A Charitable Remainder Trust (CRT) is a trust that provides for annual payments to individual beneficiaries for either life or a term of years, with an irrevocable remainder interest paid to the benefit of a charity. Because a CRT requires that the assets eventually be given to charity, the Internal Revenue Code gives the creator several tax benefits. The IRS:
Forgives any capital gains built into the assets.
Gives the creator an immediate charitable tax deduction.
Allows the trustee to invest and diversify the trust assets in a tax-free environment similar to an IRA.
Allows the creator to control the trust investments if the creator serves as a trustee.
Eliminates the estate tax on the assets held in the trust.
Example: Take the case of George and Martha Taxpayer. George is 60 and Martha is 58. Their combined estate is $4,000,000. They own $1,000,000 in an appreciated growth stock that pays no dividends and wish to sell the stock and invest the proceeds in a diversified portfolio that yields 5%. If George and Martha sell their stock and receive the $1,000,000 in sale’s proceeds, they can expect to pay nearly $250,000 in state and federal income tax. A 5% yield on the remaining $750,000, would pay them $37,500 each year before taxes. In addition, the IRS will tax the remaining $750,000 on the death of George and Martha. Applying the current marginal estate tax rate of 46%, George and Martha’s children will receive $345,000.
. What if George and Martha transfer their appreciated stock to a CRT instead? The transfer to the CRT will trigger no tax on the appreciated stock as the CRT is a tax-exempt entity. This creates an immediate savings of $250,000 in income taxes. The attorney drafts the trust to pay George and Martha 5% of the value of the trust each year while one or both of them is living. This will create an income stream to George and Martha of $50,000 ($12,500 more than our previous example).
In addition to avoiding the capital gains tax on the sale of the stock, George and Martha will also receive an immediate income tax charitable deduction. According to Ryan Belmer, a Financial Planning Specialist at Citigroup Smith Barney in La Jolla, their income tax charitable deduction would be $274,120. The calculation of the charitable deduction is complex, requiring consideration of the type of trust, term, and current IRS interest rates.
Finally, the unlimited charitable and marital deductions will work together to ensure that no estate taxes will be paid from the estate of the second of them to die. Assuming the trust principal is still $1,000,000, this will save them $460,000 in taxes.
But what about George and Martha’s children? As the assets in the CRT pass to charity on the death of George and Martha, you may be wondering how the children can be provided for. An easy solution is for George and Martha to take a portion of their CRT yearly payment and purchase a second to die life insurance policy. If the life insurance is held in an Irrevocable Life Insurance Trust, estate taxes can be avoided.
. CRTs come in two basic forms. The Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT). The Annuity Trust (or CRAT) pays a fixed payment every year to the creator. In the example above, the payments could be set at $50,000 regardless of the performance of the assets in the trust. The Unitrust (or CRUT) payment is set at a percentage of the trust assets as valued each year. The payment will vary depending on the value of the trust assets.
A CRT is an ideal planning tool for those who are charitably inclined and who own appreciated assets. A CRT is a very complex planning tool and should be considered and established only with the assistance of a qualified attorney and tax advisor.
Acknowledgments: The Author would like to thank Ryan Belmer of Citigroup Smith Barney for assistance in writing this article.