What Is a Split Interest Trust and How Does It Work?

A split interest trust is an irrevocable arrangement that divides the benefits of trust assets between a qualified charity and a non-charitable beneficiary, such as you, a spouse, or your children. One side receives payments during the trust’s term. The other receives whatever is left when the term ends. The structure lets you support a cause while providing for people you care about, and it unlocks income, capital gains, estate, and gift tax advantages that make these trusts a staple of charitable and estate planning.¹

How the Split Works

The “split” refers to how benefits are divided over time between two classes of beneficiary. One always has to be a qualified charity. The other is a non-charitable beneficiary. Every split interest trust has three roles: the grantor who creates the trust and funds it, the trustee who manages investments and makes distributions, and the beneficiaries who receive their shares on the schedule the grantor set.²

The two main forms move in opposite directions. A charitable remainder trust pays the non-charitable beneficiary first and gives the charity what remains. A charitable lead trust pays the charity first and passes the remainder to heirs. Which one fits depends on whether you want income now and a charitable gift later, or a charitable gift now and assets passed to the next generation later.

Charitable Remainder Trusts

A charitable remainder trust pays income to you or another non-charitable beneficiary for a set period, and whatever is left at the end goes to your chosen charity. The payment period can run for up to 20 years or for the lifetime of one or more individuals.³

CRTs are irrevocable. Once you transfer assets in, you cannot take them back.⁴ That is the tradeoff for the tax benefits, and it is the most important thing to understand before creating one. You give up ownership permanently in exchange for a stream of payments and a charitable deduction.

CRAT vs. CRUT

CRTs come in two versions, and the difference determines what you actually receive each year.

A charitable remainder annuity trust (CRAT) pays a fixed dollar amount each year, set as a percentage of the trust’s initial value. The amount never changes, regardless of investment performance. You cannot add assets to a CRAT after it is funded.
A charitable remainder unitrust (CRUT) pays a fixed percentage of the trust’s assets as revalued each year. Payments rise when investments grow and fall when they decline. Unlike a CRAT, you can add contributions over time.

Both types must pay at least 5% but no more than 50% of the applicable trust value each year. Both must also pass the 10% remainder test: the present value of what the charity will eventually receive has to equal at least 10% of the property originally placed in the trust.⁴ A high payout over a long term can fail this test, which effectively limits how aggressively the trust can tilt toward the income beneficiary.

Charitable Lead Trusts

A charitable lead trust works in reverse. The charity receives income during the trust’s term, and when the term ends, the remaining assets pass to your non-charitable beneficiaries, typically children or grandchildren.² The term can be a fixed number of years or measured by one or more lifetimes.

CLTs are the tool of choice when the goal is transferring wealth to the next generation with reduced gift or estate tax. If the trust’s investments outperform the IRS assumed rate of return used to value the charitable interest, the excess growth passes to heirs free of additional transfer tax. In a low interest rate environment, that arbitrage can be substantial.

CLAT vs. CLUT

CLTs also come in annuity and unitrust versions.

A charitable lead annuity trust (CLAT) pays the charity a fixed dollar amount each year. This structure maximizes the potential for excess growth to pass tax-free to heirs, because the charity’s share is locked in while investment returns above expectations accumulate for the remainder beneficiaries.
A charitable lead unitrust (CLUT) pays the charity a fixed percentage of annually revalued assets. The charity benefits from investment growth, and the remainder beneficiaries receive less upside.

Grantor and Non-Grantor CLTs

CLTs also split into two tax structures. A grantor CLT gives the grantor an immediate income tax deduction for the present value of the charity’s future payments, but the grantor is taxed each year on the trust’s investment income even though the payments go to the charity. A non-grantor CLT provides no income tax deduction to the grantor; instead the trust itself claims a deduction for its charitable payments, and the grantor is not taxed on trust income. Most CLTs are set up as non-grantor trusts because the estate and gift tax benefits are usually the point.

The Tax Benefits That Make It Worth the Complexity

Different trust types unlock different benefits. Understanding which apply to which structure is essential to picking the right one.

Income Tax Deduction

Funding a CRT produces a charitable income tax deduction for the present value of the remainder interest that will pass to charity. The deduction is not the full contribution; it is a calculated figure based on the payout rate, the term, the IRS discount rate at the time, and, if payments run for a lifetime, the beneficiary’s age. The deduction for appreciated property is limited to 30% of adjusted gross income, and the limit is higher for cash contributions.⁵ Any excess can be carried forward for up to five additional tax years.

