End of Year Giving with Charitable Trusts
As we near the new year, it is time to review and evaluate your overall financial outlook for the coming year, including any charitable, estate, or general tax planning for 2021 and beyond. While direct giving has an immediate impact, some individuals may be considering charitable planning strategies that will have a larger and longer-lasting impact on not only charities, but their own lives or their families. Other individuals may be considering year-end tax planning overall, given potential (though uncertain) Democratic tax proposals that could be implemented during President-elect Biden’s term in office. And, some individuals are considering their tax planning over the next few years – whether or not the aforementioned tax proposals are implemented, many of the individual income tax provisions of the 2017 Tax Cuts and Jobs Act are scheduled to expire after 2025. Whatever your reason may be, the following charitable trusts can provide an alternative method to meet your overall legacy wishes for your loved ones and charities.
Utilizing Charitable Trusts for Philanthropic Desires
Charitable trusts provide a charitable vehicle while ensuring current or future distributions to yourself or loved ones. Charitable remainder trusts (“CRTs”) provide an income stream either to you or individuals you select, for a set of years or throughout your, your spouse’s, or your beneficiary’s lifetimes, ultimately distributing the remaining assets to one or more charities. In contrast, charitable lead trusts (“CLTs”) pay income to one or more charities for a set term, and the remaining assets pass to individuals, such as your children.
For both CRTs and CLTs, there are two manners to determine the annual distributions during the initial term (whether to the charitable or non-charitable beneficiary, depending on the type of trust): a unitrust (CRUT or CLUT) and an annuity Trust (CRAT or CLAT). In a unitrust, the income distribution for the coming year is calculated at the end of each calendar year and changes as the value of the trust increases or decreases. In an annuity trust, the distribution is a fixed annual distribution determined as a percentage of the initial funding value and does not change in future years.
Whether a CLT or CRT will be more beneficial to the individual beneficiary or the charity will depend on the interest rate when the charitable trust is established. For example, the current historically low-interest rates yield minimal income to donors from a CRT.
Charitable Remainder Trusts. The key benefits to funding a CRT include the charitable income tax deduction (phase-out rules may apply), deferral of capital gains taxation, receipt of annual income, and a desire to ultimately support your favorite charities. Typical candidates for gifting to a CRT are those with appreciated assets desiring to increase their income are also charitably inclined. Some factors suggesting possible advantages to funding a CRT include being over age 60, no children, desire to defer capital gains taxation, and a need to diversify assets. A high-income individual maxed out their qualified plans but wants to put more away for future income on a tax-deferred basis. The best candidate for a CRT is typically a business owner with a C-corp looking to retire soon or possibly getting bought out. Another great candidate for a CRT is an owner of real estate who is thinking of selling but does not want to pay the capital gains tax or is tired of the 1031 exchange treadmill and wants to get cash out of the property in a tax-efficient manner. Transferring appreciated property or securities to a CRT instead of selling the assets can be a win-win for those with charitable intentions. This tax-advantaged technique allows an individual to defer, and potentially eliminate, all or a portion of any capital gain that may be recognized upon the sale of the appreciated assets transferred to the CRT. Further, the donors enjoy a charitable deduction and retain an income stream.
Let’s say Jack and Jill (age 70 and 68) gift an appreciated parcel of land worth $1,000,000 to a CRUT to benefit their university in December 2020, and they want a 6.5% return for life. Upon creating and funding a CRUT, Jack and Jill will first bypass a capital gain of $225,000 on the sale of the appreciated land, saving $53,500 (20% capital gains tax + 3.8% net investment income tax). They receive a charitable income tax deduction of $299,810, saving them another $112,729 (37.6% bracket). State income tax would increase this tax savings benefit. Their annual income from the CRT would initially be $65,000; the distribution would be recalculated annually. Jack and Jill can expect to receive over $1.4 million over 19 years. Suppose the income and capital appreciation of the trust exceed the income distribution to Jack and Jill, as well as any related fees. In that case, it is possible that the amount allocated to the charity upon both Jack and Jill’s passing would exceed the initial funding value of $1 million. Overall, Jack and Jill saved over $166k in taxes, received $1.4 million in distributions, and the charity received $1 million to further its purpose.
Charitable Lead Trusts. There are two types of CLTs, and the selection will determine the charitable tax deductions if any. In a grantor CLT, you can take a charitable deduction for the year of funding equal to the present value of the charitable payments over the set term. (Note: the phase-out rules may apply, though you may carry-forward the excess deduction over five years.) However, to obtain the tax benefit, the CLT’s investment income is taxable to the donors during the entire trust term. In contrast, a non-grantor CLT funding does not provide any charitable deduction for funding the trust. Still, the trust itself pays tax on its undistributed net income, which is offset by an unlimited income tax charitable deduction for the distributions to the charities.
With either CLT structure, at the end of the set term, the remaining assets are distributed to the individuals you select. Based on various factors at the time of funding, you may be required to report the remaining distribution as a gift to the individuals. However, the gift will not result in tax if you have not exceeded your lifetime gift and estate tax exemption ($11.58M in 2020). With a CLAT, you can structure the annuity payments to “zero out” the remainder, which is calculated at the time of funding based on the historically low interest rates (the Internal Revenue Code §7520 rate for November 2020 is 0.40%). This tactic results in no reportable gift to the remainder beneficiaries, though as long as the income and appreciation exceed the 0.40% “hurdle,” the excess amount will distribute to your beneficiaries without utilizing any of your lifetime gift and estate tax exclusion.
Let’s return to Jack and Jill. If they, instead, contribute the land worth $1 million to a CLUT for a 20-year term, assuming the §7520 rate of 0.40% and an actual growth rate of 6%, the charity receives $52,048 per year. Jack and Jill’s loved ones receive $1.25 million at the end of the 20-year term without utilizing any gift or estate tax exclusions. However, Jack and Jill will need to determine if they should utilize the charitable deduction of $1M, meaning they would report the CLT’s income on their individual income tax returns for the next 20 years. Or, Jack and Jill can forego the charitable deduction, but the CLT’s income does not flow-through to their joint income tax return.
Note that for Jack and Jill to receive the charitable deduction of $1M, they will forego the capital gain attributable to the land’s sale.
There are pros and cons to both CRTs and CLTs. Consult with your estate planning attorney to determine if either charitable trust is appropriate for your situation.
Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.
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