Taxes are a complex affair, but the waters can get even muddier when it comes to specific types of trusts like charitable remainder trusts (CRT). Part of the funds will be given over to charity, part of them will be paid out to beneficiaries, and some of them will be held in appreciable assets. What do you need to know about the taxation of charitable remainder trust distributions?
Learn more about how you can expect distributions to be paid out to you or your beneficiaries and what the tax burden will be here.
Tax Benefits of Charitable Remainder Trusts
Perhaps the most pressing reason to consider setting up a charitable remainder trust is the tax benefits that you will encounter. While you can fund the trust with cash, you might be better off funding it with highly-appreciated assets. These can then be sold to fund the trust, creating a stream of income for you or your beneficiaries.
The benefit to funding the trust with highly appreciated assets is that they will not incur capital gains taxes on the sale. Plus, you receive an income tax deduction for contributions to your CRT.
Namely, one of the best benefits of a charitable remainder trust is the ability to fund it with the sale of your real estate properties while avoiding capital gains tax. All you have to do is gift your real estate property to the charitable remainder trust and allow it to facilitate the sale in order to fund the trust. If there are any capital gains on the property, you avoid paying them with this savvy financial move.
Not to mention, as a form of charitable giving, you also get tax deductions for donated real estate along with other assets.
Taxation of Charitable Remainder Trust Distributions
Of course, the donation that you make to the trust is not the only type of taxation you should be concerned with. One thing you must know about a charitable remainder trust payout rate is that distributions you take out or payments made to a beneficiary could be considered taxable. Because these trusts were funded with taxable assets, distributions may also need to be reported on a beneficiary’s annual tax return.
To do this, they would need to file a Schedule K-1 form that comes from your CRT.
For the most part, this income will be taxed as ordinary income if the trust had ordinary income in that calendar year and undistributed ordinary income in the previous years. Once this ordinary income is depleted, you may pay capital gains on the distributions.
The good news is that the capital gains tax is going to be allocated over the number of years for which you will be receiving a distribution related directly to the sale of that asset. This means you will not be hit with the full force of taxation on the year in which it was sold but rather that you can shoulder the burden over several years.
What does this look like in practice?
Take a look at this quick chart to get an idea of how distributions will be taxed with the basic framework of a charitable remainder trust.
Year | Ordinary Income for the Trust | Trust Capital Gains | Distributions | Amount Taxed as Ordinary Income | Amount Taxed as Capital Gains |
1 | $10,000 | $50,000 | $15,000 | $10,000 | $5,000 |
2 | $9,000 | $0 | $15,000 | $9,000 | $6,000 |
3 | $8,000 | $0 | $15,000 | $8,000 | $7,000 |
4 | $7,000 | $0 | $15,000 | $7,000 | $8,000 |
As you can see, the math is relatively easy to follow for this type of trust account. Consider how it would look with your own numbers to see what your beneficiaries might be hit with when it comes to their taxes.
Other Tax Responsibilities
In addition to the topics of taxation of charitable remainder trust distributions that we have covered here, you should also keep tabs on tax responsibilities like a gift tax or an estate tax. Both of these could impact your gift to beneficiaries, so it is important to be well-versed in what you can expect.
Gift Taxes
When it comes to gift taxes, most people do not have to pay when setting up the trust. However, it is important to consider what happens if you give the CRT to someone other than yourself or your spouse. To this end, you have now made a taxable gift to your beneficiary, and it will be considered equivalent to the current value of the annuity or payments made over the trust term.
That being said, the grantor can help to shoulder some of the burden of the gift tax. They can use their credit to offset any gift taxes due.
Estate Taxes
One of the primary benefits of a charitable remainder trust is that it takes your assets out of your taxable estate. In other words, they are not considered taxable – even though you may be receiving income for your entire lifetime.
Consider what might happen if your charitable remainder trust was gifted to your children to ensure their futures. Though there might be some gift tax issues that are likely avoided by the use of the donor’s credit against gift taxes, the CRT would not be includable in your gross estate for tax purposes nor would it be includable in your children’s estates. In addition, they would receive an income source that would not be attachable by bankruptcy, divorce, or lawsuits.
Get Help for Your Charitable Remainder Trust
Setting up a charitable remainder trust and minimizing your taxes can be an art form which requires a comprehensive understanding of the full picture. Magellan has extensive experience in the taxation of charitable remainder trust distributions and strategies for maximizing your CRT returns. We can help you take advantage of your account while keeping more money in your pocket – and the pockets of your beneficiaries.
If you are ready to take the first steps to set up one of these tax-advantaged accounts, schedule a free consultation with Magellan today!
Tax services offered by Magellan Tax, LLC. Legal services offered by Magellan Legal, LLC. Tax and legal services offered separately from Cetera Advisor Networks LLC which does not provide tax or legal advice.