This article will focus on how the philanthropically minded client and beneficiaries seeking autonomy are using planning techniques to include charitable beneficiaries on irrevocable trusts.
Both grantors and beneficiaries of trusts are more frequently inquiring as to how they can allocate resources from their non-charitable trusts to charitable entities. Quite often beneficiaries of irrevocable trusts want the ability to use their trusts funds for philanthropic pursuits; however, through no fault of their own, trusts are most often only drafted for distributions to individuals.
Charitable Planning through Initial Drafting.
When clients are in the beginning of their estate planning process, including a charitable beneficiary in a trust is straightforward. The trusts may be limited to simply naming a specific charity as a current beneficiary or providing flexibility within the trust document to designate charitable beneficiaries or allow their individual beneficiaries to add them in the future.
A specific charity may be named as the sole beneficiary or a member of a class of beneficiaries within a trust. However, if there is a desire to provide flexibility to decide over time what charity should receive distributions, a trust may also include broader language, stating that a charitable beneficiary can be any 501(c)(3) organization that an individual beneficiary or another appropriate party chooses. Moreover, if a charity is named as the sole beneficiary, the trust may be deemed a “Charitable trust” and be subject to other rules and reporting requirements.
Further, in many states like Pennsylvania, a Trust Protector [1] can be given the authority to add charitable beneficiaries to the class of beneficiaries. However, providing this type of authority to a third party can be overwhelming to clients, as there is always a fear of a nefarious actor. However, the Trust Protector’s powers can be drafted to be limited, either by allocating a fixed amount of the trust per year to charities and/or requiring this power to be exercised only with the consent of the trust beneficiaries.
Many grantors of trusts want the beneficiaries to determine if the assets should go to a class of people or a charity. An alternative to naming a charitable beneficiary at inception, is to instead grant the beneficiaries a power of appointment. This power provides additional flexibility and possible autonomy to the class of individual beneficiaries. A trust can include a special power that allows beneficiaries to appoint the assets to a charity of their choosing, either while living or at their death. It is becoming more common to see lifetime powers of appointment allowing the beneficiary to appoint assets to charitable causes that they are either involved in or believe in their mission.
Alternatively, the trust may also name a charity as a remainder beneficiary to receive the remaining assets after the death of the beneficiaries.
While fulfilling philanthropic goals, it is also important to point out that utilizing these strategies of including charitable beneficiaries, if drafted correctly, can provide tax deductions that may help offset income and capital gains that may be attributable to the grantor to the trust, or to one or more beneficiaries. To receive an income tax benefit from a charitable distribution, trust documents must be written with specific rules and language, in close alignment with Section 642(c) of the Internal Revenue Code of 1986, as amended (the “Code”). Charitable distributions must be made to qualified Section 501(c)(3) organizations and must come from gross income and cannot be funded from the corpus, or principal, of the trust. (Gross income could include capital gains allocated to principal.) Trusts can deduct up to 100% of gross taxable income, which is higher than an individual’s (current) deduction limitation of 60% of adjusted gross income.
There are various opportunities upon a trust’s creation to incorporate a family’s philanthropic goals through proper drafting.
Modifying Existing Trusts to Accomplish Philanthropic Goals.
Making philanthropic gifts from existing trusts can be more difficult. Practitioners are limited to the trust’s language and state rules. State law provides guidance on if and how a trust can be modified to provide for charitable beneficiaries. Most states prohibit expanding the current class of beneficiaries. However, several states, through various modification statutes, allow for powers of appointment to be created or expanded to include charities.
In Pennsylvania, one option is to utilize the Non-Judicial Modification Statute under § 7740.1 of Title 20 of the Pennsylvania Probate, Estates and Fiduciaries Code (the “PEF Code”). § 7740.1(a) of the PEF Code states “a trust may be modified or terminated upon consent of the settlor and all beneficiaries even if the modification or termination is inconsistent with a material purpose of the trust.” This flexible statute allows a trust to be modified even if it is inconsistent with the material purpose, provided the grantor is alive and consenting. Therefore, if a grantor is living and all beneficiaries can consent and use virtual representation, if needed, a trust may be modified to create or expand a power of appointment that allows for contributions to charities.
In the event the grantor has died, under § 7740.1(b) of Title 20 of the PEF Code, it is up to the court to conclude that the modification is not inconsistent with the material purpose of the trust. Any evidence of the grantors’ intent for charitable purposes would certainly help the beneficiary’s argument to add a charitable power of appointment. An example of a compelling factor would be a takers of last resort clause that includes a charity or a letter of wishes that specifically enumerates using the trust distributions for philanthropic desires. However, at this time, adding a charitable power of appointment has not been litigated in the courts and this specific material purpose question has not been addressed.
Another way practitioners have been able to accomplish this modification is through a process known as decanting. Decanting, like wine decanting, is the ability to pour the assets of one trust into a new trust. Generally, if the trustee can distribute the entirety of a trust to a beneficiary or for the benefit of a beneficiary, then a trust may be decanted. This requires discretionary action of the Trustee to make a distribution from the existing trust into the revised or decanted trust. While a trustee does not need consent of the beneficiaries to exercise its ability to decant, it is best practice to have the beneficiaries sign a document consenting to the action and releasing and indemnifying the trustee, which most trustees will require. Currently, 32 states allow for decanting with each state having its own rules that must be applied and followed. Unfortunately, Pennsylvania does not have the decanting statute just yet.
Delaware’s decanting statute, found in Title 12, Chapter 35, Subchapter II, §3528 of the Delaware Code, prohibits the new trust from having beneficiaries who were not beneficiaries on the first trust; however, the statute permits the second trust to grant a beneficiary of the first trust a limited power of appointment. Thus, a beneficiary of the first trust can be given the power to appoint trust property to a non-beneficiary, which may be a charity. Expanding this power accomplishes philanthropic goals and provides the beneficiary with autonomy to make the choice as to if, what, when and where for charitable gifts.
It is important to recognize that some trust modifications in which a beneficiary consents to the changes may be deemed by the IRS as gifts and adding a charitable power of appointment have not been addressed. In December 2023, the IRS issued Chief Counsel Advice Memorandum 202352018 which addressed the gift tax consequences of beneficiaries consenting to a modification of a grantor trust to include adding a grantor tax reimbursement clause. Their conclusion was: “The modification to add the tax reimbursement clause will constitute a taxable gift by the trust beneficiaries because the addition of a discretionary power to distribute income and principal to the grantor is a relinquishment of a portion of the beneficiaries’ interest in the trust.” [2] In the strategies presented in this section, of adding a power of appointment to include a charity, the beneficiary’s consent could be construed as possibly relinquishing a portion of his or her interest. However, it would be an interesting discussion as the beneficiary would be relinquishing the interest to a charity which would normally not incur a gift tax. It is imperative that all modifications of trusts are reviewed to ensure there are no tax traps which could negatively affect GST, gift, income and/or estate tax.
There are several options for including charities and allowing for beneficiary autonomy to choose those charities while creating one’s estate plan. Although options are more limited for those with existing irrevocable trusts, one can accomplish philanthropic goals through the various avenues of modification.
Brittany Horn Cook is a Managing Director, Wealth Planner and Fiduciary Council at Tiedemann Trust Company. Brittany works with UHNW clients and their advisors across the country to develop and administer custom trust, tax and estate planning solutions. Brittany earned an LL.M. in Taxation and an Estate Planning Certification from Temple University and her J.D. from Rutgers University.
[1] 20 PA. code § 7778
[2] CCA 202352018.