CHARITABLE REMAINDER TRUSTS

Charitable remainder trusts have become a very popular planned giving vehicle over the past few years. While the name of these trusts sounds somewhat legalistic, it is really quite descriptive. These are trusts that are distinguished by the fact that after the death of the trust income beneficiary the trust assets will go to a charity or charities…therefore "charitable remainder trust."

In general, a charitable remainder trust (CRT) is a trust which provides for a specified distribution, at least annually, to one or more beneficiaries, at least one of which is not a charity (the income beneficiary), for life or for a term of years, with an irrevocable remainder interest to be held for the benefit of, or paid over to, charity (the remainder beneficiary).

Like other trust arrangements, this is a legal arrangement, evidenced by a trust document that should be drawn up by a qualified attorney. CRTs are regulated not only by the trust regulations of the state in which the trust is located, but they also fall under the federal tax regulations for charitable gift arrangements. It is, therefore, quite important that the trust document be prepared by a competent attorney who is well versed in charitable trusts.

The donor receives a sizable income tax reduction in the year the trust is created, up to certain limitations, and may be able to carry over any excess deduction for up to five additional years. The donor's estate will also benefit from the fact that the amount of the charitable gift is deductible for estate tax purposes. There are two basic types of CRTs.

Charitable Remainder Unitrust (CRUT). A standard Charitable Remainder Unitrust pays a fixed percentage of trust assets (not less than 5%) determined annually. To qualify as a CRUT under the Internal Revenue Code, the unitrust may not have a payment less than five (5%) percent of the trust's fair market value. The fair market value of the trust is determined annually, and the payout is calculated using the same payment percentage each year. The payment percentage always remains the same but, depending on the value of the trust at the end of each year, the dollar amount paid out will change.

For example, assume a CRUT is established using a payout percentage of 5%. At the end of the first year the trust is valued at $300,000. Therefore, the payout will be $15,000 (5% x $300,000). If at the end of the second year, the trust is valued at $320,000, the payout will be $16,000 (5% x $320,000).

Under federal regulations, there are several other versions of the CRUT that may be used:

• The net income plus makeup unitrust (NIMCRUT) allows the trust to pay less than the stated payment percentage to the donor if necessary and allows any shortages to be "made up" in later years when the trust income is sufficient;
• The net income trust that simply pays the beneficiary the lesser of the net income each year or the unitrust percentage.
• The Flip trust that allows payments to be deferred until some pre-specified event occurs. This type of trust is often when when a unitrust is being funded with non-income-producing assets, like real estate or land. Payments can be delayed until after the property has been sold.

To be treated as a valid CRUT, the value of the charitable remainder (the amount that goes to the charity) must be at least ten (10%) percent of the net fair market value of the property transferred in trust on the date of transfer to the trust. After the initial funding of the trust, additional contributions may be made to the CRUT by the donor if desired.

Charitable Remainder Annuity Trust (CRAT). A Charitable Remainder Annuity Trust* pays a fixed annuity and requires that a "sum certain" (not less than 5%) of the initial fair market value of the trust assets is paid at least annually to the named income beneficiary or beneficiaries. The dollar payment amount remains the same throughout the life of the trust.

For example, if the trust is initially funded with $300,000 with a 5% payout requirement, the annual payout will be $15,000 for the life of the trust regardless of how much the trust may grow. After the initial funding of the trust, additional contributions are not permitted to a CRAT.

Like the CRUT, the CRAT must also pass 10% remainder test but it also must pass what is called the "5% test." The 5% test measures the probability that the charity will receive nothing at the end of the trust term (whether for life of term of years). If the calculated probability exceeds 5%, the trust will not qualify as a valid CRAT.

Benefits to the Donor/Trustor
Donors who prefer the certainty of a fixed dollar payment annually will probably prefer the charitable annuity trust. Other donors prefer the more flexible charitable unitrust because if the value of the trust increases, so will their annual payments. They also like the fact that they can add to the unitrust rather than having to set up an entirely new trust. Some of the benefits of charitable remainder trust arrangements include:

• Bypass of capital gains tax on appreciated assets used to fund the trust;
• A charitable deduction in the year the trust is established and funded;
• Possible income increase for the donor if the trust payout is more than what the donor is currently earning on the assets;
• The trust can be set up for one or more lifetimes.

Because of the legal and administrative costs associated with CRUTs and CRATs, they are usually set up with assets of $100,000 or more. Charitable remainder trusts must have a trustee, which can be the person setting up the trust, a charity named in the trust or a financial institution with trust powers. Choosing a trustee is a very important step and should be discussed with the donor's attorney and with the proposed trustee so that everyone fully understands the duties and obligations associated with trusteeship.

*Some people confuse the Charitable Remainder Annuity Trust with the Charitable Gift Annuity (CGA). These are two entirely different types of charitable gift arrangements. For more information about CGAs, read my previous article, Is the Charitable Gift Annuity Right for You and Your Donors?