With the increase to the standard deduction under the Tax Cuts and Jobs Act, it is more important than ever to carefully plan out your charitable giving to maximize the deduction on your tax return. Charitable trusts provide a way to bunch donations to a charity into one year while still allowing the donated assets to generate an income stream.
With a charitable trust, a donor can contribute assets into the trust and can determine the timing of charitable contributions. In exchange for putting their assets into a charitable trust, the donor receives a charitable deduction in the year or years that the trust is funded based upon how much of the trust’s assets will eventually go to charity.
There are two main types of charitable trusts: remainder trusts and lead trusts. With remainder trusts, a non-charitable beneficiary (usually the donor) receives an annual distribution from the trust for a specified time period and the remainder is distributed to the designated charitable organization. The non-charitable beneficiary is taxed on the income distributed to them each year. On the other hand, charitable lead trusts are just the opposite – the charity receives the annual distributions from the trust and the amount remaining at the end of the trust’s life goes to the designated non-charitable beneficiary (usually the donor’s family member). Within charitable remainder and lead trusts, there are different ways to determine how much will be distributed from the trusts each year. Unitrusts pay out a fixed percentage of the fair market value of the assets each year, determined on a specific date, whereas annuity trusts pay out a fixed dollar amount each year, regardless of how well or poorly the assets perform.
There are several benefits of setting up a charitable trust, but there are also some disadvantages to consider. These include:
- Charitable deduction – Donors receive a charitable deduction on their individual income tax returns for contributing assets to the trust.
- Avoiding capital gains tax – If a donor has highly appreciated assets, selling the assets outside of a charitable trust can generate an enormous tax liability to the donor. When assets are sold inside a charitable trust, the gain from the sale is not taxable. Taxable income is only based on the amount of distributions made to the donor or other non-charitable beneficiary.
- Diversification – Because capital gains tax can be deferred or avoided by selling appreciated assets inside a charitable trust, this gives donors an opportunity to diversify their assets without losing a chunk of their principal to taxes.
- Excluded from the donor’s estate – Assets in a charitable trust are excluded from the donor’s estate and are, therefore, exempt from any estate taxes.
- Irrevocable – Once the trust is set up and funded, the donor cannot terminate the trust or remove contributed assets from the trust.
- Costs – An attorney is needed to set up a charitable trust and an accountant is likely needed to file annual tax returns. This means there are ongoing costs associated with maintaining a charitable trust.
- Risk of poor performance – Like any other asset, the assets in the trust may decline in value or produce less income than expected. If the beneficiary of the trust is depending on the income distributions, this can risk putting them in a poor financial position.
- Asset limitations – Not all assets can be put into a charitable trust: for example, shares in an S corporation cannot be held by a charitable trust.
Charitable trusts can be wonderful and flexible ways to give to your favorite charity, while still maintaining some control over your assets. However, charitable trusts can be complex and confusing, so please contact us if you would like to discuss whether it makes sense for you.