Why would you need a Charitable Remainder Trust ?
A Charitable Remainder Trust is useful if you are charitably inclined, have appreciated assets (meaning they are worth a lot more than you paid for them), and would like an immediate income tax deduction. IRC 664. This allows a charitably minded client with a large concentration of a single asset (or highly appreciated growth asset) to diversify without realizing income on the asset’s sale and then creating an income stream.
The appreciated assets are contributed to the Charitable Remainder Trust, and in exchange, the income beneficiary (selected by the creator of the CRT) would receive an income stream (either for life or a term of years). The creator of the trust, who is donating, receives an income tax deduction.
There are different types of CRTs.
A Charitable Remainder Annuity Trust (CRAT) allows beneficiaries to receive a fixed percentage of the initial trust value or a stated amount annually (or more frequently). This amount does not change from year to year.
Generally, the annual payment must be between 5% – 50% of the fair market value of the assets at the time of contribution. The Charitable Remainder Annuity Trust term can be for the annuitant’s life, up to 20 years, or the shorter of the two.
A Charitable Remainder Unitrust (CRUT) allows beneficiaries to receive a stated percentage of the trust’s assets revalued yearly. The distribution from the CRUT to a beneficiary will vary year-to-year due to a variation in investment performance and the amount withdrawn in the prior year.
Even within this sub-category, more derivatives are typically used if there is no immediate income from the contribution (such as real property):
- Standard CRUT: fixed percentage of not less than 5% or more than 50% of the fair market value of the trust’s assets.
- Net Income CRUT (NICRUT): This type of CRUT allows more flexibility when investments underperform and favor the remainder interest by paying out the lesser of:
- The standard CRUT fixed percentage or
- The trust’s actual fiduciary accounting income.
- “Flip” CRUT
- Same as the NICRUT during the initial period, but there is a “flip” when payments are based on the fixed percentage without regard to the trust’s income (turning it into a standard CRUT)
- Net Income with Makeup CRUT (NIMCRUT): Again, same as NICRUT, but any distributions less than the fixed percentages are tracked in a ledger to be repaid in future years when trust income exceeds the fixed percentage. While the most complex of the group, it also provides the best opportunity to maximize deferral and time income.
Some other considerations related to this type of planning require careful attention.
- When you place property into the CRT, you cannot have a binding commitment to sell.
- There is a gain if you contribute property subject to indebtedness that exceeds your basis. 26 CFR 1.1001-2.
- There is a gain if the donor receives property from the CRT in exchange for the transfer to the trust.
- Distributions in kind are treated as a sale of the property distributed and would not result in any gain in the trust. Reg. 1.664-1(d)(5).
- The income received is taxed at various levels, from ordinary income, capital gains, tax-exempt income, and non-taxable income return of principal. This is important for financial advisors to design a portfolio.
Is it irrevocable or revocable?
The Charitable Remainder Trust is irrevocable, meaning it cannot be changed once created.
Is a separate tax identification required?
The Charitable Remainder Trust does require a separate Tax Identification Number. Since the CRT is tax-exempt, assets can be sold with the trust without realizing a gain.
Is a gift tax return required?
Since this is a donation, the contribution to the trust is not a gift to the charity. To the extent, there is a gift to a beneficiary, a gift tax return would be required.
Is this subject to estate tax upon my death?
Potentially. If there is a guaranteed income stream for 20 years for you or your surviving beneficiaries, then the present value of the remaining income stream will be included. The CRT will not be included in your estate if no additional right exists beyond your life.
Is there creditor protection?
To the extent assets are in your name, they are available to your creditors. Thus, the contribution to a CRT is not accessible to creditors but is also not accessible to you. If there is a distribution to you, then that distribution is subject to the claims of your creditors.
What assets can be placed in this type of Trust?
Generally, you would place highly appreciated assets in this type of trust. If you sell the property, you will generate capital gains. If you contribute the property to the CRT, you do not generally have any taxable gains yet receive the benefit of the charitable contribution.
Contact a Trust Attorney today to schedule a consultation and learn more about how we can help you with your estate planning needs.