Charitable trusts are powerful estate planning tools to help you achieve philanthropic goals while reaping significant tax benefits. Charitable remainder trusts (CRTs) and charitable lead trusts (CLTs) sit at the heart of these strategies. This blog delves into charitable trusts and highlights the tax benefits they offer.
Charitable Remainder Trusts
A CRT is a type of irrevocable trust that provides an income stream for the donor or other beneficiaries with the remainder of the trust assets going to a charitable organization. The income can either be a fixed annuity (charitable remainder annuity trust or CRAT) or a percentage of the trust assets recalculated annually (charitable remainder unitrust or CRUT).
One of the primary tax benefits of a CRT is the immediate charitable income tax deduction. You can take an income tax deduction for the value of the assets that will go to the charitable beneficiary, spread out over five years.
Moreover, CRTs offer a way to bypass capital gains tax. When appreciated assets are donated to a CRT and then sold by the trust, no immediate capital gains tax is incurred. This allows the full amount to be reinvested, often leading to higher income payments. Additionally, the assets in the CRT are not part of the donor’s estate, reducing potential estate taxes.
Charitable Lead Trusts
On the flip side, a CLT is a mirror image of a CRT. A CLT provides an income stream to a charitable organization for a term, after which the remainder goes to non-charitable beneficiaries, such as heirs.
The tax benefits of a CLT are different from those of a CRT. If the CLT is structured as a grantor trust, the donor receives an immediate charitable income tax deduction for the present value of the income interest going to the charity.
However, future income generated by the trust is taxable to the donor. A non-grantor CLT does not provide an immediate income tax deduction, but the income paid to the charity is deductible by the trust, potentially offsetting tax on trust income.
A significant advantage of a CLT is its role in estate planning for high-net-worth individuals that are exposed to estate taxes. On the federal level, the estate tax is applied on the portion of an estate that exceeds $12.93 million. This is called the exclusion, and the Connecticut state estate tax exclusion is now equal to the federal exclusion.
First, you are removing assets from your estate when you fund the trust. Secondly, if the assets outperform the anticipated appreciation accrual that is calculated by the IRS using the hurdle rate, there will be a remainder that transfers to the non-charitable beneficiary free of transfer taxes.
Bringing It All Together
To sum up, charitable trusts offer a win-win solution for philanthropic individuals seeking tax efficiency. CRTs allow for an income stream for the donor or beneficiaries, an immediate charitable deduction, bypassing capital gains tax, and potential estate tax reduction.
CLTs, in contrast, offer immediate charitable deductions (for grantor CLTs), potential offsetting of trust income (for non-grantor CLTs), and effective wealth transfer to heirs at a reduced tax cost.
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Mr. Nirenstein is licensed to practice before the courts of the State of Connecticut and the United States District Court. He is a member of the Connecticut and Hartford County Bar Associations, and the Estate and Probate, Elder Law, Business Law and Real Estate Sections of the Connecticut Bar Association.