Income Taxation of The Charitable Trusts

A charitable remainder trust is exempt from income tax, except in any year in which it has unrelated business income. In any taxable year in which the trust has unrelated business income, all its income will become subject to income tax.

Distributions made to the noncharitable beneficiary of the trust will be taxable to the beneficiary to the extent of the income received by the trust in the current year and undistributed income from prior years. The character of that income is determined by ordering rules, which have the effect of ensuring that the highest-taxed income is distributed first. These rules provide that any distribution to the beneficiary is deemed to be comprised of the following elements:

(1) first, ordinary income of the trust for the current year, and any undistributed ordinary income from earlier years;

(2) second, capital gain income from the current year, and undistributed capital gain income from prior years;

(3) third, other income from the current year, and undistributed other income from earlier years; and

(4) fourth, a nontaxable distribution of trust corpus.