Annual charitable contributions topped $335.17 billion in 2013,1 with 98.4 percent of high-net-worth (HNW) households making charitable donations.2 Charitable giving accounted for 2 percent of the U.S. gross domestic product3 and is projected to dramatically increase over the next three decades as the world’s HNW individuals are projected to bequeath $16 trillion globally.4 Of these bequests, $300 billion are projected to be to charity.5
The use of trusts by HNW individuals has also increased dramatically since 1995. The top 1 percent currently have 38 percent of their assets in trusts, and the next 9 percent have 43 percent of their assets in trusts.6 This percentage is compared to only 12.5 percent of all gifts going to trusts in 1995.7 The reason for such growth is the evolution of the modern directed trust (MDT) in 1995, which provides the family flexibility, control, promotion of family values, governance, involvement of family members and family advisors, privacy, asset protection and tax savings.8
The combination of the growth in charitable giving and the popularity and growth of the MDT have resulted in a powerful trend with charitable giving emanating from non-charitable trusts.9
Top Seven Goals
Based on my experience, the top seven goals of a family’s trust and legacy planning, in no particular order, are generally:
1. Family governance (involvement, education and succession);
2. Control and flexibility regarding trust administration;
3. Control and flexibility regarding trust investment management;
4. Privacy;
5. Asset protection;
6. Tax savings; and
7. Family management (that is, the promotion of social and fiscal responsibility within the family).
Each family prioritizes these seven goals differently, but almost all place a very high value on family management and the promotion of social and fiscal responsibility within the family. Many families realize that family goals aren’t the same as philanthropic goals but that successful philanthropy can reinforce family values and, thereby, strengthen a family legacy.10 Typically, many families accomplish the promotion of social responsibility and successful philanthropy by using private foundations (PFs), donor advised funds (DAFs), community foundations (CFs), pooled income funds, charitable remainder trusts (CRTs) and charitable lead trusts (CLTs). Personal non-charitable trusts, however, have also become a popular trust vehicle that the wealthy are using to promote social responsibility and successful philanthropy.11
MDT
The development of charitable giving with non-charitable trusts results from the evolution and popularity of the MDT. The MDT is a collaborative relationship between beneficiaries and trustees, in which multiple fiduciaries and managers assume the duties once assigned to a single trustee. This collaborative relationship, combined with active family involvement, has provided a powerful charitable giving alternative. Generally, the directed administrative trustee in a directed trust jurisdiction12 takes direction from an investment and distribution committee. The distribution committee is usually comprised of family members and family advisors, as well as other independents for tax-sensitive distributions. Because the distribution committee is comprised of individuals the family is comfortable working with, most of these trusts are drafted as discretionary trusts.13 The distribution committee members and their advisors act as mentors for the younger family members on the distribution committee, as well as for the beneficiaries. It’s recognized that the key time for beneficiary development is generally between
ages 20 and 40.14
Charitable Deduction
Note that a charitable deduction is permitted for distributions made from non-charitable trusts to charity. To accomplish this goal, it’s important that there be mandatory direction or a discretionary power to pay funds to charity from the trust.15 Additionally, powers of appointment (POA) are used to appoint funds to charity.16 The tax advantages are generally secondary with many families.
