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Charitable Trusts and Family Foundations

Charitable Remainder Trusts


The Charitable Remainder Trust ('CRT') is a type of trust specifically authorized by the Internal Revenue Code. These irrevocable trusts permit you to transfer ownership of assets to the trust in exchange for an income stream to the person or persons of your choice (typically you, your spouse or you and your spouse) for life or for a specified term of up to 20 years. With the most common type of Charitable Remainder Trust, at the end of the term, the balance of the trust property (the 'remainder interest') is transferred to a specified charity or charities. Charitable Remainder Trusts reduce estate taxes because you are transferring ownership to the trust of assets that otherwise would be counted for estate tax purposes.
 
A Charitable Remainder Trust can be set up as part of your revocable living trust planning, coming into existence at the time of your death, or as a stand-alone trust during your lifetime. At the time of creation of the CRT you or your estate will be entitled to a charitable deduction in the amount of the current value of the gift that will eventually go to charity. If the income recipient is someone other than you or your spouse there will be gift tax consequences to the transfer to the CRT.
 
Charitable Remainder Trusts are tax-exempt entities. In other words, when a Charitable Remainder Trust sells an asset it pays no income tax on the gain in that asset. Therefore, after a sale the trust has more available to invest than if the asset were sold outside of the Charitable Remainder Trust and subject to tax. Accordingly, Charitable Remainder trusts are particularly suited for highly appreciated assets, such as real estate and stock in a closely held business, or assets subject to income tax such as qualified plans and IRAs. While the Charitable Remainder Trust does not pay tax on the sale of its assets, the tax is not avoided altogether. The payments to the income recipient will be subject to tax. 
 
There are several types of Charitable Remainder Trusts. For example, the Charitable Remainder Annuity Trust pays a fixed dollar amount (for example, $80,000 per year) to the income recipient at least annually. Another type of CRT, the Charitable Remainder Unitrust, pays a fixed percentage of the value of the trust assets each year to the income recipient (for example, 8% of the value as of the preceding January 1). A third type, perhaps the most common, allows you to transfer non-income producing property to the CRT and have the trust convert to a Charitable Remainder Unitrust upon the sale or happening of a specified event, for example upon reaching a specified retirement age.
 
At the end of the term of a Charitable Remainder Trust, the remainder interest passes to qualified charities as defined under the Internal Revenue Code. Generally, any charity that has received tax-exempt status through an IRS determination qualifies, but this is not always the case. It is possible for you to name a private foundation established by you as the charitable beneficiary.

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Charitable Lead Trusts

The Charitable Lead Trust is a type of charitable trust that can reduce or virtually eliminate all estate tax on wealth passing to heirs. In order to accomplish this goal, you create a trust that grants to a charity or charities, for a set number of years, the first or 'lead' right to receive a payment from the trust.  At the end of the term of years, your children or grandchildren receive the balance of the trust property'which often is greater than the amount contributed'free of estate tax in most instances. Although the Charitable Lead Trust is a complex estate planning strategy, the steps to implement it are few and simple from your perspective.  Here is how one of the most frequently used Charitable Lead Trusts, the Charitable Lead Annuity Trust, operates:
 
You, as grantors, create a Charitable Lead Trust as part of your revocable living trust planning.  Upon the death of the survivor of the two of you, a substantial amount of property will pass to the Charitable Lead Trust. The income beneficiary of the Charitable Lead Trust will be a qualified charitable organization, chosen by the two of you or by the survivor of you, named in your revocable living trust. The charitable income beneficiary receives a fixed, guaranteed amount from the trust for a certain number of years (determined by you with the assistance of your legal and financial advisors).  Generally, any charity that has received tax-exempt status through an IRS determination qualifies, but this is not always the case. It is possible for you to name a private foundation established by you as the charitable beneficiary. If so, you must have very limited authority over which charity is to receive money from the foundation. Too much control while you are alive will result in adverse tax consequences. 
 
At the end of the Charitable Lead Trust's term, the remaining assets in the trust pass to non-charitable trust beneficiaries such as children and grandchildren, free of estate and gift tax. These assets can pass outright to the beneficiaries, or can continue to be held in trust, either in new trusts or in trusts previously established for the benefit and protection of beneficiaries.
 
The charity will receive the same dollar amount each year, no matter how its investments perform. The remainder interest ultimately passing to the heirs, however, will be affected by the performance of the trust's investments.
 
Charitable Lead Annuity Trusts are particularly suited for hard-to-value assets (such as real estate or family limited liability company interests) and assets which are expected to grow rapidly in value.

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Family Foundations

A private foundation is a non-governmental, nonprofit organization having a principal fund of its own, managed by its own trustees or directors, and established to maintain or aid social, educational, charitable, religious or other activities serving the common welfare. A private foundation may serve as a private, family controlled receptacle for charitable contributions by family members, trusts established for their benefit (including charitable remainder trusts and charitable lead trusts) or family business entities.
 
A private foundation is established as a nonprofit corporation or trust under state law and obtains tax-exempt status for federal income tax purposes by filing an exemption application with the Internal Revenue Service.  In addition, a private foundation may be required to obtain additional exemptions from state and local income and/or property taxes. A private foundation operates under the scrutiny of the Internal Revenue Service and the Attorney General of the state in which the private foundation is organized and operates.
 
There are several types of private foundations. The most common variety of private foundation is a non-operating private foundation, which serves to make grants to other nonprofit charitable organizations (typically established public charities). The basic role of the non-operating private foundation is to receive and hold funds as an endowment, and to give its income and possibly a portion of its corpus to other entities that operate for charitable purposes.  The scope of permissible recipients includes all types of charitable organizations, ranging from large, established public charities such as United Way and the American Heart Association, to churches, colleges, universities and hospitals, to smaller local charitable organizations. A non-operating private foundation may make distributions for use in foreign countries, though such distributions are typically made to the U.S. affiliate of a foreign charitable organization.
 
The private operating foundation is a type of private foundation which directly carries on an exempt activity, and which uses a specified portion of its assets and/or income for its exempt purpose.  Examples of private operating foundations include certain museums, cultural centers and educational institutions.  Private operating foundations generally do not differ significantly in their activities from charitable institutions that constitute public charities for income tax purposes.  The significant difference between a private operating foundation and a public charity is the level of support which a public charity receives from members of the general public (typically 1/3 or more of the organization's support), whereas the private operating foundation generally receives its support from the members of one family and/or related entities established by or for the members of that family.
 
There are significant income, estate and gift tax benefits which flow from the establishment and funding of a private foundation, and the use of a private foundation has substantial estate and gift tax benefits to donors. Contributions to private foundations (both operating and non-operating foundations) are deductible for federal gift and estate tax purposes.  The private foundation may be funded during the donor's lifetime or may receive the bulk of its funding from distributions from the donor's revocable living trust at the donor's death.  In addition, the private foundation may serve as the charitable receptacle for distributions from charitable remainder trusts and/or charitable lead trusts established by the donor.
 
Significantly, the private foundation may provide a tremendous opportunity for donors to educate family members as to the donors' philanthropic goals, and may also provide younger family members with a sense of responsibility and stewardship of family wealth.  The private foundation may be structured to limit the scope of its charitable activities, by defining the permissible donees for charitable distributions, or may be structured to allow for unlimited charitable activities.  Moreover, the private foundation may employ family members (subject to limitations as to reasonable compensation) to coordinate the foundation's activities for generations to come.

 
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