Basics of Estate Planning: Charitable Trusts

This is another in a series of blogs on the basics of estate planning. Last week, we looked at Irrevocable Life Insurance Trusts. This week, we’ll look at charitable trusts.

There are two primary types of charitable trusts, they are Charitable Remainder Trusts (“CRTs”) and Charitable Lead Trusts (“CLTs”).

Trusts with split interests (in which one part goes to a charity and another part goes to a non-charitable beneficiary (like an individual)) must meet very specific rules in order to qualify as such.

A CRT is an irrevocable trust in which the lead or up front interest goes to the non-chartable beneficiary and the remainder goes to the charity. A CRT is definitely more common than a CLT. A CRT is a tax-exempt entity and may be particularly useful when trying to defer gain on an asset.

A charitable lead trust is an irrevocable trust in which the up front or “lead” interest goes to the charity and the remainder goes to a non-charitable beneficiary. Both a CRT and a CLT may be set up as either an annuity trust or a unitrust. (So, you could have a Charitable Remainder Annuity Trust (“CRAT”), a Charitable Remainder UniTrust (“CRUT”), a Charitable Lead Annuity Trust (“CLAT”), or a Charitable Lead UniTrust (“CLUT”)).

An annuity trust pays out a fixed dollar amount each year to the lead beneficiary. A unitrust pays out a fixed percentage of the trust each year to the lead beneficiary. With a unitrust, if the trust corpus grows, the amount going to the lead beneficiary grows right along with it. With an annuity trust, the lead beneficiary’s payment doesn’t change if the trust corpus increases or decreases.

As mentioned above, there are numerous, specific rules. If they are not followed precisely, the trust will not qualify. For example, split interest trusts where all income goes to the lead beneficiary do NOT qualify. So, if a trust gives all the income to John or Jane for life and then the remainder to charity, no part of the trust will qualify for a charitable deduction. Occasionally, you’ll come across a trust like this.

There are many benefits to charitable trusts. For example, a CRT is a tax-exempt entity but distributions to the lead beneficiary are flavored by the tax attributes of the income earned over the life of the CRT. (For example, let’s say you own Blackacre worth $1 million with a basis of $100,000. If you sold Blackacre, you’d be taxed on the $900,000 gain at the time of the sale. If you contribute it to the CRT and the CRT sells Blackacre, the CRT will pay no tax on the sale. The distributions to the lead beneficiary are flavored by the income received by the CRT, including the $900,000 gain.)

Also, there’d be an income tax deduction equal to the actuarial value of the interest going to the charity. The donor would be entitled to a current deduction, subject to limitations under section 170, for that amount. The greater the stream of payments going to the lead beneficiary, the smaller the actuarial value of the interest going to the remainder beneficiary. There are a variety of tests associated with this. All of this is set forth in greater detail in Core 2 regarding CRTs, and Core 3 regarding CLTs.

The important thing to remember here is that if you see or are thinking of drafting a trust that has benefits going to one person for a period and then to a charity, a CRT may be the answer.

Occasionally, private foundations are established as trusts, though more commonly they are non-profit corporations under state law. Here’s a link to more on setting up private foundations.

In upcoming blogs, we’ll look at more of the basics of estate planning.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com