Good Will Doesn’t Stop at Death: How Charitable Remainder Trusts Can Further Your Philanthropic Goals
by J. Hunter Moreland, J.D., Associate
Are you looking to climb into the upper echelons of donors to your alma mater and leave a lasting legacy? Have you always made yearly large donations to your church, synagogue or other religious organization? Do you have a charitable organization that you feel will benefit greatly from a substantial donation, but you also want to hang on to an income stream tied to your donation? Maybe you’re just looking for a creative way to reduce income taxes and want to also benefit a worthy cause on the side? If any of these are the situation you are in, a Charitable Remainder Trust might be for you.
While many estate and tax planners encourage inter vivos (lifetime) gifts to charities, one creative estate planning option, which has seen resurrected popularity during times of rising interest rates, more debt, and higher income payout, is the Charitable Remainder Trust (a “CRT”).
This unique type of trust provides many of the same tax and estate planning benefits as other irrevocable trusts, with the remaining balance of trust property at the termination of the Income Beneficiary’s interest (often the death of the Grantor or the Grantor’s spouse) passing tax-free to provide for a charity of the Grantor’s choice. As an added bonus, while the CRT is primarily an income-tax planning tool, it is also an effective tool to ultimately reduce estate tax exposure through use of the unlimited charitable deduction for assets passing at the death of the Grantor.
A CRT is commonly referred to as a “split-interest” trust, meaning you, the Grantor of the trust, can still receive a tax and estate planning benefit, as well as an income stream during your life, while also pursuing your own charitable planning goals. As is standard with irrevocable trusts, such as a CRT, the assets held by the trust are protected from possible creditor or other claims against you and since you no longer own the assets, the CRT is not included in your taxable estate. During your life, the Income Beneficiary, which can be the Grantor (you) or any other designated beneficiary and can receive a stream of income from the assets held by the trust (subject to certain limitations discussed below). The Grantor can also take an immediate partial income tax deduction for the contribution placed into the trust, then preserve those assets, or reinvest 100% of the proceeds from the sale of an asset into new assets, for a later distribution to a public charity or private foundation. The stream of income can occur for a set number of years (not to exceed 20 years), or the lifetime of one or more noncharitable beneficiaries, and must be between 5% and 50% of the initial fair market value of assets of the trust to qualify as a CRT for IRS purposes.
Types of CRTs
Income from the CRT can come in one of two forms: a unitrust amount (creating a Charitable Remainder UniTrust, or “CRUT”) or an annuity (creating a Charitable Remainder Annuity Trust, or “CRAT”) with distributions occurring annually, semi-annually, or quarterly.
With a CRUT, the income beneficiary, who could be you, another individual, or a non-charitable organization, will receive a fixed percent of the trust assets each period. This type of trust is revalued every year to determine the actual value of the income and is largely based around the performance of the income-producing assets in the trust. Therefore, if the trust assets are well-managed and produce a great deal of income, the beneficiary’s yearly income can increase each year. CRUTs also can be structured in one of several variants, such as the Net-Income CRUT (a “NICRUT”), the Net-Income-with-Makeup CRUT (a “NIMCRUT”), or the “flip” CRUT, each with its own options for how the fixed percentage of income can be distributed in a given year.
With a CRAT, the income beneficiary will receive a fixed dollar amount of the trust assets each period. This income stream does not consider the performance of the trust assets; however, it will not provide protection against inflation, since the beneficiary will be receiving the same dollar amount each year. That CRAT provides more stability, especially for an older beneficiary, since he or she can count on receiving the exact sum of money each year.
Best Assets to Gift
Some of the best features of either form of CRT come in the income-tax benefits you can receive for the assets transferred into the trust. While any asset can be transferred into a CRT, the best options are assets that have highly appreciated in value over the years (old stocks, real property, etc.), which can easily be liquidated once in the trust. Upon transferring assets into the trust, the Grantor can additionally take an immediate charitable deduction based on the value of the remainder interest and type of assets passing to the charity. Once the assets are sold in the trust, no income tax will be assessed upon the sale, which will allow for an easier and more effective diversification of income-producing assets than if the assets were sold outside of the trust.
Other Consideration in Planning
Though there are several tax benefits with a CRT, there are also several tax concerns to be aware of when using this type of trust. When the trust distributes income to the income beneficiary, the beneficiary will pay income tax. Further, if the income beneficiary is not also the Grantor, special considerations should be taken to ensure there are no issues with gift tax or generation-skipping transfer tax. This type of trust will also require careful drafting and management to ensure compliance with all relevant tax provisions, which may cause you to incur additional costs.
A common question we hear from clients when considering if a CRT is right for them is what they can do for their children and descendants. Fortunately, this type of trust can pair well with our Life Insurance Trusts, whereby the Grantor, as income beneficiary of the CRT, will use the distributed CRT income to contribute to the Life Insurance Trust. Once the funds are in the Life Insurance Trust, the Trustee of the Life Insurance Trust will pay for the premium on a life insurance policy held by and for the benefit of a Life Insurance Trust established for the benefit of the Grantor’s children. This option achieves a “best of both worlds” scenario, whereby a Grantor can preserve some generational wealth, as well as accomplish their own philanthropic goals.
How a CRT Can Be Used
For example, Widower, age 75, owns $1,000,000 of Berkshire Hathaway (BRK) stock. This stock pays no dividend, but was purchased many years ago resulting in approximately $800,000 of gain being recognized upon the sale of the stock, so Widower is conflicted on what to do with the stock. Widower is an avid fan of his Alma Mater, the University of Georgia, a frequent donor for his local Methodist Church which he attends multiple times a week, and also an Eagle Scout with lifelong support of the Boy Scouts of America. Widower would like to leave something to these organizations upon his passing since they have been so influential on his life.
Widower may choose to set up a CRUT which will pay him a 6% unitrust payout each year for the rest of his life. Widower then contributes his BRK stock, which results in approximately a
$600,000 charitable deduction based on his life expectancy. This deduction, which can be used in the year of the contribution to the CRUT and carried forward through the next five years, will save Widower approximately $270,000! Now the CRUT will sell the BRK stock and the CRUT will pay no tax on the $800,000 gain (approximately a $200,000 savings) due to the charitable deduction. The CRUT reinvests the $1,000,000 proceeds into income-producing stock, yielding an aggregate of roughly 6% and the CRUT pays 6% to Widower each year, starting with a $60,000 payout in the first year!
Widower has now taken an asset which was yielding nothing and converted it to one which yields $5,000 each month. Widower has achieved over $270,000 of income tax savings and $400,000 of estate tax savings since the CRUT reduced his overall estate. Widower has also achieved his philanthropic goals as the value of the CRUT, whatever it may grow to during Widower’s life, will go to the University of Georgia, his Methodist Church, and the Boy Scouts of America!
Navigating the landscape of charitable trusts and charitable planning can be confusing, but the good will you generate for the charitable cause of your choice, and the benefit you will see on your tax bills, makes the process more than worthwhile. Even if you can no longer attend the yearly charity auction, you can still contribute bountifully to the mission of your charity when you use a CRT.
For more information regarding charitable planning or any other estate planning matter or to speak to your attorney, please contact us at 404-255-7400 or info@hoffmanestatelaw.com.
