The Tax Benefits of Charitable Estate Planning

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• Charitable Remainder Trusts: Annuity vs. Unitrusts
• How a CRT Actually Affects Your Taxes

Many Oregon residents incorporate charitable giving into their everyday lives. But charitable gifts can also a form an important part of estate planning. For instance, placing real estate or securities into a charitable trust can help minimize potential the potential tax on any capital gains that would otherwise apply to the sale of such highly appreciated assets. “We do recommend them to some clients as being an appropriate estate planning tool,” says Abby Wool Landon, an attorney at Tonkon Torp in Portland.

Charitable Remainder Trusts: Annuity vs. Unitrusts

Although trusts are normally a function of state law, charitable trusts that wish to take advantage of certain tax benefits must also comply with Internal Revenue Service regulations. A charitable trust in this context usually refers to what is known as a “charitable remainder trust” (CRT). Basically, to establish a CRT you transfer certain assets into an irrevocable trust—i.e., you cannot remove the assets from the trust once the transfer is completed. Initially, the trust’s assets are used to benefit a non-charitable beneficiary, such as yourself, your spouse, or your children. After a certain specified period of time, the trust terminates and the “remainder” is distributed to an IRS-qualified charitable cause. The IRS generally recognizes two types of CRTs—annuity trusts and unitrusts. Here is a brief explanation of how the two charitable planing types differ:

• In a charitable remainder annuity trust (CRAT), the trust pays the non-charitable beneficiary either a fixed dollar amount or a fixed percentage of the trust’s assets each year. This amount must be between 5 and 50 percent of the trust’s assets, based on the original fair market value at the time the assets were transferred into the CRAT. The payments themselves must be first taken from the trust’s income, but if that is insufficient, then the trustee must use the trust’s principal, subject to certain IRS regulations.
• With a charitable remainder unitrust (CRUT), the trustee also makes an annual distribution to the non-charitable beneficiaries based on a fixed percentage (again, between 5 and 50 percent) of the trust’s assets. But the assets are revalued each year prior to distribution. A CRUT is also often structured to provide the beneficiary with the lesser of the trust’s net income or the fixed percentage, while also permitting the trust to “make up” in future years for prior distributions where the net income was less than the fixed percentage.

How a CRT Actually Affects Your Taxes

Under IRS rules, at least 10 percent of the “fair market value” of the property originally placed in a CRT must eventually go to a qualified charitable beneficiary. So if you or your beneficiary expect to live a very long time, a CRT may not be right for your situation, as the trust might not have enough assets leftover for the charity. But assuming everything goes as planned, a CRT can have significant tax benefits. For one thing, as the person funding the trust you receive both income and gift tax deductions for the remainder that goes to charity. And the annual payout you receive from the CRT is tax-exempt and not subject to federal or state income tax. And while you cannot revoke a CRT or remove property from it, you can change the charitable beneficiary or amend the amount of the annual payout. “If you’re going to use the charitable trust to both get your charitable deduction, and avoid the capital gains tax on the sale of a business—and you want to contribute your business interests to the charitable trust—you have to plan far ahead for signing any sale documents of the business,” says Landon. “Keep in touch with your trust & estate advisor, and know that, once you’ve signed that letter of intent or you’re in the middle of purchase or sale agreement, it’s too late to avoid the IRS making an accumulation-of-income argument.” Of course, this is a very simplified overview of charitable trusts and how they work. These are complex entities that involve specialized knowledge of federal and state tax laws. That is why you should never attempt to establish any kind of charitable trust without first consulting a qualified Oregon estate planning attorney. For more information on this area of law, see our overviews of estate planning, wills, trusts, and probate and estate administration.