A component of some estate plans may include gifts to charities (outright to a charity or, through a charitable trust), as a decedent's expression of gratitude to or advancing the interests of the charitable organization. In addition to the donor's underlying charitable intent when providing for a charity, charitable gifts qualify for deductions from income and estate taxes. Proper structuring of charitable gifts requires careful consultation with a donor to determine several factors, including the timing of the gift (during the donor's life or as part of the estate plan), type of gift (outright without restriction, outright but restricted to a certain purpose or by endowment provide a charity with ongoing income) and if the donors desires to benefit others in connection with a charitable gift (see below for discussion of charitable trusts).
Charitable Gifts
Gifts made to qualifying charities during a donor's lifetime qualify the donor for a charitable deduction on his or her income tax return, subject to certain income limitations. A donor desiring to create a permanent legacy may establish and contribute to an endowment fund providing an indefinite payment stream to the charity. The charity is prohibited from using the contribution to fund ongoing operations. Rather, the charity invests the contributions and may receive the income the fund earns, or a pre-determined percentage of fund's market value.
The source of assets for a donor's charitable gift is as important as the size and type. An important example is where a donor wants to make a gift of stock to a charity. If the donor gifts appreciated stock (where the stock's market value exceeds the donor's cost basis) the donor may claim a charitable deduction for the stock's value when transferred, but never recognizes the stock's gain. As a result, the capital gain in the stock is completely avoided. Alternatively, a gift of depressed stock results in the worst of scenarios, as the charitable deduction is equal to the stock's market value, and the donor cannot recognize the stock's capital loss for use in offsetting other income.
Another tax-efficient asset source for charitable bequests is individual retirement accounts (IRAs). Recent changes to the tax law allows for an individual age 70½ or older to make a qualified charitable distribution of up to $100,000 annually, directly from an IRA. As a tax-deferred asset, distributions from IRAs result in the recipient receiving taxable income. A qualifying distribution from an IRA to a charity excludes the amount of the distribution from the donor's taxable income, but does not give the donor a charitable deduction. Charitable gifts from retirement plans are particularly popular where the recipient has sufficient income and no need for the required minimum distributions they receive annually.
Charitable Bequests
Some donors prefer to establish their charitable legacy as part of their estate plan, by leaving a charitable bequest. A bequest to a qualifying charity entitles the decedent's estate to the estate tax charitable deduction. Bequests may take several forms, such as a specific amount, a percentage of the estate, or a specific asset. The bequest may also restrict its use by the charity for certain purposes, or may only allow a percentage of the bequest or the income earned on the bequest to be used by the charity for funding ongoing operations or for a designated purpose.
Charitable Trusts
A common desire of donors is finding a way to benefit both charitable and non-charitable beneficiaries. Providing for the financial security of a spouse, child, or other loved one can appear incongruous with a desire to provide for charities. A charitable trust, however, addresses the needs of both by having a dual beneficiary structure, and has the added benefit of providing significant income, gift or estate tax savings. A donor may create a charitable trust at any time during his or her lifetime, qualifying the donor for an income tax deduction, or in a Will or trust as part of the donor's estate plan, qualifying the donor's estate for an estate tax deduction. We generally divide charitable trusts into two categories, charitable remainder trusts, where a trust's remaining assets pass to a charity at the termination of the trust, and charitable lead trusts, where a trust's remaining assets pass to a non-charitable beneficiary at the termination of the trust.
Charitable Remainder Trusts
In a Charitable Remainder Trust (CRT), a non-charitable beneficiary (or beneficiaries) receives a payment stream from the CRT for a specified period of years or for the beneficiary's life. At the end of the trust, all of the remaining assets will pass to the designated charity (or charities). To determine if a CRT qualifies for a charitable income or estate tax deduction, the IRS requires an actuarial calculation of the trust's remainder interest at the trust's creation to exceed 10% of the value of the trust's initial assets. If this threshold is met, the income or estate tax charitable deduction is equal to the remainder amount.
There are two types of CRTs approved by the IRS, and a donor can use either type during the donor's life or at the donor's death:
- Charitable Remainder Unitrust - The non-charitable beneficiary receives an annual fixed payment, between 5% and 50%, of the fair market value of the trust valued annually for a term of years or for the beneficiary's life. The annual unitrust payment will fluctuate with changes in the CRUT's value. As result, a CRUT potentially protects a beneficiary from inflation better than a CRAT (see below), as the annual payment is based on the current value of the trust's assets.
- Charitable Remainder Annuity Trust - A non-charitable beneficiary receives a fixed annual payment based on the value of the property initially placed into the trust for a number of years or for the beneficiary's life. A CRAT works best where a beneficiary requires a constant annual stream of income to meet fixed living or other expenses.
Charitable Lead Trusts
The Charitable Lead Trust (CLT) is the direct opposite of the CRT, in that payments are made to a charity for a term of years or for the donor or a beneficiary's life, and at the end of the trust, any remaining amounts return to the donor or pass to a non-charitable beneficiary free of estate or gift taxes. Similar to the CRT, a donor selects whether a charity will receive an annuity payment, based on the initial value of trust assets, or a unitrust payment, determined by the fluctuating value of trust assets. Funding a CLT with assets expected to increase significantly in value allows future appreciation to be transferred out of the donor's taxable estate, avoiding potential estate taxes on the appreciation. For this reason, selection of assets funding the trust is critical.
If the trust's assets return to the donor, the donor will receive an income tax deduction at the creation of the trust determined by the actuarial value of the charitable payment interest. Alternatively, a trust established by a donor's Will or revocable trust qualifies the donor's estate for an estate tax charitable deduction. In either event, a CLT works best where the intended beneficiary has no immediate need for the trust's assets or income.