What Are Charitable Trusts?
In charitable trusts, a grantor (the person who creates a trust) can reduce his or her taxable estate by transferring assets out of the estate with the goal of using them for charity. Split-interest charitable trusts even allow the grantor to retain an interest in property gifted into one of these trusts. But the benefits of charitable giving come with specific obligations especially when you’re dealing with non-operating charitable foundations.
Funding a charitable trust entitles the grantor to remove these assets permanently from his or her estate and get an income tax deduction, upfront, for the transfer.
Split-interest charitable trusts: Who receives payment?
With split-interest charitable trusts, the grantor retains an interest in the trust property. Trusts of this type generally fall into one of two main categories. Trusts which enable the grantor to receive payments during a specified period of time, after which the remaining trust property is given to charity, are know as charitable remainder trusts.
Charitable lead trusts permit set payments to charity from the income and principal for a specified period. After that period, the remaining trust principal is distributed to the remaindermen, the people entitled by the trust instrument to receive whatever’s left after the charitable lead interest expires.
The four major types of split interest trusts are:
Charitable Remainder Unitrusts: The grantor receives payments for life that are fixed annually, based on a percentage of the value of the assets.
Charitable Remainder Annuity Trusts: The grantor receives payments for life, based on a percentage of the value of the assets on the date the trust is funded.
Charitable Lead Unitrusts: Charity receives annual payments, calculated on a percentage of the assets for a fixed number of years.
Charitable Lead Annuity Trusts: Charity receives a fixed annual payment every year. These payments are calculated as a percentage of asset value as of the date the trust is funded.
All of these trusts must file annual income tax returns Using Form 5227, Split-Interest Trust Information Return. Note that Form 5227 is an information return only; no tax is ever due. However, failure to file the Form 5227 carries a filing penalty, calculated on the number of days it’s late with a maximum of $50,000 per return.
Non-operating charitable foundations: Costs and benefits of giving
Non-operating charitable foundations (also called family foundations) may be incorporated. Alternatively, as is often the case with smaller foundations, they may be governed by a trust instrument and trustees. Tax reporting requirements are the same in both cases but using a trust instrument eliminates corporate filing obligations.
When you create a charitable foundation, you can claim charitable donations on your income tax return each time you transfer assets into the foundation. However, creating a charitable foundation also requires you to give at least 5 percent of the average value of the assets in the foundation each and every year.
In order for you to take charitable deductions for gifts you make to the foundation, you must obtain an IRS determination letter stating that your foundation is a qualified charity. The foundation’s tax-exempt status and annual tax reporting must be established.
Charitable trusts offer benefits for the grantor including the reduction of his or her taxable estate and income tax deductions. But certain obligations come with these benefits. Split-interest charitable trusts require you to file federal Form 5227 annually. With non-operating charitable foundations, you must officially establish you foundation as a qualified foundations and you are required to give at least 5 percent of the average value of the assets in the foundation every year.