Questions
• What is a charitable remainder trust?
• Why is a CRT often funded with highly-appreciated assets?
• Are all CRTs set up in the same way?
• What are the rules about paying trust income?
• How much of an income tax deduction does the grantor receive?
• What are some considerations when selecting a trustee?
• Why do some clients integrate life insurance into this plan?
• What are the characteristics of a CRT prospect?
• How can the Edward Jones Trust Company help?
What is a Charitable Remainder Trust?
A charitable remainder trust (CRT) is an estate planning option that may help charitably-inclined clients achieve their estate planning objectives, reduce estate tax liability, and receive current income tax benefits.
A CRT is an irrevocable trust that can allow a donor to make a current gift and receive an income stream for their lifetime. Because the trust names IRS qualified charity(s) as “remainderman” (the beneficiary receiving assets after the grantor’s death), grantors are entitled to income tax benefits during their lifetime and reduced federal estate taxes at death. Thus, the grantor receives income and tax benefits, and the charity receives a posthumous gift.
Why is a CRT Often Funded with Highly-Appreciated Assets?
Because of the trust’s charitable intentions, it is exempt from paying capital gains tax on the sale of low basis assets. Therefore, CATs may be used to convert a highly appreciated asset (e.g. stock, real estate) which has not produced much income into a current income stream for the grantor during his/her lifetime. (If the grantor had sold the asset prior to transferring it to the trust, any resulting gain would be netted on a Schedule D and carried over to his/her Form 1040. Currently, capital gains are taxed at 15%.)
This allows more of the grantor’s assets to be reinvested, often permitting better diversification for meeting current needs. It should be noted that the capital gains tax for the grantor is deferred, not avoided. The capital gains tax will be paid by the income beneficiaries under the “four-tier accounting” rules that govern the taxation of distributions to the income beneficiaries.
Are All CRTs Set Up in the Same Way?
No. One option is a charitable remainder unitrust (CRUT). This type pays a fixed percentage of the trust assets (revalued each year) to income beneficiaries. Therefore, income may fluctuate.
Another possibility is the charitable remainder annuity trust (CRAT). In this type of CRT, the beneficiary receives a fixed percentage of the initial contribution so the annual income does not fluctuate. While this choice may be fine for an elderly individual, it obviously carries some risk that inflation may affect the client’s purchasing power over an extended period of time.
What are the Rules About Paying Trust Income?
The grantor can have the attorney draft the trust to pay income for his/her lifetime. If the grantors are husband and wife, income can be paid for as long as either of them lives. The trust can also be drafted to pay income for a stated number of years, not to exceed 20 years.
How Much of an Income Tax Deduction does the Grantor Receive?
Either the estate planning attorney or a CPA should help the client estimate the possible income tax deduction that would be created. In general, the deduction varies according to the annual income received, the type and value of trust assets, beneficiary ages, and the applicable federal rate.
Federal income tax deductibility can vary from 20% - 50%, but is usually limited to 30% of adjusted gross income. Much depends on how the IRS categorizes your chosen charity and the assets held in trust. If the entire deduction created cannot be used in the first year, it can be carried forward for up to 5 years.
What are Some Considerations When Selecting a Trustee?
It is common for these types of trusts to name a corporate trustee when the trust is established. The ongoing administration and tax report for a CR1, as well as the investment of assets within the CRT, are crucial to qualifying as a charitable trust for tax purposes.
Because of the complicated nature of these responsibilities, a corporate trustee is usually in the best position to monitor the trust and its activities, although grantors can name themselves as trustee. It is critical that the trust be properly administered. If not, the trust could be penalized with a loss of tax benefits and/or penalties.
Why do Some Clients Integrate Life Insurance into this Plan?
Some clients use insurance to replace the value of trust assets transferred to the CRT. When this is done, estate planning attorneys frequently use an Irrevocable Life Insurance Trust, commonly called a wealth replacement trust, to own the insurance policy. This removes insurance proceeds from the grantor’s estate, thereby avoiding federal estate taxes. Another benefit of a wealth replacement trust is the ability to control distributions to your beneficiaries.
What are the Characteristics of a CRT Prospect?
• Have highly-appreciated assets (not annuities or tax-deferred accounts) and desire to diversify and defer capital gains tax
• Charitably inclined
• Have already established an estate plan (will, trust, etc.)
• In a high tax bracket
• Have a sizable income and seeking a current charitable income tax deduction
• A taxable estate for federal estate tax purposes (in 2004 and 2005> $1.5 million)
• A desire to create an income stream for life or a term of years