Using a Trust to Benefit a Charity

A CRAT or a CRUT? A CLAT or a CLUT? Who knew that giving to charity through a trust could be so complicated? We will try to simplify it for you here. All of these are examples of irrevocable split interest trusts, which essentially means that one beneficiary receives income and another receives the remainder at termination. They primarily differ as to which type of beneficiary the charity is and how the annual payments from the trust are determined.

Let’s start with the CRAT (Charitable Remainder Annuity Trust). As the name suggests, the charity is the remainder beneficiary, and the donor (or someone chosen by the donor) is the income beneficiary. The form of payment is a fixed annuity for at least 5% of the initial value of the contributed property that continues for the lifetime of the income beneficiary. The value of the charitable contribution is calculated as the value of the contributed property minus the actuarial present value of the annuity. An immediate tax deduction is available even though the charity may not receive the funds for decades or maybe never. To avoid the latter scenario, the income beneficiary must have a 5% or lower chance of outliving trust assets, and the estimated remainder interest must be at least 10% of the initial trust value.

CRATs are somewhat inflexible in that the income must be paid at least annually even if the principal must be invaded to make it happen. Also, no additional contributions are allowed once the CRAT is established. The CRUT (Charitable Remainder Unitrust) addresses both of these limitations of the CRAT. An income payment from a CRUT may be limited to the income actually earned by the trust, and additional contributions may be made. The primary difference between a CRAT and a CRUT is that a CRUT determines its payments based upon a constant percentage of the value of the trust assets. While it is technically impossible for the income beneficiary to outlive the assets, a CRUT must still pass the 10% test described above. One important caveat of a CRUT is to avoid using hard-to-value assets such as stock in a closely-held business.

Suppose you want the charity to get an annuity for a fixed term and either yourself or a loved one to get the remainder? That is where the CLAT (Charitable Lead Annuity Trust) and the CLUT (Charitable Lead Unitrust) come in. Less frequently used than their remainder trust cousins, they tend to be favored by high net worth investors who don’t need current income. Interestingly, they can be valued such that the remainder interest is zero, meaning that a deduction for the full amount of the assets is available with no gift tax at the time of the transfer.

In general, the types of assets that are appropriate for charitable trusts are highly appreciated (to avoid capital gains) and/or high expected-return assets (to remove them from the taxable estate).

To summarize, charitable trusts are highly valuable tools for charitable giving that contribute to both income tax and estate tax efficiency. However, given the complexity of the choices, investors should seek guidance from multiple professionals, including financial planners, accountants, and estate-planning attorneys.

NOTE: Any U.S. federal tax advice contained in this article is not intended to be used, and cannot be used or relied upon, to avoid tax-related penalties under the Internal Revenue Code, or to promote, market or recommend to another any tax-related matter addressed herein.