Promoting Social Responsibility
This combination of the MDT and successful philanthropy can reinforce a family’s values and strengthen a family legacy, resulting in various strategies to promote social responsibility and charitable giving with non-charitable trusts. Many families prepare family mission statements as both written documents and videotaped guidelines illustrating charitable desires, goals and values. This step is frequently taken for both the charitable as well as the non-charitable trusts. It may be enacted as part of the non-charitable trust document or as a letter of wishes that acts as a reference for the family, their advisors and the distribution committee. Some families develop a family learning plan, coupled with site visits to various charities, as well as obtain advice from other philanthropists. Some families prefer their members to actively participate in the charities and make direct distributions to charities. Other families want beneficiaries to have more control over charitable contributions from the trust and, consequently, make distributions to PFs, DAFs, CFs and supporting foundations.17 Some trusts have provisions that state that once a trust reaches a certain value, it must distribute the excess to a charity either directly or indirectly. This approach ensures that the family gets together to focus on charity and the family’s social responsibilities, as well as to actively support the various charitable causes in its community. Other trusts have provisions to supplement a beneficiary’s income if he decides to work for a charity, while others match a beneficiary’s contribution to charity. Many non-charitable trusts also provide a charitable gift if there are no family beneficiaries.18 Charitable giving is also built into other family incentive provisions promoting fiscal responsibility.19
Common Trust Strategies
Consequently, the MDT provides the most practical way to promote charitable giving with non-charitable trusts. Some of the common trusts and trust strategies using this approach are:
1. Dynasty trusts.20 These are the most popular non-charitable trust for the promotion of social responsibility by mentoring family distribution committee members and beneficiaries and making distributions to charity. The cryogenic dynasty trust is also a popular option for charitable giving. These vehicles not only name charities as potential beneficiaries while the grantor is in cryogenic suspension, but also name a charitable gift over at various stages if the cryogenics isn’t successful.21
2. Change situs of an existing trust coupled with a reformation/modification or decant.22 This strategy would allow the existing trust to change trust situs and add MDT provisions (including a distribution committee), convert to a discretionary trust and, possibly, add a charitable distribution provision and POA allowing for future appointments to charities.23 The latter is common with a decant.24 Beneficiary quiet statutes may also provide a family with flexibility as to when to notify a charitable beneficiary.25 The duration (that is, the rule against perpetuities) in a change of trust situs is limited to that of the original trust document and situs;26 however, the term may change.27
3. Self-settled domestic asset protection trusts (DAPTs).28 Many wealthy single individuals establish self-settled DAPTs prior to getting married so that the funds aren’t considered marital assets and are protected in the event they get divorced.29 These DAPTs can either be tax neutral or generation-skipping dynasty trusts. The trusts can name a floating spouse as a beneficiary, as well as unborn decedents but in the interim, they need another beneficiary, so frequently, a charity is designated either alone or along with family members.30 Additionally, these trusts are frequently funded with private placement life insurance,31 thereby creating a zero tax trust for both growth and future distributions.
4. Purpose trusts. These are trusts that exist for a purpose rather than a beneficiary.32 They’re established to care for something, rather than someone. Once the purpose is accomplished, the trust protector frequently reforms these trusts to add family and/or charitable beneficiaries.33 A common version of this trust is a pet trust involving both the care of a pet and an ultimate gift over to a charity.34 Another key use of the purpose trust is to provide for a philanthropic purpose that doesn’t qualify for the typical charitable income tax deduction.35
5. Health and education exclusion trusts (HEETs).36 These vehicles allow the perpetual deferral of generation-skipping transfer (GST) taxes without the need to allocate any of the grantor’s GST tax exemption. Both HEETs and their distributions avoid the GST tax. HEETs always have a charitable beneficiary, so there’s never a taxable termination for GST purposes. A taxable termination typically occurs when a trust loses its last non-skip beneficiary and only skip persons have interest in the trust. Because the charity is always a non-skip person with a HEET, there’s never taxable termination. Note that the charity’s interest must be sufficiently significant. Distributions are generally made directly to providers of education and health services. HEETs are generally grantor trusts, so income, deductions and credits are passed to the grantor. HEETs are usually funded with $14,000 annual exclusion gifts in 2015. They’re GST tax-exempt trusts without the need to use any of the $5.43 million GST tax exemption in 2015.
These are some of the more common non-charitable trusts that are designed and administered to make meaningful distributions to charities. Additionally, some charitable trusts also compliment non-charitable trusts to provide a powerful combination. The CRT is frequently combined with a wealth replacement dynasty trust,37 and the CLT frequently names its non-charitable beneficiary as the dynasty trust.38 In both instances, the dynasty trust as a non-charitable trust also plays a role in charitable giving.
Endnotes
1. Giving USA, “Giving USA 2014: The Annual Report on Philanthropy for the Year 2013” (2014).
2. U.S. Trust, “The 2014 U.S. Trust Study of High Net Worth Philanthropy” (2014).
3. See supra note 1.
4. Wealth-X and NFP, “Family Wealth Transfers Report” (2015).
5. Ibid.
6. Edward N. Wolff, The Asset Price Meltdown and the Wealth of the Middle Class (New York: New York University (2012)).
7. Al W. King III, “Preserving Family Values by Encouraging Social and Fiscal Responsibility with Incentive Trusts,” 45th Annual Hawaii Tax Institute
(Oct. 22, 2008).