Capital Gains Deferral

This is where CRTs really earn their keep for people holding highly appreciated assets. Selling appreciated stock or real estate outright triggers a large capital gains tax. Contributing the property to a CRT lets the trust sell it without owing any immediate capital gains tax, because CRTs are generally exempt from income tax.³ The full pre-tax value stays invested and generates income.

The gain does not vanish. It is spread across the payments you receive under a four-tier taxation system. But the deferral preserves more capital, produces larger payments, and spreads the tax bill over many years instead of collecting it all at once.

How CRT Payments Are Taxed

Every distribution from a CRT is classified according to a four-tier ordering system that draws from the trust’s accumulated income in a fixed order.³

Tier 1 is ordinary income, to the extent the trust has current and accumulated ordinary income.
Tier 2 is capital gains from current and prior years, used once ordinary income is exhausted.
Tier 3 is tax-exempt and other income, drawn from once the first two tiers are used up.
Tier 4 is a tax-free return of principal, reached only after all three income tiers are depleted.

The practical effect is that the highest-taxed income comes out first. Early payments from a CRT that sold appreciated assets will carry capital gains and ordinary income. Payments later in the trust’s life, after those accumulated gains have been paid out, may be partially or entirely a tax-free return of corpus.

Estate and Gift Tax

For a CRT, the contributed assets leave your estate at funding, which can reduce estate tax. For a CLT, the treatment depends on when and how the trust is funded. A CLT funded at death through your estate plan generates a charitable estate tax deduction for the present value of the charity’s income stream. A CLT funded during your lifetime as a gift reduces the taxable value of the gift to the remainder beneficiaries by the value of the charitable interest. If investments outperform the IRS assumed rate, the excess passes to heirs free of additional gift or estate tax.

Rules That Can Disqualify the Trust

Split interest trusts operate inside strict requirements. Miss one and the trust can lose every tax benefit.

The CRT payout rate must fall between 5% and 50% of the applicable value, and the charity’s projected remainder must equal at least 10% of what went in.⁴ These rules work together as guardrails against a structure that leaves the charity with scraps.

If the payment period is a fixed number of years rather than a lifetime, it cannot exceed 20 years for a CRT.³ CLTs have no statutory cap on the term of years, though the trust has to be structured so the IRS can calculate the present value of both interests.

Both CRTs and CLTs are typically irrevocable.⁴ This is the bargain that makes the tax benefits possible.

You can fund a split interest trust with cash, publicly traded securities, real estate, and many other asset types. S-corporation stock cannot be contributed to a CRT because a CRT is not a permitted S-corporation shareholder, and transferring S-corp shares terminates the company’s S election, creating a taxable event for every shareholder. Assets subject to debt can create complications including unrelated business taxable income, which strips a CRT of its tax exemption for the year it arises.

Annual Filing on Form 5227

Every split interest trust must file IRS Form 5227 each year, including charitable remainder trusts, charitable lead trusts, and pooled income funds.² For a calendar-year trust, the return is due April 15 of the following year.

Penalties for late or incomplete filing are steep. The trust faces $25 per day, up to $13,000 per return. For trusts with gross income above $327,000, the penalty rises to $130 per day, up to $65,000 per return. If the IRS sends a written demand and the trustee ignores it, another $10 per day applies. A trustee who knowingly fails to file is subject to the same penalty imposed on the trust.²

What It Costs and When It Makes Sense

Split interest trusts are among the more complex estate planning tools, and the costs match the complexity. Attorney fees to draft the document and handle funding can run from a few thousand dollars to well above $10,000, depending on the assets involved and the structure chosen. Ongoing costs include trustee fees when a bank or trust company serves as trustee, typically an annual fee based on a percentage of trust assets, plus accounting and tax preparation for Form 5227 and any related income tax returns.

For smaller estates, those costs can eat enough of the tax benefit to make a split interest trust impractical. A CRT tends to work best when funded with at least several hundred thousand dollars in assets, though the right threshold depends on the payout structure, the term, and your specific tax situation. When charitable intentions are more modest, a charitable gift annuity or a donor-advised fund can accomplish similar goals at lower cost.

1
Internal Revenue Service. SOI Tax Stats – Split-Interest Trust Study Terms and Concepts
2
Internal Revenue Service. Instructions for Form 5227 – Split-Interest Trust Information Return
3
Office of the Law Revision Counsel. 26 USC 664 – Charitable Remainder Trusts
4
Internal Revenue Service. Charitable Remainder Trusts
5
Office of the Law Revision Counsel. 26 USC 170 – Charitable, Etc., Contributions and Gifts