WHAT IS IT? – What is a Charitable Remainder Trust?
A Charitable Remainder Trust (also known as a “ CRT”) is a permanent, irrevocable trust that is established to pay an amount at least annually to the Trustor for a period of time and then at the end of that time pays the remainder in the trust to a charitable organization. The Trustor contributes assets to the CRT when it is established. The Trustor gets a current income tax deduction for the present value of the remainder interest and escapes capital gains tax on the assets placed in the trust. A CRT is established under the specific authority of Internal Revenue Code §664 and the regulations thereunder.
Joe Jones owns appreciated stocks or real estate valued at $1,000,000 which he has owned for years.
He can either sell the stocks or real estate or he can contribute them to a CRT (Charitable Remainder Trust) to his favorite charity. His cost basis is only $200,000 so if he sells the stock or real estate he would have to pay capital gains tax of roughly 30% federal and state on the $800,000 gain. After tax he would have roughly $750,000 left which he could reinvest to earn income. Assuming a 5% rate of return, he would receive $37,500 annual income. At his death, the $750,000 would be part of his taxable estate and would cost his estate 35% which amounts to $262,500. Thus, after income and estate taxes his heirs receive $487,500.
Alternatively, if Mr. Jones contributes the stock or property to a CRT, the CRT would then sell these items for $1,000,000 and invest the proceeds to earn a 5% return which would be $50,000 per year. The $50,000 per year would be paid out to Joe Jones for the rest of his life. In the year the CRT is established, he gets an immediate income tax deduction for the remainder interest in the $1,000,000 which translates roughly into about $275,000 for a Trustor who is 70 years old. This deduction translates roughly into a $110,000 reduction in income tax. Any part of the $275,000 not used is carried forward 5 years to deduct against future income. Also, he has no estate tax on the stocks and property contributed. The stock or property placed into the CRT is not part of his taxable estate so there is no estate tax. What Joe and his heirs receive is the $110,000 in saved income tax over the years and also the additional income of $12,500 per year from date of establishment of the CRT until his death which if he survives 20 years would be $250,000 for a total benefit of $360,000.
Thus, depending upon how long Joe lives, he not only ends up with increased lifetime income but in addition he provides a $1,000,000 benefit to his favorite charity.
NOTE: The Joe Jones illustration is a very rough computation to show the concepts involved. A full and qualified appraisal of the remainder interest would be needed to determine the actual amount of deductions, periodic payments and taxes saved.
BENEFITS OF A CHARITABLE REMAINDER TRUST
- Save estate taxes. The assets contributed to the CRT are not part of the Trustor’s taxable estate so there is no estate tax.
- Immediate income tax deduction. The deduction is for the appraised fair market value of the remainder interest in the assets contributed (gifted) to the CRT. The appraisal takes into consideration the age and life expectancy of the Trustor, the payout rate and the IRS-required discount rate. There are some limitations as discussed below but any deductions not able to be taken in the year of the gift carry forward five years.
- Save capital gains tax. The Trustor permanently escapes having to pay capital gains tax on appreciated assets contributed to the CRT.
- Increased lifetime income. Because the CRT can sell the assets and avoid capital gains tax there are more assets available to provide increased lifetime income.
- Protection from creditors. The CRT is a permanent trust so the Trustor’s creditors cannot attach the principal assets of the trust.
- Benefits to a charity. The entire asset amount contributed is received by the designated charity after the Trustor dies or after the income term guaranteed by the CRT ends.
- Permanent guarantee of income to Trustor. Part of the requirements under IRC §664 is that the amount of the periodic payments are fixed in the CRT trust document at no less than 5% of the net fair market value of the property placed into CRT. This avoids the uncertainty that the Trustor would have on amounts income he would receive from his assets if he didn’t place them into the CRT.
- Initially – A CRT is established by having a Charitable remainder trust Declaration of Trust prepared. Typically this is done by the charity involved. Most charities, including religious organizations and universities, have all of the documentation available and ready to use once the Trustor decides to make a gift. Also, the IRS has published various forms of CRTs that may be used.
- Appraisals – The charitable organization will have the assets appraised before the CRT is established and then from those numbers will compute what they are willing to pay as far as the periodic payments are concerned. The appraisal is of a specialized nature because it determines the present value of the charitable remainder interest which is based upon the Trustor’s age, payout rate and the IRS required discount rate. The appraisal will be needed by the Trustor for his income tax return in the year of the gift to justify the deduction for the charitable contribution.
- Sub-categories of CRT’s – Depending upon the manner in which the annual payout is determined, a CRT is either a Charitable Remainder Annuity Trust (CRAT) or a Charitable Remainder Uni-Trust (CRUT). The exact type is typically a subject of discussion between the Trustor and the charity. The charity will be capable of computing the various possibilities to give the Trustor some choices. Technically, in the Charitable Remainder Annuity Trust (CRAT) the amount that is paid at least annually is a sum determined as a percentage of the fair market value of the initial contribution to the trust. It has to be at least 5% but not more than 50%. In the Charitable Remainder Unitrust (CRUT) the amount to be paid annually is determined as a fixed percentage of the net fair market value of the assets of the trust which is determined annually.
- Choice of Trustee/management of the Trust – The charity involved is typically the trustee or selects the trustee. The Trustor has nothing to do with selecting the trustee and nothing to do with running the CRT or the assets in the CRT once it is established.
- Ongoing – The only connection with the CRT after it is established aside from receiving periodic payments at least annually is that the Trustor will receive a form from the CRT stating the amount of reportable income that he will have to report on his individual income tax return, form 1040.
- Individual income tax returns are of course required to be filed by the Trustor by April 15 in the year following the establishm
ent of the CRT to report the amount of the charitable contribution. Also, each year the income portion of the periodic payments are to be reported on the Trustor’s individual income tax returns.
- Estate tax return not required (form 706). The assets contributed to the CRT are not to be reported on the estate tax return since they are not part of the Trustor’s estate. However, if the insured’s estate exceeds the $5,000,000 exemption (or whatever exemption is in effect at his date of death), then a return will be filed for the estate and the subject of the CRT may come up, especially in an estate tax audit. Typically, nearly all estate tax returns in Orange County are audited. The auditor will examine the CRT records in detail and all must be in order and up to date or the assets contributed to the CRT will be drawn back into the estate and be taxed.
DOCUMENTATION AND STEPS TO ESTABLISH AND MAINTAIN A CRT
TAX REPORTING REQUIREMENTS
VARIATIONS OF CHARITABLE REMAINDER TRUSTS
There are variations to the typical Charitable Remainder Trust (CRT) discussed above. For example, one can do a Charitable Lead Trust in which the Trustor puts a property in a trust which allows the property income to be paid to charity for a period of time and then the Trustor or his heirs get the property back after the period expires. There are various other variations on this that major charities and universities have available and can explain to a Trustor who is interested in benefiting the institutions in question.
The information in this memo is for general informative purposes and may not fit every situation. You are cautioned to have any CRT situation thoroughly reviewed and appropriate documentation prepared by legal counsel before you actually commit to it. The tax laws and IRS regulations are constantly changing in this area. Strict compliance with the required notices and the filing of tax returns and other administrative requirements are essential to be able to claim the tax benefits of a CRT.