In a previous blog on Revocable Living Trusts [REVOCABLE LIVING TRUSTS- Practical Management & Transfer of Assets, posted July 9, 2015], I mentioned the use of Irrevocable Trusts as a tool for certain tax planning, which included reference to a “Charitable Remainder Trust”. This blog will discuss what a Charitable Remainder Trust is, how it’s created, and whether it is something you might or should consider putting into place as part of your estate plan.
If you are planning to make a substantial gift to a charity or to your alma mater, or if you own stock that has significantly increased in value that you would like to sell, but do not want to be faced with capital gains tax, a Charitable Remainder Trust [CRT] would allow you to make that gift or donate that stock to a charity and receive income for your lifetime [or the life of another]. If you have accumulated or inherited assets that exceed the current Federal Death Tax/Estate Tax exemption of $5,430,000.00 per person, transferring some of those assets to a CRT would remove the gifted assets from your gross estate thereby reducing its taxable value for death tax/estate tax purposes in addition to providing an income stream from the assets gifted to a CRT. The use of a CRT in any of these situations and many others allows you to provide a generous benefit to your favorite charity while giving you and your heirs certain tax benefits, but it must be properly created, funded and managed in order to do so.
So how do you create, fund and manage a CRT? You must first set up a trust by either including a provision in your Will to transfer property to a CRT at your death or by creating a separate, stand-alone trust document and transfer ownership of the property to that trust. The most common and preferred method is the latter of the two, but in either event, the charity you choose must be a charity that is approved by the Internal Revenue Service as tax exempt. Administration of CRT’s involves holding, investing and distributing trust funds, filing unique federal and state tax returns and, in some states, issuing annual reports to trust beneficiaries. It can be time-consuming and difficult to serve as trustee of a CRT without any expertise or experience, which is why a bank, trust company or the charity itself is typically appointed to serve as trustee. No matter how competent you think your brother-in-law the CPA is, appointing someone who does not have the knowledge or experience necessary to serve as trustee of a CRT would be a huge mistake. The preparation of the CRT document itself should likewise not be prepared by use of on-line forms or sample documents located with the assistance of Google. Such trust documents can be very complicated to prepare and an experienced estate planning attorney should be consulted to make sure the underlying trust document is prepared correctly and to make sure it is properly funded. Before taking the steps to create and fund a CRT, you must clearly understand that CRT’s are irrevocable and should not be considered lightly. Once you start a CRT, you cannot take back what you have given.
There are three primary tax benefits to creating and funding a CRT. First and foremost, after you have set up and donated/transferred property to a CRT, you are allowed to take an income tax deduction for the charitable donation and spread it out over five years. You do not, however, get to deduct dollar for dollar the amount you transferred to the CRT. Instead, the IRS calculates your total deduction using the amount you original transferred less the amount you expect to receive as a return through interest payments. Another tax benefit, as mentioned earlier, is the removal of the property from your estate for death tax/estate tax calculations. If your estate assets exceed the current $5,430,000.00 per person estate tax exemption, transferring assets to an irrevocable CRT can reduce the value of your estate, as previously mentioned. A third benefit is the avoidance of capital gains tax on the transfer of the property, also previously mentioned. If you own property that has greatly appreciated in value during your ownership, or if you own investment property that has appreciated in value but no longer producing an income, you could not sell either of those types of property without paying a capital gains tax on any profits from the sale. You could, however, donate that property to a charity and the charity could sell the property and not pay any tax on the sale. The charity could then invest the tax-free proceeds in a mutual fund, for instance, and pay you the interest from that fund for your lifetime – all without any capital gains tax.
If the tax benefits sound appealing to you, there are many other factors to be considered before proceeding with the formality of setting up a CRT. To name a few, you have a choice between two different ways to receive income from the trust: (1) a fixed dollar amount [a/k/a CRAT - Charitable Remainder Annuity Trust], or (2) a percentage amount [a/k/a CRUT - Charitable Remainder Unitrust] and this decision is made when the CRT is set up. There are pros and cons to both options which should be discussed at length with the entity you are considering to appoint as trustee, which would be either an investment representative from the charity, an experienced investment advisor, or a trust officer from the bank or trust company. You also need to give considerable thought to who the other income beneficiaries will be and when they will receive income from the trust. Let me repeat: these types of trusts are irrevocable and once you start one, you cannot take back what you have given; so careful and deliberate consideration must be given to all factors involved before starting a CRT.
If would like to see if a Charitable Remainder Trust would be useful estate planning tool for you, call Sharon Potter to discuss it (865-546-9321).