Planning Matters | Sharpe Group
Posted August 1st, 2003

Planning Matters

When a donor indicates an interest in establishing a trust to benefit your organization, what is the next step? Because “trust” is commonly used as a catchall for planned gifts, development officers, financial advisors, and donors can come to the process with different expectations, resulting in confusion and frustration for everyone involved.

Even experienced fundraisers can benefit from a refresher course on the basics. Read on to learn more about trusts and the role they play in charitable giving.

Trusts: the basics

A trust operates as a three-party arrangement whereby one party (typically known as the trustor or settlor) transfers property to a second party (the trustee or fiduciary) to manage in accordance with the trust’s instructions for the benefit of one or more third parties (the beneficiary(ies) and remainder).

Trusts may be established during one’s lifetime (inter vivos) or upon one’s death (testamentary). While some trusts may be revoked or changed at the trustor’s request (revocable), others are structured so that the major provisions or functions of the trust may not be changed (irrevocable). Trusts may operate for non-charitable purposes, for charitable purposes, or both (split-interest trusts). Of the split-interest trusts, charitable remainder trusts, charitable lead trusts, and pooled income funds are the three most common.

By far the most popular form of charitable split-interest trust, charitable remainder trusts are irrevocable trusts that typically provide payments for one or more non-charitable beneficiaries for life, for a term of up to 20 years, or for a permissible combination of lifetime and a term of years, before a charitable remainder receives the trust assets. The trustee may be an individual, bank, trust company, or charity. Charitable remainder trusts may be structured to provide either fixed (annuity trust) or variable (unitrust) payments to the current beneficiary. The minimum payment rate is 5% with a maximum of 50%. Under IRS guidelines, the charitable deduction is usually in the 20%-50% range, but must be at least 10% for a charitable remainder trust to qualify for favorable tax treatment. The trust itself is considered to be a charitable entity for tax purposes, so no income received by the trust is taxable, allowing for tax-free buildup of the trust to the extent earnings are not required to be paid to beneficiaries.

Charitable lead trusts are the second most popular type of charitable trust. Unlike charitable remainder trusts, lead trusts make a charity the beneficiary of payments and non-charitable entities the remainder beneficiaries. When the trust terminates, the assets are returned to the donor (a grantor lead trust) or others designated by the donor (a non-grantor lead trust). The payments to charity may be fixed (annuity-trust type) or variable (unitrust type). The lead trust itself is not tax exempt, and as a result any income or capital gains not paid to charity in a given year may be subject to taxation. Lead trusts have sometimes been used as “temporary family foundations” that provide payments to charity for a period of time before assets are returned to the donor or designated heirs at an agreed upon future date.

A pooled income fund is a trust established and maintained by a public charity that distributes income to non-charitable beneficiaries for the remainder of their lifetimes. The income beneficiaries receive a pro rata share of the trust earnings based upon their respective shares in the fund. All distributions are taxed as ordinary income.

Nuts and bolts

All of these split-interest trusts are subject to private foundation prohibitions provided in the Internal Revenue Service guidelines. See IRS sections 4947, 4945, 4944, 4943, 4941, etc., for more information. Various trusts are required to file annual tax returns and supply information to beneficiaries for use in preparing their taxes.

As noted in the article on page one, based upon the most recent figures available for 2000, a total of 113,075 charitable split-interest trust returns were filed that year. These trusts held approximately $94 billion in assets. Charitable remainder unitrusts accounted for 74.5% of the returns, followed by annuity trusts at 20%, lead trusts at 4%, and pooled income funds at 1.4%.

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The publisher of Sharpe Insights is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Sharpe Insights may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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