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Charitable Trust

The charitable remainder trust (CRT) is a tax-advantaged estate planning tool that allows you to plan for a future charitable gift while providing an income, lowering your taxes and reducing your estate.

The CRT is one of the only vehicles where the Internal Revenue Code permits you to benefit jointly with a charity. As a result, depending on the structure of the CRT, you can still benefit from any appreciation within the trust, while lowering your current and future taxes.

A charitable remainder trust is ideal for someone with a highly appreciated asset who has a charitable inclination and also wants an income stream from that asset.

Two Unique Types of Trusts

There are two types of CRTs that operate in different ways: the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT). Both of these irrevocable trusts offer unique benefits.

The CRAT pays a fixed dollar amount annually to one or more non-charitable beneficiaries during their lifetime, or for a term not greater than 20 years. Payments are usually between 5% and 7% (but can be higher) of the initial trust assets. These payments are determined by the age of the grantor and his non-charitable beneficiaries, an IRS-provided discount rate and the value of the assets transferred to the trust.

With the CRUT, the non-charitable beneficiary(ies) receives variable – rather than fixed annuity – income. The variable amount is determined by taking a percentage (no less than 5%) of the fair market value of the trust’s assets on the annual valuation date. Therefore, the CRUT must revalue its assets annually. CRUTs tend to be more popular because they offer greater flexibility.

Generally, there are four types of CRUTs, each with different payout rules. With a true unitrust, the percentage payout has to happen annually. With a net income unitrust, the trust pays out up to the required percentage, to the extent that there is current income in the trust. The net income with makeup unitrust is similar to the net income unitrust, except that you are required to make up any deficiency on the income in a subsequent year. Finally there’s the FLIP CRUT which forces a net-income unitrust to switch to a regular unitrust, with annual payout, when a certain contingency occurs. While all of this sounds complicated, proper financial and estate planning will determine your specific needs, backed by input from your lawyer and accountant.

Distinct Benefits of CRTs

Regardless of the type of trust you choose, CRTs as a whole have numerous advantages, both non-tax and tax-related. For instance, the grantor has the ability to designate and gift assets to a trust that will ultimately find their way to charity, while still allowing the grantor to have an interest in the assets. That means the grantor and his non-charitable beneficiaries can receive income, while the trustee maintains the right to sell any assets within the trust, reinvest the proceeds and diversify the trust’s portfolio for potential growth.

Another non-tax advantage is that the grantor retains the right to change the final charitable beneficiary through his or her last will and testament. The grantor even has the right to name a default charity or appoint his or her trustee – usually a family member – to do so, in the event a charity no longer qualifies under IRS rules.

From a tax perspective, CRTs are most useful to clients with a highly appreciated asset, who would like to reduce or eliminate capital gains tax on the appreciation. Take, for example, a couple with a $1 million asset whose basis (original purchase price) is under $100,000. If they sold the asset outright, their tax burden would be enormous. By funding a CRT, they would reduce or eliminate any immediate capital gains taxes on the donated assets, as would the charity under the law.

The CRT also removes the asset from your estate, lowering your ultimate tax burden. Finally, you can receive an income tax deduction for the fair market value of the remainder interest in the trust. You can take the deduction in the first year; however, if you don’t have the income required, you may carry over the deduction for five years, after which it is no longer available.

You will still have to pay income tax on the income received by the trust – possibly capital gains if the income generated is less than your payout rate. But this is a matter for your accountant and advisors. Overall, favorable taxation can give rise to increased growth of assets managed inside the trust, producing benefits for the charity as well as the potential for increased income for its recipients.

Yet for those with a charitable impulse who still want to protect their future heirs, CRTs provide the ultimate kicker: wealth replacement. In conjunction with the CRT, the grantor’s irrevocable life insurance trust would purchase a life insurance policy on the grantor to replace the assets the future heirs wouldn’t receive when the assets pass to charity. It’s a win for the taxpayer, the future heirs and the charity

Any discussion pertaining to taxes in this communication may be part of a promotion or marketing effort. As provided for in government regulations, advice related to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor.

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