Charitable Trusts and Foundations: A Paralegal's Guide to Nonprofit Entities

Understanding Charitable Trusts

Charitable trusts are fiduciary arrangements created to benefit the public or a specific charitable purpose rather than individual beneficiaries. They occupy a unique space at the intersection of trust law, tax law, and nonprofit regulation. For paralegals working in estate planning or nonprofit law, understanding charitable trusts and foundations is essential. These topics also appear on the CP exam in both estate planning and corporate law sections.

Types of Charitable Trusts

Charitable trusts come in several forms, each designed to accomplish different philanthropic and tax planning objectives.

Charitable Remainder Trust (CRT)

A charitable remainder trust provides income to the grantor or other named beneficiaries for a specified period (a term of years or the beneficiary's lifetime), after which the remaining trust assets pass to one or more charitable organizations. There are two main types: a charitable remainder annuity trust (CRAT), which pays a fixed dollar amount each year, and a charitable remainder unitrust (CRUT), which pays a fixed percentage of the trust's annually revalued assets. CRTs offer the grantor an immediate income tax deduction for the present value of the charitable remainder interest.

Charitable Lead Trust (CLT)

A charitable lead trust works in the opposite direction from a CRT. The charity receives income from the trust for a specified period, after which the remaining assets pass to the grantor's beneficiaries (typically family members). CLTs are effective estate planning tools because the value of the remainder interest that passes to the family is reduced for gift and estate tax purposes by the value of the charitable lead interest.

Pooled Income Fund

A pooled income fund is maintained by a public charity. Donors contribute to the fund and receive a proportionate share of the fund's income for life. Upon the donor's death, the donated amount is severed from the pool and used by the charity. This structure allows smaller donors to participate in charitable giving while receiving lifetime income benefits.

Private Foundations vs. Public Charities

The distinction between private foundations and public charities is fundamental to nonprofit law and is tested on the CP exam.

Private Foundations

A private foundation is typically funded by a single source, such as an individual, family, or corporation. Private foundations face stricter regulatory requirements, including a mandatory minimum distribution of approximately 5% of assets annually, restrictions on self-dealing transactions between the foundation and its substantial contributors or managers, limits on business holdings, restrictions on investments that jeopardize the charitable purpose, and prohibitions on certain expenditures including lobbying. The IRS classifies an organization as a private foundation by default unless it qualifies as a public charity.

Public Charities

Public charities receive broad support from the general public, government grants, or other public charities. They face fewer restrictions than private foundations and are not subject to the excise tax on investment income or the same self-dealing rules. Organizations can qualify as public charities by passing the public support test, which requires that at least one-third of total support comes from the general public, government, or other public charities.

Formation and Administration

Paralegals play a significant role in both forming and administering charitable entities.

Creating a Charitable Trust

Formation of a charitable trust requires a settlor with the capacity and intent to create the trust, a definite charitable purpose, trust property (the corpus), and a trustee to manage the assets. Unlike private trusts, charitable trusts do not require identifiable beneficiaries because the public or a class of the public serves as the beneficiary. The trust instrument should clearly state the charitable purposes and give the trustee adequate powers to carry them out.

Tax-Exempt Status

Charitable organizations seeking tax-exempt status under Internal Revenue Code Section 501(c)(3) must apply to the IRS using Form 1023 or the streamlined Form 1023-EZ for smaller organizations. Paralegals often prepare these applications, gather supporting documentation, and correspond with the IRS during the review process. Maintaining tax-exempt status requires ongoing compliance, including filing annual information returns (Form 990) and adhering to restrictions on political activity and private inurement.

The Cy Pres Doctrine

When a charitable trust's specific purpose becomes impossible, impractical, or illegal to fulfill, courts may apply the cy pres doctrine to redirect the trust assets to a similar charitable purpose rather than allowing the trust to fail. This doctrine is based on the presumption that the settlor had a general charitable intent beyond the specific purpose named in the trust instrument. Cy pres is a commonly tested topic on the CP exam and is covered in more detail in our separate article on the subject.

Deepen Your Estate Planning Knowledge

Charitable trusts and nonprofit law are important topics for the CP exam and a growing area of paralegal practice. Create your free ParalegalPrep account to access estate planning and corporate law questions. Our flashcard decks cover trust types, tax-exempt requirements, and foundation rules. Explore our pricing options to get full access to all study materials.