Private Charitable Trust: What It Is and How It Works

A private charitable trust is a legal arrangement an individual or family creates to manage and direct assets toward philanthropic goals. It is a formal tool for planned giving that provides a framework for sustained giving, often extending beyond the donor’s lifetime. The trust is governed by a legal document that outlines its charitable purpose, names the trustees, and specifies the beneficiaries, separating the assets from the donor’s personal estate.

Types of Private Charitable Trusts

There are several distinct structures for private charitable trusts, each designed to meet different financial and philanthropic objectives. The primary categories are defined by when the charitable and non-charitable beneficiaries receive their payments from the trust. Understanding these differences is fundamental to selecting the appropriate vehicle for one’s goals.

A Charitable Remainder Trust (CRT) is structured to provide an income stream to one or more non-charitable beneficiaries first, such as the donor or their family members. These payments are made for a specified period, which can be a set number of years or for the life of the beneficiaries. At the end of this term, the remaining assets in the trust are distributed to the designated charitable organization.

A Charitable Remainder Annuity Trust (CRAT) pays a fixed dollar amount to the income beneficiaries each year. This amount is determined when the trust is created and does not change, providing a predictable income stream. No additional contributions can be made to the trust after it is initially funded.

A Charitable Remainder Unitrust (CRUT) pays its income beneficiaries a fixed percentage of the trust’s fair market value, which is recalculated annually. This means payments can increase or decrease with the trust’s investment performance. This structure allows for growing income payments and permits additional contributions to be made over time.

A Charitable Lead Trust (CLT) reverses the order of payments. The trust first makes payments to a designated charity for a specified term. After this period ends, the remaining assets are transferred to non-charitable beneficiaries, such as the donor’s heirs, making it a tool for fulfilling charitable goals while potentially reducing transfer taxes.

Similar to remainder trusts, lead trusts come in two forms. A Charitable Lead Annuity Trust (CLAT) makes fixed annual payments to the charity. A Charitable Lead Unitrust (CLUT) pays the charity a fixed percentage of the trust’s value, which is revalued annually, allowing the amount to fluctuate with investment performance.

Tax Implications and Governing Rules

Private charitable trusts are governed by Internal Revenue Code provisions that provide tax advantages while imposing operational rules. A primary benefit is the potential for an immediate income tax deduction in the year the trust is funded. The deduction is based on the present value of the future charitable gift and its calculation depends on the trust type, term, payout rate, and federal interest rates.

An advantage involves the treatment of appreciated assets like stocks or real estate. When contributed, these assets can be sold by the trustee without the donor immediately realizing capital gains tax. This allows the full value of the asset to be reinvested within the trust, potentially generating more income and a larger gift to charity.

These trusts are also effective estate planning tools. By transferring assets into an irrevocable charitable trust, the donor removes them from their taxable estate. This can reduce or eliminate federal estate taxes, which is useful for estates that exceed the federal exemption amount.

The IRS imposes rules to prevent abuse of the trust’s tax-exempt status. A primary prohibition is against ‘self-dealing,’ as defined in Internal Revenue Code Section 4941. This rule forbids most financial transactions, such as selling or leasing assets, between the trust and ‘disqualified persons,’ which includes the creator, trustees, and their family members.

Trusts are also subject to rules against ‘jeopardy investments,’ which are speculative investments that risk the trust’s charitable purpose. Regulations also limit ‘excess business holdings,’ which is the amount of voting stock a trust can own in a business. Violating these rules can result in excise taxes and penalties against the trust and its managers.

Information and Decisions for Creation

Before a private charitable trust is formed, several decisions must be made to ensure the document reflects the donor’s intentions and complies with legal requirements. These include:

• Selecting the appropriate trust structure, choosing between a remainder or lead trust, and then an annuity or unitrust model based on financial goals.
• Choosing a trustee, which can be an individual or a corporate entity like a bank. The trustee’s full legal name and address are required, as is a plan for succession.
• Identifying all beneficiaries, including the full legal names and addresses of non-charitable beneficiaries and the names of the qualified 501(c)(3) charitable organizations.
• Defining the specific terms, including the trust’s duration, which can be for a beneficiary’s life or a term not to exceed 20 years. The payout rate must be at least 5% but no more than 50% of the trust’s asset value, and the charity’s remainder interest must be at least 10% of the initial contribution.
• Creating a detailed inventory of the specific assets that will fund the trust, such as the exact dollar amount of cash, specific securities, or the legal description of real estate.

The Establishment Process

Once preliminary decisions are made, the formal process of establishing the trust begins. The first step is to engage a qualified attorney to draft the formal trust instrument. This legal document will incorporate all prior decisions, including the trust type, trustees, beneficiaries, and terms of operation.

After the trust document is signed, the trustee must obtain a Taxpayer Identification Number (TIN). Because a trust is a separate legal entity, it cannot use the Social Security Number of the donor or trustee. The trustee must apply for an Employer Identification Number (EIN) from the IRS using Form SS-4, which can be done online or by mail.

The final step is funding the trust, which involves the legal transfer of the identified assets into the trust’s name. For cash, this may involve wiring funds to a new bank account opened in the trust’s name. For securities, it requires retitling the investment account, and for real estate, it requires executing and recording a new deed.

Ongoing Administrative Duties

After a private charitable trust is established and funded, the trustee assumes recurring responsibilities to maintain its legal and tax compliance. These duties are necessary for the trust to fulfill its purpose without incurring penalties. A primary duty is the annual tax filing requirement.

The trustee is responsible for filing informational returns with the IRS each year. The primary form is IRS Form 5227, ‘Split-Interest Trust Information Return,’ which reports the trust’s financial activities. Depending on the circumstances, Form 990-PF or Form 4720 may also be required to report financial activity or excise taxes.

A core function of the trustee is to make all required distributions as stipulated in the trust document. This means ensuring income beneficiaries or the designated charity receive their payments accurately and on schedule. Failure to make distributions correctly can have serious legal and tax consequences.

Meticulous record-keeping is a legal requirement for the trustee. The trustee must maintain comprehensive records of every transaction, including all income received, assets bought or sold, administrative expenses, and distributions. These records are the basis for the annual tax filings and serve as proof of the trust’s proper administration.