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Charitable Trusts

Charitable trusts are a fantastic way to balance generosity with the need for income. There are two main types of charitable trust: a Charitable Lead Trust and a Charitable Remainder Trust.

Charitable Lead Trusts

A Charitable Lead Trust (CLT) is a powerful way to significantly reduce gift- and estate-tax costs when transferring assets to your heirs—while also supporting your charity with income.

During the trust term (a specified number of years, the lives of one or more individuals, or a combination of the two), all contributions are paid to the charity of your choice. At the end of the trust term, the assets pass to beneficiaries named by the donor. The donors choose the trustee.

You can fund a CLT with cash, publicly traded securities, closely-held stock, income-producing real estate, partnership interests, or a combination of the above. You can establish a CLT during your lifetime, or as a testamentary trust through your will. A lead trust may be structured to provide a fixed dollar contribution annually (CLAT) or a fixed percentage contribution (CLUT).

There are two basic types of Lead Trusts: Non-Grantor and Grantor.

Non-Grantor Charitable Lead Trusts
In a non-grantor CLT, the most common type, the trust assets revert to your children, grandchildren, or other heirs at the end of the trust term. A non-grantor CLT provides a gift tax charitable deduction and is useful in reducing the cost of intergenerational wealth transfers.

Grantor Charitable Lead Trusts
In a grantor CLT, the trust assets revert to you, rather than to your heirs, at the end of the trust term. Donors creating grantor CLTs receive a large charitable contribution income tax deduction. Such a gift structure may be particularly useful if you wish to make a multiyear pledge and accelerate future deductions into the current year.

Charitable Remainder Trusts

A Charitable Remainder Trust is established for the life of the donor (also trustor or grantor) and/or for the life of any beneficiaries and is irrevocable. While there are certain changes that may be made, once the trust is established, it cannot be revoked.

If  desired, the income period of the trust can be established for a specified period of time not to exceed twenty years. The twenty-year maximum does not apply if the trust life is based on the life expectancy of the income beneficiaries.

Because the income is paid to one or more parties and, at the end of the trust's life, the principal and any undistributed interest is paid to a different party, a charitable remainder trust is called a split interest trust. The income portion of the trust may be either an annuity income or a unitrust income. The difference between these rests in whether the income portion changes during the life of the trust.

An annuity income is calculated at the time the trust is established in the trust agreement. It is a fixed amount of dollars based on the then market value of the trust. If the assets of the trust go up in value, the income portion does not change.

In contrast, with a unitrust, the assets of the trust are revalued annually and the percentage rate established in the trust agreement determines the dollar amount of the unitrust interest. If the value of the principal in the unitrust declined, the value of the interest portion of the unitrust would decline as well. The unitrust interest value would increase if the value of the trust assets increased.

A charitable remainder trust is an attractive planning tool for the disposal of highly appreciated assets. While the assets revert to the charity rather than the heirs of the estate, the use of an irrevocable life insurance trust in conjunction with a charitable remainder trust could replace the asset's value for the heirs.

Net Income Charitable Remainder Trust
This variation of a unitrust provides that either the specified fixed percentage of the trust assets or the net income of the trust is distributed to the beneficiary, whichever is less. This type of trust is often used to handle real estate as there is no fixed distribution requirement, giving the trustee time to arrange an orderly sale of the property.

A net income charitable remainder unitrust can be an excellent way to donate appreciated property and turn it into an income stream as well as acquire tax benefits.

A donor may also add a 'makeup provision" to the trust. This allows a trust to distribute more than the fixed percentage of the assets in years where the trust's income exceeded the fixed percentage. In this manner, previous years shortages, when the trust was not able to earn the fixed percentage payment, may be made up.

Flip Charitable Remainder Unitrust
A Flip Charitable Remainder Unitrust provides the flexibility necessary for some assets by combining aspects of a net income unitrust and a regular unitrust. It is an excellent approach for people with illiquid or unmarketable assets to fund a trust that will make an irrevocable commitment to their favorite charity (or charities).

Regulations permit the trust to function without paying any income to the trust beneficiary (or beneficiaries). After a predetermined event, such as the sale of the asset funding the trust, the Flip unitrust "flips" (becomes) a regular unitrust on the following January 1st. 

Since the asset in this case has been sold, the trustee may invest in income-producing assets for the trust and may begin making regular income payments to the beneficiaries.

A flip trust provides flexibility for donors with hard to value or illiquid assets. A flip trust can be managed so that illiquid assets may be sold in a tax advantaged manner, the proceeds reinvested in a balanced portfolio and life income payments received by the donor and/or other beneficiaries.

There will probably be expenses associated with a trust, especially a trust involving real estate (taxes, insurance, maintenance for example). The donor should recognize that prior to the trust generating income, the donor will need to fund the expenses by making additional gifts to the trust in anticipation of the expenses.

There are many different types of events that can trigger the flip. The event cannot be discretionary and must be specified in the trust documents. Examples of some events that could be used to trigger a flip are:
  • A single event
  • Birth, death, marriage, or divorce
  • The sale of all or a specified part of an illiquid asset
  • A person reaching a certain age
  • A specific date