What Is a Charitable Remainder Trust?
In a traditional charitable trust, the grantor assigns property to a trust to create a charitable foundation. Those assets are then managed by the charitable organization for a perpetual life. However, a charitable remainder trust (“CRT”) first provides an income stream either to the grantor or to someone else of the grantor’s choosing and the remainder interest is then given to a charitable organization. The grantor is allowed an income tax deduction for the charitable portion of the gift given to the CRT.
Choosing Between a CRUT and a CRAT
A CRT can either be a UniTrust (“CRUT”) or an Annuity Trust (“CRAT”). In the CRUT form, the level of income distribution for the upcoming year is calculated at the end of each period and the distribution amount changes as the value of the trust fluctuates up or down. This variable income is based on a percentage of the trust assets as valued each year. That percentage must be at least 5% and in most cases tends to be in the 5-9% range. A CRUT provides the grantor flexibility in that it provides for the acceptance of additional contributions. In the CRAT form, the distribution is a fixed distribution amount determined as a percentage of the initial funding value and does not change in future years. However, there can be drawbacks to this. For example, if the trust performs poorly for a year, the fixed distribution amount can cause a liquidity crunch in trust and/or cause the Trustee to significantly erode the principal. Annuity trusts do not allow subsequent contributions after the trust has been established.
What Are the Tax Benefits of a CRT?
Two of the key tax benefits that will result from the use of a CRT are income tax deductions and intelligent management of capital gains taxation.
When you create a CRT, you make an irrevocable commitment to a qualified nonprofit organization of a future gift. The Internal Revenue Code permits the taxpayer todeduct a portion of the amount transferred to the CRT as a qualified charitable deduction in the year the CRT is funded.
When the CRT is funded with highly appreciated stocks, bonds, or real estate owned for more than one year, the charitable tax deduction is based on the current fair market value of these assets. Additionally, the CRT is not subject to income tax, so when these highly appreciated assets are subsequently sold by the CRT, the grantor will not have a large tax bill for capital gains as they would have in the sale of these assets outside of the trust. This effectively allows more of the grantor’s money to be used for charitable purposes.
New York Issues
A CRT established in New York will be subject to the laws of the state. In New York, CRTs must register with the Charities Bureau and submit filing form CHAR001-RT. The statute requiring registration of CRTs in New York State is section 8-1.4 of Estates, Powers and Trusts Law (EPTL). Additionally, a tax return will generally need to be filed annually for the trust both with the state and the federal government. As part of this, an annual federal income tax return for a CRT is IRS Form 5227, an information return. This form is open to public inspection.
Who Should Consider Using a Charitable Remainder Trust?
This type of trust should be considered by any philanthropically minded person with assets that have greatly appreciated. The main reason for this is that the donor will be able to take an income tax charitable deduction based on the size of the remainder interest in the trust. Also, the assets in the CRT can be sold with less capital gains tax. Artists or collectors with large collections should also consider this tool because it will allow them to use the capital gains savings from the sale of greatly appreciated assets to fund an establishment that cements and legitimizes the artist’s legacy. In some situations, the qualifying charity may be one established by the grantor. However, for tax purposes, it is likely better to choose a public charity, because doing so will allow the donor’s income tax deduction to be governed by the rules applicable to gifts to public charities, which are more advantageous than those rules applicable to gifts to private foundations. In sum, the trust is a great vehicle to fulfill the grantor’s philanthropic intent
How Does This Fit into My Overall Estate Plan?
The CRT can play an important role as part of a comprehensive estate plan. The main reason for this is that this tool can help lower the taxable estate. As part of this plan, one should also consider other strategies such as establishing a family foundation or a donor advised fund. It is important to talk with an estate planning attorney to determine if these vehicles are best suited for your goals and desired legacy.