In Part 1 of this discussion, we looked at the tax nature of gifts.  We reviewed various types of assets to give and their taxable repercussions.  We defined a gift in taxable terms as giving dominion control, and enjoyment of property to another person or entity to create a complete gift.  We looked at large gifts using the IRS form 709 as well as controlling the pace and timing of deductions with donor-advised funds.  In this article, we will discuss two much more complex gifting strategies and how they might be leveraged to satisfy the need to give, and how they may impact taxes.  I would issue a word of caution at the beginning; these are complex strategies that usually require a team of folks to implement to the fullest.  We suggest that in addition to your investment advisor, you should have an attorney, CPA, and a representative from the institution you intend to give to.  Having good intentions are the best first step, but there are mechanics and promises to make here that aren’t easily unmade.

In this post, we are going to review the Charitable Remainder Trust and the Charitable Lead Trust. These are both giving tools, but the methodology and benefits from these gifts are wildly different.  I think giving always begins with the warmest wishes and donative intent of the family doing the giving.  Great care must be used in the communication of intentions, timing, taxes, and benefits.  I cannot advise it loudly enough, never start with products and work backward toward intentions.  A family must clearly define what its goals are in the giving process.  After those goals are decided, the process of giving and vehicle selection can begin.  One last note, there should also be a discussion about the actual needs of the group receiving the gift.  Initiatives, goals, and capacities of the recipients must be considered in concert with the warm wishes and giving intent of the donor.  

Overview

Charitable Remainder Trusts (CRT) allow a family to give a gift in exchange for annual income and an income tax deduction at the outset of the gift.  The unused portion of the original gift that remains at the end then goes to charity. It is that remainder value that drives the sizing of the tax deduction.  That is where the name derives from Charitable Remainder Trust.  Charitable Lead Trusts (CLT) aren’t named so clearly.  They work more like a charitable boomerang where you loan assets to charity and then the assets come back sometime into the future. Much the same as the flight path of a skillfully thrown boomerang. The charity, not the family, receives the income over the life of the Charitable Lead Trust. At the trust’s end, the Charity will give the assets back to the donor, or the donor’s heirs.  That receiving party drives much of how the available tax deductions are calculated.   So, as I hope you see, these two structures work in opposite ways to achieve the noble goal of giving. We will dig more into the mechanics below.

Charitable REMAINDER TRUST

The Charitable Remainder trust is a structure that allows the donor of the assets to give property to a charitable beneficiary through a trust, and to get a stream of income back for a period of time or for life.  This trust operates in what may appear to be a loophole.  Earlier you read that to take a tax deduction you must complete a gift with no strings attached.  This trust allows you to give something and take something simultaneously.  The reason this trust is allowable is that there is a requirement to value what remains at the end of the trust and base the tax deduction on that value. So, you are only really deducting that remainder interest, not the original deposit.  

Before we dig deeper, who would want to use a vehicle like this?  In my experience most of the people whom I’ve proposed this to are deeply grateful for something.  They feel they are repaying a debt of gratitude.  They want to give a gift while collecting income over their lives or a certain period.   Often, they do not have heirs that need to inherit these dollars.  So, it can be seen as formally arranging a gift before it is fully given in exchange for tax benefits and the satisfaction/status of being a benefactor.  The absolute key here is that the family giving the gift must want income for themselves or family members.  If that desire is lacking this is generally not a good strategy.  Also, the donor must be able to part with control and further dominion over the assets once the gift is given.  

Example

Applicable Federal Rates and calculations run using Crescendo planned gift software - See source section for more information¹.

Let’s examine this gift. Frank and Wendy Donor gift $100,000 worth of stock in 2023 in exchange for a forward annual estimated income of $6500 until they both pass away. To model this gift, I used a valuation model called Charitable Remainder Unitrust. All that means is that the account value will change every year as the stock changes in value. The income payments may see movements because of changes in stock price.  There is an annuity-based trust that can give fixed payments instead of variables. In 2023, you could have just over $27,000 in charitable deductions available after giving $100,000. Using the Charitable Remainder Unitrust, you can receive the double benefit of the income and a large front-end deduction.  Now, there are rules to play by that need a mention.  This trust form must pay out at least 5% annually and have at least 10% of the original gift left at the end. This type of trust can be set to the life expectancy of the donors (as in the example above) or several years no greater than 20 (IRS 1274)².

