Reduce Taxes with Charitable Planning
With the income tax return filing deadline just around the corner, many clients are looking for
ways to save on their tax bills. While options for clients to save on last year's taxes are limited,
now is a great time to discuss strategies to help clients reduce their income and other tax
liabilities for future years. In particular, for clients who are charitably inclined, you can discuss
tax planning tools such as charitable remainder trusts, charitable lead trusts, and gifting trusts.
Charitable Remainder Trusts
A charitable remainder trust is an irrevocable trust that allows clients to remove money and
property from their taxable estate and transfer them to a charitable organization of their choice.
While your client is alive, they may retain an annual income stream for themselves or may name
noncharitable beneficiaries to receive an income stream for a term of years (income streams
can be in the form of an annuity or unitrust amount). When the term of years expires or your
client passes, the remainder of the trust goes to the designated charitable organization.
The year the trust is funded, your client can take an immediate partial charitable deduction on
their income tax return. There will be no capital gains when the appreciated property is
transferred to the trust, nor will gains be realized if the trust sells or liquidates accounts or
property to make annual payments to the income beneficiary.
Charitable remainder trusts can be used to help your clients plan major donations to charities
they support and provide your clients with a predictable income stream for life or for a specific
time period. Because of the charitable deduction, using highly appreciated accounts or property
to fund this type of trust is a great tax-planning strategy.
Charitable Lead Trusts
Charitable lead trusts are like charitable remainder trusts - they are both irrevocable trusts
designed to help reduce a client's income taxes while benefiting a charitable organization - but
the accounts and property in a charitable lead trust are paid out to a charity over a period of
years before ultimately being distributed to your client's heirs upon the client's death.
Charitable lead trusts may be funded either during the lifetime of a client or at a client's death,
depending on whether the goal is providing savings on income taxes, gift taxes, or estate taxes.
Like charitable remainder trusts, income streams can be paid out each year as an annuity or
unitrust amount. Contributions to charitable lead trusts may be eligible for immediate, partial tax
deductions, and there are no maximum or minimum charitable payment restrictions, as long as
payments are made annually. When the trust terminates, the trust's accounts and property can
be distributed to beneficiaries in a way that can minimize or eliminate gift and/or estate taxes.
A charitable lead trust is not exempt from income tax, because the ultimate beneficiary of the
trust is not a charity. However, this can be a very beneficial strategy for a client who has a
substantial amount of income in one year.
Gifting Trusts
Gifting trusts allow clients to gift money and property, using either the annual gift tax exclusion
or the client's lifetime gift tax exemption, to a trust for the client's loved ones' benefits, while
retaining some control over the way in which the accounts and property are used through the
instructions that are included in the trust document. These trusts are often used to provide longterm care for family members who may have special needs or for minor children.
Your clients can realize several potential benefits of using a properly drafted and structured
gifting trust, such as protecting trust property from creditors or divorced spouses, providing an
alternative to guardianships for incapacitated beneficiaries, removing value from their estate,
and avoiding probate of trust property. However, one of the most beneficial aspects of a gifting
trust is the flexibility of the trustee to manage distributions to minimize income.
Gifting trusts can be structured in one of two ways. One option is to structure the gifting trust so
that the trustmaker (also known as the grantor) is treated as the owner of the trust for income
tax purposes. This qualifies the trust as an intentionally defective grantor trust because the
grantor is treated as the owner of the trust for income tax purposes only and is not treated as
the owner for any other reason. By structuring the trust so the grantor pays trust income tax, the
value of the trust can enjoy more growth because the trust principal is not being used to pay the
income taxes. Also, in the context of estate planning, any money spent by the grantor to pay
income taxes on the trust are dollars that are also removed from the grantor's taxable estate.
Alternatively, if the trust is a nongrantor trust, the trust (and not the grantor) is the owner for
income tax purposes and is responsible for the payment of income tax on taxable income
retained by the trust. If, however, a trust makes a distribution to a beneficiary, the taxable
ordinary income (but generally not capital gains) attributable to the distribution are passed to the
beneficiary and will be taxed on the beneficiary's personal income tax return. The trustee will
prepare a Form 1041 and issue a Schedule K-1 to the beneficiary, showing the amount and
type of income from the trust to be included on the beneficiary's personal tax return.
A Few Points to Remember
There are restrictions on how clients may interact with funds once transferred to a trust;
contributions to charitable trusts may only qualify your clients for a partial tax deduction based
on the value of the charitable organization's interest and the grantor trust status of the trust for
income tax purposes; and payments from trusts to a client are typically taxable to the client and
reported on Schedule K-1 of Form 1041. It is important that, as the advisor, you work closely
with your clients each year to review and prepare the proper income tax forms for each type of
trust and coordinate with their personal income tax plans.
Tax planning using charitable and gifting trusts, along with other tax strategies, can be an
effective way to reduce the tax liabilities of your clients while also helping your client support
family members and their favorite philanthropic causes. By familiarizing yourself with the
strategies outlined above, you will be able to better advise your clients and assist them by
creating comprehensive and tax-efficient plans.
MEREDITH | PC
4325 Windsor Centre Trail
Suite 400
Flower Mound Texas 75028
214-513-1013
This newsletter is for informational purposes only and is not intended to be construed as written advice about a Federal tax matter. Readers should consult with their own professional advisors to evaluate or pursue tax, accounting, financial, or legal planning strategies.
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