The Charitable Remainder Trust has become an increasingly popular vehicle for charitably minded individuals who are not quite ready to make outright gifts to charity. These trusts essentially provide for a long-term stream of payments to the donor or other designated party, while at the end of the process giving the “remainder” (what is left in the trust), to a designated charity.
Along the way, a properly structured Charitable Remainder Trust results in the following:
- A significant income tax deduction;
- A potential reduction to the donor’s taxable estate (in cases where the donor retains no right to a payment stream);
- An income stream for the donor, his or her spouse, or other designated third parties;
- The opportunity to sell highly appreciated assets without recognizing a gain to the donor, trust or the charity;
- The potential for accumulated untaxed income that will eventually be received by the charity; and
- The satisfaction of providing for a cherished institution (provided it qualifies as a charity in the eyes of the IRS.)
There are two basic forms of Charitable Remainder Trusts. The first is a Charitable Remainder Unitrust or “CRUT.” The second is a Charitable Remainder Annuity Trust or “CRAT.” The Unitrust provides for a percentage of the trust corpus (anywhere from 5% to 50% of the trust’s current value) to be paid to the “income beneficiary” on a yearly basis. (Note: “income beneficiary” may be a misnomer because such a beneficiary’s payment may include more than income, however we use this term for simplicity’s sake.) In contrast to the unitrust, the Charitable Remainder Annuity Trust provides for a flat amount (a “sum certain”) to be paid to the income beneficiary on a yearly basis. That sum certain also has to fall between 5% and 50% of the trust’s asset value. Usually the income beneficiary’s payment term will be his lifetime, but it could instead be for a specified period of years. Whatever the payout schedule and duration, the result from an actuarial perspective is that the remainder value to go to the charity must be 10% or more of the initial amount put into trust. That actuarial calculation can become complicated as it may depend on the age of the income beneficiary, current interest rates and the payout percentage or amount. However, it is essential to make the calculation for both purposes of qualifying the trust and calculating the tax deduction(s) the donor would be entitled to.
The trust itself is tax exempt. However, income tax is payable by the income beneficiary to the extent that sums are paid out to him. For example, if an income beneficiary receives a 6% unitrust payout from a million dollar trust in a particular year the beneficiary will have to report the $60,000 distribution on his tax return. Unfortunately, from the income beneficiary’s tax standpoint those distributions are characterized on a “worst-in, first out” basis. For example, our beneficiary’s $60,000 would consist of ordinary income to him up to the point where the amount of all of trust’s ordinary income from that year and all undistributed ordinary income from all prior years have been distributed. Only after the trust’s ordinary income from its most recent year and all prior years have been taxed to the beneficiary can the beneficiary begin to report a portion of his distribution as a another class of taxable item (short term capital gains) on his return (no rate relief there). Thereafter, the distribution would consist of long term capital gains (some rate relief), then tax exempt income (generally untaxed), then principal (also generally untaxed).
As this is a tax savings device, things are not as simple as they may seem. How the trust document “reads”, what type of assets the donor puts into the trust and how carefully the trust is ultimately administered can affect any of the general principles that are discussed in this article. Moreover, there are other variations on the unitrust form and the annuity trust form and even a hybrid “Flip-CRUT” that has aspects of both. Some of the sub-types of Charitable Remainder Trusts fit some donors better than others and they all should be reviewed before the trust instrument is drafted and the trust is funded.
Still the Charitable Remainder Trust is not as complicated as some estate planning devices, and the IRS has provided guidance and sample trust forms for the potential donor and his or her tax advisor. We also find that many major charities have knowledgeable individuals willing and able to help in facilitating the use of these devices.
Finally, it should be noted that the job of trustee for these trusts is not an easy one. In our experience a donor is far better off using an institution experienced in such matters to act as trustee rather than turning to a family member or friend (which may be a perfectly adequate choice in the case of other “garden variety” types of trust).
The Charitable Remainder Trust is not for everyone, but for some individuals it can accomplish many goals in one step.
– Rod Fluck