Taxation of Charitable Remainder Trusts

Types

• Charitable unitrusts pay a specific percentage of the trust assets to the trust beneficiaries each year, and the distribution amount revalues annually. A charitable annuity trust specifies the amount paid to trust beneficiaries when the trust is established, and the amount does not change. The annuity trust is less frequently used than the unitrust. Both types of charitable trusts file Internal Revenue Service Form 5227 Split Interest Trust Information Return and Form 1041 U.S. Income Tax Return for Estates and Trusts. Form 5227 is an information return that is not private and is open for public inspection.
  
  

5227 Filing Information

• A charitable remainder trust created prior to May 27, 1969, is exempt from filing tax return Form 5227 unless additions to the trust occurred after this date. Any additions remove the grandfathered tax exemption and create a tax return filing requirement. Form 5227 requires specific information on charitable remainder trusts and determines if any overage or underage occurred in the prior year unitrust payment. Unitrust payments not calculated properly carry tax penalties if not resolved within a certain period of time.
  
  

1041 Filing Information

• Since Form 5227 is an information return the actual trust tax filing is done on Form 1041. In addition, each individual trust beneficiary that receives funds from the charitable trust during the year will receive a Form K-1 tax letter with information to report on a personal income tax return Form 1040. Charitable remainder trusts have a tiered schedule regarding amounts paid to trust beneficiaries. Distributions subject to ordinary income taxes out first, followed in order by capital gains, tax-exempt income and non-taxable principal distributions. For example, if a charitable trust earns $2,000 in annual income but creates $75,000 in capital gains to meet a required $100,000 annual beneficiary distribution, the beneficiary will receive a tax letter reporting these amounts. No tax will pass out to the beneficiary in excess of the distribution received.
  
  

Seek Professional Tax Advice

• The tax law is constantly changing, and it is a complex process to coordinate the two returns that charitable trusts require. It is always a good idea to seek advice from a tax professional such as a CPA or tax lawyer who stays current on changes in tax law.