[Publisher’s note: The Philanthropy Journal does not necessarily endorse the opinions, products or services offered or cited in this paid advertorial.]
By Robin R. Ganzert
Charitable remainder trusts offer creative philanthropic financial planning opportunities for individuals who wish to leave a charitable legacy.
Charitable remainder trusts are popular planned-giving vehicles from a tax-efficiency perspective by allowing donors to reduce estate taxes, defer capital-gains tax, and claim an income-tax deduction.
Charitable remainder trusts provide for distributions of a specified payment to one or more persons, at least one of whom is not a charitable organization.
The payment may be structured as an annuity or unitrust payment.
Nonprofit organizations benefit by receiving the remainder upon the termination of the trust, either upon the death of the last beneficiary or after a stated period of time. Created under state law, the trusts are irrevocable but offer the donor flexibility, diversification and other advantages. The donor has the right and responsibility to seek independent legal advice, and many nonprofit organizations generally do not pay the legal fees to draft and execute the trust instrument due to a conflict of interest.
The Donor Profile
Who is a candidate for a charitable remainder trust?
Prospective donors may have one or more of the following situations apply:
- Strong interest in giving back to the community and leaving a legacy
- Seeking to establish an estate plan
- Seeking additional income or diversification of assets
- Large concentration in one asset
- Concern over paying estate, capital gain and/or income taxes
- Have highly appreciated, low yielding or low basis assets
- Have recently sold their business
- Own a closely-held business
Planning with charitable remainder trusts includes the identification of the appropriate funding asset. Debt-financed real estate is not an acceptable gift to a charitable remainder trust. It can produce unrelated business income.
Under the Tax Relief and Health Care Act of 2006, charitable remainder trusts no longer lose their tax-exempt status if they have unrelated business taxable income. They are, however, subject to a 100 percent excise tax on the amount of their unrelated business taxable income. If the funding asset is real estate, the donor must recognize that the entire interest must be placed in the trust, and that he/she may not enjoy any use of the property. Partnership interests can be gifted, but they may also generate unrelated business income unless they can be disposed of quickly.
Subchapter S stock cannot be contributed to a charitable remainder trust because the trust does not qualify as a Subchapter S holder. However, a Subchapter S corporation can be a donor or trustee.
Closely held business interests should raise a caution flag, as conflicts of interest and self-dealing are more possible in this environment. Oil and gas interests are generally unacceptable, and may generate unrelated business income.
Charitable remainder trusts include the following basic types:
- Charitable remainder annuity trust, or CRAT
- Charitable remainder unitrust, or CRUT
- Net income charitable remainder unitrust, or NICRUT
- Net income charitable remainder unitrust with makeup provision, or NIMCRUT
- Flip CRUT where a charitable remainder unitrust operates as a NICRUT or NIMCRUT but flips to a standard unitrust on January 1 of the year following the occurrence of a specified event
The charitable remainder annuity trust, or CRAT, is irrevocable, and pays annually to the non-charitable beneficiary a fixed amount that is not less than 5 percent nor more than 50 percent of the initial fair market value of the assets originally contributed to the trust.
The annuity payments must be made not less than annually, and the remainder interest must be irrevocably committed to an organization as described in IRC Section 170(c).
The value of the charitable remainder interest must be at least 10 percent of the initial fair market value of all property placed in the trust.
The term of the CRAT may be for a term of no more than 20 years or measured by the life or lives of the individual beneficiaries.
At the termination of the trust, the charitable remainder must be transferred to the charitable beneficiary.
The advantages of a CRAT include the fact that the payments are known up-front for the beneficiaries, and the valuation is done only once, at the creation of the trust. The CRAT often appeals to the older donor or those with need for an additional fixed increment of income. The disadvantages include the fact that additional contributions are prohibited and funding is limited to income producing or marketable assets. If the CRAT principal declines in value, the trust could be depleted, leaving little to no remainder for the charitable remainderman.
The charitable remainder unitrust, or CRUT, is also irrevocable, and pays annually to the non-charitable beneficiary a unitrust amount not less than 5 percent nor more than 50 percent of the fair market value of the trust assets revalued annually.
Unitrust payments must be made not less than annually, and the remainder interest must be irrevocably payable to an organization as described in IRC Section 170(c).
The value of the charitable remainder interest must be at least 10 percent of the net fair market value of property placed in the trust as of the date such property is placed in the trust.
The term of the CRUT may be for a term of no more than 20 years or measured by the life or lives of the individual beneficiaries. At the end of the term of the trust, the charitable remainder must be transferred to the charitable beneficiary. The CRUT appeals to donors with a longer investment horizon and those who wish to be in the market.
The advantages of a CRUT are many, including:
- The payout reflects appreciation and depreciation of trust assets.
- Additional contributions are permitted.
- Non-charitable beneficiary payout can be limited to net income earned.
- Income exception distributions can be supplemented by a make-up provision.
- The trust may be funded with non-income producing or unmarketable assets.
The disadvantages are that the annual payment may increase or decrease, and the trust may not be advantageous to the beneficiary in an economic recession.
A net income CRUT, or NICRUT, pays each year to the non-charitable beneficiary the net income earned by the trust or a fixed percentage of the fair market value of the trust revalued annually, whichever is less.
The NIMCRUT, or net income CRUT, includes an optional trust provision that provides for make-up distributions for any year the net income exceeds the fixed percentage amount to the extent prior distributions were less than the fixed
A Flip CRUT is a CRUT that begins as a NICRUT or NIMCRUT but flips to a standard unitrust after the occurrence of a specified event such as a number of years, a certain date, or the death of a donor.
The Right Planned Gift
Is a charitable remainder trust the right charitable vehicle for your donor? Consider the following points:
- Charitable remainder trusts require donative intent, and are not tax-avoidance schemes. Some assets are unsuitable for a charitable remainder trust, and individuals should confer with their legal advisor on how to fund appropriately.
- A charitable remainder annuity trust can run out of funds and collapse, resulting in a no-win situation for the beneficiary and the charitable remainderman.
- Small CRTs are generally not advisable; a general rule of thumb is a minimum of $500,000 for a CRT.
- The income tax deduction could be wasted if not completely used in the year of the gift or the five year carryover period.
- Donors should consider carefully the role and selection of the trustee, as the trustee is a critical decision.
Charitable remainder trusts provide a solution for many donors seeking tax efficiency, retention of tax dollars, and diversification.
However, the primary motivation is philanthropic intent.
Advantages are also significant by providing for the building of philanthropic capital and improving the common good, all while bringing meaning to wealth and financial success.
This communication is not a covered opinion as defined by Circular 230 and is not intended or written to be used, and cannot be used, or relied on, by the taxpayer, for the purpose of avoiding federal tax. This communication was written to support the promotion or marketing of the transaction(s) or matter(s) addressed in the written communication; and the taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.
Robin R. Ganzert, is senior vice president, national director, of Wachovia Nonprofit and Philanthropic Services.