Benefits of a Charitable Remainder Trust – Income Tax Deduction

The Charitable Remainder Trust is one of the most common tax planning techniques we use with clients here at Ainer & Fraker, LLP.

Let’s look at one of the most compelling benefits of a Charitable Remainder Trust: the Income Tax Deduction for amounts passing to Charity.

Although much of the discussion around Charitable Remainder Trusts focuses on the Capital Gains Tax benefit and the Estate Tax benefit, people often overlook the fact that you can get a substantial Income Tax deduction for the amounts passing to Charity.

A couple of key points on the Income Tax deduction:

1)   Because the Charitable Remainder Trust is Irrevocable, the deduction is available to the Grantor (the client) immediately upon donation, even though the amounts may not go to Charity for a long time

2)   At the time of the donation, the Donor is entitled to a current Charitable Deduction equal to the Net present-value of the Future Remainder Interest

3)   The law requires that the present-value of the Remainder Interest be no less than ten (10%) percent of the fair market value of the trust assets, as determined on the date the assets are transferred to the trust

These are the basic Income Tax benefits available to those who contribute to a Charitable Remainder Trust.

One additional rule is worth mentioning:

How much of the Deduction you are eligible to take depends on whether the Remainder Beneficiary (the Charity) is a Private Foundation or a Donor Advised Fund or other Publicly Supported Charity.

While you can name your Private Foundation as the Remainder Beneficiary, and thus keep it within the direction of your family, it may not always be financially advantageous to do so.

Here’s why:

As a general rule, you can deduct up to 50% of your Adjusted Gross Income (AGI) for cash gifts to a Publicly Supported Charity.  That drops to 30% of AGI for cash gifts to a Private Foundation.

For gifts of Appreciated Property (not cash), you can deduct up to 30% of your Adjusted Gross Income (AGI) if the beneficiary is a Publicly Supported Charity.  That drops to 20% of AGI if the beneficiary is a Private Foundation.

In addition, the value of the contribution to a Private Foundation is limited to the cost basis of the asset, not the fair market value – a substantial detriment.

One solution:  Set up a Donor Advised Fund (DAF) at your local community foundation in your family’s name, and name it as the beneficiary of the CRT.

A Donor Advised Fund has all the tax benefits of a Publicly Supported Charity, but you can direct the money to your preferred charities over time (much like a Private Foundation).