The interest in charitable giving increased in 2020 for two reasons. One was a dramatic increase in need as a result of the COVID pandemic, reports The Tax Advisor’s article “Income tax deductions for trusts and estates.” The other was more pragmatic from a tax planning perspective. The CARES Act increased the amounts of charitable contributions that may be deducted from taxes by individuals and corporations. What if a person wishes to make a donation from the assets that are held in trust? Is that still an income tax deduction? It depends. The rules for charitable contribution deductions from an estate are substantially different than those for individuals and corporations.
The IRS code allows an estate or nongrantor trust to make a deduction which, if pursuant to the terms of the governing instrument, is paid for a purpose specified in Section 170(c). For trusts created on or before October 9, 1969, the IRS code expands the scope of the deduction to allow for a deduction of the gross income set aside permanently for charitable purposes.
If the trust or estate allows for payments to be made for charity, then donations from a trust are allowed and may be tax deductions. Otherwise, they cannot be deducted.
If the trust or estate allows distributions for charity, the type of asset contributed and how it was acquired by the trust or estate determines whether a tax deduction for a charitable donation is permitted. Here are some basic rules, but every situation is different and requires the guidance of an experienced estate planning attorney.
Cash donations. A trust or estate making cash donations may deduct to the extent of the lesser of the taxable income for the year or the amount of the contribution.
Noncash assets purchased by the trust/estate: If the trust or estate purchased marketable securities with income, the cost basis of the asset is considered the amount contributed from gross income. The trust or estate cannot avoid recognizing capital gain on a noncash asset that is donated, while also deducting the full value of the asset contributed. The trust or estate’s deduction is limited to the asset’s cost basis.
Noncash assets contributed to the trust/estate: If the trust or estate acquired an asset it wants to donate to charity as part of the funding of the fiduciary arrangement, no charity deduction is permitted. The asset that is part of the trust or estate’s corpus, the principal of the estate, is not gross income.
The order of charitable deductions, compared to distribution deductions, can cause a great deal of complexity in tax planning and reporting. Required distributions to noncharitable beneficiaries must be accounted for first, and the charitable deduction is not taken into account in calculating distributable net income. The recipients of the distributions do not get the benefit of the deduction. The trust or the estate does.
Charitable distributions are considered next, which may offset any remaining taxable income. Last are discretionary distributions to noncharitable beneficiaries, so these beneficiaries may receive the largest benefit from any charitable deduction.
If there are charitable contribution deductions from an estate, it must file form 1041A for the relevant tax year, unless it meets any of the exceptions noted in the instructions in the form.
These are complex estate and tax matters, requiring the guidance of an experienced estate planning attorney for optimal results. If you would like to learn more about charitable giving in your estate planning, please visit our previous posts.
Reference: The Tax Advisor (March 1, 2021) “Income tax deductions for trusts and estates”