Charitable Trusts Can Work for You
By David N. Chazin In conjunction with Sagemark Consulting, a division of Lincoln Financial Advisors, a registered investment advisor. Mr. Chazin is a regular contributor to PlannerConnect
A charitable remainder trust (CRT) may be an estate planning tool that fits well into your financial picture. A CRT is a type of trust generally used to donate appreciated assets to charity and avoid immediate capital gains taxes. Let s review the basics of a CRT and the benefits it can provide when planning your estate.
Simply stated, a charitable remainder trust is an irrevocable trust that pays annual income to one or more individuals for a specified period of time, after which time the trust terminates and the principal is paid to a charitable organization. The trust could be set up to provide income to you and your spouse for your lives. After your deaths, the charity would receive the trust s assets. The charity could be a university, foundation, church, museum, or any other qualified charitable institution.
Here s how it works. Typically, the donor transfers appreciated assets -- such as stock, real estate or closely held shares of a business -- into the trust on behalf of the charitable organization of the donor s choosing. The trust, in turn, sells the assets and invests the proceeds into high income-producing investments. Since the trust is charitable in nature, it pays no capital gains tax on the profit. The trust then pays the donor an income stream each year (usually for life) and then turns over the principal to the charity upon the donor s death.
If all the requirements are met, there are several tax advantages to this arrangement. First, by giving the asset away instead of selling it, you avoid paying the IRS immediate capital gains taxes (which, under the tax law, may be up to 15% depending upon your tax bracket, the type of asset, how long you owned the asset, and other factors), as well as any capital gains tax levied by your state.
Second, you have available a current income tax deduction, subject to limitations. When you contribute stock to a CRT, for instance, you can deduct a portion of the value of the stock (since the stock won t pass to the charity for several years, the deduction will be less than the stock s current market value).
Third, your estate taxes may be reduced: by making a gift to a charity -- either directly or through a CRT -- the value of the asset plus any future appreciation in its value are removed from your taxable estate, which may ultimately lower your estate tax bill.
CRTs do not entirely escape taxation, however. Depending upon the type of property in the trust, the annual amounts received by the donor from the trustee are generally taxed at either capital gains or ordinary income tax rates.
A CRT may be particularly useful if you hold an investment that has appreciated substantially but throws off minimal yearly returns, such as low-basis stock paying a dividend rate of one or two percent. The trust, as a charitable organization, can sell the stock and reinvest the proceeds to provide you with a higher annual return than you earned on the stock, possibly as high as six or seven percent.
Two kinds of charitable remainder trusts are charitable remainder unitrusts and charitable remainder annuity trusts, respectively known as "CRUTs" and "CRATs." The primary difference between the two is that they are funded differently and they generate different income streams.
You may make contributions to a CRUT over time, but a CRAT can t accept transfers after its initial funding. Additionally, CRUT payments are determined annually and are based on a fixed percentage (at least 5%) of the fair market value of the assets sitting in the trust. So payouts fluctuate from year to year based on the performance of the funds invested by the trustee.
On the other hand, CRAT payments are calculated just once -- when the trust is first set up -- and are fixed at a specific dollar amount each year, for example, $7,000. You can set the percentage in the trust agreement but you must annually receive at least 5% of the initial value of the contributed assets. Upon your death, or after a period of up to 20 years, the asset passes to the charity.
The payout option you choose -- CRUT or CRAT -- will depend on your financial and tax planning strategy, your age and tax bracket, the type of assets you are donating to the trust, its prospects for further appreciation, and other factors.
Additional issues you should know:
-There is a ceiling on the yearly annuity and unitrust payments from a CRT. The maximum annual CRAT payment to the donor cannot exceed 50% of the initial fair market value of the trust assets, or 50% of the annual value of the trust assets, in the case of a CRUT. (The minimum 5% payment requirements remain for both.) This requirement applies to transfers into the trust after June 18, 1997. -The value of the trust principal -- also known as the "remainder interest" -- that passes to the charitable entity when the trust ends must be at least 10% of the fair market value of all assets placed in the trust. This rule, effective for transfers made after July 28, 1997, was intended to ensure that the charity receives at least a minimal portion of the property transferred to the trust.
These rules may effectively limit the use of the charitable remainder trust as a tax planning tool for some relatively young individuals. A mother in her forties, for instance, may be unable to establish a CRUT, which lasts for her lifetime and then the lifetime of her 21-year-old daughter because even if they retain the minimum 5% payout, the charity s remainder interest may be less than 10%.
If a middle-aged taxpayer puts $1 million into a CRT, the deduction may be worth roughly $300,000 or 30% of the assets transferred. But if the donor is a 30-year-old who is expected to live for another 50 years or so, that $1 million trust may only be worth $70,000 in today s dollars. In that instance, the 7% deduction fails the 10% test and the CRT would be disqualified.
Although CRATs cannot accept additional contributions, CRUTs can. Accordingly, the 10% test must be met for each donation of property to a CRUT. However, the law allows some flexibility with regard to transfers that fail to meet this test such that the entire trust may not lose its qualification as a CRT.
If you are thinking about creating a CRT, ask your advisor how the rules affect your personal tax situation and whether the trust or an alternative tax planning tool make the most sense for you.
David N. Chazin is part of a network of qualified financial planners affiliated with PlannerConnect. You can reach him at David.Chazin@LFG.com, or to connect with a financial planner in your area please call (800) 318-7848, or visit www.PlannerConnect.com.
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.
David N. Chazin, is a registered representative of Lincoln Financial Advisors, a broker/dealer, and offers investment advisory service through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor,3000 Executive Parkway, Suite 400, San Ramon, CA 94583, (925) 275-0300. Insurance offered through Lincoln affiliates and other fine companies. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.
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