Want to Benefit Your Loved Ones?

Consider Split Interest Trusts

If you’re considering ways to benefit your loved ones, be sure to look into charitable remainder trusts (“CRTs”) and charitable lead trusts (“CLTs”). Often referred to as “split interest” trusts because of their dual beneficial interests, they have the ability to benefit both qualified charities, as well as noncharitable beneficiaries.

How CRTs Work

A CRT grants noncharitable beneficiaries the exclusive rights to all distributions until their interests have terminated. Once that happens, charitable beneficiaries receive the remainder — the assets remaining in the trust.

A CRT can be an especially effective tool if you would like to divest yourself of a significantly appreciated asset in order to diversify your portfolio, but are reluctant due to the capital gains tax. Simply create a CRT, name yourself the noncharitable beneficiary and then transfer the appreciated asset to the trust. The CRT can then sell the asset (tax-free for the trust, since the CRT is tax-exempt) and use the proceeds to purchase a portfolio of diverse, income-producing assets.

You can receive annual payments from the trust for a period of time up to 20 years, or for your lifetime, increasing your cash flow. A portion of each payment may be taxable to you based on the income earned or capital gains recognized by the trust. You might, for example, have capital gains income due to the sale of the highly appreciated shares you transferred to the trust, but the gain you report will be recognized and taxed to you only as you receive payments over time.

You will receive an immediate income tax charitable deduction upon the creation of the trust, which is calculated as the present value of the charity’s remainder interest. You may also receive recognition within the charitable organization(s) and the community as a result of the contribution, unless, of course, you prefer to donate anonymously.

If you are concerned that, should you decease early in the CRT’s existence (before you’ve received substantial payments from it), there won’t be sufficient assets in your estate for your heirs to receive any inheritances, there are at least two potential solutions.

One solution is, upon creation, to set the CRT term for a specified number of years (rather than your entire lifetime) and then name your heirs as contingent beneficiaries. The other solution would be to purchase a life insurance policy which would replace any of the shortfall your heirs might experience.

You can name someone other than yourself as a noncharitable beneficiary and even fund the trust upon your death, but the tax consequences will be different.

Where CLTs Differ

A CLT differs from a CRT in that it reverses the timing of when distributions are received by the charitable and noncharitable beneficiaries. Charitable beneficiaries would receive the initial distributions and noncharitable beneficiaries would receive the remainder.

A CLT can be useful when an asset you currently hold generates substantial income every year, you don’t need the income and you wish to eventually pass the asset to your heirs. The CLT generates an income stream for the charity during the trust term, and at your death (or the end of the CLT term, if you’ve set it for a specific number of years) the asset would be transferred to your heirs.

If the CLT is structured as a grantor trust, the trust would be in effect disregarded for income tax purposes. The CLT then works similarly to a CRT in that you would receive an immediate income tax deduction on the transfer of assets into the trust. But, in subsequent years, the income generated by the CLT would be taxable to you. If you do not structure it as a grantor trust, the CLT income won’t be taxable to you, and you will not receive an income tax deduction when you fund the trust.

Unlike a CRT, where you are the noncharitable beneficiary, a CLT has a gift tax component which is calculated as the present value of the noncharitable beneficiary’s remainder interest. As with CRTs, CLTs can also be funded upon your death, but the tax consequences will be different.

Who Can Help

In the world of estate planning, utilizing the benefits of either a CRT or CLT can assist the charities you support, while also benefiting your beneficiaries. So, be sure to consult with your tax advisor to determine whether a CRT or CLT benefits your estate plan.

© 2015


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