There are many ways of giving to charities that can have a tremendous benefit to the charity and a tax benefit to the donor. Clients have asked me the difference between Charitable Trusts and Charitable Gift Annuities. Here is a quick summary:
Charitable trusts are an extremely helpful tool in estate planning, although the terminology can be confusing. Some explanation may be helpful. Charitable trusts may be set up as “inter vivos” trusts, during a donor's life, or as “testamentary” trusts, through a donor’s last will and testament to take effect at the donor’s death. A charitable trust may be also be set up as either a “remainder trust” or a “lead trust.”
Remainder Trusts. Charitable remainder trusts are irrevocable trusts established by a donor to provide an income stream to one or more income beneficiaries. A public charity or private foundation receives the remainder value when the income stream ends and the trust terminates. These “split interest” trusts (split between income and remainder interest beneficiaries) are defined in §664 of the Internal Revenue Code of 1986 as amended and are normally tax-exempt. A remainder trust pays either a fixed amount (charitable remainder annuity trust §664(d)(1)(D)) or a percentage of trust principal (charitable remainder unitrust §664(d)(2)(D)), to whomever the donor chooses to receive the income.
Normally, the donor may claim a charitable income tax deduction in the year of the donation on the full value of the remainder passing to charity. The donor should not be required to pay an immediate capital gains tax when the trustee of the charitable remainder trust disposes of the appreciated asset and purchases other property as it diversifies its portfolio of trust property.
Lead Trusts. Charitable lead trusts make payments, either of a fixed amount (charitable lead annuity trust) or a percentage of trust principal (charitable lead unitrust), to charity during its term, which may be a specified number of years or for a beneficiary’s lifetime. At the end of the trust term, the remainder can either be distributed back to the donor or to heirs named by the donor. The donor may claim a charitable income tax deduction or a gift/estate tax deduction for making a lead trust gift, depending on the type of a charitable lead trust.
Charitable Gift Annuity
What is It? A Charitable Gift Annuity involves a contract between a donor and a charity, whereby the donor transfers cash (usually) or property to the charity in exchange for a lifetime stream of annual income from the charity. When the donor dies, the charity keeps whatever remains of the gift. The amount of the income stream is determined by many factors including the donor's age and the policy of the charity. Most charities use payout rates defined by the American Council on Gift Annuities.
A charitable gift annuity can result in income and estate tax benefits. A donor may claim a current income tax deduction for the gift of the remainder to the charity. None of the assets transferred to the gift annuity will be included in the donor’s estate for estate tax calculation purposes. Depending on the tax basis of the assets transferred, the payments to the annuitant (the beneficiary receiving annual payments) may not be considered income to the annuitant.
Payments from a charitable gift annuity to the annuitant are fixed from the outset. Payments will neither increase nor decrease, regardless of what happens to interest rates or the stock market. A charity is contractually obligated to make the payments, even if it has to dip into its general funds to do so. Gift annuities can be very attractive to individuals who want simultaneously to support a favorite charity and provide payments to themselves or others.
Gift Annuity Rates. Since 1927, the American Council on Gift Annuities (ACGA) has periodically published a schedule of suggested charitable gift annuity rates. Although a charity is free to offer any schedule of rates it wishes - so long as its rates don't exceed the limits imposed by federal and state laws - most charities, in fact, follow the rates suggested by the ACGA. Thus, donors generally find that the rates offered by various charities are identical. This encourages donors to make philanthropic decisions based on the cause of the charities they consider supporting, rather than the rates offered.
Taxation of Gift Annuity Payments. If the gift annuity is funded with cash, part of the payments will be taxed as ordinary income and part will be tax-free. If funded with appreciated securities or real estate owned more than one year, and the donor is receiving the annuity payments, part of the payments will be taxed as ordinary income, part as capital gain, and part may be tax-free. The charity that issues the annuity will send a Form 1099-R to the annuitant. This form will specify how the payments should be reported for income tax purposes. For details regarding the taxation of gift annuity payments, it is wise to consult with representatives of the charity as well as financial advisors.