The Family Legacy Trust

There is another solution that could help salvage charitable income tax deductions.  The Family Legacy Trust is a creative planning strategy that can provide 100% deductibility of annual charitable donations even if the donor doesn’t itemize.  One of the most attractive benefits of the Family Legacy Trust it can also serve as a platform for families who wish to cultivate philanthropic values among children and grandchildren.    

 

The Family Legacy Trust is a “non-grantor” trust (also known as a “complex” trust) established as a complementary component of a donor’s overall estate plan.  As a separate taxpaying entity, the Trust has its own tax ID number and is required to file its own income tax return (Form 1041) each year.  With the advice of a financial advisor, the donor estimates how much of the donor’s investment portfolio will be required to produce the amount of income that the donor wants to give annually to nonprofit organizations.  That portion of the portfolio is transferred to the Family Legacy Trust. [1] 

 

The beneficiaries of the Family Legacy Trust can be as many nonprofit organizations as the grantor wishes to identify currently, and others can be added in the future.  In addition to nonprofits, individual family members can be named as discretionary beneficiaries of the Trust. [2] 

 

Here’s how the Trust saves taxes.  Non-grantor trusts, such as the Family Legacy Trust, do not have a “standard deduction.”  Instead, under Section 642(c)(1) of the Internal Revenue Code, the Family Legacy Trust enjoys an unlimited deduction for all income distributed for charitable purposes.  In other words, all income distributed to nonprofits by the Trustee produces a dollar-for-dollar charitable income tax deduction.  That frees-up the full amount of the grantor’s standard deduction to offset non-Trust income reported on the grantor’s personal return. 

Example.  Dave and Doris Donor are married North Carolina residents, both over age 65, and have an adjusted gross income of $260,000.  The Donors are committed to supporting several nonprofits by making annual donations totaling $10,000.  Since the “doubling” of the standard deduction and the capping of state and local tax deduction, it’s unlikely that the couple’s tax deductions will exceed their $26,600 standard deduction.  The couple wishes to continue making charitable donations to their favorite nonprofits, but they don’t want to give up the tax savings that their generosity has provided in past years.

 

The Donors transfer $200,000 of income-producing assets (from a non-tax deferred account) to a Family Legacy Trust, assuming that, on average, the Trust assets will generate about $10,000 of annual income.  The couple names their favorite nonprofits as possible beneficiaries of the Trust.  Each year the Trustee distributes the Trust income to the named charities and deducts the full amount of those distributions as charitable donations.  If the Donors name children or grandchildren as beneficiaries of the Trust, an Independent Trustee could distribute Trust income to those family members, who would report the income on their personal tax returns. [3]  In this hypothetical example, if the couple is in the 24% federal tax bracket, the annual tax savings from shifting $10,000 of taxable income to the Family Legacy Trust would be approximately $3329 ($2400 federal tax + $549 NC tax + $380 Medicare Surtax).

As with a QCD from an IRA, the income tax benefit created for the grantor of the Trust is not in the form of a tax deduction for the grantor.  Instead, the tax benefits arise due to the fact that income which otherwise would be included in the grantor adjusted gross income is shifted to the Trust.  Consequently, the grantor might also benefit from some of the other potential tax benefits that can result from a QCD.

 

As noted above, the benefits of a Family Legacy Trust go beyond saving taxes.  An increasing number of families are interested in passing more than financial wealth to their children and grandchildren—they’re seeking to create a generational family legacy.  Ultra-wealthy families have many opportunities to create family legacies by establishing entities such as family foundations, endowments, and charitable lead trusts, to name a few.  In practicality, the funding levels required to establish and maintain such entities are substantially greater than most families are willing to undertake.  The Family Legacy Trust offers families of moderate wealth the opportunity to explore and identify family values and pass them along to future generations for a relatively low cost.  The Trust can be designed to terminate on the death of the last-surviving grantor or continue the family’s charitable giving legacy through successive generations. [4]

 

Footnotes

[1] This transfer can be structured as a gift, utilizing a portion of the donor’s $11.18 Million federal gift tax exemption, or as an incomplete gift, thereby preserving the donor’s gift tax and estate tax exemption. 

[2] Under IRC § 674(b)(4) if distributions are irrevocably restricted to charitable organizations, the grantor and family members can serve as trustee and allocate income and principal among the charitable beneficiaries.  However, if family members are added as discretionary beneficiaries, an independent trustee who is unrelated to the grantor must be appointed as trustee to retain the non-grantor status of the trust.

[3] Beware of the “Kiddie Tax.”  To discourage the shifting of taxable income to family members whose marginal tax rates are low, Congress chose to tax a child’s unearned income greater than $2100 if the child is under age 18, or if the child is under age 23 and a full-time student.  The previously-applicable tax rates were those of the child’s parent, however, under the TCJA, the tax brackets applicable to trusts and estates now apply, making the tax even more onerous.    

[4] It is uncertain how long a trust can continue under NC law.  In 2007 the NC Legislature repealed the Rule Against Perpetuities (RAP), a law that prohibited a trust from continuing for longer than 90 years or a life in being (when the trust is created) plus 21 years.  However, there is some question among estate planning attorneys as to whether or not the repeal the RAP conflicts with Article I, Section 34 of the NC Constitution, potentially rendering the repeal unconstitutional.

This website and all materials appearing herein are presented solely for educational purposes and cannot be relied upon by anyone for elder law, estate planning, tax or any other purpose.  You must seek advice from competent legal, financial and tax advisors before attempting any form of elder law planning or any other form of estate planning.  Nothing presented on this website implies or creates an attorney-client relationship between a site visitor and the author, Jay H. Krall.  Attorney Krall is licensed by the North Carolina State Bar and not in any other state.  Links to other internet sites are not endorsements of any products or services described at those sites.   

Circular 230 Disclosure: Pursuant to U.S. Treasury Department Regulations, we are required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.

© 2020 Jay H. Krall,  Attorney at Law

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