Copyright, J. Michael Pusey, CPA

First, a note about what CRTs can't do for you. They can't give you your money (or property) back because they are irrevocable. So don't fund a charitable remainder trust with assets that you may need in an emergency.

Our title poses a fair question because CRTs benefit the donor or others designated by the donor. The trusts also benefit charity. They are not purely personal or charitable but hybrid in nature. You should have some charitable motive and place some value on the ability to make a nice gift to charity if you are to consider a CRT.

As the name implies, charitable remainder trusts are trusts under local law. The decisions vest in the trustee who is subject to the directions of the trust agreement, which is drafted with an eye to the tax rules. There are at least two beneficiaries, one noncharitable and one charitable. The trust pays an annuity or percentage of annual value to you or family or others you designate. When the trust winds down, the assets go to the charitable beneficiary. The charity is at the end of the line but eventually gets whatever is left in the trust after paying the noncharitable beneficiaries. It is possible to reserve the right to change your mind about which charities ultimately benefit from the trust but you cannot change your mind about the assets ultimately going to charity.

Since it involves drafting a trust and making a number of decisions, and administering the trust after it is set up, the CRT isn't appropriate for small gifts.

Can CRTs avoid capital gains tax? Yes. Usually, only operating charities are tax-exempt. But CRTs are also exempt if they're up to Code (the Internal Revenue Code) and they don't have certain types of income that can cause them to lose their exempt status.

So the basic plan is typically as follows. You make decisions about the trust, the lawyer drafts it, then you contribute appreciated property to it. The transfer is not a sale so there is no tax to you as a result of giving assets to the trust. The trustee then usually decides to sell the property. The gain is realized within the trust, but the trust is exempt, so there is no capital gains tax.

What kind of income does the trust give back to the donor or donor's family? Usually ordinary income, but it depends on the type of income within the trust. The tax rules state that first the trust drains all of its ordinary income, then capital gains, then muni-bond income, then it returns capital. So if the trust doesn't have enough ordinary income to account for the payments to the beneficiary, it is possible that it pay you capital gains income. So this mitigates our statement that a CRT avoids capital gains tax. Sometimes, the trust will distribute capital gains income back to the beneficiary.

How much income does the trust give back? It depends on the terms of the trust. There is much flexibility in designing a CRT. And technically, the trust doesn't pay "income" but rather an annuity or percentage of value (unitrust amount) which may be more or less than the trust's income. The payout rate can't exceed 50% or be less than 5%. An annuity pays a percentage of initial value. A unitrust pays a percentage of the value of the trust's net assets as revalued each year.

Unitrusts, but not annuity trusts, are permitted to receive additional contributions. So the same unitrust may be used as an on-going charitable planning vehicle if its terms continue to satisfy the donor as he or she contemplates deferred gifts to charity in future years. On the other hand, there is no limit on the number of CRTs a donor can set up and fund.

What type of assets should go into a CRT? Usually appreciated capital gain property held more than one year, typically listed securities or real estate. It is less common for a CRT to be funded mainly with cash because the basic idea is usually to avoid capital gains tax inherent in appreciated property. IRA or pension benefits sometimes fund testamentary CRTs - trusts funded after your death that benefit heirs then charity.

How long will I get paid? A CRT can last for a term of years (twenty years maximum) or life or lives of the beneficiaries. The actuarial value of the charity's interest must be at least 10% which can limit the ability to provide lifetime interests to younger beneficiaries or multiple beneficiaries. A husband and wife can use the same trust and frequently name themselves as beneficiaries with undiminished payments going to the surviving spouse after the death of one spouse.

Can a CRT help me diversify? Yes, typically a CRT is funded with "winners" that are sold by the trust, then the trustee invests in a balanced portfolio. State laws governing trust investments apply, and the trustee has to consider both the donor or family and the charity. Also, the tax rules prohibit the donor and family and certain others from "self-dealing" with assets in the trust. If your daughter is an aspiring playwright and you want to be an "angel" for her play, don't put those assets into a CRT.

Can CRTs give me a tax deduction? Yes. Even though the charity doesn't get paid until the end, the one who funds the trust gets a tax deduction in the year of transfer. The benefit to the charity is projected up front assuming certain earnings and life expectancies. The deduction is not re-adjusted as the trust's actual operations unfold. The starting point for measuring the deduction is usually fair market value, even though taxes haven't been paid on the appreciation. The deduction is only a portion of the value because the charity doesn't get paid until the trust winds down.

How do I calculate the tax deduction? Usually, you give your information to your advisor or a friendly charity that has the right software.

Can the benefits of CRTs be combined with goals I have for other members of the family? Yes. CRTs can be smart ways to help fund a college education or take care of an elderly parent who needs some financial help. Also, consider testamentary transfers to CRTs. There is no income tax deduction unless there is a lifetime transfer, but CRTs can work nicely as estate-tax-saving and administrative vehicles to take care of immediate family or relatives after your death. Large charities will often do the work of administration and investment.

CRTs can involve gift and estate tax issues, but generally they can save on these transfer taxes. If a husband and wife set up a CRT for themselves and then it all goes to charity, the combination of marital and charitable deductions in the gift/estate tax rules eliminate any transfer tax on assets that go into the trust. Note that we didn't say that the CRT solved all estate tax problems just because some of the couple's assets went into a CRT.

