Let’s say your client is the beneficiary of a family trust (meaning here a noncharitable irrevocable trust) that was created by a grandparent who made a fortune by founding a restaurant chain. The client is inclined to give some of the funds to an environmental cause she feels strongly about, but the trust is not set up to allow donations to charity. What can she do, if anything, to use some of the trust funds to support her chosen charity?
This philanthropic situation was the focus of a presentation called “Charitable Giving with Noncharitable Trusts,” at the AICPA & CIMA’s ENGAGE 2023 conference in June.
The conference presentation, by Kim Kamin and Carl Fiore, also addressed how clients can design new family trusts with options for philanthropy to facilitate tax planning and allow current and future beneficiaries some charitable flexibility.
A difficulty with many existing family trusts
Affluent families sometimes meet with their adviser and say, in effect, “We’re stuck with this trust grandpa set up, but we really want to be diverting some of the trust income to the philanthropy that the family cares about,” said Kamin, a partner and chief wealth strategist at Gresham Partners LLC.
A review of the trust’s governing instrument may indeed reveal that charitable distributions are not authorized, especially if it is an “old and cold” trust, Kamin said. In that situation, getting funds out of the trust for philanthropy might involve trying to add charity as a current beneficiary or use a lifetime power to appoint assets to charity, among other possibilities. More dramatic steps might include merging or decanting the trust into a more flexible trust instrument, she said.
Alternatively, the trust could simply make a distribution to an individual beneficiary who, in turn, donates the funds to charity. But the trust’s governing instrument may limit the trustee’s fiduciary ability to do this if it contains a provision that, for instance, allows distributions only for the beneficiary’s health, education, maintenance, or support; the trustee could still make the distribution if it qualifies under the standard, but the trustee would have broader authority with a standard like best interests.
Apart from these considerations regarding distributions to individual beneficiaries, having the trust make the donation directly might be preferable for income tax reasons. For example, the charitable deduction may be worth more to the trust because trusts reach the highest marginal tax rate more quickly than individuals and do not have adjusted gross income limitations on their deduction, Kamin and Fiore said.
Designing new family trusts better
In their ENGAGE conference presentation, Kamin and Fiore stressed the important role that advisers can play in highlighting for clients the value of designing new family trusts with some degree of charitable flexibility.
Clients sometimes think, “Oh no, but these assets are for family members,” Kamin said, without considering the potential tax planning and other benefits of giving the family trust the option of making distributions for philanthropy.
When clients are creating a new family trust, an adviser can ask if they would like to name the family’s private foundation or donor-advised fund, or qualified public charities generally, as permissible beneficiaries. To limit the trustee’s discretion, the clients may wish to specify in the trust instrument that the trust can donate to charity only if no current beneficiary objects to the distribution after being provided 30 days’ notice, Kamin suggested.
Other ways to provide philanthropic flexibility include defining powers in the trust instrument to appoint assets to charity or specifying that property can go to charity upon a beneficiary’s qualified disclaimer, Kamin and Fiore said.
Tax aspects
In his portion of the ENGAGE conference presentation, Fiore, a managing director in the Andersen U.S. national tax office, focused on the tax issues involved when a family trust makes a distribution to charity. He pointed out that while “at first blush it seems like the rules are relatively straightforward,” things can “become very complicated very quickly.”
Under Sec. 642(c), there are two basic requirements for the family trust to take a charitable deduction, but there are “lots of things open for interpretation and lots of things that could potentially go wrong,” Fiore explained.
First, the trust’s donation must be made “pursuant to the terms of the governing instrument.” The IRS has taken a “hardline approach” to this, looking at the trust’s governing instrument for evidence of charitable intent, Fiore said. Again, the way the trust instrument is drafted is crucial.
Second, the charitable donation must be paid from gross income, which can be a tricky requirement because of trust accounting rules and income-tracing concepts, Fiore said.
As a workaround in certain circumstances, a family trust may be able to make a deductible donation to charity through a passthrough entity that it invests in. In Rev. Rul. 2004-5, the IRS ruled that a trust could take a deduction for its distributive share of a charitable contribution made by a partnership from its gross income, even though the trust’s governing instrument did not authorize the trustee to make charitable contributions.
But before using the passthrough strategy, Fiore said, ensure that everyone is comfortable with the idea, because otherwise “you could end up with some angry beneficiaries.”
Additional thoughts
In a post-presentation interview, Kamin emphasized that “there are opportunities here for families to be thinking more holistically about all of the assets that are available for their philanthropy and which buckets of assets might make the most sense from a tax perspective to be using for their philanthropic giving.”
Fiore said the most important things for practitioners to understand in applying Sec. 642(c) are “the gross income and tracing concepts and understanding the overlap between that and some of the accounting issues” that arise in determining whether the trust’s charitable donation is from gross income.
For more information on this topic, see Kamin’s article “Considerations for Charitable Giving with Noncharitable Irrevocable Trusts.” A video recording of Kamin and Fiore’s conference presentation is available to those who bought an all-access pass to ENGAGE 2023. The video is also available for purchase.
On philanthropy broadly, listen to the PFP Section podcast episodes “Philanthropy Techniques for Your Wealthier Clients” and “Guiding Families in Their Philanthropic Endeavors.”
— Dave Strausfeld, J.D., is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact him at David.Strausfeld@aicpa-cima.com.
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