Charitable Trust (CRT)

A Charitable Remainder Trust ("CRT") is an irrevocable tax-exempt trust that is comprised of two parts. The first part is the income interest, which provides that during a designated period (e.g., the joint lives of you and your spouse), the income from the trust is paid to you or to your heirs. The second part is the remainder interest, which provides that at the conclusion of the income interest period, the trust assets are distributed to a qualifying charity. The charity is the beneficiary of the trust’s remainder interest.

Documents establishing a charitable remainder trust (CRT) must be carefully prepared to satisfy the requirements set by applicable portions of the Internal Revenue Code and Regulations. As a split-interest trust (see glossary below), the trustee has complete financial management responsibility for the donor's property placed in a CRT. Generally, the trust must qualify as an annuity trust, a unitrust, or a pooled income fund (see glossary). The donor retains an income interest for which he, she, or they receive income payments for a period that generally cannot exceed 20 years, or the remaining lifetime of the income beneficiaries. The charity receives the remainder interest upon termination of the income beneficiary's life interest in the trust assets — usually this occurs upon the death of the beneficiary or beneficiaries.

Starting with the tax year with the CRT is established, the value of the remainder interest qualifies as a charitable gift deduction for purposes of the donor's income tax return. This deduction is subject to the 30-percent rule or the 50-percent rule as applicable according to the nature of the charity receiving the remainder interest. Excess contributions can be carried forward to the donor's income tax returns for up to five years. Any unused charitable deduction lapses at the end of the fifth tax year after the year the trust is established.

The amount of the tax-deductible remainder interest is determined from tables in Internal Revenue Service Publication 1457. Primary determining factors are the age of the income beneficiary or beneficiaries at the time income payments start, the applicable federal interest rate, and the qualification of the trust as an annuity trust, a unitrust, or a pooled income fund. Generally, the size of the remainder interest increases with the age of the beneficiary at the time income payments are to start. For a given age at the time income payments start, the size of the remainder interest is greater when the applicable federal interest rate is lower. When they have data on the type, amount, timing, recipient, and income beneficiary of a proposed gift, your legal and tax advisers can use Publication 1457 tables to provide you with an estimate of the remainder interest value for tax purposes.

Assets placed in a CRT meeting annuity trust or unitrust requirements are not included in the donor's estate for gift or estate tax purposes. If the donor's spouse is an annuity beneficiary, there are no gift or estate tax adverse consequences upon the death of the spouse. The trust assets are included in the spouse's estate and also are deductible from that estate as a charitable gift.

Income earned by an annuity trust or a unitrust CRT is not subject to income tax unless the CRT has business taxable income not related to the charity beneficiary. Payments from the CRT to the annuity beneficiary generally are taxable as ordinary income or capital gain income (short-term or long-term depending on circumstances). If annuity payments to the donor exceed the earning capacity of assets in the CRT, part of the payment may be nontaxable distribution of the corpus of the trust. There are numerous other specific aspects of charitable giving using a CRT that may or may not be important depending on your situation. Consult your tax and legal advisers before making decisions.

A Charitable Annuity

Charitable annuities are offered by many charitable organizations. In using this form of charitable giving, the owner of assets transfers (donates) them to the charity and the charity agrees to pay the donor or other beneficiary (beneficiaries) a lifetime annuity. The present value of the annuity contract is calculated using Internal Revenue Service tables and varies with the age of the donor and the applicable federal interest rate. A portion of each annuity payment received by the donor is taxable income. The remainder is a nontaxable return of assets.

If the fair market value of assets donated to the charity is greater than the present value of the annuity contract, the donor receives an immediate charitable deduction equivalent to the difference. If the value of the annuity contract exceeds the fair market value of the donated assets, there will be a taxable gain to the donor — a taxable gain that can be avoided by using a charitable remainder trust instead of a charitable annuity.

If the charity has an established charitable annuity program, the donation and establishing of the annuity are easily accomplished. Donors are attracted to charitable annuities when the fair market value of the donation will exceed the value of the annuity contract and the donor is receiving significant levels of taxable income. The certainty of lifetime income in combination with an immediate tax deduction make the charitable annuity particularly attractive.

In circumstances where it's likely a surviving spouse will be unable or unwilling to manage family assets, a charitable annuity or a charitable remainder trust can be a means of ensuring an income stream throughout the remainder of the lifetime of annuity beneficiary or beneficiaries.

