Managing your estate to maximize your wealth for you and your family can be accomplished through the use of two types of charitable trusts. Charitable Remainder Trusts (CRTs) and Charitable Lead Trusts (CLTs) are two types of trusts known as, split-interest trusts used by individuals and families for managing taxes in an estate plan while at the same time providing financial support charitable organizations that they admire. The term “split-interest trust” is used due to the fact that financial interest in the trust is divided between two parties, between family-members and charitable beneficiaries. Charitable Remainder Trusts pay income to family-member beneficiaries for predetermined number of years, and afterwards the assets in the trust are given to a charitable beneficiary. Charitable Lead Trusts can be consider to have the reverse timing for trust distributions. Essentially, the CLT pays income to a charitable beneficiary, and then gives the remainder interests to the family-member beneficiaries.
The tax treatment of CRTs and CLTs are different. Concerning Charitable Lead Trusts, the grantor cannot claim an income tax deduction and must pay a federal gift tax on the value of the contribution earmarked for family-member beneficiaries. However, at the grantor’s death trust assets pass to heirs estate tax free. Concerning a Charitable Remainder Trust, the grantor can claim a tax credit for a portion of each contribution based on the grantor’s life expectancy with the remainderman interest passing to family-member beneficiaries without gift or estate taxes.
Although Charitable Remainder Trusts (CRTs) and Charitable Lead Trusts (CLTs) are known as “split-interest trusts”, they have different sequence of events which accomplish different objectives. For example, CLTs pay income to a charitable beneficiary for a certain period of time, after which the remaining assets in the trust (the remainder interest) passes to family-member beneficiaries, such as children or grandchildren, or even the donor. CRT assets are placed in a trust to provide a stream of income to family-member beneficiaries for a period of time, after which the assets become the property of a charitable beneficiary. Income tax, capital gains tax, and estate and gift tax differ significantly between CLTs and CRTs, but both are a function of life expectancy calculations. For greater detail about which type of charitable trust is best for you consider the following.
Charitable Lead Trusts
A CLT can be set up to pay either a fixed annuity or a unitrust amount to a charitable organization, which means that it can pay either a fixed dollar amount each year or a fixed percentage of the fair market value of the trust’s assets. While there is no limit on the amount of time a CLT can remain in effect, it must be for either a predetermined number of years or until the death of the donor.
CLTs are often the tool of choice for individuals with assets that have a high potential for future appreciation. They may also be well suited for those with heirs who are minors or otherwise not ready to assume full control of significant assets. By creating and funding a CLT, a grantor can make final arrangement for the disposition of an estate, but defer the date at which beneficiaries actually receive and control the property. In the meantime, the charity of choice receives immediate and ongoing benefits. When the assets do eventually pass to the family-member, noncharitable beneficiaries, they are not subject to the federal estate tax.
Keep in mind, however, that the grantor is not able to claim an income tax deduction for making contributions to a CLT. In addition, the grantor may have to pay a federal gift tax on a portion of each contribution, albeit only on the value of the remainder interest earmarked for family-member, noncharitable beneficiaries.
Also remember that while a CLT allows assets to pass to heirs with no federal estate taxes, a CLT is not a tax-free entity. Any income the trust generates in excess of the amount paid to charity is still taxable. And the sale of appreciated assets held within the trust may trigger capital gains taxes.
Charitable Remainder Trusts
In the eyes of a charity, a CRT is the mirror image of a CLT. A CRT first pays income to family-member beneficiaries before permanently awarding ownership of its assets to the charity. But in the eyes of Uncle Sam and taxpayers, the most significant differences lie elsewhere.
First and foremost, a CRT is a tax-exempt entity, meaning income and realized capital gains are not subject to taxation. For this reason, CRTs can be extremely useful for individuals who want to sell appreciated assets, such as investors eager to liquidate highly appreciated, concentrated stock portfolios in order to reallocate the money within more diversified portfolios or to create income streams for themselves or beneficiaries.
In addition, a grantor can claim a tax deduction for his or her donation to a CRT, equal to the present value of the charitable remainder interest. And although a CRT’s assets are ultimately distributed to the charity free of estate and gift taxes, the family-member beneficiaries of a CRT must pay income taxes on the income received from the trust.
As with CLTs, CRTs are classified according to their payment methods. A charitable remainder annuity trust pays a fixed dollar amount at least annually, whereas a charitable remainder unitrust pays a fixed percentage of the fair market value of the trusts assets. According to IRS guidelines, each type of CRT must pay no less than 5%, but no more than 50%, of its fair market value annually. A CRT may remain in effect for life or for a predetermined period of time, not to exceed 20 years.
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This is a hypothetical example used for illustrative purposes only.
This article should not be used for tax advice.
You should seek the guidance and advice of your own tax advisor.
