As promised during his campaign, on April 26, 2017, President Trump unveiled a new broad tax-cut plan. Besides slashing business and individual tax rates and eliminating the net investment income tax and the alternative minimum tax, the proposal also includes eliminating certain itemized deductions such as the state and local income tax deductions. However, deductions for mortgage interest and charitable giving are expected to stick around.
One vehicle for charitable giving is “Charitable Remainder Trusts” or CRTs. In this article we will review what a CRT is, the tax advantages of setting one up, and how it works.
What is a CRT?
A charitable remainder trust is a tax-exempt irrevocable trust created under the authority of the Internal Revenue Code. The trust provides an upfront income tax deduction and an annual stream of payments to one or more non-charitable beneficiaries (e.g. the donor (grantor) or any individual the donor names) for a defined term or for life. At the termination of the trust, any remaining assets pass to a charity specified by the donor.
What are the tax advantages of CRTs?
A CRT can provide a means of diversifying an investment in highly appreciated assets without incurring capital gains tax, while generating an income tax deduction upon initial funding. For example, when assets with a low basis are transferred to a CRT and the CRT sells those assets, no income tax is due on the realized gain since the trust is exempt from income tax. At the same time, the grantor of the CRT receives an income tax charitable deduction equal to the present value of the remainder interest that will ultimately pass to charity.
How does it work?
A CRT is set up by creating a trust and gifting property (like stocks or cash) to it. The trust agreement will specify the term of the CRT, the trustee, and the charitable and non-charitable beneficiaries. The charitable beneficiary of the trust specified in the agreement must qualify as a public charity under general IRS tax deduction rules. The agreement will also specify how much the non-charitable beneficiary will receive every year – either a fixed amount or a percentage of the trust property. A portion of the trust earnings and/or initial principal is then paid every year to the donor or other non-charitable beneficiary, and is potentially reportable by the beneficiary as taxable income. When the trust terminates, the remaining assets in the trust pass to charity.
For estates large enough to trigger an estate tax at death, CRTs can also be set up to generate an estate tax deduction, potentially eliminating estate tax by transferring estate assets to charity instead of to the IRS. For more information related to planning for or setting up CRTs, or any other estate and trust matters, please feel free to contact us anytime.