What Is A Charitable Trust? 7 Steps To Setting One Up

What Is A Charitable Trust - Charitable Trust Fund - Set Up A Charity Trust

What is a charitable trust and how do they work?  

In this article, you’ll learn about: 

  • what a charitable trust is
  • the types of charitable trusts
  • benefits, tax benefits, and disadvantages of charitable trusts
  • how to set one up
  • unique situations (and obstacles) to look out for
  • mistakes to avoid
  • the IRS guidelines for setting one up
  • tax exemptions from the IRS
  • what assets you can put in a charitable trust

Let’s dig in.

Table of Contents

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What Is A Charitable Trust?

A charitable trust is a type of trust set up to benefit a charitable organization or cause. 

It is established by a person, known as the grantor or settlor, who transfers assets into the trust. 

A trustee, selected by the grantor, manages these assets.

The trust generates income from the assets, usually through investments. 

This income, or a portion of it, goes to the charitable organization for a set period. 

After that period, the remaining assets can revert back to:

  • the grantor
  • their heirs
  • permanently benefit the charity

A charitable trust offers benefits such as tax deductions because it serves public or charitable interests.

It must meet specific IRS guidelines to qualify as a charitable trust (more below).

Charitable trusts are a meaningful way to contribute to causes you care about while also providing financial or estate planning benefits.

Types Of Charitable Trusts

There are two main types of charitable trusts: 

  • the Charitable Remainder Trust (CRT) 
  • the Charitable Lead Trust (CLT)

A Charitable Remainder Trust lets you place assets into the trust and receive income from it. 

The remaining assets go to the designated charity when the trust ends. 

This can happen after a set number of years or upon the death of the trust’s income beneficiaries.

A Charitable Lead Trust works oppositely. 

The chosen charity receives the income from the trust for a set period.

And, at the end of that time, the remaining assets return to the donor or their named beneficiaries.

Both types offer unique tax benefits and serve different estate planning goals.

Pros And Cons Of Charitable Trusts

Let’s look at the pros and cons of charitable trusts. 

Benefits Of A Charitable Trust

Charitable trusts offer significant benefits. 

These benefits include both tax advantages and societal contributions.

  • Tax Advantages: When you set up a charitable trust, you can obtain an income tax deduction. This deduction is based on the fair market value of the property or assets you contribute to the trust, subtracting the present value of the income interest retained.
  • Estate And Gift Tax Exemption: Transfers of assets to a charitable trust are not subject to estate and gift taxes. This means the full value of your gift goes to the charity, not a portion to the government in taxes.
  • Capital Gains Tax Avoidance: If you contribute appreciated property or assets to a charitable trust, you can avoid capital gains taxes that would be due if you sold the property.
  • Income Stream: Charitable remainder trusts provide an income stream for the donor or other beneficiaries. The trust pays out income for a specified period, and then the remaining assets go to the charity.
  • Philanthropic Goals: Establishing a charitable trust lets you give back to the community or support causes you care about. This creates a positive impact and helps fulfill your philanthropic goals.
  • Legacy Preservation: Charitable trusts can also help establish your legacy. The charitable work continued in your name helps keep your philanthropic efforts and memory alive.

Tax Benefits Of Charitable Trusts

Charitable trusts offer several tax benefits.

First, when you transfer assets into a charitable trust, you get an immediate income tax deduction. 

This deduction depends on the estimated amount the charity will receive. 

The IRS uses a formula that considers:

  • Type of Charitable Trust: There are different types of charitable trusts such as Charitable Remainder Trusts (CRT) and Charitable Lead Trusts (CLT), and the tax implications vary for each.
  • Payout Rate: This is the percentage of the trust’s assets that are paid out annually. A higher payout rate will reduce the charitable deduction because less is expected to remain for the charity.
  • Term of the Trust: The length of time the trust is set to run can impact the deduction. A longer term might reduce the amount the charity is expected to receive, and therefore lower the deduction.
  • Projected Return on Investment: The IRS uses a federal rate (Section 7520 rate) in its calculations to estimate how much the assets in the trust will grow each year.
  • Age of the Income Beneficiary: In trusts where an individual receives income, the age of the beneficiary is a factor. The older the beneficiary, the less that is expected to be left for the charity, which reduces the charitable deduction.
  • The Timing of Payouts: Whether the income interest is an annuity (fixed dollar amount) or a unitrust interest (variable amount) can also impact the charitable deduction.

Second, charitable trusts can help avoid capital gains tax. 

Let’s say you transfer appreciated assets like stocks or real estate into the trust and the trust sells them.

The charitable trust won’t owe capital gains tax. 

This means the full market value of your assets can be put to work for your charitable cause.

Third, charitable trusts can reduce estate taxes. 

Assets placed in the trust are removed from your estate, potentially decreasing the estate tax liability for your heirs.

Finally, charitable trusts provide a way to give back while receiving an income stream. 

You can set up the trust to pay you an income for a set period. 

This income might be subject to income tax.

