I am routinely asked by my clients regarding charitable giving and advanced planning to provide for charitable foundations, starting a charitable foundation, or even leaving a sizeable amount of assets to a charitable foundation. There are a number of reasons to engage in charitable giving and charitable planning as part of your estate planning strategy, including possible tax advantages.
One type of charitable giving planning is called a charitable lead trust. This is a type of trust where the trust provides for income to be paid over to a charitable foundation of the grantor/settlor’s choosing. The length of the trust can be for a set number of years, until the death of the settlor or other person, or for any other predetermined length of time. At the conclusion of the measuring period of the trust, the remaining trust assets are then transferred to the beneficiaries identified in the charitable lead trust.
A second type of charitable giving planning is called a charitable remainder trust. This type of trust is a little different than a charitable lead trust. When you establish a charitable remainder trust, the trust provides for set income to be paid out of this type of irrevocable trust to the grantor/settlor of the trust or to another named person of the settlor’s choosing. In addition, this trust is measured by a fixed period of time or the life of a person such as the grantor/settlor of the trust. At the conclusion of this measuring period, the remainder of the assets in the trust are distributed to the charitable foundation named in the trust.
There are a number of reasons and benefits that an individual and/or a family may want to engage in this type of charitable giving planning. First, there are income tax benefits for gifting away a portion of your assets. For instance, a portion of the assets that were gifted away to the charitable foundation may be tax deductible. Another important reason to engage in this type of planning is that it can be an estate tax planning strategy.
The federal estate tax applies to gross estates with a value of $5.43 million on the date of death. However, utilizing the first deceased spouse’s $5.43 million exemption through portability, the exemption can reach to $10.86 million as of 2015. However, for estates that are above the exemption limit for the estate and gift tax, this can create a situation for advanced estate tax planning through a charitable giving strategy.
For example, let’s say that John and Jane have an estate that is worth approximately $11 million. Now, let’s further assume that John previously passed away and Jane filed an estate tax return and properly utilized portability within nine months of John’s death. Therefore, Jane has a $10.86 million exemption from the federal estate tax. However, Jane also has an $11 million estate, and upon her death, there would be a possibility of $140,000 in assets being subject to the federal estate tax. As of 2015, this $140,000 would be taxed at 30% creating an estate tax liability of $42,000.
However, Jane would be able to reduce her federal estate tax liability and pursue her passion toward charitable giving and providing a lifetime gift to her grandson. Let’s say that Jane would like to leave a gift to her favorite charity, ABC Charitable Foundation. Let’s further say that Jane wants to provide gifts to her grandson who is pursuing his medical degree. Well, Jane could set up a trust that provides for Jane to gift a portion of her assets each year to her grandson, and then provide gift to ABC Charitable foundation at the end of a specified term. Let’s say that Jane sets up a trust where $14,000 is paid each year to her grandson for 10 years, at which point the trust terminates, and the remaining assets ($25,000) in the trust are distributed to the ABC Charitable Foundation.
The reason this would benefit Jane from an estate tax perspective is that under the Federal Estate and Gift Tax, you can gift away $14,000 each year without any tax consequences. However, if you gift away more than $14,000 in a year, that does not mean that you owe taxes on the gift above $14,000. What it means is that your lifetime federal estate tax exemption of $5.43 million (or $10.86 million with portability) is reduced by the amount above $14,000 gifted away in that specific year. Therefore, under this example, by gifting away $14,000 for 10 years to her grandson, Jane has reduced her taxable estate from $11 million to $10.86 million. In addition, as Jane did not give away more than $14,000 each year, her estate tax exemption has not been reduced.
However, in this example, this trust which provided for a distribution of $25,000 upon the termination of the trust, reduced her lifetime federal estate tax exemption from $10,860,000 to $10,849,000 ($25,000 minus $14,000). As a result, the projected estate tax liability of $42,000 has been reduced to $2,200.00 (20% on $11,000.00). Therefore, as you can see, this is an estate tax savings for Jane and her family of $39,800.00. These were assets that went to Jane’s family and the ABC Charitable Foundation, as opposed to being used to spend on estate taxes.