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Charitable Remainder Trust and Charitable Lead Trust Planning

Fact Checked by Jason Herring & Barry Brooksby
Licensed Agents & Life Insurance Experts.
Insurance and Estates, a strategic life insurance provider composed of life insurance professionals, is committed to integrity in our editorial standards and transparency in how we receive compensation from our insurance partners.
Hand Donating Money To Charity

Giving to charity is proper stewardship and is no doubt good for the soul. However, did you know that charitable donations also offer huge tax advantages?

Better yet, the advantages of charitable giving can be maximized through charitable trust planning.

Tax Advantages of Charitable Donations

Charitable donations can reduce your income taxes because the IRS allows a tax deduction for contributions to valid charities. Among the various reasons for this special tax break is a strong public policy in favor of helping non-profit organizations who are working to help the less fortunate or support a worthy cause.

Charitable donations offer tax benefits NOT ONLY because they are income tax deductible but also because they reduce the size of the donor’s estate, which is an added benefit for federal estate tax planning.

So when the average person gives from their disposable income to a valid charity, he or she can deduct (subtract) it from taxable income, and thereby pay less income taxes, while also reducing exposure to federal estate taxes.

An income tax deduction means that a contribution to a valid charitable organization is deducted (subtracted) from your taxable income, thus reducing your income taxes.  This could be called savings level 1 in the world of charitable planning.

A second level, that we might call savings level 2, would be realized in the form of a lower federal estate tax at the time of the asset owner’s death when the gross estate is tallied for federal estate tax purposes.  The reason for the lower federal estate tax is that the charitable donations reduced the overall size of the estate and federal estate taxes are calculated based upon the gross estate.  Simply put, a smaller estate arising from lots of charitable donations results in lower estate taxes.

I point out the two levels of savings above because they are ALSO a large part of the basis for charitable trust planning.

Charitable Trust Planning Basics

Like most other areas of trust planning, giving money or assets to a trust created for a particular purpose (instead of directly to the beneficiary) allows for much greater flexibility and additional advantages that come from “splitting the interest”…more on this concept to follow.

So, what can happen when we donate to a charitable trust instead of directly to the charity?  

The short answer is that you just put your charitable giving on steroids, but explaining this requires a bit of background information.

Backtracking to our recent article on irrevocable trust planning, I suggest that you mark this spot and review that article, because some background in understanding trusts is helpful before diving into charitable trusts.

Also, in that article, we describe the basic types of charitable trusts and the differences between them.

Our prior article answered the question “what is a trust” AND highlighted the fact that a trust is an agreement to accomplish a given set of purposes as specified in the trust agreement. That article also distinguished between revocable and irrevocable trusts which are respectively used for very different estate planning purposes. Finally, that article identified charitable trusts as “irrevocable” and described four various type of charitable trusts and their meanings.  We will touch on them again below in our discussion of charitable trust planning.

Key Strategies for Charitable Trust Planning

The purpose of a charitable trust will be to take advantage of the tax benefits that are available when giving to charitable organizations AND adding a number of advantages including ways to share in the wealth while preserving a portion for the charity.

Remember, the basic idea behind ALL trust planning is to create a agreement to accomplish any number of specific purposes which may include

Using a charitable trust provide the SAME income tax and estate tax advantages discussed above while ALSO offering the following major benefits for saving on capital gains and estate taxes.

Most people really don’t know much about the advantages of charitable giving, much less how a charitable trust works AND the options that this strategy offers.  Among the reasons for the mystery, is the fact that much of these discussions tend to involve the IRS tax code, and thus, eyes can glaze over and a severe case of ADD can kick in.

The types of beneficiaries AND advantages sought will determine the type of charitable trust that will be used.  

There are two types of trust beneficiaries which are income beneficiaries and remainder beneficiaries.

Charitable trusts are a specific type of irrevocable split interest trust, because a portion the income is paid to charity and/or the grantor and the remainder is designated to pass either to the charity of beneficiaries.

A charitable remainder trust (CRT) designates a charity as the remainder beneficiary and will most likely be used for resolving issues with capital gains while also offering income tax advantages.