But it’s usually less than the tax benefits received from the charitable deduction.

The specifics can vary based on individual circumstances and the structure of the trust.

Fill out the form on this page to speak with our trust lawyers.

Disadvantages Of A Charitable Trust

Charitable trusts carry some disadvantages which are important to understand:

  • Irrevocability: Once you establish a charitable trust, you can’t undo it. The assets you’ve transferred to the trust are no longer yours.
  • Complexity: Setting up and managing a charitable trust can be complex. This process involves intricate tax laws and trust regulations.
  • Cost: The legal fees and administrative costs of establishing and maintaining a charitable trust can be significant.
  • Limited Beneficiaries: A charitable trust benefits charities, not your heirs. This could potentially result in family disputes.
  • Oversight: Charitable trusts require ongoing oversight and administration. Trustees have to meet their fiduciary duties and comply with annual reporting requirements.
  • No Direct Control: Although you can designate where the funds go, you can’t directly control how the charity uses your donation.
  • Risk Of Obsolescence: The charity of your choice might cease to exist, or its mission may change over time, which might conflict with your original intent.
  • Inflexibility: If the trust’s income isn’t fully distributed to the charity in a given year, the undistributed income may be subject to high excise taxes.

Next, let’s talk about how to set up a charitable trust.

How Do I Set Up A Charitable Trust?

Here’s a straightforward, step-by-step guide on how to set up a charitable trust:

  1. Identify Your Charitable Purpose: Decide on the charitable goal for your trust. This could be supporting a specific charity, educational institution, or another cause that serves the public good.
  2. Choose Your Trustee: Select a trustworthy individual or organization to manage the trust. This could be a bank, a law firm, or even yourself.
  3. Prepare Your Trust Document: Draft a trust agreement detailing the trust’s purpose, the trustee’s duties, and the management of trust assets. It should also specify the charitable organization(s) that will benefit from the trust.
  4. Sign And Notarize The Document: After drafting the trust agreement, sign it in the presence of a notary public. Trust documents must be notarized to be valid.
  5. Transfer Assets To The Trust: Transfer your chosen assets, such as money, real estate, or stocks, into the trust. This may involve changing the title of the assets to the name of the trust.
  6. File Required Tax Forms: For a charitable trust, file Form 1041 with the IRS. If the trust’s income exceeds a certain amount, you may also need to file a fiduciary income tax return.
  7. Manage The Trust: The trustee is responsible for managing the trust, making distributions to the charity, and complying with any relevant reporting requirements.

What unique situations or options should you be aware of when setting up a charitable trust? 

Unique Situations Or Options For Charitable Trusts

When setting up a charitable trust, there are several unique considerations to keep in mind:

  • Cy Pres Doctrine: The cy pres doctrine allows a court to amend the terms of a charitable trust if the stated objective becomes impractical or impossible to achieve. The courts may apply this doctrine in certain situations, changing the trust’s terms while trying to adhere as closely as possible to the original intent.
  • Trust Codes: Trust Codes offer certain provisions that impact the setup and administration of a charitable trust. For example, the statute allows the modification or termination of a charitable trust under specific circumstances. Understanding these provisions can be critical when setting up your trust.
  • Variety of Trust Structures: There are different types of charitable trusts you can establish, each with its unique benefits and potential challenges. For instance, a Charitable Remainder Trust (CRT) provides a stream of income for a designated period, with the remaining assets going to a charity. In contrast, a Charitable Lead Trust (CLT) gives the income to a charity for a specific period, with the remainder going to non-charitable beneficiaries.
  • Tax Considerations: While charitable trusts provide significant tax benefits, they also come with complex tax reporting requirements. For instance, some charitable trusts are subject to the Excise Tax on Undistributed Income. It’s important to understand these tax implications when establishing your charitable trust.
  • Trustee Considerations: The choice of a trustee is crucial, as they will be managing the trust. Some individuals prefer to manage the trust themselves or with a co-trustee, while others may prefer a corporate trustee like a bank or a trust company. Each option has its own advantages and responsibilities.
  • Fulfilling Charitable Purposes: Trust law requires that the charitable purpose of the trust be fulfilled. If circumstances change and the original charitable purpose can’t be fulfilled, it’s important to have a plan for redirecting the trust’s assets.

Mistakes To Avoid When Setting Up A Charitable Trust

The mistakes that you should avoid when setting up a charitable trust are:

  1. Misidentifying The Charitable Purpose: Ensure the purpose of your trust is clearly defined and qualifies as ‘charitable’ under IRS and state guidelines. An unclear or invalid purpose can lead to legal complications or denial of tax benefits.
  2. Inadequate Trust Document: The trust document should be comprehensive, detailing the grantor, trustee, charitable purpose, and the principal and income of the trust. Missing or incorrect details can invalidate the trust.
  3. Failing To Meet Filing And Reporting Requirements: You must file the trust document with state authorities and fulfill all annual reporting and tax obligations. Neglecting these duties can result in penalties or dissolution of the trust.
  4. Overlooking Trustee Responsibilities: Trustees must understand and fulfill their fiduciary duties. Mismanagement can lead to legal consequences and potentially damage the trust’s mission.
  5. Misunderstanding Investment And Distribution Rules: The trust assets must be managed according to trust law, and distributions must align with the stated charitable purpose. Violations can result in legal actions and potential loss of tax benefits.
  6. Not Planning For Trust Termination: Prepare for the eventual winding up of the trust by understanding the conditions for termination and procedures for distributing remaining assets. Lack of planning can cause confusion and legal issues at a later stage.

