A charitable trust is an estate planning strategy that can provide tax savings for the donor, the charity, and the heirs, depending on the type of charitable trust that is created. Most charitable trusts are established by high net worth individuals who need to reduce the value of their estates to avoid or reduce estate taxes or who wish to avoid substantial capital gains taxes on appreciated property.
The IRS requires charitable trusts to be irrevocable, meaning that once you turn assets over to the trustee, you cannot take them back or otherwise exercise control over them. You can receive income from the trust for yourself and leave assets to your heirs while greatly reducing your taxes.
There are two types of charitable trusts—remainder and lead.
Charitable Remainder Trust
A charitable remainder trust allows you to leave assets to a charity, but first earn income from the assets for a certain period of time. To set up a charitable remainder trust, you first need to select an IRS-approved, tax-exempt entity to receive the assets. The charity will serve as your trust’s trustee and will control the assets as long as directed by the trust agreement. You will receive a portion of the income produced by the trust’s assets, with the charity receiving the trust’s assets after a period of time specified by you in the trust agreement.
Charitable Lead Trust
Lead trusts work in the opposite way from remainder trusts. Income produced by a lead trust goes directly to the charity, with the assets reverting to either the grantor or to the charity at the end of the trust’s term.
Under the first option, the donor can still leave the assets to heirs at their current market value and with no taxes on the gift. This option is typically used by donors who can allow the assets to be held in trust for at least 5 years. The donor gets a big deduction in the setup year, and then receives the assets back at the end of the trust period.
Under the second option, any income generated for the charity inside the charitable trust is deductible by the grantor, which is discounted at the federal rate. The lower the rate, the larger the value of the gift.
For lead trusts, the income goes to the charity with no regard over what remains in the trust at the end of the period. In a remainder trust, there are restrictions on how much the trust pays out since any remaining assets are going to the charity.
In a lead trust, the deduction can be taken for the value of the gift, spread over 5 years. Any income you receive is subtracted from the gift’s value. Of course, giving the asset to charity takes it out of your taxable estate.
Remainder trusts do get higher interest rates than lead trusts. They are also recommended for highly appreciated assets like some stocks in which you risk having to pay substantial taxes on high capital gains taxes when you sell it after its value has soared. The income generated can be put in a remainder charitable trust so when the stock is sold, no taxes are due at that time. The entire amount realized can be reinvested. Any taxes that will be due are deferred out for the life of the trust.
Consult Charitable Trust Lawyer Dan McKenzie
This is a simplified explanation of how charitable trusts operate. They are not for everyone but even if you are not a high roller, a charitable trust can work for you if you do have significant assets and wish to reduce capital gains and other taxes on income producing property for yourself and your heirs. Dan McKenzie is a charitable trust attorney in Denver who has been advising clients on estate planning matters for over 20 years. Call his office today for all your estate planning needs.