Charitable Remainder Trusts

These are found in the IRS Code in Section 664 and allow a donor to gift to an IRS-recognized charitable entity, through a trust, an highly appreciated asset. The Trustee of the ILIT sells the gifted asset, free of any capital gains taxes, and invests the sales proceeds. The Trustee then pays an income stream to the designated income beneficiary of the CRT. The donor also receives an income tax deduction for a per centage of the gift and the gift is heavily discounted for estate tax purposes. If the income beneficiary is the donor (or their spouse) a discounted value (at least 10% of the value of the gift) remains with their Net Taxable Estate because of the reversionary income interest. If the income beneficiary is another person, such as a child, then there is no reversionary estate tax issue, but the same amount is seen as an amount necessitating the reporting of a gift tax (the $10,000 exclusionary rule does not apply here).

The income stream is for either (1) 20 years, or (2) life. If the 20 year income option is chosen the income stream will continue to the income beneficiary for 20 years. If they die during that period of time, the income continues to their estate until the advent of the 21st year. If the life option is chosen the income continues as long as the income beneficiary lives. In either case, the income is taxable as ordinary income.

There are two kinds of CRTs. The first is the Annuity Trust (CRAT) which pays a set percentage of the initial gift for the income period. The other is the Uni-Trust (CRUT) which pays a set percentage of the value of the principal calculated each year. IRS tables determine the maximum allowable income in both cases. By law the CRT must pay at least 5% per year. If the investment does not earn a full 5%, then the shortfall must be paid from trust principal. Few people use CRATs anymore. A CRUT can pay an increasing income each year if the investment is wisely made. In addition, a CRUT, unlike a CRAT, can receive future dditional gifts.

There are minimum ages for income beneficiaries. In addition, the complex math formula must be adjusted each month according to the Average Federal Midterm Rate to calculate the size of the income stream. The size of the income stream is largely determined by the age of the income beneficiary. The younger they are the lower the income will be.

Most frequently gifted to a CRT are appreciated real estate, stocks and bonds. The gift asset must be transferred to the ownership of the CRT prior to its sale. Some assets may be taxed prior to this. This includes U.S. savings bonds and annuities. This may also include property which has enjoyed "double depreciation" allowances. In some cases the income tax deduction allowed for the CRUT may be sufficient to "wash" the income tax due on the conversion of these assets.

CRTs are valuable estate planning tools with a wise use:

  1. They can be used to convert hgihly appreciated (and taxable) assets into a retirement income stream.
  2. They can dramatically reduce the Net Taxable Estate's size and thus lower estate taxes. The heirs may not inherit a specific asset, but they could receive a lifetime income stream in its place.
  3. It can be used in a divorce to provide child support payments.

And in every case, they can greatly benefit a charity(ies) of the donor's choice. The Trustee must be a disinterested third party at arm's length and they must give the donor and income beneficiary(ies) an annual accounting.

Similar to an ILIT, the CRT must be registered with the IRS. The Trustee must sumbit a completed SS-4 form and Form 56 along with a copy of the trust instrument. If this is not done then the arrangement will not be recognized. In addition, the charitable entity(ies) must be those which are IRS-recognized as well.


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