Most of us have our favorite charities that we contribute to each year and for these gifts, we take an income tax deduction. Upon death, many of us also leave gifts to charities in our Wills or Trusts. This article outlines a strategy that will accomplish your charitable objectives at death and give you a current income tax deduction and a stream of income. This strategy involves the creation of a Charitable Remainder Trust (a "CRT").
A CRT is an irrevocable trust. You act as the Trustee and you (and or other beneficiaries) receive an income stream from the CRT. Because your charities ultimately receive the CRT assets, you receive a current income tax deduction.
There are two types of CRT: the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT). The difference between the CRAT and the CRUT is how the income stream is calculated. With the CRAT, you contribute assets with a certain value to the CRAT and choose an interest rate. Every year thereafter, the income you receive is set and never changes. For example, if you put $100,000 into a CRAT and selected an 8% interest rate, then every year you would receive $8,000 ($100,000 x 8%). Because you receive this set amount every year (regardless of the value of the CRAT assets), the named charities bear the risk of depreciation in value.
In a CRUT, the interest rate chosen is applied to the fair market value of the assets in the CRUT at the beginning of each year. As a result, the income that you receive changes every year. For example, if you put $100,000 into a CRUT and selected an 8% interest rate, then in year one you would receive $8,000. At the beginning of the next year, the assets are re-valued. Assuming no change in value, you would apply the 8% interest rate to the CRUT value of $92,000, and would receive $7,360 ($92,000 x 8%). Because the CRUT distributes a changing amount every year to the non-charitable beneficiary (you and/or your beneficiaries), it is the non-charitable beneficiary who benefits from any appreciation in value of the CRUT assets and who suffers from any depreciation in value.
Because a CRT is considered a charitable entity, there is no income tax payable by the Trustee. Thus, if you own appreciated assets that you wish to sell, the CRT is a great vehicle to accomplish the sale, tax free. You contribute those appreciated assets to the CRT and then the Trustee sells those assets. The Trustee will pay no capital gain tax and all of the proceeds from the sale is available to pay the income stream.
The steps for creating a CRT are as follows:
- Determine the type of income stream desired - a set amount or variable amount. (Must be at least 5%.)
- Name the charities, execute the trust and contribute the assets to the CRT.
- Calculate the income tax deduction.
- Although a CRT is irrevocable, the Donor may change the designated charities at any time.
- Calculate the first year's income amount if a CRUT, or the income for the entire lifetime of the CRAT. Make payments to the Donor as scheduled.
Benefits of the CRT:
- Your charitable bequests are settled, but you retain the right to change the charitable beneficiaries.
- You receive an income tax deduction today that you would otherwise never receive.
- You have the full value of appreciated assets working to provide you with an income stream (no capital gain tax reduction).
- You receive the income stream!
