Charitable Trusts
Charitable Lead Trust
A charitable lead trust is an irrevocable trust designed to provide financial support to one or more charities for a period, with the remaining assets eventually going to family members or other beneficiaries. Charitable lead trusts are often considered to be the inverse of a charitable remainder trust.
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Useful for reducing transfer taxes, such asgiftandestate taxes.
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Any investment earnings that the trust accrues are taxed to the grantor.
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A grantor may get a one-time tax deduction for the fair market value of their full donation for the initial funding of the trust.
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It is generally not possible to change the charitable beneficiary of the trust.
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They are complicated enough to require legal help in setting them up and carry ongoing maintenance costs.
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They must be carefully planned so that there is enough money in them to make all required payments during their existence.
Charitable Remainder Trusts
Under a charitable remainder trust arrangement, a stream of income is paid by the trust to one or more noncharitable beneficiaries until the trust terminates, at which point the remaining assets are transferred to a charitable beneficiary.
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Duration - The duration of the trust can be a specified number of years (not to exceed 20 years), or it can be for the life of a particular individual (often, the donor or donor’s spouse).
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Charitable Donation - On creation, the donor is allowed an income tax deduction based on the estimated amount to be donated to charity at the trust’s conclusion.
How will the donation amount be determined? It is based on the trust’s type and term, the projected income payments to the charitable beneficiaries, and interest rates set by the IRS that are determined by assumptions about the growth rate of trust assets. Usually the charitable organization that is the ultimate beneficiary will provide these computations to the donor prior to completion of the trust arrangement.
To prevent various tax-avoidance schemes, the IRS requires the charitable distribution to be at least 10% of the fair market value of the initial trust assets. Donors may structure the lifetime payments to the trust’s private beneficiaries as either fixed (an annuity trust) or flexible (a unitrust), depending on the desired results of each arrangement. Payment amounts are determined by applying a specified percentage (between 5% and 50%) to the fair market value of the trust assets.
Pooled Income Funds
Pooled income funds can be thought of as mutual funds that are created and maintained by a charitable organization. Donors contribute assets to the fund, and in return receive lifetime income payments. The assets of all donors are commingled and invested together as a pool.
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Donor Distributions - Each donor’s income stream is calculated as a pro-rata share of the investment pool.
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Tax on Distributions - All distributions made to private beneficiaries are taxed as ordinary income. No capital gain taxes are paid by donors on appreciated assets, which allows them to benefit from the assets without paying the usual taxes.
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Death of Donor - When a given donor passes away, his or her prorated share of the investment pool is removed from the fund and given to the charity itself.
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Schedules A & B – Do not need to be included.
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Required Attached Statement - Pooled income funds require the attachment of a statement (see 1041 instructions (2022) page 15 for contents of the statement).
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Form 5227 – May need to be completed (see 1041 instructions (2022) page 15).
For the year in which a contribution is made, the donor is entitled to a tax deduction based on the estimated remainder value of the gift to the charity. Deduction annual limits are:
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50% of adjusted gross income for cash gifts, or
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30% of adjusted gross income for gifts of appreciated assets.
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Any excess deduction amount can be carried forward for up to 5 years.
Split Interest Trust
Split-interest trusts are, essentially, hybrid trusts having both charitable and noncharitable beneficiaries. While they are not actually recognized by the IRS as being tax-exempt entities, they have many tax-exempt characteristics, and offer to donors many of the same benefits available to donors to charities. There are three main types of split-interest trusts:
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Charitable remainder trusts,
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Charitable lead trusts, and
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Pooled income funds.
A split interest trust:
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Is not exempt from tax,
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Has some unexpired interests that are devoted to purposes other than religious, charitable, or similar purposes; and
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Has amounts transferred in trust after May 26, 1969, for which a deduction was allowed under section 170 (for individual taxpayers) or similar Code sections for personal holding companies, foreign personal holding companies, or estates or trusts (including a deduction for estate or gift tax purposes)
The fiduciary of a split-interest trusts must file Form 5227 annually to report financial activity and determine if they should be treated as a private foundation.
See 1041 instructions (2022) beginning on page 19 for further details related to Sec 4947(a)(1) nonexempt charitable and split-interest trusts.
Private Foundation (IRC Sec 509)
A private foundation is a 501(c)(3) organization, usually established for the purpose of granting money to charitable causes. It is the default category the IRS assigns a nonprofit seeking 501(c)(3) status unless the applicant has requested and demonstrated suitability for public charity status. That said, private foundations make up less than 10% of 501(c)(3) organizations nationwide.
The 5 Rule - A private foundation must make a charitable “payout” — in grants and qualifying operating expenses — totaling at least 5% of total assets annually to remain in compliance with federal and state tax codes. Distributions that satisfy the 5% criteria include gifts and grants to charities and administrative costs associated with such activity. Also, qualifying distributions more than 5% can roll forward to help offset the distribution requirement of the next year.
Charitable Deduction - Charitable deductions for contributions to foundations are limited to30% of adjusted gross income for cash and 20% of adjusted gross income for long-term publicly traded appreciated securities.
Form 990-PF - All private foundations must complete and file Form 990-PF each year, regardless of size or revenue base.