Charitable Deductions for Trusts

Charitable Deductions for Trusts

“I don’t always ask questions about trusts, but when I do, I ask the Tax School…”

As promised when we presented our trust in-depth webinars in June 2020, we are addressing the most frequently asked questions that arose during those sessions here on the blog. In a previous post, we covered allowable deductions for trusts. The issue of charitable deductions for a trust was a prevalent topic, so we are providing more guidance on this issue. 

From a tax code standpoint, the driving law for the deductibility of charitable contributions made by a trust is Internal Revenue Code Section 642(c)(1).

Let’s begin with the basic requirements for a trust to take a charitable deduction:

1. The trust document must state there are to be charitable contributions.
2. The funds must be distributed for a charitable purpose during the year.
3. For a deduction to be allowed, it must be made from the gross income of the trust. Charitable contributions made from the assets (corpus) of the trust are not eligible for a deduction.

This is confusing because in most cases, we (as well as other providers of continuing education) have told you that trust rules are very similar to the personal taxpayer rules. Well, this is one instance where that is not the case.

So what differences are there between individual taxpayers and trusts regarding charitable deductions? 

(Note: the regulations for charitable contributions made by individuals are covered under IRC §170(a). IRS Publication 526 provides additional guidance in this area.)

• Trusts are not limited to a percentage of income (well, they are limited to 100% of the trust’s gross income), while with individuals, the deduction cannot be more than 60% of their adjusted gross income.
• As stated earlier, for a trust to receive a charitable deduction, the deduction must be traceable back to trust gross income.
• Sometimes a trust can elect to deduct charitable contributions made in the current year and treat them as though they were made in the previous year. (IRC §642(c)(1)(b)).
• A trust can’t carry forward any unused charitable deductions like an individual taxpayer can.

Let’s discuss charitable deductions as they relate to popular trust arrangements typically encountered:

Revocable (Grantor) Trusts. In most cases, while the grantor is living, these types of trusts are disregarded for tax purposes. The grantor simply continues to report their income on their personal tax filing. Therefore, a charitable contribution would likely not be made from the trust income, and the deductibility of the contribution would be subject to the individual rules of §170(a). Furthermore, an attempt to make a charitable contribution from a revocable trust would likely fly in the face of the trust gross income requirement for which there is likely none.

Irrevocable (Nongrantor) Trusts. Now here’s the type of trust that could receive a charitable deduction based on the factors we outlined earlier. This type of trust will likely have income; we will still need to check if the trust document is provided for charitable contributions to be made. Also, there needs to be certainty the contribution is to a qualified charity for a charitable purpose.

The trust would also need to be complex in that distributions are at the discretion of the trustee. In a simple trust arrangement, all income is treated as though it was distributed (even if it hasn’t been) so any charitable contributions made by a simple trust would end up being a separately stated K-1 item for the beneficiary to potentially use on their personal return subject to the rules of §170(a). No deduction would be available to the trust since it doesn’t have any taxable income.

What do we mean by “traceable to income”?

An important rule for a trust to take a deduction for a charitable income tax deduction is that the gift is made from the gross income of the trust. Therefore, we have to determine what the source of funds was from which the contribution was made. The goal is to demonstrate that the contribution came from the income of the trust and not from trust assets. If the trust took the income and purchased assets and then later made a contribution of those purchased assets as an in-kind donation, such a move would likely be permissible as well.

Additional limitation on what the trust can deduct. If a trust donates property it purchased, is the deduction limited to what the trust paid for the asset, or can the trust deduct the current fair market value of the purchased asset? In a recent court case, Green v U.S., the court ruled that the trust deduction was limited to what the trust paid for the property.

Making charitable contributions from a trust may accomplish several goals. The donation may represent the grantor’s wishes, or it may be a planning tool to maximize charitable deductions. Especially during the TCJA years, limitations provided by the higher standard deduction and income limitations placed on individuals may limit or eliminate tax benefits available for making donations. That’s why it’s advisable when discussing the potential of establishing a trust with a client that the taxpayer takes time to consider what they are trying to accomplish by establishing a trust.

As we strive to provide more trust information for you to familiarize yourself with, we will address more complex gifting and charitable planning arrangements that a client may benefit from.

A journey of a thousand miles begins with a single step.

Again, stay thirsty for knowledge, my friends…

by Tom O’Saben, EA