A "trust" is a legal entity or creature that is created when the person making the trust (the "settlor" or "grantor"), transfers ownership of certain property or assets to a "trustee." The trustee, in turn, is responsible for using the property or investing it for the benefit of a third party (the "beneficiary"), who was specified by the settlor when he or she made the trust.

There are numerous types of trusts, each designed with different purposes or goals. Some trusts, for example, are designed to benefit only the settlor and/or his or her family. Other trusts are designed to benefit a charitable organization or a charitable cause. Charities that qualify as beneficiaries of trusts are determined by the Internal Revenue Service ("IRS").

Two of the most common charity-driven trusts are:

• Charitable remainder trusts (CRT), and
• Charitable lead trust (CLT)

In general, charitable trusts are made for the benefit a pre-existing charity, like the American Red Cross, or for the purpose of creating and funding a new charity, like a school for disadvantaged children.

There are various tax advantages to charitable trusts, but the trust has to drafted properly in order for it to qualify for the tax benefits. So, if you're thinking of creating a charitable trust, you need to read the federal tax laws carefully, or seek the advice of an experienced tax attorney or estate planning attorney.

Charitable Remainder Trusts (CRT)

A CRT is a type of irrevocable trust, which means that it cannot be changed or cancelled by the settlor. The settlor can transfer assets to a CRT and keep either a set dollar amount of annual income or a set percentage of the trust assets valued each year. When the settlor keeps a set dollar amount, the trust is referred to as a charitable remainder annuity trust. When the settlor chooses to keep a set percentage, the trust is known as a charitable remainder unitrust.

In both instances, the federal tax code (Internal Revenue Code, or "IRC") states that the trust must met a certain minimum distribution or payment to the settlor in order to qualify for benefits:

• For a charitable remainder annuity trust, the payment has to be at least five percent of the initial value of the trust assets and no assets can be added after the trust is created
• For a charitable remainder unitrust, the payments cannot be any less than five percent of the value of the trust assets from year to year and assets can be added at any time

For either one of these trusts, the income generated can be paid to the grantor for up to 20 years or for his or her lifetime. When the time expires or the grantor dies, the balance outstanding in the trust (the "remainder") is paid to or "distributed" to a qualified charity.

With a CRT, the settlor gets an income tax deduction at the time the trust is funded because of the irrevocability, the set payments to the settlor, and the fact that the remainder has to go to a qualified charity. Tables issued by the IRS are used in a complex process to calculate the amount of the deduction.

One advantage of the income tax deduction allowed by a CRT is that the settlor gets a present deduction for a gift that he continues to use (as income). Also, a CRT itself is not taxable: the settlor only has to pay the tax that arises as a result of distributions from the trust to the individual beneficiary. So, if a settlor transferred assets to a CRT and the CRT sold those assets at a large capital gain, the settlor would not have to pay any tax on that gain (unless the gain was paid to him).

In addition to the income tax deduction, the settlor's estate will get a federal estate and gift tax deduction.

Charitable Lead Trusts (CLT)

In some ways, a charitable lead trust (CLT) is the opposite of a CRT. For example, a CRT pays income to an individual for a period of time and then pays the remainder to a charity. In contrast, a CLT pays income (usually a percentage of the trust's annual income) to a charity for a period of time and then pays the remainder to a beneficiary, like the settlor's child.

Unlike a CRT, a CLT is taxed and has minor income tax advantages. For example, you get an income tax deduction only if the remainder passes back to you, the settlor.

However, a CLT has major estate tax advantages. These are obtained through the "discount" the settlor gets on the remainder that passes to his beneficiaries: at the end of the trust, the beneficiaries get the original trust assets and any income that it has accumulated without having to pay federal estate taxes.

Some Things to Consider

A charitable trust, like any trust, must have a valid purpose and the purpose can't be illegal or against public policy. So, you need to make sure that the trust does not discriminate on the basis of race, sex, or religion, because if such a discriminatory intent is found, the trust might not be enforced.

Who enforces the trust? Because a charitable trust benefits the public, many states authorize the state's attorney general not only to file a law suit to enforce such a trust, but also to oversee or supervise the trust's administration. In addition, co-trustees often have authority to file suit to enforce a charitable trust.

Questions for Your Attorney

Which is better for me, a CRT or CLT?

Can I create a charity for my disabled son and then create a trust to fund my own charity?

What kind of property or assets should I include (or exclude) from my charitable trust?

Related Resources on Lawyers.com^sm

- Trust Basics article
- Trusts and Estates
- Estate Planning
- Wills and Probate FAQ
- Estates, Wills, and Probate message boardfor more help