Glossary of Terms

The terminology used in describing charitable remainder trusts includes a number of terms with specialized meanings. Several of the most important are briefly defined here:

Contribution base

The base amount used when calculating and individual's or family's maximum allowable tax deduction for contributions made during a tax year. The contribution base is calculated as the individual's (the family's) adjusted gross income before adjustments for net operating loss carryback, if any.

50-percent rule

The rule limiting a taxpayer's charitable deduction for gifts given to a "public charity," a "private operating foundation," or a "private distributing foundation" (see definitions, below). With certain exceptions for gifts of appreciated property, in any tax year this deduction is the amount of the gift up to 50 percent of the donor's contribution base. Gift amounts above the 50 percent limit are carried forward as "excess contributions."

30-percent rule

The rule limiting a taxpayer's charitable deduction for gifts given to a "private foundation" (see definition). In any tax year this deduction is the tax basis of the gift up to 30 percent of the donor's contribution base. Gift amounts above the 30 percent limit are carried forward as "excess contributions."

Public charity

A charitable organization of a type listed by IRS in Internal Revenue Code § 170(b)(1)(A)(i) through (viii). Gifts to a public charity qualify as charitable deductions for income tax purposes. Organizations such as churches, not-for-profit schools, hospitals, community service organizations, and other similar units are public charities.

Private foundation

A charitable organization that does not qualify as a "public charity" is designated as a private foundation. Gifts to a private foundation are valued at the donor's cost basis rather than the market value of the gift. (See exception under definition of "30-percent rule", above.) Unless a private foundation meets the requirements for designation as a "private operating foundation" or a "private distributing foundation" (defined below), the value of gifts it receives in a given tax year from individual or family donors are tax deductible to the donors in amounts up to 30 percent of the donor's contribution base (the 30-percent rule).

Private operating foundation

A private foundation that's actively engaged in carrying out its charitable purpose. Examples include, operating a public facility or conducting research or education programs. In a given tax year, an individual or family donor to a private operating foundation is entitled to a tax deduction for gifts in amounts up to 50 percent of the donor's contribution base.

Private distributing foundation

A private foundation that serves as a "pass through" for the gifts it receives by distributing each gift to public charities within two and one-half months of receiving the gift. In a given tax year, an individual or family donor to a private operating foundation is entitled to a tax deduction for gifts of up to 50 percent of the donor's contribution base.

Excess contributions

Contributions made during any tax year in excess of the 30 percent rule or the 50 percent rule. Subject to the 30 percent or 50 percent limits, excess contributions can be carried forward and deducted in the five tax years following the tax year when the contribution was made. The maximum amount of the excess contribution deduction is the difference between the donor's current tax year contributions and 50 percent or 30 percent of the donor's contribution base, as determined by the rule applicable to the excess contribution.

Split-interest trust

A trust containing property in which both charitable and noncharitable interests are beneficiaries; a trust that holds property for the benefit of a charity and for the benefit of a person (persons) or entity that's not a charity. In most cases, the noncharitable beneficiary is the donor of property placed in the trust or is a close relative of the donor.

Charitable remainder trust

A split-interest trust in which the remainder interest is held for the benefit of a charitable organization, and the trust meets requirements for classification as an annuity trust, a unitrust, or a pooled income fund.

Charitable income trust

A split-interest trust in which the charitable interest is an income interest for the charity. This trust also must meet requirements for classification as an annuity trust, a unitrust, or a pooled income trust.

Annuity trust

An annuity trust is defined completely in Internal Revenue Code § 664 and its Regulations. In lay language, an annuity trust is one that specifies a fixed dollar amount to be paid at least once a year to the income beneficiary. The minimum payout allowable is 5 percent of the fair market value of the trust property at the time the trust is established. Upon the death of the owner, the balance of the trust goes to the charity.

Unitrust

A split-interest trust similar to an annuity trust in which the annual payment to the annuity beneficiary is based on a fixed percentage of the fair market value of the trust assets when the trust assets are valued annually. (An alternate and less-frequently used form of unitrust limits the annual payment to the actual income earned on the trust assets.) Upon the death of the owner, the balance of the trust goes to the charity.

Pooled income fund

An agreement under which a donor transfers assets to a charity in return for a stream of annual payments based on the value of the donation times the earning rate for all funds held by the charity for investment purposes. The stream of payments continues throughout the remaining lifetime of the beneficiary or beneficiaries, and upon the death of the last surviving beneficiary, the remainder goes to the charity. The remainder interest is a deductible contribution for the donor if certain technical requirements are met.