Thought Leaders: Understanding the importance of Charitable Remainder Trusts

Are you interested in retaining a lifetime of income, saving on taxes, and benefitting a charitable organization beyond your lifetime? A Charitable Remainder Trust may be right for your estate planning needs.

What is a Charitable Remainder Trust?

A Charitable Remainder Trust (CRT) is a tax-exempt irrevocable trust designed to reduce the taxable income of individuals by first dispersing income to the beneficiaries of the trust for a specified period of time. Generally, this is for the life or lives of the individuals named in the trust or for a set term of no more than 20 years. After the expiration of the term, the remainder of the trust is donated to the designated charity. CRTs are formed under Internal Revenue Code 26 §664(a). A CRT is considered a “split-interest” trust because the assets contained in the trust are split between charitable and non-charitable beneficiaries. The Trust can be funded with money, securities or other property. The initial funding is valued at fair market value. Therefore, any real property contributions to the trust will require an appraisal to determine the fair market value prior to conveying the asset to the CRT.

A CRT must be set up properly and the trust must receive ownership of the property intended to be donated prior to any sale of the property. If the sale occurs prior to being contributed to the CRT, the owner may realize income for tax purposes. It is also important to note that a CRT is irrevocable and can be very difficult, if not impossible, to unwind once it has been established. Individuals interested in creating such a trust must be certain about their charitable donations prior to the establishment of the trust.

Additionally, the provisions contained in a CRT as well as IRS tax rules must be strictly followed. In Atkinson v. Commissioner, 309 F. 3d 1290 (11^th Cir., 2002), the Court held that because the CRT trustee failed to make the required annuity payments to the donor during her lifetime, the donor's estate bore the full tax liability of the income and principal of the trust. The Court noted that, it is not enough to merely create a CRT and then ignore the provisions of the CRT which thereby defeats “the policy interest advanced by Congress in enacting the rules.”

There are two types of CRTs: 1) A Charitable Remainder Annuity Trust (CRAT) which distributes a fixed annuity each year and 2) Charitable Remainder Unitrust (CRUT) that distributes a fixed annual percentage based on the balance of the trust assets. A trustor will need to keep in mind that a CRAT does not provide for additional contributions to the trust; however, a CRUT does permit additional contributions to the trust. The annuities distributed out of a CRAT or CRUT must between 5 percent and 50 percent of the value of the trust assets.

The benefit of setting up a CRAT is that the settlor's annuity will never decrease regardless of the value of the assets in the trust. Some pitfalls to setting up a CRAT is that no further assets can go into the trust. The benefit to a CRUT is that as the property in the trust appreciates, the settlor will receive the set percentage of that appreciation which could be more depending on the assets contained in the trust.

Who Can Be the Trustee of a Charitable Remainder Trust?

In general, proper administration of a CRT requires experience and expertise with regard to investments, accounting, and reporting and therefore, a corporate trustee is likely the best entity to act as trustee. It is permissible for the settlor of the trust to be the trustee; however, the trust must be administered properly. The consequences of an improper trust administration range from the loss of tax advantage to criminal charges by the IRS. In general, those that name themselves as trustees, have the trust administered through a third-party servicer. A selected charity can also act as trustee of the trust.

What Does the Trustee Do?

The trustee is required to follow the instructions contained in the trust. The trustee will take possession of the assets and will sell them at full market value and re-invest the proceeds from the sale into other income-producing assets. The trustee manages and invests the assets contained in the trust so that it will continue to produce income for the beneficiary. For the remainder of the settlor's lifetime or the set number of years, the trustee controls the assets.

Using Life Insurance to Provide for Your Heirs

If you are interested in creating a CRT but want your heirs to realize the benefit of some of the wealth that will ultimately go to a charity, you can retain the annuity payments provided by the CRT and use them to fund a life insurance policy that has your heirs listed as beneficiaries of the life insurance policy. By proceeding in this manner, the charity receives the benefit of the trust assets and your heirs also receive the benefit of the insurance payout. The combination of a CRT with life insurance allows you to receive tax benefits within your lifetime without impacting the inheritance rights of your heirs.

Charitable Remainder Trusts and Estate Planning in general are complex and some choices can be permanent. It is important to discuss all of your options with a qualified attorney before committing to a specific plan to ensure your specific needs are met.

This article was written by Jennifer McMenomy, an attorney with Allison MacKenzie in Carson City, which sponsors this content.