Don't the heirs get "disinherited"? If the CRT doesn't benefit them directly, they are in a sense "disinherited." But the children may eventually benefit from the income and tax savings accruing to the parents as beneficiaries. Also, with CRTs and other charitable gifts, Mom and Dad sometimes consider wealth replacement life insurance. Wealth replacement planning also involves some tax planning.

How does the math work? The advisor usually compares:

Keep,

Sell, and

Value of CRT.

Estate/gift taxes can enter into all of the alternatives. If grandchildren are involved, even generation-skipping tax can be a factor.

Keep in mind "actual versus actuarial." The tax deduction flows from certain IRS assumptions - that is an actuarial world. But in deciding what the value is to you, the planner usually shifts to "actual" - projected actual results or range of values.

Under the "Keep" option, the basis of property steps up to fair market value at death, so your heirs may not have the same capital gains problem you have with appreciated property. The step-up (or step-down) rule that says the heir's basis is usually fair market value at your death doesn't apply to IRA or pension benefits and certain other types of income.

So while we keep the "Keep" option in mind, the main focus in the math is usually comparing the Sell and CRT alternatives.

Under "Sell," we consider capital gains tax, disposition costs, and any extraordinary factors. For example, a large gain can have adverse side effects in your tax return by phasing out certain benefits.

The value of the CRT is usually the tax savings from the charitable deduction and projected present value of future payments. The projected value or range of values for the income stream is enhanced by the fact that the asset base is not depleted by the capital gains tax. The value of the CRT compared to what is left under the Sell alternative can be surprising even if there are no estate taxes to consider.

It may be possible to enhance the value of the income stream by means of income deferral (deferring tax increases the earnings base) or by deflecting income to a low-bracket family member. Deferral may be possible depending on investments and how the trust is structured, but it is only possible with the unitrust type of CRT, and then only if it has an income limitation with "make-up." The income limitation may limit payments initially while the make-up feature lets the trust pay more than normal later when income is high. This can result in deferral of income to the noncharitable beneficiary.

The income limitation and make-up features are options only available with the unitrust type of CRT. It is possible to structure the trust so that the income limitation is dropped when it is no longer needed. This is known as a "Flip unitrust," which typically is considered when the trust is funded with land or other property that can't be sold soon enough to meet the annual payout requirements. The income limitation feature can override the annual payout requirement.

Quantifying the value of the annuity or unitrust amounts requires some up-front judgments as to discount rates and how much and how long the trust will pay you or the family. Discount rates are needed to convert future income into today's value since income down the road isn't as valuable as an asset in hand.

Highlights of our introduction to the math of CRTs: Typically, you compare the sales proceeds net of capital gains tax with the value of the CRT. The CRT's value flows from the tax deduction times your tax rate plus the discounted, present value of the future annuity or unitrust payments.

If you're inclined to keep the math as simple as possible, as a first step, get someone to calculate the charitable deduction. Then think of it as a pie. The tax deduction is the value to the charity. The value to you or your family is the rest of the pie - total value less the charitable deduction. Add the family's share of the pie to the tax savings on the tax deduction, and you have one approach to estimating the value of the CRT to you. This is staying in the IRS "actuarial world." It doesn't reflect the "actual" value or range of values when you make projections that consider your particulars. Nevertheless, it can be a useful approach to estimating the value of the CRT alternative which can then be compared to the after-tax proceeds from selling the asset.

The family's share of the pie can't be more than 90%, because the charity's actuarial interest must be at least 10%. If the CRT is a "long-distance runner" - pays the noncharitable beneficiary over a long period, you can readily see how the CRT can compare favorably to an after-tax sales alternative. The Sell alternative will not be as high as 90% unless appreciation is fairly small so capital gains tax is small. On the other hand, rarely will the value of the income stream from the CRT be as high as 90% - that's just the maximum it can be under the actuarial calculations.

And it is the combination of the value of the tax deduction and value of the income stream that determines what the CRT can do for you - and every situation is unique.

It is more common for the projected value of the CRT alternative to be less than Sell alternative, as one would expect when making a significant charitable gift.

Annuity payments are stable, fixed amounts that are easy to predict. The annuity is paid regardless of the success of trust's investments, so you can count on being paid a steady stream (unless the trust exhausts all of its assets with losses and expenses). With an annuity arrangement, there is still the matter of predicting the years or range of years that an annuity will be paid since it is typically paid over someone's lifetime.

For a unitrust, annual payments will vary. There is the matter of projecting future values since the unitrust type of CRT pays a percentage of annual value. There is the matter of projecting how long payments will be made or projecting values for a range of years.

With an annuity or unitrust, the trust pays you annually, or monthly or quarterly as the trust provides, but the initial year's payment is prorated. You get a tax deduction for funding the CRT even though it is late in the year, but of course you don't get a full year's income payment.

If you prefer lifetime payments rather than the term-of-years approach, keep in mind that premature death of the beneficiary may unexpectedly cut off projected value to the family unit. This can require some planning, if the goal is to retain value in the family unit rather than just meet the needs of the named beneficiary.

So what can a CRT do for you? It can save taxes and pay you an annuity or percentage of annual value over an extended period.

The present value of what a CRT can do for you may even exceed sales proceeds after taxes, although typically that's not the case. And the CRT can be a wise way to eventually make a nice gift to charity.

The rules and the math can be a bit complicated but a CRT can be a highly effective, unique tool for meeting both charitable and family goals.

CRTs are fairly flexible in the planning stage but rather inflexible once in place, so plan carefully.