The advantage of a CRT created during life is that it provides an immediate income tax charitable deduction even though it may be years before the charity receives a distribution.  A second advantage is that it allows assets gifted to the trust to be sold without any income tax consequences. A CRT created at death produces a charitable deduction which may reduce estate and inheritance taxes.

 

CRAT Examples

 

Consider the following example.  John, age 65, owns substantial stock in ABC Company valued at $1 million.  John purchased the stock 20 years ago at a cost of $20 per share.  The stock is now worth $100 per share.  The company pays dividends of approximately 2% or $20,000 per year.  John would like to have more income.

 

John would also like to sell the stock and diversify his investments.  However, a sale of the stock will produce capital gain tax to John of approximately $120,000, leaving John net proceeds of $880,000 after the sale.  John hates paying tax.

 

John has one or two favorite charities, but he is unwilling to make any substantial gifts to charity during life as he may need the funds to provide for himself.  He would like to leave assets to his favorite charities at death.

 

The CRT works as follows:  John creates a CRT with the ABC stock which will provide for a distribution to John of $70,000 per year for life.  This is a fixed sum.  The trust is referred to as a Charitable Remainder Annuity Trust or CRAT.  John transfers his ABC Company stock into the trust.  The stock is sold.  Because the trust is a charitable trust, there are no income tax consequences of the sale.  This leaves 100% of the proceeds, or $1 million, in the trust.  John will receive payments of $70,000 per year from the trust for life.

 

At John’s death, the assets that remain in the trust, if any, will be payable to his favorite charities.  John may change the charitable recipients during lifetime.

  

Advantages

 

The advantages of the CRAT are as follows:

 

1.      The ABC Company stock can be sold without capital gains and the assets can be invested in a more diversified portfolio.

 

2.      John receives a fixed payment from the trust of $70,000 per year for life.

 

3.      John receives an immediate charitable deduction of approximately $300,000 even though the charity is not scheduled to receive the trust assets until John’s death which may be 20 years away.  The charitable deduction available to John can be used in the year of the gift or it can be carried over for up to five years for use in future years.

 

4.      The assets, once placed in the trust, will not be subject to estate or inheritance tax at his death.

 

5.      John’s income has gone from $20,000 to $70,000.  Depending on how the trust assets are invested, the payments to John will be partially taxed to him as ordinary income and partially taxed as capital gains.  Some portion may possibly be tax free. 

 

CRUT

 

Another form a CRT can take is a Charitable Remainder Unitrust or CRUT.  With a CRUT, the payment to the beneficiary is a fixed percentage based on the fair market value of the trust assets as valued on the first day of each year rather than the fixed amount as provided in the CRAT.  With a CRUT, the payments to John go up or down in future years based on the performance of the assets in the trust.  If the trust pays out 7% to John but it earns 8%, then the principal of the trust will increase and future payments will be greater.  On the other hand, if the trust investments earn 5% and the trust pays out 7%, then the trust principal will fall and the payments the following years will likewise fall.

 

CRUTs are more appealing where the beneficiaries are younger and where the Grantor is more optimistic about investment returns.

 

CRTs for a Term of Years

 

In the example above, the CRT was structured to run for the lifetime of John.  It may be appropriate in some cases to run the trust for a specific number of years.  CRTs such as this are often used to provide a stream of income for the Grantor or another family member for a given number of years and then leave the balance to charity.

 

Charitable Lead Trusts

 

A Charitable Lead Trust (CLT) is the exact opposite of a CRT.  The trust provides for distributions to charity either for the lifetime of an individual or for a fixed number of years.  The trust makes payments each year to a charity during the term of the trust and at the end of the term the balance remaining in the trust, if any, is then distributed to designated beneficiaries.

 

CLT Examples

 

John desires to distribute $50,000 per year to his favorite charity.  He would like to make this distribution for the next 15 years.  John transfers assets having a value of $1 million into trust.  The trust provides that 5% or $50,000 will be payable to charity each year for the next 15 years.  At the end of the term, the assets pass to John’s son, Jack. 

 

From an estate planning standpoint, this trust is beneficial because the present fair market value of the gift to Jack, which he will not receive for 15 years, is valued at only $500,000.  If, over the term of the trust, the trust earns 8% per year, then at the end of the 15 years Jack actually receives $1.8 million.  The gift to Jack has been deeply discounted.

 

The Charitable Deduction

 

Unlike the CRT, a CLT is not necessarily a tax exempt entity.  Normally the CLT is taxed under the usual rules for taxation of income to trusts.  The CLT receives an income tax deduction for the amounts of gross income that are paid to charity.  Thus, in most cases there is no charitable deduction immediately available when the trust is created.

 

An alternative is to structure the trust in a way that secures an immediate charitable deduction.  While this may be a good thing for John, the trust provides that the future income of the trust is taxed to John as earned.  John will pay tax on future income that will go to charity.  This technique accelerates the charitable deduction available to John for his future gifts to charity and may be appropriate in limited cases. 

 

CLUTs and CLATs

 

CLTs come in two forms.  The first is a CLAT which is a Charitable Lead Annuity Trust where a fixed dollar amount is payable to charity each year during the term of the trust.  The second type is a Charitable Lead Unitrust (CLUT) where a fixed percentage based on the fair market value of the trust assets on the first day of each year is payable to charity each year.  The CLAT is often more appealing because it produces a fixed payment rather than payments which fluctuate based on future investment results.

 

Conclusion

 

The examples above are based on IRS interest rates in effect for January 2007.  The rates change monthly.  The calculations are also based on life expectancies.  The actual results of any proposed CRT or CLT must be calculated on an individuale basis.

 

CRT and CLT trusts are not for everyone.  However, for the client with charitable goals, the techniques produce amazing results which benefit not only the charity but the family as well.

A. Stephen McDaniel

Williams, McDaniel, Wolfe & Womack, P.C.

5521 Murray Avenue

Memphis, Tennessee 38119

901-767-8200

smcdaniel@wmww.com