Charitable Remainder Trusts: How the IRS 7520 Rate Determines your Income Tax Savings

Give and receive with charitable trusts

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In the realm of charitable giving and financial planning, Charitable Remainder Unitrusts (CRUTs) offer a compelling blend of philanthropy and fiscal prudence. For a basic introduction to Charitable Remainder Trusts see our prior blog post. Central to their appeal is the potential for an immediate income tax deduction, the calculation of which hinges significantly on the IRS 7520 rate. Understanding how this rate affects the deduction, when the deduction is most beneficial, and the option to spread the deduction over five years can empower donors to optimize their charitable contributions and financial outcomes.

The IRS 7520 Rate and Its Impact

The IRS 7520 rate, a critical factor in establishing a CRUT, directly influences the immediate income tax deduction available to the donor. This rate, set monthly by the IRS, reflects current interest rates and is used to determine the present value of the charitable remainder interest—the portion of the trust’s assets that will eventually go to charity. A higher IRS 7520 rate decreases the present value of the income interest retained by the donor or other beneficiaries, thereby increasing the present value of the charitable remainder interest and, consequently, the immediate tax deduction. Conversely, a lower IRS 7520 rate increases the present value of the income interest, reducing the charitable deduction.

In a CRUT a higher IRS 7250 rate leads to a higher income tax deduction

For example, consider a scenario where the IRS 7520 rate increases from 2% to 2.5% between two consecutive months. For a CRUT funded with $1,000,000, the higher rate might reduce the present value of the income interest, thereby increasing the charitable remainder interest’s value and the donor’s immediate tax deduction. This demonstrates the sensitivity of the deduction to fluctuations in the IRS 7520 rate.

Strategic Selection of the IRS 7520 Rate

Donors have the flexibility to choose the IRS 7520 rate from one of three consecutive months: the rate in effect in the month the trust is funded or the rate from either of the two months preceding the month of funding. This selection can significantly affect the immediate tax deduction. By strategically choosing the most advantageous rate, donors can maximize their tax benefits. For instance, if a donor anticipates funding a CRUT in a month where the IRS 7520 rate is particularly low, they might opt for a higher rate from one of the two previous months to increase their immediate tax deduction.

Optimal Timing for the Immediate Tax Deduction

The immediate tax deduction for funding a CRUT is most beneficial in years of unusually high income or for individuals nearing retirement with high salaries. For high-income earners, the deduction can provide significant tax relief in the year the CRUT is established. For someone anticipating a decrease in income, such as impending retirement, the deduction can offer a substantial tax advantage while still earning a high salary.

Spreading the Deduction Over Five Years

If the immediate tax deduction exceeds a certain percentage of the donor’s Adjusted Gross Income in the year of the CRUT’s funding, the IRS allows the deduction to be carried forward and spread over up to five subsequent tax years. This flexibility ensures that donors can fully benefit from their charitable contribution, even if their income in the year of the donation does not allow them to utilize the entire deduction.

Conclusion

The IRS 7520 rate plays a pivotal role in determining the immediate income tax deduction for CRUT donors, influencing the present value of the charitable remainder interest. With the ability to select the most favorable IRS 7520 rate from three consecutive months and the option to spread the deduction over five years, donors have significant flexibility to optimize their charitable contributions. Whether facing a year of unusually high income or preparing for retirement, understanding and strategically leveraging these aspects of CRUT funding can enhance the benefits of charitable giving, both for the donor and the recipient charities.

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