Charitable Remainder Trusts: Everyone (But the IRS) Benefits

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Although most potential donors are not motivated to make charitable gifts solely because of the tax benefits they can receive, it is important for your 501(c)(3) tax-exempt organization to have a basic understanding of the means available under the current tax laws to enhance the value of these gifts to both a potential donor and to the charity you serve.

The opportunities for such gifts are certainly more available than ever, as over the past decade the market and our economy have enjoyed unprecedented growth. This, in turn, has yielded significant appreciation for the individual investor. As these individuals grow older, it is likely that large amounts of money will change hands between generations. A recent study by researchers from Boston College estimated that, over the next 50 years, $41 trillion to $135 trillion could pass from the baby boomers and older generations to their younger heirs.

If the current estate tax laws and capital gains regulations remain in effect, planned charitable giving is an opportunity for a 501(c)(3) organization to maximize the contributions it receives from these potential donors through the proper use of the donor’s appreciated assets. One vehicle to effectively transfer such assets to your organization is through a charitable remainder trust (CRT). In fact, in the July 15, 1999 issue of the Chronicle of Philanthropy, it was noted that “CRTs have more than doubled between 1994 and 1997, when there were 82,000 trusts with a value of $60.5 billion”.

A trust is created when one holds property for the benefit of another. The “grantor” creates the trust. The one for whose benefit the property is held is the “beneficiary” and holds “equitable” or “beneficial” title to the property. The trustee, usually a party independent of the grantor and beneficiary, is the fiduciary who manages and administers the trust and holds legal title to the property.

A charitable remainder trust (CRT) is a tax-exempt trust that provides benefits to multiple parties: the donor, the individuals receiving income from the trust during their lifetimes or a specified number of years (20 or less) and the chosen charity or charities receiving the remaining principal at the end of the trust term.

CRTs are not a new tax planning strategy but certainly they are an effective and efficient one. The CRT can provide a proven way to reduce your donor’s tax burden while making the most of their appreciated assets.

CRTs can take on two forms: the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT). The main difference between the two is that the CRAT pays a fixed distribution every year based on the value of the trust at the time of funding, while a CRUT pays a variable distribution that will increase or decrease based on the annual valuation of the trust.

Additionally, there are two forms of CRUTs: the Standard Charitable Remainder Unitrust (SCRUT) and a Net Income with Make-Up Charitable Remainder Unitrust (NIMCRUT). (The details of these variations along with more specifics related to the tax advantages of this type of giving are available in the complete copy of this article entitled “Planned Giving” at the web address: www.raffa.com/interior/ ArtPlangiv.html.)

Income Tax Charitable Deduction—The donor receives an income tax deduction at the time the trust is funded.

No Capital Gains Tax Paid on Asset Conversion/Sale of Assets—The full value of the donated assets will keep working for the donor and their beneficiaries.

Tax-Free Growth of Assets in the Trust—The value of the assets placed in the Trust will increase faster through tax-free growth.

Possible Gift/Estate Tax Charitable Deduction—The donor’s heirs and the charity should benefit rather than the Internal Revenue Service.

Typically, a donor will donate a highly appreciated asset(s) to a trust with an understanding that at the end of the trust term, the proceeds from the remaining assets will go to the donor’s chosen charity. The donor will receive a charitable deduction in the year the asset is donated into the trust. If necessary, this deduction may be used annually for five additional years. The trust would then typically sell the asset to replace it with a more diversified investment portfolio. There is no capital gains tax assessment on the sale. The trust assets grow tax-free and income beneficiaries who are specified by the donor within the trust documents receive income from the trust for the rest of their lives or for a period not to exceed twenty years. When the trust terminates, the assets remaining in the trust go to the selected charity or charities.

The Jones are about to retire. Their home is paid for and the remainder of their assets are in stocks bringing their total estate value to a level at which it would be accessed at a 50 percent estate tax rate. The Jones want to maintain their current lifestyle for as long as they both live. They also would like to make a significant donation to a local charity. Their stock portfolio does not produce enough after-tax income to allow them to do both.

The Jones can consider a CRAT. They donate stock with a cost basis of $20,000 and a fair market value of $500,000. The new trust sells the stock and invests the proceeds in a more diversified portfolio. This allocation of investment assets should produce a less volatile earnings stream. As the trust pays no capital gains, the Jones have already saved $96,000 in capital gains tax on the sale of the gifted assets, (that is, $480,000 capital gain taxed at 20 percent). They also receive more than $184,000 in income tax charitable deductions, which saves them approximately $66,000 in income tax (assuming a federal income tax bracket of 36 percent).

Assuming a life expectancy of 14 years and a gross income of $40,000 (or 8 percent annually), their trust will provide them (or named beneficiaries) with about $418,000 in total lifetime after-tax income. This is an increase in their gross annual income from the gifted asset of $7,500 outside the trust to $40,000 inside the trust. And, they can take pride in knowing that their local charity will benefit from their gift of approximately $500,000.

Although the trust vehicle may seem complicated or even elaborate, most reputable financial service firms should be able to make this process simple. Many have presentations and publications that can be modeled to your specific donor(s) and to your Board or management. Such information can assist in conveying and selling the concept. Then, once the proper trust vehicle is selected, a good firm should be able to provide you with the trust documents, trust accounting and tax filings and management of the trust investments.

With all the benefits of a CRT to the donor, their heirs and the charitable organization, it should be a part of your organizations know-how in fundraising.

Thomas Raffa is the managing partner of Raffa and Associates, P.C., a certified public accounting and consulting firm based in Washington D.C. with a financial services subsidiary in Maryland. The firm currently employs 100 professionals who serve the nonprofit sector by providing a wide variety of services to over 300 international, national, and community-based nonprofit organizations. Tom has 24 years experience and currently serves on the board of directors of two national nonprofit organizations.