A Great Time To Give: Charitable Trust Planning in the Current Environment

Carl Fiore, JD, LLM
Published Date:
Jan 1, 2016

While charitable giving has always been an important part of tax planning, the current tax and economic environment has greatly incentivized many wealthy individuals to give more.  Higher tax rates and a concentration of asset growth from both an appreciation and net-worth standpoint have created optimum conditions for charitable giving.  For many high-net-worth individuals, charitable planning not only serves to meet philanthropic goals and reduce taxes, but can also alleviate non-tax concerns such as too much wealth going to heirs.  Not surprisingly, charitable giving has increased significantly in recent years.  Given these realities, there exists a need for integrated, short- and long-term charitable planning in order to maximize efficiencies for both income and transfer tax purposes. 

Whether giving outright or through charitable trusts, it is important to know the rules so that the expected result is achieved.  Not only do these rules impact an individual’s deduction, but they can also be helpful in determining the type of charitable planning best suited for an individual’s particular tax situation. 

Charitable deductions can be limited depending on what type of property is contributed, the type of receiving organization, and the taxpayer’s adjusted gross income (AGI).  For example, a cash gift to a public charity (including a donor advised fund) generates a deduction up to 50% of the taxpayer’s AGI (30% for contributions to private foundations), while a contribution of appreciated assets generates a deduction up to 30% of AGI (20% for contributions to a private foundation).  Any portion of the contribution that is not deductible due to these limitations in the current year carries over for 5 years. 

Along with these AGI limitations, taxpayers must also be cognizant of whether their deduction base is fair market value or basis, which is also dependent on the asset and organization.  When giving to public charities or donor advised funds, assets held long term (in other words, for more than 12 months) will qualify as fair market value property.  If giving to a private foundation, however, only long-term stock trading on an established market would qualify.  As assets get more complicated, so too do the rules establishing the deduction base. 

Finally, when making outright contributions, taxpayers should follow IRS requirements to ensure deductions are allowed.  For example, depending on what and how much is contributed, an appraisal may need to be prepared and filed with the tax return to substantiate the deduction. While outright giving is an easy way to accomplish charitable goals on a yearly basis, other charitable planning techniques can provide greater efficiency for more complex situations.   

For individuals looking to diversify a highly appreciated, concentrated position, a charitable remainder trust (CRT) can be a very attractive option.  This type of trust allows for an immediate charitable deduction and gain deferral, while still providing the donor or their spouse an income stream until the trust terminates and the remainder goes to a charity of the donor’s choosing, including a private foundation.

In a typical fact pattern, a grantor contributes an asset, such as low basis stock, to a CRT.  The grantor then retains an annual income interest in the trust, either for life or for a term no longer than 20 years.  This income interest is calculated either as a set amount determined by a percentage of the initial value of the trust (a Charitable Remainder Annuity Trust), or as a percentage of the trust value that is recalculated each year (a Charitable Remainder Unitrust).  Upon contribution, the grantor receives an immediate income tax deduction equal to the present value of the remainder interest, calculated by subtracting the present value of the income interest from the value of the asset contributed.  Although there is flexibility in how much of an income interest a grantor may retain, from a present value standpoint, that income interest must be at least 5% of the trust value and the remainder interest must be at least 10% of the initial trust value. 

Once contributed, the trust normally sells the assets and reinvests the proceeds.  Because the trust is itself a tax-exempt entity, it pays no tax on the gain recognized from that sale.  Instead, the grantor is taxed on the annual income payments.  The tax paid by the grantor is determined by the character of the income generated in the trust as compared to the dollar amount distributed, with the highest rate income being passed out first. 

For example, if in Year 1 the grantor is entitled to a payment of $10,000 and the trust in that year generated $1,000 of interest, $2,000 of dividends, and $1,000,000 of long-term capital gain, the grantor would be taxed on $1,000 of interest, $2,000 of dividends and $7,000 of long-term capital gain.  The remaining $990,000 of gain is then carried over to the next year.  If no additional taxable income is generated in Year 2 and the grantor receives the same $10,000 distribution, it would all be taxed as long-term capital gain and the remaining $980,000 is again carried over to the next year.  These tax mechanics are repeated for the duration of the trust. 

Upon the trust’s termination, the remaining assets are then distributed outright to charity.  Depending on the specific fact pattern, CRTs can be tailored to an individual’s specific tax and non-tax needs, which can include greater flexibility over how and when the income interest is paid, as well as early termination of the trust.  

For taxpayers looking to achieve both income and transfer tax benefits, a charitable lead trust (CLT) can be a very powerful tool.  Essentially the opposite of the CRT, a CLT provides for an annual income stream to a charity of the donor’s choosing (that can include a private foundation), with the remainder going to heirs.  Like a CRT, the income stream can be structured as an annuity or an amount based on the annual fair market value of the trust, although most CLTs are structured as annuities.  There is also a great deal of flexibility in how the annuity payments can be calculated, which can create greater tax efficiencies.

From a gift tax perspective, the trust can be structured so that the present value of the remainder interest is worth 0, thereby avoiding any gift tax issues when transferring assets to the trust.  To the extent those assets outperform the prescribed interest rate used to determine the present value of the remainder interest (2% in November), that appreciation passes to heirs free of transfer tax. 

From an income tax perspective, a CLT can be either a grantor or a non-grantor trust.  If structured as a grantor trust, the donor gets an immediate charitable deduction, typically equal to 100% of the value transferred to the trust, and then pays the trust’s income tax bill until termination.  If structured as a non-grantor trust, the donor does not get a charitable deduction for the gift.  Instead, income attributable to the assets transferred that would have been taxed on the donor’s individual income tax return is moved to the trust’s income tax return, where it is typically offset by the trust’s charitable deduction as it makes annual payments to charity.  Non-grantor CLTs can be particularly effective if an individual’s AGI limitations discussed above are exceeded.  Like a CRT, a CLT can be tailored to fit a specific situation.  In addition to the CLT itself, it may also be possible to engineer financial instruments to maximize CLT efficiencies as well. 

In today’s tax and economic environment, charitable giving can be highly effective.  From simple outright contributions to very sophisticated charitable trust planning, charitable giving can take many forms and provide several benefits.   To meet both tax and non-tax objectives, proper planning is critical and should be viewed with short- and long-term goals in mind.   

fioreCarl C. Fiore, JD, LLM, has significant experience with tax and financial matters affecting entrepreneurs, executives and other high net worth individuals.  He has worked with numerous families and closely held businesses to develop and implement wealth maximization plans through the use of family entities, income tax planning, stock option planning, charitable giving strategies, and effective gift and estate tax planning. Carl’s primary practice areas are gift and estate planning, planning for same-sex couples and fiduciary income tax.  He also has experience in federal and state income tax consulting and compliance for individuals, partnerships, fiduciaries, estates, corporations and private foundations. He can be reached at carl.c.fiore@andersentax.com or 646-213-5125.

Views expressed in articles published in Tax Stringer are the authors' only and are not to be attributed to the publication, its editors, the NYSSCPA or FAE, or their directors, officers, or employees, unless expressly so stated. Articles contain information believed by the authors to be accurate, but the publisher, editors and authors are not engaged in redering legal, accounting or other professional services. If specific professional advice or assistance is required, the services of a competent professional should be sought.