In this article we explain charitable trust taxes and exemptions. We explain the income tax, estate tax, and capital gains tax benefits of charitable trusts.
For some foundational information about charitable trusts, check out our article: Charitable Trusts Explained.
When it comes to tax breaks, charitable trusts are a win-win for both charities and donors, helping minimize donors’ income, estate, and capital gains taxes. High value assets like stocks are extremely vulnerable to capital gains and estate taxes, but under charitable lead trusts, donors can receive an immediate federal income tax deduction based on the trust’s value. Some of the largest and most influential private charitable organizations in the world were founded as charitable trusts.
As helpful as charitable trusts are, they are not tax-exempt, and all of the unexpired interests are devoted to one or more charitable purposes. Charitable contribution deductions are allowed under a specific section of the Internal Revenue Code. Charitable trusts are treated as private foundations, unless they meet the requirements for one of the exclusions to be classified as a public charity. That being said, they are typically subject to the private foundation excise tax provisions, including termination requirements and governing instrument requirements.
Donors can make an income tax deduction for the value of their trust. They can take the entire deduction in the year they decide to execute the trust, or they can spread it out over five years. Determining the amount of the deduction can be difficult, because the deduction isn’t only the value of the assets. The Internal Revenue Service deducts the amount of income the donor is likely to receive from the property from the value of the assets, so the donor will need to subtract the amount of the payments that he or she expects to receive from the trust over the payment period. The calculation also includes a number of factors like life expectancy, the number of heirs, the details of the trust document, and inflation. For example, if you donate assets worth $50,000 and you expect to receive income payments of $20,000, the IRS will calculate your gift’s value, and your available deduction, at $30,000.
Because the trust is now the legal owner of the assets, they are not included in your estate when the trust matures – so they aren’t subject to federal estate tax. This benefit is really only valuable to estates worth more than $11.4 million, as of 2019.
For more on estate tax planning, check out: How to Avoid Estate Tax.
For assets that have significantly increased in value since acquisition, donors can turn appreciated property into cash without paying capital gains tax on the profit through a charitable trust.