What Is a Charitable Split-Interest Trust?

A charitable split-interest trust is a legal arrangement that provides financial benefits to both a charitable organization and a non-charitable beneficiary, such as the donor or their family. This irrevocable trust is established by transferring assets like cash, securities, or real estate into its control. The core concept involves splitting the interest in these assets; one party receives payments for a designated period, and the other receives the remaining assets when that period ends.

Key Parties and Core Mechanics

A split-interest trust operates through several defined roles. The Grantor, or donor, is the individual who creates and funds the trust, establishing its fundamental terms. The Trustee takes on the legal and fiduciary responsibility of managing the trust’s assets, investments, and distributions according to the trust document. The Income Beneficiary, often the grantor or their family, receives regular payments for a set term. The Remainder Beneficiary is the qualified charitable organization that receives all remaining assets after the payment period concludes.

Types of Charitable Remainder Trusts

Charitable Remainder Trusts (CRTs) provide a stream of payments to a non-charitable beneficiary first. After a set term, which can be for a number of years up to 20 or for the beneficiary’s lifetime, the remaining assets are transferred to a charity. The annual payout rate must be between 5% and 50% of the trust’s value. To qualify, the present value of the charity’s remainder interest must be at least 10% of the initial contribution.

Charitable Remainder Annuity Trust (CRAT)

A Charitable Remainder Annuity Trust (CRAT) provides a fixed dollar amount to the income beneficiary each year. This amount is calculated as a percentage of the initial fair market value of the trust’s assets and does not change, regardless of investment performance. For example, if a CRAT is funded with $1 million and a 5% payout rate is selected, the beneficiary receives $50,000 annually for the trust’s term. No additional contributions can be made to the trust after it is funded.

Charitable Remainder Unitrust (CRUT)

A Charitable Remainder Unitrust (CRUT) pays the income beneficiary a fixed percentage of the trust’s value, which is recalculated annually. The actual dollar amount distributed can fluctuate based on the investment performance of the trust’s assets, offering a potential hedge against inflation. For instance, if a CRUT funded with $1 million has a 5% payout, the first-year payment is $50,000; if the value grows to $1.1 million the next year, the payment increases to $55,000. Unlike a CRAT, a CRUT allows the donor to make additional contributions.

Types of Charitable Lead Trusts

Charitable Lead Trusts (CLTs) function as the inverse of remainder trusts. In this structure, an income stream is first paid to a qualified charitable organization for a specified period. At the end of this lead term, the remaining assets are transferred to non-charitable beneficiaries, such as the donor’s heirs. This makes CLTs a tool for individuals who want to make a significant immediate philanthropic impact while planning for the eventual transfer of wealth.

Charitable Lead Annuity Trust (CLAT)

A Charitable Lead Annuity Trust (CLAT) makes fixed annual payments to a charity based on the initial value of the assets. Because the payment does not change, any appreciation in the trust’s assets during the lead term benefits the non-charitable remainder beneficiaries exclusively. This feature makes CLATs effective for transferring appreciating assets to heirs with potentially reduced gift and estate tax implications.

Charitable Lead Unitrust (CLUT)

A Charitable Lead Unitrust (CLUT) pays the designated charity a fixed percentage of the trust’s assets, which are revalued annually. If the trust’s assets grow, the amount paid to the charity also increases. This structure means the charitable beneficiary shares in the appreciation of the trust’s assets.

Grantor vs. Non-Grantor CLTs

A distinction within CLTs is whether they are a grantor or non-grantor trust, which has significant tax consequences. In a Grantor CLT, the donor is treated as the owner for income tax purposes, allowing for a large, upfront income tax deduction, but the donor must then report and pay taxes on all income the trust earns. With a Non-Grantor CLT, the trust is a separate taxable entity, and the donor receives no upfront deduction. The trust pays its own taxes but can deduct its charitable payments, making it a tool for reducing gift or estate tax on assets passed to heirs.

Tax Treatment and Implications

The tax treatment for split-interest trusts varies by structure and affects the donor, beneficiaries, and the trust. When a donor establishes a trust, they may be eligible for an immediate income tax deduction. For a CRT, the deduction is based on the present value of the charity’s remainder interest. For a Grantor CLT, the donor can claim an upfront deduction for the present value of the income stream designated for the charity.

Gift and Estate Tax

These trusts are effective for reducing gift and estate tax. Assets transferred into a Charitable Remainder Trust are removed from the donor’s taxable estate. For Charitable Lead Trusts, the value of the gift to heirs is reduced by the present value of the payments made to charity. A CLAT can sometimes be structured so the charitable deduction equals the full value of the assets, resulting in a tax-free transfer to heirs.

Taxation of Beneficiary Payments

The taxation of payments to non-charitable beneficiaries from a Charitable Remainder Trust is determined by a four-tier accounting system. Distributions are characterized first as ordinary income, then as capital gains, then as tax-exempt income, and finally as a non-taxable return of principal. This ordering rule means beneficiaries often pay tax at ordinary income or capital gains rates on the distributions they receive.

Trust Taxation

Charitable Remainder Trusts are tax-exempt entities, meaning the trust does not pay income tax on its investment earnings. This allows assets to be sold within the trust without triggering immediate capital gains tax. Non-Grantor Charitable Lead Trusts are not tax-exempt but can deduct payments made to charity. In a Grantor CLT, all income is taxed directly to the grantor.

Establishing and Administering the Trust

Creating a split-interest trust begins with making several foundational decisions. A potential grantor must determine:

• The appropriate type of trust (CRAT, CRUT, CLAT, or CLUT) based on financial and philanthropic goals.
• Who will serve as the trustee, which can be an individual, bank, or trust company responsible for managing assets.
• Which specific assets, such as cash, securities, or real estate, will be used to fund the trust.
• The income and remainder beneficiaries and the duration of the trust’s term.

Once these decisions are made, an attorney drafts the formal trust document outlining all provisions. After the grantor signs the document and legally transfers the assets into the trust, a process known as funding, the trustee assumes control. The trustee’s ongoing duties include managing investments, making required distributions, and handling tax compliance, which involves filing Form 5227, Split-Interest Trust Information Return, with the IRS annually.