UTC§ 405 (a) (2000) – “A charitable trust may be created for the relief of poverty, the advancement of education or religion, the promotion of health, governmental or municipal purposes, or other purposes the achievement of which is beneficial to the community.”
Charitable trusts are powerful tools used in order to generate income to grantors and provide a benefit to charities. The advantages of these types of trusts can increase depending on the state law that the trust follows.
Section 2055
This is a very important tax code that allows a deduction from the gross estate for qualified charitable, religious, public, or for other purposes. It was created by the Revenue Act of 1918. This code details what is a qualified transfer, who is an eligible recipient, and split-interest gifts. In order for a transfer of property or money to be qualified as a charitable event, there are certain requirements that must be met. In turn, this encourages charitable giving, and is commonly used in estate planning.
- The transfer must be made by the decedent
- A deduction for a split interest gift is disallowed unless it meets one of the specified forms state in section 2055(a)
- Four major categories of recipients for charitable transfers: (1) Transfers for public purpose, (2) transfers for charitable corporations, (3) Transfers to trustees, (4) transfers to veterans
Charitable trusts vs. Personal trusts
A charitable trust differs from a personal trust. A personal trust is typically set up for the benefit of an individual while a charitable trust is set up for a specific purpose or cause. The oversight is also different. For example, the attorney general of the state is usually the one who looks over and regulates the charitable trusts. This is because a charitable trust has the ability of going untaxed, so the government will step in and make sure that these funds are being properly cared for.
Charitable trusts are exempt from The Rule Against Perpetuities and may endure forever. Personal trusts can only receive these benefits in certain states that fall under leading trust states having South Dakota trust law benefits that have dynastic trust features allowing for trusts to last almost indefinitely.
Are you the beneficiary of a trust?
A charitable trust is a trust that an individual can make a gift in support of a certain charity. A charitable trust MUST be for a charitable purpose rather than for an ascertainable beneficiary. A charitable trust does not require ascertainable beneficiaries. Usually, these trusts are created to qualify clients for tax deductions. A trust is not charitable simply by being beneficial to a large number of people. A trust can be benevolent without being charitable. To be charitable, a trust has to serve a charitable purpose. Charitable purposes include the relief of property, the advancement of education, the advancement of religion, the promotion of health, governmental or municipal purposes, and other purposes the accomplishment of which is beneficial to the community.
Common types of Charitable Trusts
CLAT vs. CLUT
These common trusts are designed to make annual payments to a designated charity, and after the stated trust term or the grantor’s death the remaining trust property, including any growth, is transferred to non-charitable beneficiaries (typically the donor’s descendants), free of transfer taxes.
Charitable Lead Annuity Trust
A charitable lead annuity trust (CLAT) pays a set amount to a charity for a specified amount of time. The remainder is then passed to the beneficiaries. These are powerful tools that can increase the tax break due to low interest rates. It is also a way for a grantor to transfer assets to the next generation with a little to no penalty of estate or gift taxes.
Charitable Lead Unitrust
A charitable lead unitrust (CLUT) is similar to a CLAT for being able to receive tax deductions. The difference is that at CLUT is based on percentage. A percentage of the trust is paid to a charity and the remainder falls to future generations. This percentage of the trust is fixed and is revalued every year. If the value of the trust increases then so will the payments and vise versa if the value decreases. This is taxable, but helps reduce the tax impact of the initial gift and cushion the tax hit from capital gains.
CRAT vs CRUT
With these trusts the assets are donated to a charity. The donor can still continue to receive income from the trust during their life or for a specific time frame. The grantor is able to defer income tax on the contributed assets, and may receive an income tax deduction for the fair market value of the remainder interest.
Charitable Remainder Annuity Trusts
Assets that are contributed to a charitable remainder annuity trust (CRAT) are paid to in a fix income amount to a beneficiary. This generates an income stream to the donor or beneficiaries. The annuity is calculated as a percentage of the trusts and cannot be less then 5%. The remainder is then paid to a charity after the donor passes. The fixed percentage paid from the annuity will not very regardless of the performance of the value of the trust, and additional contributions are not allowed.
Charitable Remainder Unitrust
A charitable remainder unitrust (CRUT) is similar, but distributes a fixed percentage based on the value of the trusts and additional contributions can be made. Income is also provided to the donor or beneficiary during their life then the remainder is passed to a charitable organization. The income can vary based on the value of the trust and this is revaluated every year.
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Trustee Responsibility
The two key responsibilities are to manage and distribute the trust assets. Above all, the trustee must follow the instructions outlined in the trust document. Here is a list of a few other responsibilities:
- Administration
- Duty of care
- Safeguard trust estate
- Accounting
- Investment management
A trustee plays a crucial role in the lives of beneficiaries and the donors. As a result, it is a huge responsibility paired with potential liability. If the trust document allows for discretionary distributions, a trustee will be mindful of the charitable intent. When a trustee is administering a charitable trust there are three primary concerns that they account for:
- Inappropriate asset allocation for the trust investments
- Distributions not in accordance with the terms of the trust
- The type of Charitable Trust is not appropriate for what the donor intends
The trustee has a major responsibility to safeguard the assets and to make sure that all actions inside the trust do not cause issue, and potentially place a high tax burden on the donor or the beneficiaries. That is why it is important to select the right trustee and to speak with an estate planning attorney to discuss the objectives of the charitable trust.