What Is a Split Interest Agreement and How Does It Work?
Understand how a split-interest agreement structures a charitable gift, dividing an asset's value over time to benefit both the donor and a nonprofit.
A split-interest agreement is a method of charitable giving where a donor irrevocably transfers assets to a trustee, allowing the donor to contribute to a charity while sharing the benefits with non-charitable beneficiaries. The primary parties involved are the donor, a trustee who administers the assets, an income beneficiary who receives payments for a set term, and a remainder beneficiary who receives the assets when the term ends. The agreement specifies how the assets are invested and how distributions are made.
Common Types of Split Interest Agreements
Charitable Remainder Trusts
In a Charitable Remainder Trust (CRT), a non-charitable beneficiary, often the donor, receives an income stream first. Payments are made for a set number of years, not to exceed 20, or for the beneficiary’s lifetime. After this period, the remaining assets are transferred to one or more designated charitable organizations.
There are two main variations of this trust. A Charitable Remainder Annuity Trust (CRAT) pays a fixed dollar amount to the income beneficiary each year, which must be at least 5% but no more than 50% of the assets’ initial value. The payment is constant regardless of investment performance, and no additional contributions can be made after the trust is funded.
A Charitable Remainder Unitrust (CRUT) pays the beneficiary a fixed percentage, between 5% and 50%, of the trust’s fair market value, which is revalued annually. Because the payment amount can fluctuate with investment returns, a donor is permitted to make additional contributions to a CRUT.
Charitable Lead Trusts
Charitable Lead Trusts (CLTs) operate as the inverse of CRTs. In this arrangement, a designated charity receives the lead interest payments for a specified term. At the end of the term, the remaining assets are transferred to non-charitable beneficiaries, such as the donor’s family. This structure is often used to transfer assets to heirs with potentially reduced gift or estate tax consequences.
Similar to remainder trusts, lead trusts come in two forms. A Charitable Lead Annuity Trust (CLAT) provides a fixed dollar amount to the charity each year. A Charitable Lead Unitrust (CLUT) pays the charity a fixed percentage of the trust’s assets, which are revalued annually. CLTs have no minimum or maximum payout requirement, but payments must be made at least annually.
Other Forms
A Pooled Income Fund is a trust managed by a public charity that combines contributions from various donors. Donors or their beneficiaries receive a share of the fund’s income for life, after which their portion of the principal passes to the charity. This arrangement allows donors to participate with smaller contributions than are needed for a private trust.
A Charitable Gift Annuity is a contractual agreement where a donor transfers assets to a charity in exchange for fixed income payments for life. The payment amount is based on the annuitant’s age at the time of the gift. Most charities follow rates suggested by the American Council on Gift Annuities.
Nonprofit Accounting and Financial Reporting
When a nonprofit organization is a party to a split-interest agreement, it must follow specific accounting guidance under Accounting Standards Codification 958. The organization records the assets it receives at their fair value at the time of the donation. Simultaneously, the nonprofit must recognize a liability on its balance sheet, representing the present value of future payments owed to non-charitable beneficiaries.
The difference between the fair value of the assets and the liability for future payments is recognized as contribution revenue when the agreement is executed. In its financial statements, the nonprofit should present this revenue as a separate line item or disclose it in the notes. As payments are made to beneficiaries, the liability is reduced. The liability is also re-measured periodically to reflect changes in life expectancy and other actuarial assumptions.
Valuation of Agreement Interests
The valuation of interests in a split-interest agreement is necessary for both the donor’s tax purposes and the nonprofit’s accounting. This process relies on the concept of present value to determine the current worth of future payments. The inputs for this calculation include the term of the agreement and the projected payment amounts.
A discount rate is used to translate future payments into today’s dollars. The IRS mandates the use of the Section 7520 rate, which is published monthly and is defined as 120% of the federal mid-term rate. Donors can use the rate for the month of the gift or for either of the two preceding months, allowing them to select the most favorable rate.
Tax Implications for the Donor
Donors who establish split-interest agreements can receive several tax advantages, including an immediate income tax charitable deduction. The deduction amount is the calculated present value of the remainder interest that will ultimately pass to the charity, not the full value of the donated assets.
Another benefit involves capital gains tax. By funding a trust with highly appreciated assets like stocks, a donor can often defer or avoid immediate capital gains tax. The trust, as a tax-exempt entity, can sell the asset without triggering a tax liability, allowing the full proceeds to be reinvested to generate income.
These agreements are also a tool for estate planning. Assets transferred into an irrevocable split-interest trust are removed from the donor’s taxable estate. This can reduce or eliminate federal estate taxes that might otherwise be due upon the donor’s death.