If you are committed to supporting a cause about which you feel passionate — while obtaining potential financial advantages for you and your loved ones — then forming a charitable trust might be the best option for you.
Charitable trust formation is especially advantageous when engaging in estate planning. At this stage in their lives, many individuals are considering the long-term consequences of their financial future.
By creating a charitable trust in New Mexico, not only can you support an organization whose mission you believe in wholeheartedly, but you also may be able to provide financial support to yourself and your loved ones through a tax-advantaged arrangement.
New Mexico Financial & Family Law can work with you to determine your goals and settle on the best option for preserving your legacy. Reach out to one of our experienced New Mexico financial planning attorneys for a no-risk, confidential consultation when you call 505-503-1637 or contact us online to schedule an appointment today.
There are two main types of trusts that can be used for charitable donations: a charitable lead trust and a charitable remainder trust.
Both types of charitable trusts are referred to by the IRS as a “split interest” charitable giving vehicle. What that means is that the interest (i.e., proceeds) from the trust are distributed to two different beneficiary pools: charitable and non-charitable.
Any distributions to non-charitable beneficiaries are counted as income by the IRS and taxed normally. Donations to charitable causes, on the other hand, can allow the original donor to qualify for a partial income deduction, along with other possible tax advantages.
It is important to note that both types of trusts are irrevocable. What that means is that once assets are transferred into the ownership of the trust, the trust creator (or “grantor”) is unable to recover those assets or take control of them.
Instead, their designated trustee manages the assets while making distributions according to the terms set in the original trust agreement.
A charitable lead trust is a trust that pays out set donations to a designated charitable institution on a regular schedule. The donations can be of a pre-established amount (a charitable lead annuity trust), or they can be based on the current value of the assets held in the trust (charitable lead unitrust).
These donations are made for a set term, which can be a number of years or the lifespan of the grantor. After the term expires, the remaining funds are distributed to beneficiaries.
A charitable lead trust allows the grantor to easily predict the final amount that will be donated to the charitable cause of their choice. This arrangement is not only advantageous for the charity since they can reasonably predict the amount they will receive over a set schedule, but it can also provide tax advantages to the grantor.
The grantor is able to pre-emptively make a deduction of up to 30% of their adjusted gross income for the year using the total value of their donation. They can also parcel this deduction out for up to five years in order to reduce their taxable income by up to 30% for that given year.
The final beneficiaries of the trust’s balance after the term has expired may also see reduced gift taxes or estate taxes, depending on the configuration of the trust.
A charitable remainder trust follows the opposite plan of the charitable lead trust: non-charitable beneficiaries receive regular ongoing distributions until the trust’s term expires, but then the remaining value of the assets held in the trust are donated to a charitable cause.
Establishing a charitable remainder trust is a fantastic, tax-advantaged way to create a reliable income stream for the grantor or any other non-charitable beneficiaries they choose. In addition, assets that appreciate in the trust and are sold may have no or reduced taxation on their capital gains.
Further, the grantor can still report the estimated final value of the remainder as a partial income deduction for one or multiple years.
One key differentiator from a charitable lead trust is that the term of distributions must be no more than 20 years unless the term is set to the lifespan of one or more beneficiaries. Additionally, the value of distributions made must be no less than 5% but no greater than 50% of the trust’s current value.
Finally, the end value of the trust, which is to be donated to the charitable cause of the grantor’s choice, must be at least 10% of the original value of the assets held within the trust.
Assets held within a trust are allowed to earn interest, which can mean both financial interest for cash balances (AKA usury) as well gains stemming from appreciation of the value of the asset. Importantly, any income generated within the trust itself is taxed similarly to a private foundation, reducing or eliminating its taxes compared to investment gains made by an individual or a business interest.
Any distributions made to a charitable institution are, in most cases, going to be entirely tax-exempt. That can refer to annuity payments made in a charitable lead trust or the donation of the remainder of the trust’s value in the case of a charitable remainder trust.
All distributions made to non-charitable beneficiaries of a charitable remainder trust are taxed as income. However, distributions to non-charitable beneficiaries from the remains of a charitable lead trust may be taxed at a reduced rate — or, in some cases, not taxed at all.
Refer to an attorney and a financial advisor for guidance on how to best structure your trust and make optimal decisions in order to maximize the tax benefits of your charitable trust in New Mexico.
Because both types of charitable trust must be irrevocable, the property and funds transferred into the trust become the property of the trust until they are distributed to other parties. This status means that the assets are able to circumvent probate.
It may also mean that the assets may be shielded from certain claims by creditors and those entitled to a financial reward as the result of a judgment in their favor.
Interestingly, the IRS considers every charitable trust as either its own private foundation or a component of an existing registered public charity. This classification does not provide the trust with total tax-exempt status, as private foundations are still subject to excise taxes.
The trusts must also comply with termination and governing instrument requirements, meaning that the IRS will exercise oversight over how the trusts are managed and whether they are following the strict rules created to ensure that no financial abuse takes place.
Once assets become the property of the trust, the trustee is vested with the responsibility of ensuring their management. They may buy, sell, or trade assets in order to maintain the trust’s value and keep up with ongoing distribution obligations.
Crucially, the trustee cannot take actions to specifically benefit non-charitable beneficiaries. Doing so would be considered “self-dealing” and could invalidate the terms of the trust under IRS rules.
Most assets can be used to fund a charitable trust in New Mexico, including:
In addition to the types of charitable trusts described above, there are several other options available to New Mexico residents:
As you can see, there are quite a few options available for the creation of charitable trusts or charitable institutions. All of the options involve some substantial up-front considerations, including the need to pay the registration fees and the costs of setting up the account.
In addition, the trustee will need financial support to compensate them for their duties while ensuring that the trust is well-maintained.
The decision of which type of trust to create and how to structure it is, ultimately, up to the decision of the grantor. To ensure they arrive at the right conclusion for their goals and intentions, they should provide an estate planning attorney with clear documentation of the interests and assets that they intend to place within a trust.
They should also discuss their goals for supporting their friends and family, including how they wish to reduce the burden of estate or gift taxation in connection with their distributions.
One fact to consider is that all of these charitable vehicles can be established either before or after your lifetime. In many cases, the trusts are formed so that you can watch your investments go to support the people or causes you care about deeply.
You can even have a charitable remainder trust support you and your household for the duration of your remaining life, even if that duration is for many more decades to come.
You can also elect to have a charitable trust established through your last will and testament. It may be possible that the assets involved in funding these trusts will pass through probate, however, so consider your options carefully with the assistance of your estate planning attorney and your financial advisor.
Remember that, no matter what your choices may be, the trust(s) you create will be irrevocable. Their terms may not be altered, in other words, once they are formed, so ensure that you are ready to commit to the arrangement that you decide is in the best interests of yourself, your loved ones, and the charitable causes you care about most.
Charitable trusts are some of the most powerful forms of giving anyone can establish. Institutions uphold both lead and remainder trusts as a gold standard in giving because they essentially create a contract for a pre-ordained — or, at least, reliably predictable — source of funds to support their mission.
When you are ready to take the next step towards securing your legacy, our law firm is ready to help. New Mexico Financial & Family Law has been assisting individuals, foundations, and families throughout the state for over 25 years.
We cannot wait to meet with you and learn more about the world you intend to leave behind for the people and causes that inspire you. Reach out to our offices at any time to schedule a no-risk, confidential appointment to discuss your estate plans and possible trust formation when you call 505-503-1637 or contact us online.
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