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F. Charitable Remainder Trust

F. The Charitable Remainder Trust (CRT)

Here, the Grantor has a charitable motive and wants a big current income tax deduction, too. Often, however, the Grantor does not want to give up all benefit of the property to be donated. If the Grantor needs lifetime income, a CRT, which is irrevocable, can be an extremely useful tool.

This is a very complex topic, with many variations on a common theme. Great flexibility is possible, but very competent advice is required. Tax laws and rulings pertaining to CRTs will always be subject to changes that could drastically affect what was a well-conceived arrangement when drafted. So an important clause in any of these Trusts can be included, giving the Trustee the right to “doctor-up” the Trust in the future, to comply with presently unforeseen tax law changes. This provision should allow you – and your lawyer – peace of mind, with regard to tax issues. Note, however, that you cannot reserve the right to just end the CRT.

In the most basic form of CRT, called a Charitable Remainder Annuity Trust (CRAT), a pre-selected, fixed dollar payment is made from the Trust to the Grantor each year for life, or for a certain term of years, with the remainder (i.e., the left over Trust principal) to a charity or educational institution at the Grantor’s death. In a more commonly used variation, called a Charitable Remainder Unitrust (CRUT), the Grantor receives a fixed percentage of the Trust’s value each year, rather than an unchanging dollar amount.

The CRUT is often preferred because it can provide inflation protection: As the Trust (presumably) grows in value each year, so, too, will the dollar amount of the Grantor’s annual draw. Additionally, the CRUT, but not the CRAT, permits additional contributions in the years after the trust is set up.

Some people use a special type of CRUT as a retirement savings vehicle. Usually, a CRUT pays the Grantor a percentage of trust assets each year irrespective of trust income. That’s great for many folks who aren’t getting a paycheck any more. But a CRUT can also be designed to keep its early-year payments low. CRUT payouts can be limited to just the income actually earned, with no dipping into principal – yet. If the CRUT funds are invested in assets that yield little or no current income, payments to the Grantor in the early years of the trust will be minimal.

That suits many retirement savers who don’t want or need more taxable income right now. During the working years, they can make partially tax-deductible contributions to one or more CRUTs and let the money grow tax-deferred. Meanwhile, the Trustee retains and keeps track of the annual payments the Grantor could have received if he had taken his full percentage of CRUT assets each year as called for when the CRUT was established. Then, during the Grantor’s retirement years, the accumulated CRUT payouts that he didn’t need earlier are made up to him.

With either a CRAT or CRUT, the remainder interest that will eventually go to charity has a value today, established with a financial calculation, using an “assumed” future interest rate. (After all, a promise that property will go to charity in the future is worth something today.)

The IRS publishes the interest rate each month to be used in this calculation of the value – in today’s dollars- of the charity’s right to receive the remainder of Trust assets at the specified future date. That is the amount the Grantor is giving away. It is, therefore, the value of the current income tax deduction. A big additional benefit is that the donated property, and all future price appreciation, is removed from the Grantor’s taxable estate.

The IRS rate is 6.0% in September, 2006, and is assumed in this very simple example:

A $1,000,000 CRAT is established, providing the Grantor (or somebody of his/her choice) with a fixed, $75,000 (taxable) payment each year for 10 years. The present value of that 10 year stream of payments is $552,007. Subtracting that figure from the full $1,000,000 placed in the Trust results in $447,993 – the present value of the charity’s remainder interest in this CRAT. In other words, we’re putting a price tag today on the value of a lump sum the charity will not get for 10 years. That’s the value of the donation. For the same CRAT, but with a 15 year stream of payments, this remainder (and value of the donation) would have a present value of $271,581.

Note that when the IRS interest rate goes UP, the present value of the income stream goes DOWN. The result is that the remainder (and therefore the tax deduction) also goes UP when the official interest rate rises, and vice versa. The present value of the remainder also DECREASES as the length of the trust term INCREASES, and vice versa. (This makes sense because a longer trust term means the charity will have to wait longer for its payday, and more benefit from the trust will have gone to the Grantor.)

Those present values of the remainder interest represent the income tax deductions that would be available to be taken in the year the CRAT is established. (Ten and fifteen year terms have been arbitrarily chosen for illustration. Usually, the Grantor wants to receive annual payments for life. In that case, the actual figures would depend on the Grantor’s life expectancy, taken from an official table.)

The Trust also provides that if income is insufficient to make the annual payments, Trust principal can be invaded. This is a “safety feature” that helps provide peace of mind about giving away the money. Note that computational rules – as a practical matter – may limit the usefulness of the CRT to taxpayers much below age 50 who desire to receive payments for life.

Often, part of the tax savings from the deduction is given to the children, who buy life insurance on the Grantor to fund a “wealth replacement Trust,” so that their “inheritance” will not be reduced, despite the gift. In these cases, everybody wins.

This strategy can be especially useful in dodging an income tax bullet – capital gain. If a Grantor owns property that has increased in value since acquisition, there is generally income tax due on the gain if and when the property is sold. For property that has been held over decades, that potential gain – and tax – can be enormous. If a CRT is set up, the property is donated and the charitable Trustee sells it, however, there will be no tax.

Example: The Smiths’ largest asset is a block of IBM stock, purchased many years ago for a small fraction of its $1 million value today. If they sell it themselves on the open market, most of the proceeds will be taxed as a capital gain, probably at 15%. But if the stock is placed in an irrevocable CRT, the Trustee can then sell it and pay no tax. The full $1 million is then available for the Trustee to invest to provide lifetime income for the Smiths. Their current income tax deduction equals the value of the remainder interest in the Trust, to go to the qualified charity selected.

The CRT is also an excellent tool for those without appropriate beneficiaries. Indeed, in many situations, the CRT is the closest thing to “tax magic” that exists.

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