A charitable lead trust (CLT) designates a rate of return or income to be paid to the charity over a specified time period and is more commonly used for estate tax planning because the balance of the estate assets will pass to beneficiaries free of estate taxes upon expiration of that time period.

Within the two broad types of charitable trusts mentioned above, an important distinction is whether an “annuity trust” or “uni-trust” (a/k/a “unit trust”) is used.

Charitable Remainder Trust Planning to Save Capital Gains

For business owners who are seeking an exit strategy and doing some form of business continuity succession planning OR for others who hold appreciated assets with a very low basis, such as stock or real estate investments, a charitable remainder trust can offer massive advantages.

When referring to appreciated assets with low basis, we are referring to the concept that the IRS taxes “gains” on assets at the time of sale.  So, if you paid $10,000 for a parcel of real estate 20 years ago which now worth $100,000, you would face approximately $90,000 of taxable gain under normal circumstances.  

Capital gains rates rose under the Obama administration and apply to all types appreciating assets.  Small business owners and family businesses may be especially impacted by capital gains because the tax ramifications of selling and retiring (or transferring ownership) can seriously hinder the owner’s retirement plans.  Thus, business owners often seek a solution to the major capital gains that will result from the sale of the family business.

Using a charitable remainder trust (CRT) offers a solution to the capital gains problem that goes something like this…

Appreciated assets, such as the stock of a closely held business or the assets of the business, are transferred (assigned) to the charitable trust. This transfer results in an income tax deduction to the business owner.  The business interest or assets are then sold by the charitable trust with NO capital gains AND the proceeds may be used to purchase other income producing assets.  Either a portion of the income, a rate of return or the percentage of trust assets will be designated to the charity as described in the charitable trust.

Charitable Remainder Annuity Trust vs Charitable Remainder Uni-Trust

How to calculate the portion of income that goes to the charity relates directly to the type of trust designated as discussed in our prior article on irrevocable trusts:

Charitable Remainder Annuity Trust (CRAT)

A CRAT will designate an annuity payment to the trustmaker-donor (hereafter “grantor”) over a specified time period.  The annuity payment will be based upon the value of the initial accounts (or assets) contributed to the trust with the possibility for adjustments down the road.

Charitable Remainder Uni-Trust (CRUT)

A CRUT will designate the income to the grantor based upon a percentage of the overall value of the trust that is usually reviewed annually.  This is a more stringent calculation that may likely result in higher income payments made to the trustmaker so this approach may or may not be preferred depending upon whether the goal is to transfer MORE or LESS income to the grantor.

Charitable Lead Trust Planning to Save Federal Estate Taxes

A charitable lead trust (CLT) is often used save on federal estate taxes and this scenario may go something like this…

Assets are contributed to the CLT which provides that an income stream is paid to a charity for a period of years. The remainder of the assets will pass to desired beneficiaries estate tax free upon expiration of the specified term.  This specified term is based upon the desired payout period and a formula to arrive at the amount to be paid to the charity.

The CLT also is more likely to be used to limit the grantor’s taxable income because a portion of the income generated by the charitable trust assets will be paid to the designated charity.

Similar to the CRAT and CRUT scenario above, the charitable lead annuity trust (CLAT) will utilize an annuity payment to determine what is paid to the charity based upon the initial account value of the trust, whereas a charitable lead uni-trust (CLUT) will be a percentage of the total trust value reviewed annually.

Grantor and Non-Grantor Trusts

Another key distinction for CRATs, CLATs and CRUTs, CLUTs, is whether the trust will be treated as a grantor or non-grantor trusts.  Simply put, grantor trusts recognize taxable income to the grantor because he or she retains an interest, whereas non-grantor trusts do not.

The details and formulas touched on above should be considered a brief outline of the options that are available, whereas your actual strategy should be examined in detail based upon the needs and goals of your estate and all parties concerned.  This is where expert advice is needed.  Contact us today to start your evaluation process.

1 comment… add one
  • Bellus86553 starting a business May 9, 2017, 3:07 pm

    Greetings! Very helpful advice within this post! It’s the little changes that make the most significant changes. Many thanks for sharing!

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