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What is a Charitable Split-Interest Trust?

Estate Planners | Monday, March 7th, 2011

A split-interest charitable trust will allow you to pass the wealth that you accumulate during your lifetime to your heirs in a manner that promotes tax efficiency while also allowing you to support your favorite charity, either now or on down the road. The split-interest charitable trust’s name is derived because the financial interest from these trusts is split between a charity and a non-charity (your heirs). The two most common kinds of split interest charitable trusts are the charitable remainder trust and the charitable lead trust. Both of these trusts are related, but they are fundamentally different and work in different ways. Basically, the charitable lead trust will pay income to a charity for a particular amount of time, and then the assets within the trust, which are called the remainder interest, will pass to your beneficiaries, or even back to you. With the charitable remainder trust, the assets that are placed within the trust will provide income to your beneficiaries for a certain time period and then the assets will become property of the charity. Thus, these two trusts are almost exact inverses of one another, and are taxed in very significantly different ways. Let’s look at both of these charitable split interest trusts in finer detail.

Charitable Lead Trusts

The charitable lead trust can designed to pay in two different ways – as a fixed annuity payment or a uni-trust amount to the charity. This means that the charity can be paid a fixed dollar amount annually or a fixed percentage of the fair market value of the assets in the trust. Many people choose the charitable lead trust when their assets have a high potential for appreciation in the future. This is often a trust that is well suited for donors whose heirs are still young and not capable of assuming control of a substantial amount of assets. In creating and funding a charitable lead trust, the grantor or donor makes final arrangements for the disposition of his or her estate, but defers the time when the beneficiaries can actually take control of and receive property. In the interim, the charity receives ongoing and immediate benefit from the trust. And when assets do eventually pass to the beneficiary or beneficiaries, they are not subjected to federal estate tax. One drawback to the charitable lead trust is that the donor cannot claim an income tax deduction on the contributions made to the trust, and may have to pay a gift tax on those contributions that are earmarked for the beneficiary. A charitable lead trust is not tax-free, although it does allow your heirs to bypass federal estate tax. Income generated by the trust above the amount that is paid to the charity is taxable and selling the appreciated assets within the charitable lead trust can trigger capital gains taxation.

Charitable Remainder Trusts

The least common type of charitable split interest trust is the charitable remainder trust. It can be considered the exact opposite of the charitable lead trust in many ways. The charitable remainder trust will first pay the beneficiary before being permanently awarded to the charity. This is a tax-exempt trust and can be useful for those donors who wish to sell appreciated assets in order to reallocate their money to a more diversified portfolio or to create an income stream, either for themselves or for their beneficiaries. Another difference between the two is that the charitable remainder trust allows for a tax deduction for funds to the trust that are equal to the value of the charitable remainder interest. And even though the assets in charitable remainder trust will be ultimately given to the charity free of tax, including estate and gift tax, any income received by your non-charitable beneficiaries is taxable.

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