The charitable remainder trust (CRT) is a multipurpose tool

by Christopher L. Kelly, Esq.

A charitable remainder trust (CRT) takes a bit more complex planning than other trusts, but for the right donor, it can be greatly beneficial. It has the unique ability to support a charity (like a Baptist cause), guarantee income for him/herself or family for a season, and earn a tax deduction all at once. 

A CRT is an irrevocable trust created by a donor whereby the donor or other individuals (usually a spouse or other family members) receive income for a certain period of time from the trust, and when that time has passed, the trust terminates and the remaining funds in the trust are paid to a charity. 

In addition to having a desire to help a charitable cause, donors more ideally suited to implementing this strategy usually have an appreciated asset or retirement assets that could be used to make the gift to the charity. With both of these types of assets, if the donor were to sell them or access the assets themselves, he/she could incur substantial tax obligations. 

A CRT helps address these taxation issues. First, by using the types of assets listed above, the donor can shift the taxable consequences for selling the appreciated asset or accessing retirement funds to the CRT (which itself pays no taxes). For example, if a donor owns an asset with a low-cost basis (such as stocks, bonds, mutual funds, real estate, etc.), if he or she sold it outright, he or she would realize a capital gain in the year of the sale. However, the same low-basis asset can be gifted to a CRT. Even if the CRT sells the asset as soon as it is received, no capital gains are realized by the trust immediately, but are instead spread among a number of years to those persons receiving income from the CRT. Thus, when the donor begins receiving income from the trust after the gift, he or she has effectively converted a taxable asset to an income stream for him/herself without having to pay the full capital gains tax bill in one year. 

Additionally, using retirement accounts (such as IRAs, 401(k)s, 403(b)s, etc.) to fund a CRT after a donor’s death can be a tax-efficient way of making the initial gift into the CRT. While an individual who receives money directly from a retirement account has to include the retirement distribution in his or her ordinary income in the year, a CRT does not realize the same tax obligation. Thus, a retirement account can be fully paid out to a CRT in a lump sum without recognizing this usually large income tax bill. The beneficiaries then begin receiving income from the trust, only paying income tax on the distributions they receive in a particular tax year (see the paragraph below about how the income tax obligation is calculated). This strategy can be particularly effective when a donor wishes to provide income to family members after his or her death while still ensuring that the charity receives a benefit in the future from his or her retirement assets. 

Secondly, while it is true that the income paid from a CRT to a recipient is taxable, the exact taxation is calculated based on a tiered system. Without going into full detail on the system, the bottom line is that using the calculation usually softens the income tax impact on the individual receiving income because each dollar received is taxed according to the type of income to which it is attributed (i.e. capital gains, ordinary income, tax-free income, etc.)  Some income tax classes are taxed more favorably than others. The full impact of taxation on the beneficiary will depend on the assets used to fund the CRT, how assets within the trust are sold, and the type of income the CRT earns each year. For most, however, the tiered system gives a more favorable result when it comes to individual taxation. 

Finally, in the year of the gift, the donor gets the added benefit of a possible tax deduction. This can be especially useful if the donor has been blessed with higher income in a particular year. 

As to the structure of a CRT, there are two main types of CRTs: the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT). The primary difference between these two CRTs is how the income distributed to the persons is calculated. In a CRAT, the beneficiaries receive a fixed amount each year, while with a CRUT, the beneficiaries receive a fixed percentage of the assets held in the trust. The best method for payout depends on the unique situation that the donor is trying to address. 

A CRT is a sophisticated strategy, and as you might imagine, there are particular rules that must be closely followed from beginning to end. However, for the right donor, the CRT may be a perfect solution, accomplishing many long-term benefits at the same time.

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Please note that the advice offered in this article is not intended to be construed as tax, legal or accounting advice. This material has been prepared for general informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice for the reader. You should consult your own tax, legal and accounting advisors before engaging in any transaction.