Charitable trusts offer high net worth individuals, business owners, and entrepreneurs a powerful tool for strategic philanthropy. By establishing such a trust, you can not only support the causes you care about but also enjoy significant tax benefits.
A charitable trust is an arrangement where one donates money or property in trust to benefit nonprofits – organizations established generally for educational, religious, scientific, or medical purposes. In addition to furthering your charitable intentions, incorporating philanthropy into your estate plan through charitable trusts can lead to reduced estate taxes for your heirs. But it is important that you select competent trustees who can effectively manage your charitable trust's assets and responsibilities.
Charitable Trust Structures
A charitable trust is an estate planning tool that allows individuals to donate assets for the benefit of charities or specific causes, often generating income for either the donor or designated non-charitable beneficiaries before ultimately benefiting chosen charities. There are different forms of charitable trusts that high net worth individuals and entrepreneurs can choose from, but the more common vehicles used are charitable remainder trusts and charitable lead trusts. These vehicles are often referred to as “split-interest” trusts since they are structured to benefit both non-charitable and charitable beneficiaries.
- Charitable Remainder Trusts: There are two main types of charitable remainder trusts, each of which offers a way to generate income for the donor or designated non-charitable beneficiaries, while reducing both income and estate taxes and supporting charitable causes important to you:
- Annuity Trust: A charitable remainder annuity trust pays out a fixed percentage (not less than 5%) based on its initial value upon funding to the donor or to other non-charitable beneficiaries each year until it terminates upon death of the beneficiary(s) or after a specified number of years (no more than 20). The remaining assets are transferred to the donor’s named charitable beneficiaries. No additional contributions to the trust are permitted.
- Unitrust: Each year the charitable remainder unitrust distributes a fixed percentage of the trust’s annual fair market value to the donor or non-charitable beneficiaries so the amount of the annual distributions can vary year to year. However, because the trust assets are valued annually, additional contributions from the donor are permitted. When the trust terminates, remaining assets in the unitrust are distributed to the donor’s selected charities.
- Charitable Lead Trust: A charitable lead trust is the reverse of the charitable reminder trust and is generally used to transfer assets tax-free to the donor’s children. In a charitable lead trust, the donor’s selected charity(s) receive the initial distributions of the annual fixed percentage amounts during the trust's stated term. Properly structured, at the end of the lead trust term, the remaining trust assets are distributed free of estate or gift taxes to the donor’s children. The charitable lead trust is an effective wealth transfer strategy when the donor’s children are financially well off enough to delay receiving a portion of their inheritance until the lead trust terminates.
Tax Advantages of Charitable Trusts
When properly structured and managed, charitable trusts can offer significant income and estate tax benefits for high-net-worth individuals.
- Income Tax Deductions on Contributions: Donations to qualified charities are eligible for income tax deductions, with certain limitations. This could mean that a portion of your charitable contributions can be deducted from the amount you owe in taxes when filing. Deduction limits vary based on factors such as the type of charity and your overall income.
- Capital Gains Tax Exemptions on Asset Sales: Transferring assets like stocks or real estate into a charitable trust before selling them can exempt any unrealized appreciation in value from capital gains taxes. Charitable trusts are generally tax-exempt entities and can sell such assets and reinvest 100% of the sales proceeds.
- Reduced Taxable Estate Values: Incorporating a charitable trust in your estate plan can reduce the overall value of your taxable estate upon death since any amounts left to qualified charities are eligible for an unlimited estate tax charitable deduction. Including a charitable trust as part of your estate plan could lead to lower state and federal estate taxes owed by your designated beneficiaries.
Selecting Appropriate Trustees
Trustees must manage trust assets efficiently while considering your charitable goals. They select suitable investment strategies that align with the trust's risk tolerance and time horizon while maximizing returns for designated beneficiaries. Trustees also are responsible for distributing funds from the charitable trust according to the donor’s intent. Therefore, they should understand the donor’s objectives, evaluate potential grant recipients, monitor funded projects' progress, and ensure transparency in reporting outcomes.
Trustees maintain compliance with relevant tax laws, substantiate charitable deductions, and meet annual distribution requirements required by the terms of the trust. Trustees should always act with integrity, transparency, and accountability.
Richard P. Breed, III is a shareholder at Tarlow Breed Hart & Rodgers, P.C. in Boston, Massachusetts. Please connect with Rick at www.linkedin.com/in/rick-breed/