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Estates & Trusts

You made it happen! Now what?

By July 23, 2015No Comments

When a trust has both charitable and non-charitable beneficiaries, it is referred to as a split-interest trust. The two most common types of split-interest trusts are the charitable remainder trust (CRT) and the charitable lead trust (CLT).

The names of these trusts tell you when the charity gets its share of the assets that you’ve put into the trust. With a charitable remainder trust, the charitable beneficiary gets the remainder of the assets after the non-charitable interest expires. Most commonly (but certainly not always), the non-charitable interest expires at the passing of the second spouse to die. Conversely, with a charitable lead trust the charity’s interest leads that of the non-charitable beneficiary. Most often, the charity receives a fixed dollar amount that is determined at the initial funding of the trust for a term of years specified in the trust document. After the term has expired, the remainder of the trust assets goes to one or more non-charitable beneficiaries.

The name of the trust will also tell you how the distributions are figured. For example, a charitable remainder unitrust (“CRUT”) pays out a percentage of the current market value of the trust’s assets as of a specified date. To illustrate, assume your trust document says that the trust is to pay you 5% of the value of the trust’s assets as of January 1 each year. If the value of your assets on January 1, Year 1 is $1 million, your distribution for Year 1 is $50,000; if the value on January 1, Year 2 is $500,000, your distribution for Year 2 will be $25,000. Provided your trust agreement does not say otherwise, you can add assets to this trust at any time, and your distributions will be adjusted to reflect the addition to the trust.

A charitable remainder annuity trust (“CRAT”) pays out a fixed dollar amount no less frequently than annually based on a percentage of the initial value put into the trust.  For example, say that you put $1 million in to a CRAT and the trust document states that you are to receive 5% of the initial value of the trust on an annual basis. Whether the assets in the CRAT are worth $2,000,000 or $20,000 on January 1, Year 2, the trust is still required to pay you $50,000 in Year 2.

A charitable remainder trust is a tax-exempt entity. As a result, it generates an income tax deduction for taxpayers who add assets to the trust for the present value of the remainder interest of those assets in the year the assets are transferred to the trust. The trustee is required to file information returns with the IRS (Form 5227) and the appropriate state taxing authority reporting the trust’s activities during the year. However, except in uncommon situations where the trust is determined to be operating a business, the trust will not pay any tax. This makes a charitable remainder trust an attractive wealth transfer vehicle if the taxpayer setting up the trust funds it with marketable securities that he has low basis in.

Charitable lead trusts come in both unitrust and annuity variations as well. Charitable lead trusts, however, are not tax-exempt entities and are required to file both Form 5227 and Form 1041 every year. Depending on how the trust document is drafted, either the trust itself or the taxpayer that gives assets to the trust gets a deduction for some portion of the trust’s income. As a result, ordinarily, such trusts are drafted in order to make the value of the remainder interest very small to maximize the wealth that transfers to the non-charitable beneficiaries while minimizing the transfer tax cost of the transfer.

If you are thinking about setting up one of these types of trusts, here are a few items to consider:

-Would you like to receive the non-charitable distributions yourself? Would you like your spouse or children to receive them?

-Are you comfortable with your trust dissolving after a fixed period of time or would you rather it paid out for the remainder of someone’s life (whether it’s yours or someone else’s)?

-Most split-interest trusts are drafted so that one or more charities is named to receive the charitable interest in the trust’s assets. What organization or organizations do you want to support?

-In the event that the charity you named in your trust document ceases to qualify as an “IRS-approved” charity, what is your backup plan? Would you like to name a special trustee whose only power is to be able to change the charitable recipient? Alternatively, would you prefer to establish a donor-advised fund at a community foundation (e.g. the San Diego Foundation, the Jewish Community Foundation) to take custody of the assets if the organizations named in your trust document cease operations?

There are as many variations of charitable trusts as there are taxpayers who establish them. Please don’t hesitate to give us a call if you would like to discuss how a charitable trust might work for you.

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