Charitable Remainder Trusts: Maximizing Tax Benefits

Mike Pusey  |

I'm a tax oriented CPA and set out to write an article on charitable remainder trusts (CRTs) just as a way to understand these peculiar trusts and what they can do. The article became three and that became a book of about 1,900 pages, so I've studied the topic.

I recall during the writing process a speaker saying if you had $2,000 of unrealized gains on stocks, you needed to create a CRT - after buying his handbook. There needs to be much more unrealized gain involved to justify creating such a trust - you have to get a lawyer to draft the trust, and gear up to file annual tax returns for the trust. And it is also true that the IRS can take microscopic, narrow positions on these trusts because they are by statute exempt (unless you mess up) even without going to the IRS to get an exemption letter.

The Basics of CRTs

You create the trust and name who gets the income which can be a fixed amount (an annuity) or a set percentage of the fluctuating annual value of the trust. You decide on how long the trust is to exist before distributing its assets to charity. This can be a period of years or for life or lives; e.g., our life, you and your spouse's lives, your kid's life, your parent's life, etc.

You designate the charity or charities that get the assets when the trust terminates, though you can decide this later. It is more common to make the charity's interest revocable but it has to go to some charity sometime. It is rare but technically possible to keep the assets in the trust that later becomes a charity after the term when it is a charitable remainder trust.

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The transfer to the trust doesn't trigger gain to you, so the earnings base is not depleted by the tax you'd pay had you sold the stock. The transfer yields a current income tax deduction even though the charity or charities get the assets down the road.

How does the deduction work? It is actuarially calculated to reflect what the charity gets at the termination of the trust. A five-year term yields a greater deduction than a twenty20income beneficiary is young, or if there are multiple income beneficiaries. It is very common to pay the husband and wife then the surviving spouse. Software is readily available to make these calculations.

How does the income tax deduction work if I do this in my estate documents? It doesn't work. These trusts can be useful in your estate planning as a tool to provide an income interest to someone with the assets eventually going to charity. To reduce your income tax, the transfer (funding the trust) has to occur during your lifetime. Properly structured, the charity's interest in the trust is also deductible for estate tax purposes.

Can I undo the trust later? The trusts are very difficult to unwind and you will need to go to court if you make a mistake and the trust agreement needs to be modified.

Charitable remainder trusts are very nice vehicles in many circumstances, and the high net worth individual needs to understand this alternative.

By the way, corporations can also fund such trusts in which case they have to specify a term of years; corporations that retain the income interest have no life and so are limited to the term of years approach.

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