Saving Money on Taxes: A Simple Guide to Charitable Trusts
Chris Peden, CPA, CMA, CFM
I help small business owners grow their profits, cash flow and reduce their taxes by understanding their financials and creating an action plan to get there. Free Financial Assessment available (Link in “About” below).
If you're looking to save money on taxes, you're in the right place. Taxes can be confusing, especially if you're not familiar with accounting. But don't worry, I'm here to help. With years of experience as a CPA, I've guided many clients through strategies to save on taxes, and one of the most effective tools is the charitable trust.
What is a Charitable Trust??
A charitable trust is a way to avoid taxes when you sell appreciated assets like real estate, a business, or securities. It involves splitting the asset into two parts: an income part, which pays out for a term of up to 20 years or a lifetime, and a remainder part, which goes to charity when the income period ends. The most common form is the Charitable Remainder Trust (CRT). Let’s break down how it works.
How Charitable Remainder Trusts Work?
First, you establish the trust with one or more charitable beneficiaries. You can even act as the trustee and manage the assets yourself, following the “prudent trustee” rule, which means you have to manage the assets wisely and in the best interest of the trust. Plus, you can change beneficiaries if needed.
Next, you give property to the trust. When you do this, you get an immediate tax deduction equal to the present value of the remainder interest you give to the charity. This value is calculated based on your age, the income interest you keep, and the current “Section 7520” rate, which is a rate set by the IRS. Giving property to the trust also removes its value from your taxable estate, which can significantly reduce estate taxes.
The trust then sells the assets tax-free and reinvests the proceeds. This means you can avoid paying capital gains taxes on the appreciated value of the assets. The trust pays you an income either as a percentage of the trust assets (a “unitrust”) or a specific dollar amount (an “annuitrust”). You can choose to start drawing this income immediately or wait until a later date.
Finally, when you pass away, the remainder of the trust goes to the charity. This way, you get the dual benefit of supporting a cause you care about while also saving on taxes.
Example of a Charitable Remainder Trust in Action?
Let’s say you’re a 60-year-old man with $1 million in stock that you bought for $250,000. The current Section 7520 rate is 5.6%. If you sell the stock outright, you would pay up to $178,500 in federal taxes, leaving you with less to reinvest. But if you give the stock to a CRT and keep a 6% income, you’ll get a $312,349 tax deduction and keep the full $1 million to reinvest. That’s a significant tax saving!
Charitable Gift Annuities?
Another option is a charitable gift annuity, which is a partially-deductible gift in exchange for annuities payable directly from a charity. The deductions are calculated using the same rules as for charitable trusts, but you don’t have to set up a trust or manage assets. However, this option doesn’t offer flexibility to invest the sale proceeds or change beneficiaries, and you have to rely on the charity to make the annuity payments. Most charities secure these payments by buying commercial annuities.
Additional Uses for Charitable Trusts?
Most people use charitable trusts to sell appreciated assets, but they can also be used for supplemental retirement savings. You get up-front deductions for the income or remainder interests you give, with fewer annual reporting requirements than qualified retirement plans and no required distribution dates or amounts.
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Remainder trusts, which leave nothing for your heirs, might sound concerning. But considering that income and estate taxes can devour over 80% of large qualified plan balances, this may not be as big an issue as it seems. You can also use the tax savings from these strategies to buy life insurance in an irrevocable “wealth replacement trust,” ensuring your heirs are taken care of.
Tax Savers?
Using charitable trusts effectively can save you a lot of money on taxes. Here are a few key points to remember:
1.? Immediate Tax Deductions:? When you give property to a charitable trust, you get an immediate tax deduction based on the present value of the remainder interest you give to charity.
2.? Tax-Free Sales:? The trust can sell appreciated assets without paying capital gains taxes, allowing you to reinvest the full value of the assets.
3.? Income Payments:? You can receive income from the trust, either immediately or at a later date, which can provide financial stability during retirement.
4.? Estate Tax Reduction:? By removing the value of the gifted property from your taxable estate, you can significantly reduce estate taxes.
?Action Items for Business Owners?
Now that you understand how charitable trusts work, here are some steps you can take to start saving money on your taxes:
Saving money on taxes might seem complicated, but with the right strategies and professional guidance, you can significantly reduce your tax burden while supporting causes you care about. If you have any questions or need personalized advice, feel free to reach out. I’m here to help!
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