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Close-up on Charitable Remainder Trusts

June 22, 2017

CRTs allow charitably inclined people to share their good fortune with the less fortunate. Before contributing assets to a CRT, it’s important to know your options.

Thinking about making a major contribution to your favorite charity? A charitable remainder trust (CRT) might be just what you’re looking for. These irrevocable trusts are designed to benefit charitable organizations. But they also continue to provide the donor (or the donor and another beneficiary) with an income stream for life (or a term up to 20 years) plus some significant tax breaks. At the end of the trust term, the charity receives the remaining trust assets. Here’s a closer look at this unique estate planning tool.

CRUTs vs. CRATs

There are two types of CRTs: charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs). The main difference is how their annual payouts are calculated. A CRAT pays a fixed percentage (generally between 5% and 50%) of the trust’s initial value. On the other hand, a CRUT pays a fixed percentage of the trust’s value, recalculated annually.

Many people prefer CRUTs because annual revaluations allow the payouts to keep pace with inflation. Of course, if the value of the trust declines, payouts also decline. A CRAT makes uniform payouts, regardless of fluctuations in the trust’s value. Another advantage of CRUTs is that, unlike CRATs, they allow you to make additional contributions during the term.

Tax Benefits

When you fund a CRT, you’re entitled to an immediate charitable income tax deduction (subject to applicable limits). The deduction is equal to the present value of the charity’s remainder interest. That value depends on:

  • The value of the contributed assets,
  • The trust’s term (or the income beneficiary’s life expectancy if payouts are for life),
  • The payout percentage, and
  • An IRS-prescribed interest rate.

Generally, you can get a larger deduction by shortening the term and/or reducing the payout percentage.

A CRT also provides a vehicle for disposing of highly appreciated assets without generating a substantial current capital gains tax bill. Suppose you own $1 million in stock that you purchased for $200,000. You’d like to sell the stock, but you’re reluctant to take the capital gains tax hit. If you contribute the stock to a CRT, the trustee can sell the stock tax-free at the trust level and reinvest the proceeds in assets that offer more attractive returns. That translates into higher payouts to you and greater benefits to charity. Keep in mind that annual payouts are taxable as follows:

  • First, as ordinary income for the trust’s taxable year and its undistributed ordinary income for prior years,
  • Second, as capital gain for the trust’s taxable year and its undistributed capital gain for prior years,
  • Third, as other income (i.e., tax-exempt income) for the trust’s taxable year and its undistributed other income for prior years, and
  • Finally, as a distribution of trust corpus.

These ordering rules assure that income subject to the highest federal income tax rate is deemed distributed prior to income subject to a lower (or no) federal income tax rate.

Powerful Combo

CRTs allow you to give to charity while taking advantage of several financial and tax benefits. To explore the full range of charitable-giving options, talk to a member of our private client services team. We can help you devise a gifting plan that suits your charitable goals and personal financial needs.

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