By Amanda White, CPA, Manager, Tax & Advisory
ASL High Net Worth Group
The idiom “Have Your Cake and Eat It Too” is defined by the Cambridge dictionary as “to have or do two good things at the same time that are impossible to have or do at the same time”. In this article, we will go over why we believe that Charitable Remainder Trusts (CRTs) are similar to this idiom.
So What Exactly Is a Charitable Remainder Trust?
A charitable remainder trust is a split interest trust. What this means is that there is one charitable beneficiary and at least one non-charitable beneficiary. This trust is an irrevocable trust, meaning once assets have been contributed to the trust, they cannot be taken back. The trust generates a potential income stream for the named beneficiaries for a specified term and upon expiration of that term, the remaining assets go to the donor taxpayer’s favorite charity or charities. The specified term can be set up to 20 years or for the life of the non-charitable beneficiary, whichever is longer.
The CRT is a tax-exempt entity and pays no income tax on any of its income, and it recognizes no gains on sales of appreciated properties.
What Are the Benefits of Setting One Up?
In addition to providing a predictable stream of income for the beneficiary and ability to provide for donations to qualified charities at the end of the term of the trust, there are other benefits to setting up a CRT. The donor taxpayer receives an immediate income tax deduction for a future transfer to a charity. A CRT facilitates the postponement or avoidance of capital gains taxes; highly appreciated assets can be transferred into the CRT without triggering recognition of capital gain.
There are two different types of charitable remainder trusts: charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs). The difference between the two is based on how the distributions to the non-charitable beneficiary are calculated. CRATs distribute to the recipients based on a fixed income amount, whereas CRUTs distribute based on a fixed percentage of the fair market value of the fixed assets, which allows the non-charitable beneficiary to benefit from investment growth. Each Charitable Remainder Trust is created individually based on the plans and preferences of the donor. The distribution amount or percentage is specified in the trust document.
How Does It Work?
Once the taxpayer identifies the asset to be contributed to the trust, it should be appraised by a qualified appraiser, unless value can be readily determined (i.e. marketable securities). The qualified appraisal is a key piece and can cause issues long term if not done properly. Then the trust instrument should be created, which is typically done by an attorney. The trust is funded by transferring the identified asset or cash to the entity. There is no need to do anything else for the entity to qualify as tax exempt, as this status is met by the use of required language provided by the IRS.
Depending on the terms of the agreement, distributions to the non-charitable beneficiary will be calculated annually at minimum, but can be as frequent as monthly. The distribution amounts will either be a set amount if you have a CRAT or a set percentage of the fair market value of the assets if you have a CRUT. The distribution percentages can vary from 5% up to 50%, which is set in the trust agreement.
At the end of the life of the trust, which is either when the non-charitable beneficiary passes away or when the specified term has been met, the remaining assets are transferred to the charitable beneficiary, which needs to be a minimum 10% of the initial value of the property contributed.
What Filings Are Required?
All Charitable Remainder Trusts are required to file Form 5227, Split-Interest Trust Information Return, annually. Depending on the state of residency, state tax filings will also be needed. These forms are due by April 15th each year and are eligible for a 6 month extension until October 15th. In the initial year of the contribution or upon any future funding to the CRT, donor taxpayer will need to file Form 709, Gift Tax Return. If assets valued over $500 are contributed to the trust and are sold within 3 years of the receipt date, this will also trigger a filing requirement of Form 8282, Donee Information Return With Sale of Certain Assets. The donor taxpayer is also required to file Form 8283, Noncash Charitable Contributions, with their individual income tax return to report the asset contributed to the CRT, in years for property contributions, and for any carryover years.
Conclusion
It is possible to “have your cake and eat it too” when it comes to CRTs. A taxpayer can give property and get both income and a deduction, and yet also save money on taxes. It seems impossible to have all of these things, but in the tax world, there are many things that can be made into a possibility with knowledge of the tax code and a great CPA!
We, at Abbott, Stringham & Lynch, are here to help you navigate the complexities and help you with planning opportunities and implementation related to CRTs. Please contact us for more information and assistance.