Charitable Remainder Trusts

  1. Overview.  A charitable remainder trust allows one or more individuals ("noncharitable beneficiaries") to receive designated annual payments during their lifetime or during a set term of years (up to 20 years).

    1. The annual payments are usually stated in terms of a percentage (e.g., 8%) of the value of the trust's assets, but they can be stated in terms of a specific dollar amount if the amount is at least 5% of the value of the trust's assets. Upon the death of the noncharitable beneficiary or beneficiaries or upon the expiration of the specified term, the remainder of the trust passes to one or more charitable organizations.

    2. Charitable trusts require charitable intent. Even if that is not the primary motivation for establishing the trust, one or more charitable organizations must be the intended recipients of some benefit from the trust. If the trust is structured so that no benefit will pass to charity, the charitable deduction will be denied, and it is possible that the trust can be disqualified as a tax-exempt entity.

    3. Grantors of charitable trusts can be the noncharitable beneficiaries. If the trust is established during the grantors' lifetime, the grantors are entitled to a charitable deduction for the present value of the remainder interest, which is calculated according to the IRS tables based on the grantors' life expectancies or the term of the trust, current interest rates, and the rate used to calculate annual payments for the life or term beneficiaries.

    4. There are two types of charitable remainder trusts: charitable remainder annuity trusts (CRAT's) and charitable remainder unitrusts (CRUT's). CRAT's provide for fixed payments despite asset valuation fluctuations, and CRUT's allow for payments that can increase with inflation and provide flexibility for the timing of trust payments.

      1. A CRAT essentially provides a fixed annuity payment to the noncharitable beneficiary(ies) based on the value of the trust's property at the time of the contribution of the property. Additions to a CRAT are not permitted.

      2. A CRUT provides for a calculated payment of a "unitrust amount" that is a percentage of the value of the assets, which is determined each year. A CRUT requires annual appraisals.

    5. Charitable remainder trusts are tax exempt, so the trust itself does not pay any income taxes, even as to retained income. The life or term beneficiary is taxed on income distributed to the beneficiary. The income paid to the noncharitable beneficiary(ies) is taxed to them on a "worst-first" basis, which means that if the trust has had ordinary income and capital gain, distributions will be considered ordinary income until all of the ordinary income has been distributed, and then distributions will be considered capital gain.

  2. Variations of the Charitable Remainder Trust.  A charitable remainder trust ("CRT") can be structured in several ways, providing planning opportunities to meet different needs and objectives.

    1. Mandatory Payments.  Sometimes we refer to the annuity or unitrust distributions as "income" distributions, but sometimes those distributions actually include trust principal. If a CRAT or CRUT provides for mandatory annuity or "unitrust" payments and trust income is insufficient, the principal must be used. This mandatory for a charitable remainder annuity trust ("CRAT"), but it is only one option for a charitable remainder unitrust ("CRUT").

    2. NIMCRUT.  Because many CRTs are given illiquid and even hard-to-sell assets, it is often not practical to make distributions of trust principal. For example, trust funded with stock in a closely-held corporation would quickly be dissipated if distributions of stock had to be made, particularly when valuation discounts are applied to the distributions. The law permits a CRUT to provide for the payment of the annual unitrust amount or net income, whichever is less. Any portion of the unitrust amount is a deficiency that accumulates. In any year in which the net income exceeds the unitrust amount, the trustee can pay out the income to the extent of the cumulative deficiency. This type of CRUT is called a "NIMCRUT", which is a CRUT with a "net income" limitation with a "makeup" provision.

    3. Income "Spigot". The income payable from a NIMCRUT can be manipulated to some degree by the investments that are made.

      1. If the grantor or other income beneficiary does not require distributions for a period of time, investments can focus on capital growth. When income distributions are desired, the investments can shift to assets that produce higher income.

      2. To control the income flow even further, the CRUT can put its investments in a limited-liability company ("LLC") or a limited partnership ("LP"). If the trust provides that "distributable income" or "accounting income" does not include any income not actually distributed to the trustee, the income reported by the LLC or LP does not trigger a distribution to the income beneficiary from the CRUT. This allows investments to accumulate until such time as distributions are desired. If the trust's definition of distributable income includes capital gain, capital growth can be included in distributions when distributions from the LLC or LP are actually made to the CRUT.

    4. Reasons to Create a Charitable Remainder Trust.  There are as many reasons to created a charitable remainder trust ("CRT") as there are people who create them. Some of the most common reasons include the following:

      1. Charitable Intent.  The grantor of the trust wants to benefit charity (i.e., one or more charitable organizations). If the grantor does not feel that the amount contributed to the trust needs to pass to his children or other beneficiaries, no further planning is necessary. If the grantor wants to replace the gifted assets, a life insurance trust is appropriate.

      2. Reduction of Capital Gain. Highly appreciated assets are often contributed to charitable trusts in order to eliminate potential capital gains tax that will become due when the asset it sold. For example, rental properties having a current fair market value of $1,000,000 and a cost basis of $0 are contributed to a charitable trust. When the properties are subsequently sold, the capital gain tax of some $150,000 has been avoided inside the charitable trust, leaving more proceeds available to generate the income necessary to pay the life or term beneficiary. Because there is no immediate lump-sum payment of the capital gain tax, the available income for the noncharitable beneficiary(ies) is maximized.

      3. Diversification. Some people have significant investments in a single company. This is particularly true for one of the original founders of a company that has gone public. By contributing undiversified assets into a charitable remainder trust, the portfolio can be partially liquidated and reinvested in a more diverse portfolio. Because a CRT is a tax-exempt entity, the sale of the appreciated property does not trigger capital gain.

      4. Retirement Planning.  Charitable remainder unitrusts can serve as a quasi retirement plan. A trustee can defer some of the annual payments in the early years of the trust by investing in high-growth, low-income assets. When the life beneficiary has a greater need for income, the trustee can invest in assets producing a higher income yield. The combination of a NIMCRUT with an LLC or LP is even better at deferring income, allowing a working grantor to accumulate "retirement" funds. Once the grantor retires, the LLC or LP can distribute assets (or be dissolved), allowing the CRUT to have distributable income. To protect against a premature death, this plan is combined with a life insurance held in an irrevocable life insurance, as discussed in subsection 3.4 of this memo.

    5. CRT and ILIT.  A charitable remainder trust can be an "income maximizer trust", but the trust's assets eventually pass to one or more charities, and there is nothing that passes to children or other noncharitable beneficiaries. For many people, the wealth that passes to one or more charities can be replaced with life insurance, which can be purchased with the savings that result from the income tax deduction and from the additional income that results from a tax-free sale of appreciated assets inside the trust. If the insurance is purchased by the trustee of an irrevocable life insurance trust ("ILIT"), the insurance proceeds are not taxable for estate tax purposes. The ILIT acts as a "wealth replacement trust", allowing the children or other beneficiaries to receive benefits after all.

Contact Us.  For more information or to meet with an affiliated member of our planned giving team, please contact:

J. Russell, Raker, III, PhD, ACFRE
Associate Vice President
Office of Institutional Advancement
Nevada State College and Foundation
1125 Nevada State Drive, Henderson, NV 89002
Office: (702) 992-2356
Fax: (702) 992-2351