The Investment Scientist

Charitable Giving and Estate Planning

Posted on: May 5, 2011

[Guest Post by Christopher Guest] Many people I work with to plan their estate want to make some type of charitable gift. Charitable giving through a person’s estate plan falls into three categories: a simple bequest through a will, a charitable remainder trust or a charitable lead trust1. Most people want to make an altruistic donation to some cause that holds a special place in their heart. However, for the more sophisticated estates, charitable giving can be a valuable estate tax planning tool.

The simplest and most popular form of charitable giving is a bequest through a will. Basically, there will be a clause in the will that says “I give X amount of money to charity Y.” If the estate plan is more sophisticated, the bequest could be based on a percentage of the estate’s value or a part of the residue of the estate2. Like all charitable bequests, it is tax deductible.

A second popular type of charitable gift is called a charitable remainder trust or “CRT.” A CRT offers flexibility. It can provide an income stream for life, or a term of years, to the donor and also provide significant tax benefits to the donor and the donor’s heirs. It is called a charitable remainder trust because the charity receives the remainder of the asset after the term.

A CRT is an irrevocable, tax-exempt trust. Assets, like bonds, mutual funds, stocks or real estate, are transferred into the CRT. The assets provide income to the donor for a specific period of time (i.e., the donor’s lifetime or a term not to exceed 20 years). At the donor’s death or term, the remaining assets will be turned over to the charity.

A CRT can offer great tax benefits if the transferred assets have appreciated and would cause large capital gains taxes on the sale of the transferred asset. But, if the transferred assets go to a charity through a CRT, the trustee may be able to sell the asset with no gift, estate, or capital gains tax consequences for the donor. While the income stream from the asset will generate a taxable liability, the donor can take the charitable income tax deduction.

There are numerous restrictions related to designing a CRT. Speaking to an estate planning attorney in working through designing a CRT is very important to ensure compliance with the tax code.

The last most popular type of charitable gifting strategy is the charitable lead trust or “CLT.” A CLT is essentially the opposite side of the coin of a CRT. The donor creates an irrevocable trust for a set term of years. Each year, payments are made from the trust to the donor’s designated charity/charities. When the term is up, whatever is left of the asset is transferred to a designated beneficiary.

It is called a lead charitable lead trust because the charity is entitled to the lead (or first) interest in the trust asset and the noncharitable beneficiary receives the remainder. Handling assets in this way can shelter the assets’ appreciation from estate taxes. But, also like a CRT, designing a CLT is a sophisticated tool with numerous issues that need to be addressed. A potential donor should talk with an estate planning attorney to ensure tax compliance.

When a testator is planning their estate and the testator has the means to donate to charity, the testator should consider making a charitable contribution. In addition to the altruistic benefits a testator gains, there can be significant advantages to the testator’s estate and income tax liabilities.

1 There are other charitable giving strategies, including creating a private or family foundation, donor advised fund or pooled income funds.

2 The “residue” of an estate is the amount remaining after all costs, debts and taxes have been paid and after all monetary and specific bequests have been satisfied. This form of charitable bequest can be especially appropriate if you want other bequests to have priority.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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