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Charitable Remainder Trust Definition
A charitable remainder trust refers to a tax-exempt trust intended to cut down the taxable income of various individuals by dispersing trust income to the trust’s beneficiaries for a certain period. The next step usually involves donating the remainder to the charity. This is usually a split-interest that allows a trustor to contribute to the trust and avoid income and estate taxes, while also taking care of beneficiaries. As such, here are the benefits of a charitable remainder trust:
- Reducing your existing income taxes through the deduction of charitable income tax
- Benefitting from various charities
- Leaving more money to your beneficiaries through life insurance trust with the aim to replace the asset
- Reducing your estate taxes
- Receiving asset protection from creditors
- Having a second stream of income
A Little More on What is a Remaining Charitable Trust
A charitable trust is achieved when you transfer a high valued asset into an irrevocable trust. Usually, this removes the specified asset from the estate. When you die, there won’t be estate taxes. You’ll also be eligible to receive an income tax deduction.
The main idea of a charitable remainder is to cut down taxes. This is achieved by donating various assets or estates into the trust fund. The process is usually followed by having the trust pay the beneficiary, particularly for a certain period. Once the time-frame has expired, the remainder is transferred to different charities where there are beneficiaries. As such, charitable remainder trusts have been irrevocable, implying that they can’t be modified or ended without the consent of the recipient.
A few years ago, Max, as well as Jane Brody, bought some stock worth $100,000. Currently, the same commodity is $500,000. The due would like to trade it for some retirement income. If the stock is sold, they shall have gained $400,000. They would also pay $60,000 in tax gains. The equation would leave them with a balance of $440,000. If the stock is re-invested such that they earn a return of 5%, the two will make $22,000 in yearly income. To achieve the total lifetime income, the return is multiplied by their life expectancy which is 26 years. Therefore, the total income tax would be $572,000. Since they are still the owners of these assets, they won’t have protection from creditors. They will also not have a charitable income tax deduction. But, if the assets are transferred to a charitable remainder trust, they can take a charitable income tax deduction of approximately $90,375 instantly. The duo is in the 35% tax bracket. Therefore, their existing federal income tax will have reduced by $31.325.
Charitable Remainder Trusts come in two forms:
- Remaining Charity Annuity Fund – This type of trust holds that a certain percentage of the fair market value of the available assets in a trust, compiled annually should be paid to the beneficiaries once per year for up to 20 years.
- Charitable Remainder Annuity Trust – This type of charitable trust holds that a specific dollar amount of at least 5 percent of the market value of assets should be paid to the income beneficiaries at least once annually.
Usually, the trust’s term is tailored for the donor’s life. However, it can’t exceed 20 years. In the long run, the total balance is channeled to a charity. As such, charitable remainder trusts are utilized by older people. The use of charitable trusts is specifically for charity because there’s no asset in the trust fund that may be directed to the heir.
How is the income tax deduction determined?
While determining the deduction is often the most challenging step in the entire process, the amount is based on the beneficiaries of the income as well as the IRC 7520 rate that often fluctuates.
Some of the best assets an individual can invest in are those that have appreciated throughout the years. Notably, they should be publically traded securities or real estate. Others can invest in stock in successful corporations. However, S-corp doesn’t qualify for this type of income tax deduction.
One can be their own trustee. However, they have to be sure that they have hired an excellent administrator for the trust such that every asset is administered appropriately. If the administration is not done accordingly, one can’t see their tax advantages.
Of course, you still have some control as long as you live. This is also dependant on the trustee you’ve elected and not the actual charity. The person you select should control your assets. Therefore, your trustee needs to follow your instructions to be able to allocate all the portions accordingly.
Immediately an irrevocable trust has been signed; one cannot make any form of change. You need to be sure that you internalize the contents of the document before signing it.
If you’re worried about the value of the asset your recipients are likely to receive, you can take your income tax savings as well as part of the total income from the charitable remainder trust to fund a life insurance trust.
When it comes to handling a trust, the insurance proceeds will be excluded from the estate. Therefore, you’ll successfully avoid estate taxes. One can also keep the proceeds of the trust for more than five years while making distributions to the children as well as grandchildren. Life insurance may end up being affordable as a way of replacing children’s assets.
In the past, the IRS has come down on various individuals who have set up a charitable remainder trust and ended up withdrawing up to 90% of the total savings in a year. This implies that a charitable remainder trust can quickly blow up on someone’s face. As such, beneficiaries may end up receiving up to 5% of the yearly income.
References for Charitable Remainder Trust
Academic Research on Charitable Remainder Trust
- The charitable remainder trust as an executive benefit tool, Allen Jr, J. R. (1999). Journal of Financial Service Professionals, 53(4), 34. This paper seeks to highlight the benefits of a charitable remainder trust as a popular investment vehicle for gifting the society while retaining some right to the source of income. The trust may also have various applications such as an executive benefit tool.
