If you’d like to benefit your favorite charities while creating an income stream for yourself or a loved one, consider incorporating a charitable remainder trust (CRT) into your estate plan. It can reduce the size of your taxable estate and provide a charitable income tax deduction.
What is a CRT?
A CRT is an irrevocable trust to which you contribute stock or other assets. The trust pays you (or your spouse or other beneficiaries) income for life or a term of up to 20 years, then distributes the remaining assets to one or more charities. When you fund the trust, the assets are removed from your taxable estate and you’re entitled to a charitable income tax deduction (subject to applicable limits) equal to the present value of the charitable beneficiaries’ remainder interest. (If you name someone other than yourself or your U.S. citizen spouse as the income beneficiary, there could be gift tax consequences.)
There are two types of CRTs, each with its own pros and cons:
1. Charitable remainder annuity trusts (CRATs). A CRAT pays out a fixed percentage of the trust’s initial value and doesn’t allow additional contributions once it’s funded.
2. Charitable remainder unitrust (CRUTs). A CRUT pays out a fixed percentage of the trust’s value recalculated annually, and allows additional contributions.
CRATs offer the advantage of uniform payouts, regardless of fluctuations in the trust’s value. CRUTs, on the other hand, allow payouts to fluctuate because they increase as the trust’s value increases. And, as noted, CRUTs allow you to make additional contributions. One potential disadvantage of a CRUT is that payouts shrink if the trust’s value declines.
Why can a CRT be a good tax strategy?
A CRT can help you diversify your portfolio in a tax-efficient way if you own non-income-producing assets that would generate a large capital gain if sold. Because a CRT is tax-exempt, it can sell the property without paying tax on the gain at the time of the sale. The CRT can then invest the proceeds in a variety of stocks and bonds.
If you’re the income beneficiary, you may owe capital gains tax when you receive the payments. But the payments will be spread over time, so much of the liability will be deferred. Plus, a portion of each payment may be considered tax-free return of principal. This may help you reduce or avoid exposure to the top 20% long-term capital gains tax rate or the 3.8% net investment income tax.
Keep in mind that, to ensure that a CRT is a legitimate charitable giving vehicle, IRS guidelines require that the present value of the charitable beneficiaries’ remainder interest be at least 10% of the trust assets’ value when contributed. The computation of the present value is affected by several factors, including the length of the trust term (or the beneficiaries’ ages, if payouts are made for life), the size of annual payouts and an IRS-prescribed Section 7520 rate.
Will it work for you?
If you’d like to incorporate charitable giving into your estate plan, a CRT could be a good move — especially if you can fund it with highly appreciated assets. But it’s important to consult with your estate planning advisor to help evaluate whether it’s a good fit for your situation.
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