Summarizing the Charitable Remainder Unitrust

• Great for people who need income and deductions now in exchange for the gift being fully realized later.
• The donor must be willing to part with the gifted assets.
• There should be a desire for income.
• The gift calculation must be such that a minimum payout to the non-charitable party is at least 5% per year.
• There must be 10% of the original gift left to pass to the charitable beneficiary at the end of the payment period. 

Charitable Lead Trust 

I refer to this structure as a charitable boomerang. The point here is to lend assets and their income to a charitable beneficiary (throw the boomerang) in exchange for those assets to be given back to the donor (or the family) down the road (catch the boomerang as it comes back). Again, we think about the completed gift concept. How can I get a tax deduction for giving something that the charitable beneficiary cannot even keep forever? In general, the given property would have an income element that is transferred to the charitable beneficiary for some time. That income interest is valued, and a deduction is made available.  

Why would someone want to loan assets to a charitable entity? There could be any number of reasons, but in some cases, the goal was estate size management. The families wanted to bless their respective charities with income, but they also wanted to avoid certain estate taxes. So, what you would you do if your estate was likely to attract federal taxation? What if you had heirs who could agree to a partially delayed inheritance?  What if you also had a charity that was dear to you that needed income? One viable solution might be to loan assets and their income streams to that charity to shrink your estate and possibly avoid estate tax.  After you have passed, that charity would return your borrowed property to your chosen heirs. This Charitable Lead Trust structure also has complexity, but it has been known to reduce tax in the right circumstances.  Before we see an example, I would mention these trusts can be set up to return assets to the original donor, or someone else.  The tax deductions and considerations are largely based on whom the charity returns the property to and when.  For this example, we’ll look from the estate planning perspective. As in the prior example there are rules here that will not be covered here but must be considered before using this structure in your family. 

Example

The goal here might be that Frank and Wendy have a large estate. The family has a dividend-paying stock they want to ultimately pass on to their children. Instead of leaving that stock to the children directly at death and perhaps incurring estate tax, they decide to forgo the income on the stock by loaning it to charity.  If the Charitable Lead Trust owns the stock when the last of Frank and Wendy’s death occurs, that stock is not included in their taxable estate. Thus, they effectively avoid the federal estate tax which is roughly 40% in 2023 (IRS 706)³.  In this example that tax could be as much as $40,000 on the $100,000 example above.  Instead, at the time the gift occurs, a $33,081 deduction is created. As with the Charitable Remainder trust, there is a double benefit here.  The original donor, in this case, Frank, gets an immediate deduction as the gift is given.  The assets pass out of Frank and Wendy’s estate along with any appreciation that might add up over the term of the trust.  The stock is returned to Frank and Wendy’s children after the last estate settles.  So, the Donor family got a tax deduction at the outset of the Trust and likely avoided the estate tax at death all while giving the dividends from the stock to their favorite charity.  

Summarizing the Charitable Lead Trust

• Great for families who have assets they can forgo the income on for a period of time in exchange for income or estate tax deductions.
• No requirements for payouts
• Complex income tax calculations
• Can be a great estate size management tool.

CONCLUSION

As we conclude this two-part discussion on charitable gifts, I wanted to mention once more that giving is firstly an act of the heart. Aesop once said that no act of kindness, however small, is wasted. Whether you give only love to your family, or enough money to fund the wing of a hospital, you are doing good for your soul and the world around you. 1914 and 1917 are examples of the first legislation to give tax incentives for gifts in certain circumstances. Sadly, after all this time we still see situations where there could have been taxes saved, or other benefits harvested by taking a step back to examine the good intentions of the family and how best to execute those wishes. As we say so often here in the series, please reach out to us if you or your family have questions or needs related to simple or complex gifts. We are happy to serve you as you serve those you care about.  

Sources:

¹Solutions for Increasing Major & Planned Gifts. (n.d.). Retrieved April 28, 2023, from https://crescendointeractive.com/

²Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property. (n.d.). Retrieved April 28, 2023, from https://www.irs.gov/pub/irs-drop/rr-23-06.pdf

³Instructions for form 706 (09/2022). (n.d.). Retrieved April 28, 2023, from https://www.irs.gov/instructions/i706