Charitable Trusts [Important Tax and Estate Planning Benefits]

At a recent meeting of the Heckerling Institute, which is an annual educational event for the top estate planning attorneys in the country, there was a toldfold emphasis on using charitable trusts. The first emphasis was the increasing importance of income tax planning AND the second was on estate planning as it relates to charitable trusts.

For most people, the eyes inevitably glaze over when this topic arises, perhaps with the exception of the few who have benefited financially from this powerful tool. Today’s article will serve as an introduction and overview of the powerful planning options that are available through the various types of charitable trusts.

Florida Charitable Trust Planning 

Planning for Estate Preservation and Income Taxes

To avoid confusion, there is a somewhat different focus when planning for income taxes vs estate preservation a/k/a federal estate tax planning.

For many years, trust attorneys have used charitable trusts for estate planning as an option to limit federal estate tax exposure. Estate taxes are an issue when the gross estate of someone who recently passed is in excess of the exemption amounts allowed under Federal or State laws. So prior to the Republican tax overall, the exemption amount was a tad over $5,4 million for individuals about double that ($11.8 million) for a married couple. As of the 2018 overhaul, the exemption amounts have expanded considerably at $11.2 million for individuals and $22.4 million for married couples.

If the gross estate is less than these amounts, there will be no Federal estate tax issue. There may be a state estate tax issue depending upon whether the state has an estate tax. In FL and CA there is no state estate tax, whereas there is one in NY.

Using Charitable Trusts in Florida For Estate Tax Planning

So a very simplified explanation of charitable planning as a Florida estate planning tool is that charitable trusts may be used as a way to allocate to the charity the portion of the estate which exceeds the Federal estate tax exemption in order to limit or avoid Federal estate taxes. Notably, Florida doesn’t have an inheritance tax, so we are talking about Federal taxes only here. Depending upon the type of charitable trust used (to be discussed), either the charity can be paid an annuity payment for fixed timeframe and the remainder of the asset can go to the family OR the family can receive an annuity and the remainder can go to the charity. Under either scenio, the family avoids the estate tax burden while contributing to a charitable cause. Estate tax planning of this type is especially common when a family business is concerned and Florida business succession planning is necessary to assure that the business will weather the estate taxes.

Using Charitable Trusts in Florida For Income Tax Planning 

So with the relatively high estate tax exemption amounts, charitable planning seemed to fade for a time due to a lessened need to use this planning. However, as discussed at Heckerling, income tax planning is beginning to take center stage in the estate planning attorney’s world. Income tax planning with a charitable trust can be described with potential real life scenario:

If Tom and June wish to sell an office building worth $2,000,000 which they’ve owned for 28 years and has been fully depreciated, they could sell it outright and they will incur income taxes for a recapture of depreciation and will also face capital gains. If instead of selling it outright, they place the real property in a charitable remainder trust, they will receive a substantial income tax deduction for gifting the real property and avoid the income tax/capital gains due to the exempt status of the charity. They can then sell/convert the asset (sell it) inside of the trust into an asset that will offer them an annuity payment for life and the remainder of the asset will go to the charity.

The above example is intended to illustrate the usefulness and application of charitable planning tools as an income tax savings strategy. There are many more possibilities, and of course every situation requires an in depth analysis of the specific situation.

Charitable Remainder Trusts vs.

Charitable Lead Trusts 

The 2 primary types of charitable trusts are the charitable remainder trust AND the charitable lead trust. Among these types, there are further distinctions depending upon whether the trust is an “annuity trust” or “uni-trust” and these distinctions can lead to some different acronyms for those who market unique variations of these trusts.

For the remainder of this article, we’ll focus mostly on defining these 2 broad types, noting some distinctions, and reserving the more complex discussions about the pros and cons for other targeted articles.

Charitable Remainder Trusts (CRT) are the most common type of these 2 and usually work something like this:

You set up the trust by creating the document, appointing the charity as trustee, and then transferring property to it as a donation. The trust must be approved by the I.R.S. The charity then manages the trust property so that it produces an agreed amount of income for you as the trustmaker OR someone designated by you. The payment period is specified in the trust documents.

You get to take an income tax deduction, spread over 5 years, for the value of your gift to the charity. Upon your death, the balance of the trust property will go to charity free of estate taxes.

Back to our annuity trust vs. unitrust notation above, a charitable remainder annuity trust (CRAT) then would provide that the income to the trustmaker (or designated payee) would be paid like an “annuity” or a fixed percentage of the initial value of the assets placed in the trust. A charitable remainder unitrust (CRUT) would provide that the income is based upon a specified percentage of the trust assets revalued each year. The major difference is the former pays based upon a initial fair market value, whereas the latter pays based upon a percentage that is revalued every year.

Charitable Lead Trusts (CLT) operate in reverse of the CRT by providing a certain amount of agreed income to the charity (based upon and I.R.S. approved formula) for an agreed period of time. Any overage of income may be reinvested in the trust and upon the trustmaker’s death, the balance of the trust can pass to heirs free of estate taxes. The tax deduction for the assets donated still applies.

The annuity trust example above also applies to charitable lead trusts, swapping the acronym with a charitable lead annuity trust (CLAT) and charitable lead unitrust (CLUT). The difference in payout formula for the CLAT and CLUT is basically the same as the CRAT and CRUT, either as a percentage of the initial assets to trust OR as a percentage revalued every year; however, this time the dollar amount paid out is to the charity (not the trustmaker).

One more important thing to understand about charitable trusts, applicable to the CRT, is that they may be especially beneficial in a low interest rate climate because of the lower amount that will be required to be paid to the charity.

Steve Gibbs, Esq.

This is an updated version of an original post dated January 8, 2015.