Charitable remainder trusts are irrevocable trusts that let you donate assets to charity and draw annual income for life or for a specific time period.
We closely examine charitable remainder trusts to ensure they:
- Correctly report trust income and distributions to beneficiaries
- File all required tax documents
- Follow all applicable tax laws and rules
How a Charitable Remainder Trust Works
In a charitable remainder trust:
- A donor transfers property, cash or other assets into an irrevocable trust
- The trust's basis in the transferred assets is carryover basis, which is the same basis that it would be in the hands of the donor, for assets transferred to the trust during the lifetime of the donor
- The trust pays income to at least 1 living beneficiary
- The payments continue for a specific term of up to 20 years or the life of 1 or more beneficiaries
- At the end of the payment term, the remainder of the trust passes to 1 or more qualified U.S. charitable organizations
- The remainder donated to charity must be at least 10% of the initial net fair market value of all property placed in the trust
Charitable remainder trusts are irrevocable. Assets that go in can't be taken back.
Reasons to Create a Charitable Remainder Trust
Charitable remainder trusts can offer many benefits, including:
- Help you plan major donations to charities you support
- Provide a predictable income for life or over a specific time period
- Allow you to defer income taxes on the sale of assets transferred to the trust
- May allow you a partial charitable deduction based on the value of the charitable interest in the trust
Types of Charitable Remainder Trusts
There are 2 types of charitable remainder trusts based on how they pay beneficiaries. Both types of trusts can be made while the donor is alive (inter vivos) or upon death (testamentary).
Charitable Remainder Annuity Trusts
A charitable remainder annuity trust (CRAT) pays a specific dollar amount each year. The amount is at least 5% and no more than 50% of the value of the corpus (property in the trust) when the trust is established.Use tab to go to the next focusable element
Charitable Remainder Unitrust
A charitable remainder unitrust (CRUT) pays a percentage of the value of the trust each year to noncharitable beneficiaries. The payments generally must equal at least 5% and no more than 50% of the fair market value of the assets, valued annually.
Taxes on Income Payments From a Charitable Remainder Trust
Payments from a charitable remainder trust are taxable to the non-charitable beneficiaries and must be reported to them on Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions and Credits.
The payments to a non-charitable beneficiary are taxed as distributions of the trust's income and gains in the following order:
- Ordinary income: Payments are considered ordinary income first to the extent the trust had ordinary income for the year and undistributed ordinary income from prior years. If the trust has enough ordinary income to cover all payments, the entire payments are taxed as ordinary income. Beneficiaries must report payments as ordinary income as reported to them on Schedule K-1.
- Capital gains: Once the trust's ordinary income is exhausted, payments are taxed as capital gains based on the sale or disposition of the trust's capital assets. These payments are taxed as capital gain to the extent of the capital gain of the trust for the current year and any undistributed capital gain income from prior years.
- Other income: Once all ordinary income and capital gains in the trust are fully distributed, payments are characterized as other income to the extent of the trust's current year and accumulated other income. This includes tax-exempt income.
- Corpus: After all current-year and accumulated income and gains are fully distributed, payments would lastly be considered corpus or "principal" of the trust not subject to tax.
Charitable Deductions for Contributions to a Charitable Remainder Trust
Contributions to a charitable remainder trust qualify for a partial charitable deduction. The deduction is limited to the present value of the charitable organization's remainder interest. This is calculated as the value of the donated property minus the present value of the annuity. See Treas. Reg. 1.664-2(c).
The charitable deduction is also subject to adjusted gross income limits and limitations under Internal Revenue Code (IRC) Section§ 170(e).
Tax Filings for Charitable Remainder Trusts
Charitable remainder trusts must annually file Form 5227, Split-Interest Trust Information Return. Form 5227:
- Reports financial activities, including the disposition of the trust's assets
- Accounts for current-year and accumulated trust income
- Documents deductions
- Accounts for and characterizes distributions or payments from the trust
- Includes as an attachment Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions and Credits, characterizing and reporting payments to each beneficiary
- Determines if the trust owes excise taxes for prohibited transactions
Beneficiaries of charitable remainder trusts must report on their personal income tax returns payments received from the trust reflected on Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions and Credits.
Illegal Uses of Charitable Remainder Trusts
Charitable remainder trusts must not be misused to evade taxes or illegally benefit their beneficiaries. By law, a charitable remainder trust may not:
- Inflate the basis of an asset to its market value when the asset was transferred into the trust, instead of recording the asset at carryover basis, or the basis in the hands of the donor, to illegally minimize or eliminate capital gains or ordinary income
- Omit or fail to account for the sale of any assets of the trust
- Mischaracterize distributions of ordinary or capital gain income as distributions of corpus
- Give non-charitable beneficiaries any payment beyond the prescribed annual income payments, called self-dealing
- Transfer the charitable remainder interest of the trust to an organization that isn't a qualified tax-exempt organization
- Make an upfront cash payment to a charitable beneficiary in lieu of the remainder interest
By law, charitable trust donors and beneficiaries may not:
- Pay personal expenses with trust funds
- Borrow from the trust
- Change the character of payments from the trust from ordinary income or capital gains
- Use loans, forward sales of assets or other financial schemes to hide capital gains or income in the trust