Charitable Remainder Trusts

By Stuart G. Schmidt, Esq.

A charitable remainder trust (hereinafter “CRT”) can allow you to defer the income tax on the sale of appreciated property, diversify your investments and obtain an income tax deduction while making a charitable gift. A CRT is a trust where the donor transfers property in exchange for a right to receive yearly payments. These payments can be paid to the donor for a number period of years (up to 20 years) or for the life or lives of the beneficiaries. At the end of the chosen term, the assets remaining in the trust must be for the benefit of a qualified public charity or a family foundation.

Through the proper creation and implementing of a CRT as an estate planning strategy, individuals can achieve the following primary goals:

•   Avoiding capital gains taxes on highly appreciated assets (e.g., low basis or founders stock , real property or closely held businesses), which, once transferred to fund the charitable remainder trust, may be sold with reduced or no capital gains tax consequence to the donor or the trust.
•   Obtaining an income tax deduction for the value of the remainder interest as a charitable contribution in the year of the transfer to the trust.
•   Obtaining a charitable gift tax or estate deduction for the value of the remainder interest given to the charitable remainder trust.
•   Providing income to one or more persons during their lifetimes or for a period of years.
•   Directing some of their wealth to charitable organizations of their own choice, instead of having their wealth taxed and having the government determine how the money is used.

The Variations of a the Charitable Remainder Trusts

A CRT can created so that the yearly annual payments are a fixed yearly amount or a percentage of the assets in the CRT.

The Charitable Remainder Unitrust (hereinafter “CRUT”) provides annual payment to the donor (and/or family) which are equal to a fixed percentage of the current market value of the trust. Thus, if the value of the assets increases, the payout increases; but if the value of the assets declines, the payout will decline as well. Under this trust additional assets can be added to the trust after its initial creation. If the overall yield of a CRUT is greater than the distribution, the trust retains and invests the difference tax-free which increases the market value and subsequent distributions.

The Charitable Remainder Annuity Trust (“CRAT”) ensures the annual payment to the donor (and/or family) will be a fixed dollar amount each year set when trust is created. Because the fixed annual amount cannot be changed, additional assets cannot be added to trust.

The choice between a CRAT or a CRUT will generally depend on several factors, including how the trust estate will be invested (bonds favor a CRAT while equities favor a CRUT), whether inflation protection or “income” protection is more valued and the likely term of the trust.

Avoiding Capital Gains

A CRT is often used when a person wants to sell appreciated assets, because the trust pays no current income tax on a sale. Money that otherwise would go to the government in taxes on a sale will, instead, be invested and held in the trust. This can postpone a payment of 25% of the assets value through payment Federal and State long term capital gain income tax. Distributions from the trust will be taxed to the beneficiary as ordinary income, capital gain income or tax free income, depending on the type of income earned by the trust, each year.

The Value of the Income Tax Deduction

Upon the creation of a CRT during your lifetime, the donor will be entitled to income tax deduction. The amount of the deduction will depend on what kind of CRT (Unitrust or Annuity Trust) is used; the payout rate; interest rates when the trust is funded; how long the non-charitable beneficiaries will benefit; the type of asset (stocks, artwork, real estate, etc.) given to the trust; and the type of charity (public or private) which can benefit at the end. Thus, the potential income tax deduction is based on what the charity will ultimately receive, which is known as the “remainder interest”.

A major limitation to the actual income tax deduction received is that it cannot exceed 50% of the donor’s adjusted gross income in any one year. If the property contributed to the CRT is appreciated property, this deduction is limited to 30% per year. Additionally, if the ultimate charity is a private foundation, a charitable entity created by the donor, the yearly deduction is limited to 30% of adjusted gross income and 20% if the donors transferred appreciated property. While the deduction is limited in any one year, any deduction which cannot be used in the first year can be carried forward and used over the next five years.

Conclusion

When a donor and any secondary beneficiary live long enough, because of the tax savings the donor may actually net more from a CRT than just selling a low-basis asset outright. Moreover, ultimately the charity will receive a substantial amount which has been financed by “Uncle Sam.” Because the actual benefits of a CRT depend on numerous factors, the best way to understand the actual tax benefits is to have a proposed transaction analyzed. A proposed sale can be compared under two different scenarios, an outright sale and a contribution to a CRT and then a sale. This comparison can easily be provided based the specifics of the transaction, tax rates, projected income, and the family goals.

It is time to review your estate plan. If you don’t yet have an estate plan, it’s time to get it done. Your death or incapacity will be emotionally traumatic for your family; don’t make it legally difficult as well. Contact one of our estate planning attorneys, Stuart G. Schmidt or David J. Lee, to assist in the creation, review and/or update of your estate plan. Our job as your attorneys is to make this process easy and painless and, most importantly, put a proper plan in place. Call us today at (408) 356-3000 or send us an email at sschmidt@smwb.com.