What Are The IRS Guidelines For A Charitable Trust?

Charitable trusts must adhere to IRS guidelines to qualify for tax advantages. 

Here are key points to consider:

  • Defining Charitable Purpose: The IRS defines charitable purposes to include relief of the poor, the advancement of education or religion, promotion of health, governmental or municipal purposes, and other purposes that benefit the community.
  • Qualifying Organizations: A charitable trust must distribute its assets to an IRS-qualified charity. This includes nonprofit organizations, religious groups, scientific organizations, and governmental entities, among others.
  • Charitable Remainder Trusts (CRT): The IRS allows two types of CRTs: Charitable Remainder Annuity Trust (CRAT) and Charitable Remainder Unitrust (CRUT). These trusts provide income to beneficiaries for a term of years or for life, and then the remainder goes to the charity.
  • Charitable Lead Trusts (CLT): With a CLT, the charity receives income for a term of years or for life, and then the remainder goes to non-charitable beneficiaries.
  • Taxation: The trust can take a tax deduction for the amount of income that is distributed to the charity. Furthermore, the property placed in the trust is removed from the donor’s estate for estate tax purposes.
  • Filing Requirements: Charitable trusts must file Form 1041-A with the IRS annually unless they meet certain exceptions.

Charitable Trust Tax Exemptions

Certain charitable trusts are exempt from filing Form 1041-A under IRS regulations. 

The exceptions typically include:

  • Charitable trusts that are not split-interest trusts: A split-interest trust is one that has both charitable and non-charitable beneficiaries. If all of the trust’s income goes to charities, the trust does not have to file Form 1041-A.
  • Charitable trusts that are required to file Form 5227: This is a form for split-interest trusts and must be filed by charitable remainder trusts, pooled income funds, and charitable lead trusts. Trusts that file Form 5227 do not need to file Form 1041-A.
  • Trusts that are not classified as trusts under IRS rules: For instance, charitable trusts that are treated as private foundations must file Form 990-PF instead of Form 1041-A.
  • Trusts that distribute all their income to charities during the tax year: If a trust does not have any undistributed income, it doesn’t have to file Form 1041-A.

Who Are Charitable Trusts Ideal For?

Charitable trusts are ideal for people with significant assets who desire to leave a legacy. 

These individuals often have a strong commitment to a charitable cause or community.

If you’re looking for tax benefits, a charitable trust may also be a good fit. 

They can offer estate, gift, and income tax deductions, reducing your overall tax liability.

Let’s say you’re concerned about maintaining an income stream during your lifetime.

Certain types of charitable trusts, like Charitable Remainder Trusts, can be beneficial. 

They provide an income stream to you or a designated beneficiary, with the remainder going to charity.

Let’s say you have a specific asset that you’d like to give to charity, such as real estate or stocks.

A charitable trust can be a valuable tool. 

It allows for the transfer of these assets in a controlled and beneficial way.

What Assets Can I Put Into A Charitable Trust?

You can put various types of assets into a charitable trust. 

Here’s a breakdown:

  • Cash: This is the simplest asset to contribute. You deposit cash directly into the trust.
  • Stocks And Bonds: You can transfer these into the charitable trust. If they appreciate in value, they can offer significant tax benefits.
  • Real Estate: You can place residential, commercial, or undeveloped property into the trust. Selling the property inside the trust can avoid capital gains tax.
  • Business Interests: Ownership in a business, such as shares in a corporation or interest in a partnership, can go into the trust.
  • Collectibles And Art: High-value items like artwork, coins, or antiques can become part of the trust.
  • Life Insurance Policies: You can also put a life insurance policy into a charitable trust, with the trust as the policy beneficiary.

Remember, the choice of assets to place in a charitable trust depends on your:

  • financial situation
  • the nature of the assets
  • your charitable objectives

Get A Charitable Trust Set Up

If you want help from a trust law firm, fill out the form below. 

At The Hive Law, we understand the importance of:

  • protecting your hard-earned assets 
  • ensuring your family’s future
  • not losing everything to creditors and lawsuits
  • properly (and legally) distributing assets 

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  • Tailored solutions to fit your unique needs and goals
  • Expert guidance in navigating complex tax and legal matters
  • Preservation of your wealth for future generations
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Avoid the pitfalls of inadequate estate planning strategies:

  • Creditors seizing your assets
  • Lawsuits jeopardizing your family’s financial security
  • Family disputes over inheritance
  • Costly and time-consuming probate processes

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