A charitable trust is one way to fulfill your philanthropic goals; it comes with benefits like income tax deductions for the fair market value of the donated assets, a potential reduction in real estate taxes, and the avoidance of capital gains taxes on appreciated assets. Charitable trusts are one way to create a family legacy of giving as part of savvy tax planning within your estate plan.
Here’s how to establish a charitable trust:
- Identify the charitable organization(s) and noncharitable heirs — a spouse, children, or grandchildren.
- Select a trustee to manage the trust — a friend, a family member, or a third party like a bank.
- Fund the trust with assets — cash, real estate, publicly traded securities, and some types of closely held stock and bonds.
There are two kinds of charitable trusts:
- Charitable remainder trusts — In these, the donor or other designated individual(s) receive income from the trust either for their lifetime(s) or for a period of up to 20 years, after which the remaining assets go to the designated charity.
- Charitable lead trusts — These offer the income to the charity for a set period, and the remaining assets then pass to your beneficiaries.
Both of these are also known more broadly as split-interest trusts because they split payments between the donor and a noncharitable beneficiary.
Establishing the charitable trust
Under the Internal Revenue Code, you can deduct your contributions to a CRT, subject to percentage limitations. The annual deduction limit is up to 30% of adjusted gross income for donations of noncash assets held longer than one year and up to 60% of AGI for donations of cash. If your charitable deduction amount exceeds these limits, you can carry the excess amount forward for up to five additional tax years, subject to the AGI limits each year.
Donations of appreciated noncash assets held more than one year can create additional funds for charity because you can potentially eliminate the 15% or 20% capital gains tax you would incur if you sold the assets yourself and then donated the proceeds. You may claim a fair market value charitable deduction for the tax year in which the gift is made and may choose to pass on those tax savings in the form of an additional gift.
If you have a traditional individual retirement account and are age 70 1/2 or older, you can utilize a qualified charitable distribution of up to $50,000 once in your lifetime to establish a very basic CRT. The CRT has to be funded exclusively with the QCD, and it is limited to paying income to just you and your spouse. You cannot claim an income tax charitable deduction for the QCD used to fund the CRT, and there are additional limitations on funding, income deferral, and taking a charitable deduction that make this strategy less flexible compared to other ways of funding a CRT.
Drawbacks of charitable trusts
Setting up and administering a charitable trust can be complicated and costly, requiring legal and financial knowledge to ensure compliance with laws and regulations. Additionally, most are irrevocable — once they are set up, you cannot change your mind about the terms and beneficiaries. In some states, you may need to register the trust with a government agency, such as the state attorney general or secretary.
CRTs have been attractive when interest rates climb. In addition to an income stream, they offer an up-front charitable tax deduction as well as a vehicle for disposing of appreciated assets without immediate taxation on the gain — all while supporting a charitable cause that you believe in.
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