Written by Succession Advisors
A charitable remainder trust (“CRT”) is an example of a “split interest” trust. It has two sets of beneficiaries:
(a) the “income” beneficiary that is not a charity; and
(b) the “remainder” beneficiary that is a charity.
The CRT states that a specified payment be made to the non-charitable income beneficiary either for a set number of years (not to exceed 20), or for the lifetime (or lifetimes) of the non-charitable income beneficiaries. At the end of this term, the remainder passes to charity.
A gift to a CRT allows the settlor an immediate income tax deduction equal to the actuarial value (using the IRS 7520 rate) of the remainder interest that charity will receive.
If cash is contributed, (a) if the remainder beneficiary is a public charity the deduction is available up to 60% of the settlor’s adjusted gross income (“AGI”) for the year; and (b) if the remainder beneficiary is a private foundation the deduction is limited to 30% of the settlor’s AGI.
If a capital asset is contributed, (a) if the remainder beneficiary is a public charity the deduction is available up to 30% of the settlor’s AGI; and (b) if the remainder beneficiary is a private foundation the deduction is up to 20% of the settlor’s AGI.
In order to qualify as a CRT, at the time of creation the remainder interest gift to charity must equal at least 10% of the value of the asset contributed. The settlor can control the value of the remainder interest. The less the payment the non-charitable beneficiary receives each year (or the shorter the period of such beneficiary’s income interest) the more will be actuarially deemed to be passing to charity. When the income beneficiary is young, and the 7520 rate is low, it is likely that the 10% requirement cannot be met for a lifetime reserved payment by the income beneficiary; rather, 20 years will be the maximum time period over which he or she can receive payments.
There are two kinds of CRTs: (a) charitable remainder unitrust (“CRUT”); and (b) charitable remainder annuity trust (“CRAT”). The difference is how the payment to the income beneficiary is calculated. For a CRUT, that payment is equal to a percentage of the value of the CRUT’s assets determined annually. For a CRAT, that payment is equal to a set dollar amount determined based on the value of the assets at the time the CRAT is initially created.
CRTs are used when the settlor has an appreciated asset that he or she wants to sell. If the asset is contributed to a CRT and then sold, no income tax is due. That’s because the CRT is a tax exempt entity. When the unitrust or annuity payment is made to the noncharitable income beneficiary, the recipient will pay income tax on what he or she receives. The income tax character of receipts by the income beneficiary are deemed to be ordered as follows: ordinary income, capital gain, qualified dividends, tax exempt income, and return of principal. In effect, the CRT gives an immediate income tax deduction and a deferral of the capital gains tax on sale.
Most CRTs used for deferral of income tax on capital gains are established so that the settlor retains a 90% actuarial interest in the initial contribution. The settlor receives an immediate 10% income tax deduction and a deferral of capital gains over the period of the annuity payment. The remainder charity is typically the settlor’s family foundation, used to fund the family’s charitable ventures.
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