Charitable Trusts Leave a Legacy and Save Taxes

Charitable Remainder Trusts - Overview

• A charitable remainder trust allows one or more noncharitable beneficiaries to receive designated annual payments during their lifetime or during a fixed term of years (up to 20 years). The annual payments to the noncharitable beneficiaries must be at least 5% of the value of the trust's assets, they cannot exceed 50%, and the present value of the amount going to one or more qualified charities must be at least 10% of the amount contributed. Upon the death of the life beneficiary or beneficiaries, the remainder of the trust passes to one or more charitable organizations.

• Grantors of charitable trusts can be the life or term beneficiaries. If 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.

• 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 regardless of asset valuation fluctuations, and CRUT's allow for payments that can increase with inflation and provide flexibility for the timing of income payments.

• 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.

• 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. This can be an "income maximizer trust". For example, rental properties having a current fair market value of $1,000,000 and a cost basis of $50,000 are contributed to a charitable trust. When the properties are subsequently sold, the capital gain tax of some $266,000 has been avoided inside the charitable trust, leaving more proceeds available to generate the income necessary to pay the life or term beneficiary.

• 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. Under the 1997 Taxpayer Relief Act, the present value of the charitable remainder must have a present value (determined under IRC Section 7520) equal to ten percent of the amount contributed. Because of this, middle-age and younger beneficiaries qualify only for a 20-year term rather than a lifetime term, making this technique less attractive.

"Income Maximizer Trust" and the "Wealth Replacement Trust":

• A charitable 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 "lost" wealth can be replaced by purchasing life insurance 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 (or "ILIT"), the insurance proceeds are not taxable for estate tax purposes. The insurance trust becomes a "wealth replacement trust", allowing the children or other beneficiaries to receive benefits after all.

• The combination of a charitable remainder trust (CRT) with an irrevocable life insurance trust (ILIT) is one of the most popular planning techniques, particularly for those who have highly appreciated assets that would otherwise generate significant capital gain taxes.

Multi-Generational ("Near Zero") CRUTs

Charitable Lead Trusts

• In very large estates, the 55% estate tax can result in the liquidation of hard-to-sell assets (such as family businesses), often resulting in "fire-sale" prices which reduce even further the net distribution to the family or other beneficiaries. Estate liquidation can result in losses that make the estate tax seem like 65% to 80% or more (instead of the actual rate of 55%).

• A charitable lead trust is a trust for a term of years, and during the trust term a specified annual payment (based on a percentage of the trust assets) is paid to one or more designated charitable organizations. Children or other beneficiaries are designated as the remainder beneficiaries who will receive the trust assets at the end of the trust's term.

• The creation of a charitable lead trust results in a gift to the noncharitable remainder beneficiaries based on the present value of the remainder interest. That value -- which is determined from the IRS tables -- depends on the term of the trust and the rate or amount of the specified payment going to the charitable organization(s). It is possible to design a charitable lead trust that provides a small value or even a zero value for the remainder interest.

• Although the specified payments are made to one or more charities during the trust's term, the asset itself is preserved for the children. While the children may have to wait 5, 10, 15, or even 20 years in order to benefit from the trust's assets, it is often the best way to pass some assets to the children without the combined effects of estate taxes and asset liquidation costs. The longer they wait, the lower the value of the remainder interest is for gift tax purposes.

Life insurance is an important estate-planning tool, and it is discussed in the article entitled "Uses of Insurance in Estate Planning".

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