Irrevocable Trusts
In an irrevocable trust, the donor makes an irrevocable gift of property to a trust that is itself not a charity.
Normally the donor retains, until her or his death, the right to receive the income generated by the investment of the property given to the trust. The trust’s income paid or payable to the donor each year is included in the donor’s income for income tax purposes. Income of the trust that the donor designated at the time the trust was created as payable to a charity is not income for the donor. Any income of the trust not paid or payable to beneficiaries in the calendar year in which it is earned is subject to income tax in the trust at the top personal marginal tax rate.
The trustee of such a private trust could be a trusted friend or family member, a trust company or the charity that will be the capital beneficiary. The thing to remember is that whoever acts as trustee of the private trust is not the beneficial owner of the property in the trust. The beneficial owner is the person or persons named as the capital and income beneficiaries. Even if a charity that is a capital beneficiary become the trustee, the funds given to the trust do not become the charity’s property until the donor dies. For that reason, the charity acting as trustee must keep the funds of the private trust segregated from its own funds. In other words, the funds in the private trust should not be reported in the charity’s operating balance sheet even if the charity provided the donor with an official receipt for income tax purposes as described below.
The advantage of setting up a private trust of which a charity is the capital beneficiary and the donor is the income beneficiary are as follows:
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The donor irrevocably gives property (usually money) that he or she had planned to give in their will at the present time. Because the charity becomes the rightful future owner of the gift, it can issue an official receipt for income tax purposes to the donor at the time the private trust is established. The value of the receipt will be the present value of money that the charity will receive at the donor’s death.
For example, a donor who has a life expectancy of nine year gives $25,000 to a private trust of which a charity is appointed the irrevocable capital beneficiary at the donor’s death. The value of the charitable receipt at the time the gift is made will be determined in accordance with the formula:
P = V (1+i)n - P = present value
- V = fair market value of the gift at this time
- i = the discount rate used = the current prime interest rate (assume 5%)
- n = the life expectancy of the donor
Applying this formula to the above example would give a result as follows:
$25,000 = P or $25,000 = $15,755 (1+0.05)9 0.6302 The donor would, therefore, receive a receipt for $15,755 at the time the private trust is established.
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A gift made to a private trust with a designated capital beneficiary does not become part of the donor’s estate. It is, therefore, a gift that does not become public knowledge. It also cannot normally be challenged at the time of the donor’s death because the property transferred to a trust with designated third-party capital beneficiaries passes to those beneficiaries outside of the will.
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Since the property in the private trust is not part of the estate subject to probate, probate fees do not apply to such gifts.
People might name charities as residual beneficiaries of trusts that are established for other purpose, i.e., to fund income for a disabled child during that child’s lifetime. This gives the charity an irrevocable capital interest in the trust. The donor is considered to have made a gift to the charity of the capital interest when the trust was created. The eligible amount of the gift to the charity would be its present value as determined in the above example.
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The purpose of CCCC Stewardship Services is not intended to replace legal and other professional advisers. The goal is to provide Christians with information based on biblical principles to enhance the stewardship of resources entrusted to them.
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