- Income Taxation of Charitable Remainder Trusts and Decedents’ Estates: Sixty-Six Years of Astigmatism, Schmolka, L. L. (1984). Tax L. Rev., 40, 1. This article discusses the administration of the income tax charitable remainder trusts and decedent’s estates. As such, it was established that over the last century, taxation has become increasingly complicated. Although many fiduciaries share responsibility when it comes to wealth planning, there’s little information that has been published to help guide them through the processes.
- Charitable Remainder Trusts: Some Considerations to Draftmanship, Wren, H. G. (1973). U. Rich. L. Rev., 8, 25. This paper points out to each state’s laws as reflected in the study based on the Tax Reform Act of 1969 that arguably eliminates alternative tax imposed on long-term capital gains for individual taxpayers such that they have more capital gains of over $50,000. Such capital gains have been received by people who continue to qualify for the standard 25 percent alternative.
- The Truth about Charitable Remainder Trusts, Hoisington, W. L. (1991). Tax Law., 45, 293. This paper highlights the truth about charitable remainder trusts. As such, it was noted that there’s hype and then there’s the genuine need to gift the community while investing in the second stream of income. A charitable remainder trust takes advantage of the lifetime gifts that are often superior from the tax standpoint. Since the market interest rates got high, a few businesses retained their trusts because they had the capability.
- The economics of charitable remainder trusts and related asset management issues, Paulson, B. L., & Owens, G. (2000). The Journal of Wealth Management, 3(3), 33-38. This article points out the research of economics of charitable remainder trusts as well as asset management problems that surround the strategy. The authors used a case study to highlight mathematics as well as asset optimization problems that are unique to various portfolios in the structure. They provided planning observations alongside conclusions with the individual asset classes.
- Charitable Remainder Trusts-New Trust Vehicles for Tax Planning, Crockett Jr, U. S. (1974). Louis ULJ, 19, 161. This article was written based on the research regarding charitable remainder trusts and the use of new trust vehicles for tax planning. It was concluded that the 1969 tax reform act provided for the pooled income alongside the charitable remainder trust. As such, a gift of a remainder interest must be made for one to qualify for either charitable trusts.
- Tax professionals’ interpretations of ambiguity in compliance and planning decision contexts, Spilker, B. C., Worsham Jr, R. G., & Prawitt, D. F. (1999). Journal of the American Taxation Association, 21(2), 75-89. This paper disintegrates the interpretations of ambiguity in planning decisions. As such, research indicated that in compliance with decision contexts, tax preparers often take advantage of tax ambiguity rules to assist clients in reaching invaluable reporting positions. In an experiment that involved six partners such as senior managers and subjects, the study sums up three main objectives. By manipulating the depth of ambiguity in a single unit of tax scenario, the study confirms the findings that tax professionals use this ambiguity to exploit tax rules to their advantage.
- Charitable giving: How much, by whom, to what, and how, Havens, J. J., O’Herlihy, M. A., & Schervish, P. G. (2006). 542-567. This chapter discusses four main elements of charitable giving including how much is usually given, what are the patterns of giving, what is given to particular needs, and what strategic methods are used. A review of the charitable remainder trust indicated that there are various trends and patterns of giving to charitable trusts. Individuals give the largest shares.
- Charitable Remainder Trusts: A Study of Current Problems, Cannon Jr, A. S. (1975). BYU L. Rev., 49. This study highlights the current issues affecting charitable remainder trusts. As with anyone associated with documenting the trust is aware, a long and complicated set of treasury rules has been promulgated through the Internal Revenue Code. The confusion in this section has caused many individuals to stop investing in charitable remainder trusts.
- Charitable Remainder Trusts: An Overview, Callister, P. D. (1998). The Tax Lawyer, 51(3), 549-569. This chapter gives an overview of charitable remainder trusts. As it was earlier discussed, charitable remainder trusts provide a second stream of income for the grantor while preserving the balance to be used by the charity. The value of the assets that will remain will be used for tax after the death of the estate owner.
- Charitable Remainder Trusts under Section 664, Berwind, M. W. (1975). ABAJ, 61, 635. This article indicates that a charitable remainder trust offers an opportunity for the grantor to receive a deduction on the current income tax for a deferred gift to the charity as stated in section 170(f)(2)(A) of the IRC.
- Charitable remainder trust: A powerful financial planning tool, Phillips, L. C., & Robinson, T. R. (1997). Journal of Financial Planning, 10(4), 70. This paper indicates that a charitable remainder trust is a powerful financial planning tool that can be used to create several streams of income. It entails a discussion of wealth and income transfer. It also highlights the fact that charitable remainders trusts can be used to achieve multiple objectives in the world of financial planning.