Charitable Remainder Trusts

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	Charitable Remainder Trusts Personal Finance Advisor by Deloitte & Touche OnLine August 31, 1998

How to make use of this important estate planning tool.

Charitable remainder trusts (CRTs) have been used in a variety of ways as an estate planning tool. A CRT is a vehicle for a grantor (individual who establishes the trust) with charitable intentions to (1) receive a current charitable deduction, (2) retain an income interest in assets contributed to the CRT, and (3) donate assets remaining in the trust to one or more qualified charities (remainder interest).

To prevent certain abuses, the Taxpayer Relief Act of 1997 included two important rule changes for CRTs -- the present value of the charitable remainder interest was increased to a minimum of 10% of the value of assets/property on the date of contribution, and the maximum income interest payout percentage in any one year cannot exceed 50% of the fair market value (FMV) of the CRT assets.

How CRTs Work: A grantor can establish an irrevocable CRT during his/her lifetime, or can arrange for a CRT to be established upon his/her death. The grantor (or specified beneficiary) retains an income interest in assets contributed to a CRT for a stated amount of time (lifetime, or period not exceeding 20 years). The income interest can be for the benefit of the grantor, his/her spouse, or another individual (for example,, child). One or more charities are named as recipients of assets remaining in the trust after the period of the beneficiary’s income interest.

In most cases, there are no gift or estate tax consequences if the grantor and his/her spouse are beneficiaries of the income interest. If the grantor’s children (or other non-spouse individuals) are beneficiaries, there may be gift tax consequences -- the present value of future payments to the non-spouse beneficiary(s) is generally a taxable gift on the day the CRT is created and funded. The present value of the income interest is subject to estate tax if (1) the CRT is set up at the time of the grantor’s death, and (2) a non-spouse individual is the income interest beneficiary.

The following chart illustrates a simple CRT where the grantor is the income interest beneficiary.

How charitable remainder trusts work

Types of CRTs: Two basic types of CRTs are available -- charitable remainder annuity trust (CRAT) and charitable remainder unitrust (CRUT).

Under a CRAT, income interest beneficiaries are annually paid either (1) a fixed dollar amount, or (2) a fixed percentage of the initial value of CRAT assets. The fixed percentage must be at least 5% of the initial value of the trust assets, regardless of the amount of income earned by the trust (i.e., payments can reduce trust principal). The grantor is not permitted to make additional contributions to a CRAT after the initial contribution. With a CRAT, any appreciation in the trust’s assets will benefit the charities that have a remainder interest, because annual income payments to beneficiaries are based on the FMV of the initial contribution (or a fixed dollar amount).

A CRUT is more flexible than a CRAT. Grantors may make additional, deductible contributions to a CRUT after the initial contribution. Any appreciation in the CRUT assets will increase the amount of annual income payments to beneficiaries, because these payments are based on the current FMV of the CRUT assets. Under a CRUT, annual income payments to beneficiaries are based on either: (1) a fixed percentage (at least 5%) of the FMV of the CRUT assets (recomputed annually), or (2) the lesser of the CRUT’s current year income, or a fixed percentage (at least 5%) of the FMV of the CRUT assets (recomputed annually). A provision may be added to the CRUT document to make up the income deficiency when current year earnings are more than the fixed percentage of the trust’s FMV.

Charitable Deduction: If the CRT is funded during the grantor’s lifetime, the grantor receives a current charitable deduction for the present value of the charities’ remainder interest. The charitable deduction is subject to the grantor’s adjusted gross income limitation; however, a five-year carryforward is available. Additional limitations apply if the charity is a private foundation. The amount of the current charitable deduction increases as the period of beneficiaries’ income interest (or amount of annual income payments) are reduced.

CRT Taxation: Earnings on CRT assets are generally exempt from federal and state income taxes, provided specific procedures are followed. The CRT will lose tax-exempt status if certain prohibited transactions occur (for example,, the CRT has unrelated business taxable income). Donors with highly appreciated assets can contribute the assets to a CRT, and the CRT can then sell the assets without incurring federal or state taxes on the gain. The CRT could then reinvest the proceeds from the sale, and annual income payments would be based on the FMV of the assets originally contributed. Under this approach, the grantor avoids capital gains taxes on the sale of the assets, and the grantor (or other beneficiary) receives the income.

Taxation of Income Interest Payments: The taxation of income interest payments to beneficiaries will depend on the type of income earned by the CRT. The following rules govern the taxation of income interest payments:

Ordinary income to the extent of current and accumulated undistributed ordinary income.
Capital gains to the extent of current and accumulated undistributed capital gains (short-term gains are distributed before long-term gains).
Tax-exempt income to the extent of current and accumulated undistributed tax-exempt income.
Tax-free payment of trust principal.

These are some thoughts to consider about charitable remainder trusts. Your Deloitte & Touche financial and tax advisors can provide more information and should be consulted before any action is taken.