Independent Trustee Services for Charitable Trusts
A Charitable Trust is a form of trust which can be set up to benefit charities and beneficiaries simultaneously. The advantages of using a Charitable Trust for philanthropic giving can be significant if properly considered within an overall estate planning strategy.
While using a Charitable Trust for mitigating potential capital gains on highly appreciated assets, it is also a way to leave a family legacy in the community.
The two basic forms of charitable trusts are Charitable Leads Trusts and Charitable Remainder Trusts.
- A Charitable Lead Trust (CLT) is a split-interest irrevocable trust with two or more beneficiaries. The lead income beneficiary is the charity(ies) named in the CLT, and the remainder beneficiary(ies) is either the Grantor (known as a Grantor CLT) or the Grantor’s heirs (a Non-Grantor CLT).
- Charitable Remainder Trusts (CRTs) are a type of trust where a portion of the assets in the trust are distributed to an income beneficiary with the remainder being donated to one or more charitable beneficiaries.
Grantor Charitable Lead Trust Basics
There are various types of Grantor Charitable Lead Trusts; two of the most common are:
- A Grantor Charitable Lead Annuity Trust (GCLAT), in which the charitable beneficiary receives annual payments (an annuity) and the remainder passes to the Grantor or Grantor’s estate.
- A Grantor Charitable Lead Unitrust (GCLUT) is where a charitable beneficiary receives a fixed percentage of the trust principal over the trust term. The fixed percentage is based on the fair market value of the trust, which is calculated on the first day of the tax year. At the end of the trust term, the remaining assets revert back to the Grantor or the Grantor’s estate.
The Grantor takes a charitable income tax deduction for donating the property to the trust and becomes the trust’s taxpayer for all future net income and recognized gain.
GCLTs are often used for income tax planning purposes. They are usually beneficial in years when a Grantor has unusually high adjusted gross income (AGI). They are often funded with illiquid assets anticipated to appreciate rapidly but generate little or no recognized capital gains or net income.
Non-Grantor Charitable Lead Trust Basics
A Non-Grantor Charitable Lead Trust (NGCLT) is where the “remainder” beneficiaries are the Grantor’s heirs (either outright or in trust.). An NGCLT is an “estate freeze” technique where the gift-tax value of the assets is determined on the date of funding and all future growth will be outside of the Grantor’s taxable estate.
In an NGCLT, the Grantor does not receive an upfront charitable income tax deduction, but the Grantor is also not taxed on net income or recognized gains. Instead, the trust pays its own income tax and claims an unlimited charitable income-tax deduction for its distributions to charity.
There are also various types of Non-Grantor Charitable Leads Trusts, including:
- Non-Grantor Charitable Leads Annuity Trust (NGCLAT): The payout is fixed (set) based on the fair market value of the trust on the date it is established. The payout can be set as either a percentage or a set number.
- Non-Grantor Charitable Leads Unitrust (NGCLUT): The payout to charity is based on a percentage of the fair market value of the trust, typically calculated on the first day of the tax year.
- Non-Grantor Charitable Leads Step Trust (NGCLST): A standard CLAT makes payments of the same amount every year to the charitable lead beneficiary(ies). A CSLT makes payments to a charity that increase in “steps” during the trust term, i.e., 10% per year.
Charitable Remainder Trust
In a CRT, a Grantor contributes assets to an irrevocable trust. A CRT provides payments to an initial beneficiary, such as the Grantor. At the end of the trust term, any remaining assets will pass to one or more charitable remainder beneficiaries—which may include a private foundation.
The Grantor will receive an income tax deduction equal to the present value of the remainder interest that is calculated to go to charity when the CRT ends. The present value of the remainder interest is calculated based on factors such as trust term, the payout rate, and Internal Revenue Code §7520 Additionally, it must pass two (2) tests:
- 10% Remainder Test: The charity should anticipate receiving at least 10% of the original fair market value of the donated asset when the remainder is distributed; and
- 5% Probability Test: There must be a greater than 5% likelihood that there will be enough assets to last to the end of the trust term.
While there are several types of Charitable Remainder trusts, the two most common are the Charitable Remainder Annuity Trusts and Charitable Remainder Unitrusts.
Charitable Remainder Annuity Trust Basics
Generally, a Charitable Remainder Annuity Trust (CRAT) pays income beneficiaries a fixed amount of the trust principal over a measuring life/lives, or over a term of years (not to exceed 20 years). The grantor, the grantor’s spouse, or a lineal ancestor of either is considered a measuring life. A minimum of 5% and a maximum of 50% annual payment to the beneficiary is required.
CRATs provide the grantor with the opportunity to defer tax upon the sale of an asset, diversify a concentrated asset portfolio, and provide an immediate income tax deduction. They are often funded with a single or concentrated stock position with a low basis.
The Advantages of a CRAT
- The grantor receives an income tax deduction upfront
- Tax-deferred growth occurs within the trust
- Deferred capital gains upon the sale of a concentrated stock position
- The trust can last for one or more lives, or a term of years – not to exceed 20 years
- The payout to an income beneficiary is protected against down performance years
The Disadvantages of a CRAT
- There is no remainder benefit to heirs
- No transferring additional assets into the CRAT after the initial setup
- The payout is fixed and will not increase, even if the portfolio does better than expected
Charitable Remainder Unitrust (CRUT)
Generally, a Charitable Remainder Unitrust (CRUT) pays a beneficiary a percentage of the principal in the trust. The percentage is recalculated annually over the measuring life/lives or term of years (not to exceed 20 years). The payout percentage is distributed based on the fair market value of the trust and recalculated annually, as specified in the trust document.
Charitable Remainder Unitrusts are often used to: provide a grantor the ability to diversify a portfolio within a tax-exempt entity, to provide an income beneficiary more income, to defer taxation upon the sale of an asset, and to provide an income deduction. They are often times funded with a single or concentrated stock position.
The Advantages of a CRUT
- The upfront income tax deduction
- Deferred tax growth within the trust
- Diversification of a single, or concentrated, stock position without paying capital gains (until the trust states income is to be treated as capital gains)
- The trust can last for more than one measuring life
- Additional assets may be transferred into the CRUT over time
- The payout to income beneficiaries may increase in years when the portfolio performs better
The Disadvantages of a CRUT
- There is no benefit to the heirs
- The payout to income beneficiaries may decrease during poor portfolio performance years
Charitable Giving Benefits
Charitable planning within an estate plan is about transferring a philosophy of giving and caring across multiple generations, not just transferring assets. It aligns your generous nature with the principle and values you may seek to pass on to your children. Being a steward of wealth comes with responsibility, and the best way to cultivate the next generation in your personal philosophy is by showing what an opportunity giving can do for others in need.
Studies have shown that charitable giving produces a positive feeling in the giver, not to mention what is being done for those who are on the receiving end. While there is clearly a benefit to giving from a tax perspective, the satisfaction of knowing you are doing something good for another person is unmatched.
By creating a planned giving strategy within your estate and your family, you are able to accomplish multiple goals with one act – getting a tax benefit, giving to others, and teaching the next generation to be generous and responsible stewards of wealth.
Alliance Trust Company can serve in various roles, including trust administrator, directed trustee, special trustee, or as a full discretionary trustee. In addition, Alliance Trust Company is available to work with the drafting attorney on trust design and with the beneficiaries on cash flow needs from the trust.