A Legal Navigation Guide
Charitable Remainder Trusts
By Jessica L. Estes
With the holidays fast-approaching, things can get quite hectic: family gatherings, holiday decorating and shopping for that unique, but perfect gift for each of your loved ones. This year, as you make your list and check it twice, you may want to consider a charitable remainder trust.
What is a charitable remainder trust? A charitable remainder trust is an irrevocable trust that allows the donor, or another individual you name, to receive each year either a fixed dollar amount from the trust or a percentage (at least 5 percent) of the value of the trust. The right to receive this distribution is either for the individual’s lifetime or for a period of years not to exceed 20 years. At the end of the term, the amount remaining in the trust is distributed to a qualified charity. Generally, a qualified charity is one that has been deemed tax-exempt by the Internal Revenue Service.
Moreover, the charity will serve as trustee of the trust and will be responsible for investing and managing the asset(s) in order to produce income for you. Because the charity is also the remainder beneficiary, it has an incentive to increase the value of the trust, which in turn, benefits not only the charity, but you or the income beneficiary of your trust.
What are the tax benefits of a charitable remainder trust? There are three primary tax benefits. First, after you have transferred the asset(s) to the trust, you may take an income tax deduction, spread over five years. You are not, however, allowed to deduct dollar for dollar the amount that you gave. Rather, you are only allowed to deduct the amount of the “gift,” which is the amount donated less the amount of income you are expected to receive. For example, if you donate $100,000 to the trust, but are expected to receive income of $30,000, then you are only able to deduct $70,000.
Another benefit is that whatever the charity receives at the end of the trust term is not subject to estate tax. Similarly, the donation will not be subject to gift tax for the amount of the “gift.” However, if the income beneficiary of the trust is someone other than the donor, or their spouse, then there may be a gift tax imposed on the amount of the income that is paid to the income beneficiary.
Finally, because the charity is tax-exempt, there is no capital gains tax on the sale of the asset(s) in the trust. So, you can turn nonincome-producing property, which has increased significantly in value from the time at which you acquired it, into cash without having to pay capital gains tax on the profit. This enables you to invest the full proceeds of the sale into an income-producing asset. For example, you own stock that currently is worth $200,000, but you only paid $10,000 for it 20 years ago. If you were to sell the stock, you would have to pay capital gains tax on the $190,000 profit. On the other hand, if you transferred the stock to a charitable remainder trust and the trust sold the stock, there would be no capital gains tax. Furthermore, the full $190,000 profit could be invested in a mutual fund that would pay you a portion of the income it produced.
Fixed annuity or percentage of trust? You can elect to have either fixed annuity payments or a percentage of the current value of the trust. If you choose the fixed annuity, you will receive a fixed dollar amount each year. This is beneficial if the trust has a lower-than-expected income return because you will still receive your fixed payment. Sounds great, but be careful. The higher your annuity is, the lower your income tax deduction. Also, if the trust does not generate enough income to cover your annuity payment, then the trust’s principal will be used. The more principal that is used, the less likely it is that the charity would receive anything at the end of the trust term and consequently, the less likely it is that the charity would accept your donation in the first place.
Conversely, if you elect a percentage of the value of the trust, your payments will reflect any gains or losses in value of the investments each year. And, it is important to note, that once you make a decision, you cannot change it later. If you are considering a charitable remainder trust, consult a qualified attorney and financial planner before making a final decision.
Jessica L. Estes is an elder law and estate-planning attorney at Byrd & Byrd, LLC with offices in Bowie and Prince Frederick. She can be reached at 301.464.7448 or on the website at byrdandbyrd.com