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It is possible to set up a special charitable trust, receive benefits from the trust, and get an income tax deduction for a portion of the gift. These types of charitable trusts are referred to as "charitable remainder trusts." The beneficiary gets a payment for lifetime and the charity gets the "remainder," or what is left over when the trust terminates.
The advantage of the trust is that there is an immediate income tax deduction for a portion of the gift. The Internal Revenue Service uses tables that show the value of a charitable deduction for income tax purposes based on the person's age, the value of the gift, and the amount of payments received. This gift can run from approximately 10-40% of the value of the asset at the time that the trust is established.
A 1998 change in the tax laws requires that the value of the charitable remainder be at least 10% of the trust value when the trust is established. Depending upon interest rates it is possible that a young couple (in their 30s) would not qualify. It is now more difficult to have a charitable remainder unitrust continue after the person or couple's death for others and still qualify.
The second and very important consideration is that the trust is totally income tax exempt, including exemption for capital gains purposes. If a person transfers an asset which has appreciated to such a trust he or she gets an income tax deduction based in part on the current value of the asset. The trust can then sell the asset without payment of any capital gains.
A couple in their 70s owns an small apartment building worth $300,000, and yielding approximately $17,000 per year in income. The couple wishes to be rid of the building and are considering selling it, but they do need the income. Their cost basis, based on 25 years of ownership, is approximately $30,000. If they sell the building, they will have a capital gains on $270,000 ($300,000 value minus $30,000 cost). The current capital gains tax will be approximately $62,000, leaving them $238,000 to invest. If they invest the $238,000 at a 4% return, their income will be $9,500 per year.
Instead of selling the building, they contribute the property to a charitable trust. They elect a 7% variable return, which means that every year the 7% is paid on the then fair market value of the asset or assets. They get an immediate income tax deduction of approximately $60,000 when they establish the trust. The first year they receive $21,000 (7% of $300,000). The charity later sells the property but there is no income tax on the capital gains. Because of the cost of sale, the second year the assets are only worth $250,000. The couple then receives 7% of this amount, or $17,500. In all cases their income is much higher because they do not pay the capital gains tax and they receive a large charitable deduction at the time of the gift.
The disadvantage is that at the time that they both die, the trust terminates and the assets belong to the charity. Their children or other relatives will not receive the $300,000 apartment building. To compensate for this some people will buy life insurance with their children or set up an irrevocable trust as the owner and use the income tax savings to pay the premiums. If $300,000 of life insurance were purchased, it would replace the apartment building.
There are two types of charitable trusts. The first is called a charitable remainder annuity trust. Here, the individual or husband and wife receive a fixed amount which does not change during their lifetime. They must elect to receive at least 5% each year and it can be for a higher amount. The higher the amount and the larger the payments, the lower the charitable deduction.
If one puts $200,000 of assets into trust and elects a 6% return, then the couple and the survivor after one's death would receive $12,000 per year for life. At the death of the individual or both husband and wife, the trust will terminate and the assets pass to the charity. The trust is tax exempt and pays no income tax, but the beneficiary or beneficiaries pay tax on the moneys they receive to the extent that it is taxable income in the trust.
A charitable remainder annuity trust does not allow additional contributions of assets after it is set up. The payments are fixed and do not change, and the trust must terminate upon the death of the individual or upon the death of both husband and wife.
A charitable remainder unitrust is a slightly different vehicle. The trust can run for the lifetime of an individual or couple and continue for up to another 20 years or for the lifetime of someone after he or she dies (providing the trust actuarial qualifies when it is created). The percentage selected cannot be less than 5% and cannot change, but the payments may vary. The trust is valued annually and the payments for the following 12 months are based on the value.
If a couple puts $200,000 in a charitable remainder unitrust and selects a 6% return, they will receive $12,000 during the first year. On the anniversary date of the establishment of the trust it is valued again, and the payments for the following 12 months are the percentage of this new value. At the end of the first year the trust has increased in value from $200,000 to $220,000. During the second year the couple then receives 6% of $220,000, or $13,200. This type of trust is like a variable annuity in that the payments change yearly based on the value of the assets.
It is also possible to make additional contributions of assets to a charitable remainder unitrust (but not an annuity trust). If someone wishes to contribute additional assets, a new trust does not have to be established if the donor is happy with the terms of the existing trust but the assets can be added to this charitable trust.
Although the charities must be designated when the trust is established, the donor can make provision in the trust to change the charities as long as a charity which is qualified under tax law receives the assets when the trust terminates. While many charities will act as trustees of these types of trust, an individual and even the donor or donors of the trust may be the trustees.
The reverse of a charitable remainder trust is a charitable lead trust. This type of trust is used for an entirely different purpose.
An individual dies with a taxable estate of $10,000,000. The estate tax is approximately $4,000,000. To reduce this tax, the assets stay in trust for a specified number of years with the income from the assets being paid to a designated charity or charities. Based on tax tables, this $10,000,000 estate is reduced by the actuarial value of the period of time and value of the trust. If the trust lasts 15 years and pays out 7% annually, the estate tax may be cut by $1,000,000 or more. The larger the annual payout and the longer the term of years for the charity, a smaller amount is left to be taxed.
The disadvantage is that the estate beneficiaries, such as the children, do not receive the assets for a number of years. This type of trust normally only works for large estates and works where the estate beneficiaries can afford to part with the assets for a lengthy period of time.
Anyone contemplating some form of charitable trust should first consult with the charity involved. Larger charities have individuals who can explain the trust, without obligation, and can determine the actuarial value of the gift and estimated payments. After obtaining such information the individual or couple should then consult with their attorney and tax advisor to review the proposed gift to this charitable trust.
© Milton Berry Scott, 1998-2005