Helping a charity and a family member at the same time, while achieving a tax break, is an attractive proposition. One such vehicle for doing this is the charitable remainder trust. With proper planning, it can provide you and your family with many tax and estate planning advantages.
Basically, you contribute cash to a trust. You designate your child to receive income from the trust for a fixed period of years or for life. When the child’s income interest ends, the trust property is paid to a charity that you choose when you set up the trust.
One immediate tax advantage is that you get a substantial income tax deduction for a charitable contribution in the year you set up the trust. The amount of the deduction is the present value of the “remainder interest” (as it is technically called) that you gave to the charity. Furthermore, you do not have to pay gift tax for the charity’s remainder. You also will save any estate tax that may have been due from the donated property because the property will not be included in your estate.
The income interest that you give to your child, however, is subject to gift tax. Even so, you may not have to pay any tax out-of-pocket. First, the annual exclusion can be used to reduce or eliminate gift tax. And, if the value of the income interest exceeds the annual exclusion amount, $15,000 for 2021 and 2020 ($30,000 if your spouse consents to gift splitting), you still may not have to pay gift tax if you have not previously used all of your unified credit.
You cannot just set up any trust and gain the advantages outlined above. You must use a trust that satisfies the IRS requirements for a charitable remainder unitrust, a charitable remainder annuity trust or a pooled income fund. There is only one donor in the case of a charitable remainder annuity trust or unitrust, whereas pooled income funds involve commingling of funds from several donors. In that sense, pooled income funds offer better protection in the form of greater diversification.
The key difference between a unitrust and an annuity trust is how the income payment is computed. If you set up a unitrust, your child’s income payment each year will be a fixed percentage of the trust’s assets. This percentage must be at least 5 percent. With an annuity trust, the payment is a fixed amount, which must not be less than 5 percent of the initial value of the trust property. You cannot fix payments from a pooled income fund. They depend solely on the fund’s earnings.
You don’t have to fund an annuity or unitrust with cash. You can transfer, for example, the stock you own that has greatly appreciated in value from the amount you paid for it. An advantage of doing this provided the transaction is properly structured, is that you would not pay tax on the gain like you would if you sold the stock. The trust could sell the stock without paying tax. A pooled income fund, however, is not exempt from tax and you would be taxed on property it sells at again.
Please do not hesitate to contact us to explore the proper vehicle for you, your family and your favorite charity.