Consider using a charitable trust for lifetime gifts
There are many techniques available to those who wish to use the increased exemption during their lifetime. One “tool in the toolbox” that can be combined with using the exemption is a charitable trust. An individual may leave the bulk of her estate in a charitable trust, saving millions of dollars in gift and estate taxes and allowing her heirs and selected charities to receive a significantly larger portion of her estate. Through a charitable trust, a donor can make an irrevocable future gift to a charity and still claim a current income tax deduction to the gift. In addition, she can take advantage of the current gift and estate tax exemption for
the noncharitable portion of her gift.
There are two types of charitable trusts: a Charitable Remainder Trust and a Charitable Lead Trust.
Charitable Remainder Trust
When a Charitable Remainder Trust is established, a gift for cash or property is made to an irrevocable trust. The donor retains an annuity from the trust for a specific number of years or for the life or lives of the noncharitable beneficiaries. At the end of the term, the charity specified in the trust document receives the property in the trust, including any appreciation.
Charitable Remainder Trusts may take either of two forms, depending on whether the income payments are determined based upon the trust’s initial value or the value of the trust property determined on an annual basis. Payments under Charitable Remainder Annuity Trusts remain the same for the entire term of the trust, while payments under a Charitable Remainder Uni-Trust vary depending on the trust’s investment return.
Because their assets are intended for a charity, Charitable Remainder Trusts do not pay any capital gains taxes. For this reason, Charitable Remainder Trusts are ideal for assets like stocks or other property with a low-cost basis but high appreciated value. Funding a Charitable Remainder Trust with highly appreciated assets allows a donor to sell those assets without paying any capital gains taxes; thus, the full value of an asset transfers to the trust and to the donor’s family and favorite charity.
Many donors use Charitable Remainder Trusts to supplement their current retirement plans. If the donor sets up such a Remainder Trust in his peak earning years, he can make contributions and let it grow without taking income from it during the early years. Upon the donor’s retirement, the Remainder Trust can begin making payouts to him. These payouts can include makeups for any shortfalls in income the donor did not receive earlier. Unlike an IRA or a 401(k), there are no limits on how much a donor may contribute.
Charitable Lead Trust
A Charitable Lead Trust provides a stream of income for a stated period of years to the designated charity. When the period ends, the property held in trust returns to the donor or to the donor’s designated beneficiary.
Under a Charitable Lead Trust, the donor receives an immediate federal income tax deduction when she makes the gift, equal to the present value of the future income string. The donor is taxed each year, however, on the value of the income interest that is payable to the charity. The donor may establish a charitable lead trust during her lifetime, or may establish it at her death under her will. If the donor establishes the trust at death, the estate claims an estate tax deduction instead of an income tax deduction. Like Charitable Remainder Trusts, Charitable Lead Trusts offer a reduction of capital gains taxes and any appreciation on the value of the residual assets is free of gift and estate taxes.
Why would a donor consider a trust that produces a high deduction in the first year but requires the donor to report income he didn’t receive in later years? One benefit is the acceleration of a deduction. If you have just won the lottery or sold a highly appreciated asset, or you expect your income to drop significantly in coming years, taking a very high deduction in a high-bracket year even if you have to report that income in lower-bracket years is sound planning.
Charitable Trusts are not for everyone and there are other methods to think about when looking at using the gift and estate tax exemption. All the factors that need to be considered in determining whether or not a Charitable Trust is right for the reader are beyond the scope of this article. This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.
Lisa Lowe is an attorney in the Vancouver office of regional law firm Schwabe, Williamson & Wyatt. Lisa focuses her practice in the area of estate planning and can be reached at alowe@schwabe.com or (360) 905-1434.
