many characteristics with the CRUT. The main differences are that:

1. Beneficiaries are paid a fixed dollar amount instead of a
2. Unlike CRUT donors, CRAT grantors are prohibited from making additional gifts following the trust's creation.

Selecting an effective CRT variety comes down to understanding your financial situation and estate planning goals. For instance, although both types are associated with immediate income tax deductions corresponding to the size of the contribution, those who use CRATs only get to take such deductions once.

CRUT donors, on the other hand, may prefer the freedom of making contributions according to their ability, but the calculated percentage payment amount isn't guaranteed to rise or even remain stable. Market factors and valuation changes could cause unforeseen fluctuations that limit what donors actually receive.

CRAT benefits also run the risk of running out prematurely. With non-cash assets that depreciate, the predetermined payment may exceed what's actually in the trust at some point. It's vital to plan carefully.

The needs of beneficiaries and comparative tax obligations are also important considerations. The potential downsides of CRATs and CRUTs can be minimized with smart planning and sound legal advice, but each situation is unique. Earlier we wrote about taxation of charitable trusts.

Consider the case of an older individual who owns $300,000 in low-earning stocks that only pay around $6,000 in cash dividends. If she's in the 15 percent capital gains tax bracket, selling these assets would cost her some $45,000 in capital gains tax. By using her shares to fund a CRAT with herself as the beneficiary, however, she could avoid capital gains and increase the amount of money she receives on a monthly basis. Someone whose beneficiary has regular medical costs, such as hospice care bills, might feel similarly attracted to CRATs and their predetermined payouts.

A younger person with far fewer assets may not be able to make such a large initial contribution and therefore favor a CRUT. With smaller gifts, the fluctuations wouldn't be as severe, and if the beneficiary planned on receiving benefits for many years, the differences might even out in the long run.

As the University of Nebraska-Lincoln Cooperative Extension notes, many taxpayers are subject to higher income tax rates and taxable incomes before they retire. As such, taking gift deductions earlier in life may be more beneficial to your overall income tax outlook.

Of course, factors like CRTs generating business taxable income could significantly change these considerations and your tax avoidance strategy. Deductions are also subject to percentage limits, meaning that no matter what kind of CRT you choose, it's vital to think ahead about how and when you'll donate.

Ready to learn more about estate-planning tools like CRTs? Talk to a professional estate planning lawyer at Citadel Law Corporation by calling (800) 662-0882 today.