Charitable giving is a method used to reduce the size of a taxable estate. A donor may make gifts to charitable or tax exempt organizations, but retain the right to receive the income from the asset given for the remainder of his life. With proper planning the value of the asset given may be replaced for the family with the use of a wealth-replacement Irrevocable Life Insurance Trust (ILIT). So, you can give your estate away — and keep it!
It’s like having your cake and eating it, too! Combined with a wealth replacement irrevocable life insurance trust or family limited partnership, you may pass your estate to your heirs tax free! Sometimes you may even be able to increase the amount you would be able to give to your heirs.
Charitable giving has always been a fundamental aspect of estate planning. Most people who plan have a strong sense of family and community and are therefore inclined to make charitable gifts a part of an overall estate plan.
Many estate planning attorneys have a good deal of knowledge about charitable planning. This knowledge is extremely important given the complex nature of the charitable giving provisions of the Internal Revenue Code. Charitable planning is not an area that should be approached lightly. There are a myriad of issues that must be considered, including control; income, gift, and estate tax ramifications; current finances; future income and principal needs; the extent of your charitable inclination; and the types of property you own.
These questions and answers will give you an excellent overview of all of those issues and how to deal with them. It also has a number of examples which will help you visualize the concepts included in the broad topic of charitable planning.
Split-interest trusts have gained popularity because they can satisfy personal financial needs as well as philanthropic desires. The most commonly used split-interest trust is the charitable remainder trust. A less frequently used split-interest trust is the charitable lead trust.
A CRT is a split-interest trust. Its donated assets are shared between noncharitable beneficiaries and charitable beneficiaries. Typically, a CRT is designed to pay income to one or more trust noncharitable beneficiaries (usually the donor and the donor’s spouse) for life or for a term of years, after which the trust assets are paid to or held for qualified charitable beneficiaries.
The percentage of income that must be paid annually to the income beneficiaries cannot be less than 5 percent of the value of the trust assets. There is no limit as to the number or type of income beneficiaries (individuals, corporations, trusts, etc.), except that at least one income beneficiary must be a taxable entity and that unborn individuals (such as grandchildren not yet born when the trust is created) do not qualify unless the trust’s duration is limited to a term of years.
A CRT can continue for the lifetimes of the persons selected as income beneficiaries or for a term of years not to exceed 20. When the last income beneficiary dies or the term of years expires, all assets remaining in the trust must be distributed to one or more charities, called charitable remaindermen.
Mr. and Mrs. Smith have stock for which they paid $10,000. The stock has grown in value over the years and is now worth $110,000. The stock pays them a dividend of $1500 per year, which is a 1.36 percent return. Mr. and Mrs. Smith are each 61 years old. Their total estate is large enough for this stock to be taxable in their estate at a 50 percent marginal tax rate.
If the Smiths sell the stock, they will have a capital gain of $100,000 ($110,000 sale price – $10,000 basis). Their federal capital gain tax rate is currently 28 percent. Accordingly, if the Smiths sell the stock, they will pay a $28,000 capital gain tax, leaving them with only $82,000 ($110,000 sales price – $28,000 tax) to invest. If they invest the $82,000 and receive a 7 percent return, they will receive $5740 in income.
Instead of selling the stock, the Smiths can create a CRT and donate their stock to it. The CRT then sells the stock. Since the CRT is charitable in nature, it pays no capital gain tax. Accordingly, the trust now has $110,000 to invest.
The Smiths can write into the trust that they want a 7 percent annual income from the trust. They will then be receiving $7700 per year in income. This income will continue to be paid to the Smiths or, after one of them dies, to the surviving spouse for life. Upon the death of both Mr. and Mrs. Smith, the balance of the funds in the CRT will be paid to a charity which Mr. and Mrs. Smith designate.
When the trust is signed and the Smiths contribute their, stock to it, they are making a charitable contribution of a portion of the value of the stock. The value of the charitable deduction that the Smiths receive is the original value of the gift less the present value of the income going to the Smiths on the basis of their actuarial life expectancies. In the case of the Smiths, they receive a charitable deduction of $23,770 (based on a 7 percent rate from IRS tables for the month of contribution), which will save income tax of $9508 (assuming a 40 percent tax rate).
Since the stock is now in an irrevocable trust, the $110,000 has been removed from the Smith’s estate for estate tax purposes, thus saving $55,000 in estate taxes ($110,000 x 50 percent marginal estate tax rate). Upon the death of both Mr. and Mrs Smith, the balance of the proceeds in the trust will go to the charity or charities of their choice.
It is common for a donor to a CRT to establish a wealth replacement trust (an ILIT). This way insurance proceeds in the amount of the gift given to the charity may be distributed to charity. The beneficiaries receive this distribution tax free.