8. Al W. King III and Pierce H. McDowell, “Delegated vs. Directed Trusts,” Trusts & Estates (July 2006) at p. 26; Al W. King III, “Myths About Trusts And Investment Management: The Glass is Half Full!” Trusts & Estates (December 2014) at p. 12.
9. King, supra note 7; Marty McKeeven, “Planning with Dynasty Trusts & Charity,” Estate Planning Magazine (May 18, 2011) at pp. 4-6.
10. Al W. King III, “The Next Tsunami–Charitable Giving with Non-Charitable Trusts,” Advisors in Philanthropy Conference on Philanthropy, April 28, 2015.
11. McKeeven, supra note 9 at pp. 4-7; King, ibid.
12. See supra note 8. Popular directed trust jurisdictions are Alaska, Delaware, New Hampshire, Nevada, South Dakota and Wyoming.
13. See supra note 9, plus the added advantage of asset protection with discretionary trust. Alaska, Delaware, Nevada and South Dakota are a few key jurisdictions that have enacted statutes stating that a discretionary interest isn’t a property right or enforceable right, rather a mere expectancy.
14. U.S. Trust, “U.S. Trust Insights on Wealth and Worth 14” (2012).
15. Distributions from non-charitable trusts to charities aren’t considered distributions to beneficiaries and aren’t subject to limitations. See Internal Revenue Code Section 1.663(a)(2). They’re deductible only if they meet the requirements of IRC Section 642(c)(1). See also IRC Section 6034(b)(1),
Form 1041-A.
16. Private Letter Ruling 200906008 (Oct. 8, 2008).
17. Al W. King III, “Preserving Family Values by Encouraging Social and Fiscal Responsibility with Incentive Trusts,” 45th Annual Hawaii Tax Institute,
Oct. 22, 2008; McKeeven, supra note 9 at pp. 6-7.
18. See supra note 7.
19. Jon and Eileen Gallo, “Use and Abuse of Incentive Trusts,” Heckerling Institute on Estate Planning (2011).
20. Al W. King III, Pierce H. McDowell and Dan Worthington, “Dynasty Trusts: What The Future Holds for Today’s Technique,” Trusts & Estates (April 1996).
21. Al W. King III, “Freezers–Our Future Coffins?” Trusts & Estates (August 2002) at p. 8.
22. Popular states for reformation/modifications and decanting are: Alaska, Delaware, New Hampshire, Nevada, South Dakota and Wyoming. See PLR 201516020 (Dec. 22, 2015) (modification of generation-skipping transfer (GST) tax-exempt trust won’t cause the trust to lose GST tax-exempt status).
23. See supra notes 15 and 16.
24. Some states’ statutes specifically allow for the trustee to grant a beneficiary a power of appointment in the decanted trust, such as Alaska, Delaware, Illinois, Nevada, New Hampshire, Ohio, South Dakota, Tennessee and Texas.
25. Al W. King III, “Should You Keep a Trust Quiet (Silent) From Beneficiaries?” Trusts & Estates (April 2015) at p. 12.
26. Generally, you can’t extend the rule of perpetuities of grandfathered or GST tax-exempt trusts, see Treasury Regulations Section 26.2601-1(b)(4),
PLR 200919009 (Jan. 12, 2009), PLR 200714016 (Nov. 15, 2006).
27. Generally, the trust term can be changed, but not the trust’s duration.
28. Some of the popular self-settled domestic asset protection trust (DAPT) states are: Alaska, Delaware, Nevada and South Dakota. See
Al W. King III, “What’s Trending in the Estate-Planning World,” Trusts & Estates (August 2014) at p. 11.
29. If assets are transferred to a DAPT prior to marriage, they’re not usually considered marital property; thus, they’re protected, depending on the DAPT jurisdiction.
30. A floating spouse clause typically defines “spouse” as an individual to whom the individual is married to and living with at the time.
31. Lynnley Browning, “Tax-Free Life Insurance: An Untapped Investment for the Affluent,” N.Y. Times (Feb. 9, 2011).
32. Al W. King III, “Trusts Without Beneficiaries–What’s the Purpose?” Trusts & Estates (February 2015) at p. 11.
33. See supra notes 22 and 32.
34. See supra notes 8 and 32.
35. See supra note 32.
36. Michael N. Delgass and Deborah S. Gordon, “HEET Wave,” Trusts & Estates (March 2005) at p.
