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CHARITABLE REMAINDER TRUSTS

• PRESENTED TO DISTRICT OF COLUMBIA BAR ESTATES, TRUSTS AND
  PROBATE LAW SECTION
  MAY 18, 2004 

CHARITABLE REMAINDER TRUSTS

Tax Legislative History

The Tax Reform Act of 1969 (the "1969 Act"), Public Law 91-172, completely re-wrote the rules limiting the availability of charitable income, estate and gift tax deductions for lifetime and testamentary gifts of remainder interests in so-called "split-interest" trusts (i.e., trusts which provide for the payment of income to an individual for a certain period followed by the distribution of the remainder to charity). The 1969 Act allowed income tax deductions for gifts to split-interest trusts and where the trusts qualify as charitable remainder trusts as defined in Section 664 of the Internal Revenue Code of 1986 ( the "Code"), and provided coordinated rules in Code Sections 170, 2522, 2055 and 2106. Code Section 4947 was adapted to prevent taxpayers from using non-exempt charitable remainder trusts to avoid the strict rules applicable to private foundations.
In the 1988 Miscellaneous Revenue Act (Public Law 100-647) Congress added Code Section 7520. This provision requires that the value of any annuity, as interest for one or more lives or term of years, and any remainder or reversionary interest be determined using tables or formulae prescribed by the Secretary of the Treasury. Any charitable valuation under the new tables is to be based upon an interest rate under Code Section 1274(d)(1) in effect for the month in which the valuation date falls (or either of the two preceding months, as the taxpayer selects).
In the 1997 Taxpayer Relief Act (Public Law 105-34) Congress responded to perceived abuses of charitable remainder trusts by imposing two additional rules on all charitable remainder trusts: (1) the charitable interest must have a minimum value; and (2) a maximum was imposed on the non-charitable payout rate.

General Definition of Charitable Remainder Trust ("CRT")

As defined in Code Section 664, a CRT must provide for the distribution of a specified payout, at least annually, to one or more persons (at least one of which is a non-charitable beneficiary). The payout period must be either --
for the life or lives of the individual beneficiaries (all of whom must be living at the time the trust is created); or
for a term of years, not in excess of 20 years.
Upon the termination of the non-charitable interest or interests, the remainder interest (i.e., the amount of the tax deduction) must have a present value of at least 10% of the total amount transferred to the trust and must either be held in continuing trust for charitable purposes or be paid to or for the use of one or more charitable organizations described in Code Section 170(c). In practice, in a climate of low interest rates like we have today, the 10% rule makes it difficult to use multiple measuring lives as successive CRAT beneficiaries unless all are senior citizens, or to create a CRAT for the lifetime of a relatively young person. A CRUT, on the other hand, will often work in such circumstances.

A qualified CRT is exempt from income tax, and the grantor is entitled to a charitable income, gift and/or estate tax deduction based on the present value of the remainder interest ultimately passing to charity.

Two Types of CRTs: Charitable Remainder Annuity Trust and Charitable Remainder Unitrust

There are two types of CRTs.
A charitable remainder annuity trust ("CRAT") is required to pay and distribute a sum certain at least annually to one or more beneficiaries, at least one of which is not a charity, for life or for a term of years, with an irrevocable remainder interest to be held for the benefit of, or paid over to, charity. The sum paid out annually must be equal to at least 5% but not more than 50% of the fair market value ("FMV") of the trust assets valued as of the date such assets are transferred to the trust.
A charitable remainder unitrust ("CRUT") is required to pay a fixed percentage of its net fair market value at least annually to one or more beneficiaries, at least one of which is not a charity. The fixed percentage must be equal to at least 5% but no more than 50% of the net fair market value of the trust assets as valued annually. Thus the amount paid by the CRUT fluctuates with the FMV of the trust assets, whereas the annual payout from a CRAT remains constant. In addition, a CRUT may provide for the payout of the lesser of the fixed percentage or the trust accounting income (i.e., a "net income only" unitrust). In the case of a net income only unitrust, the unitrust may, but need not, provide that any amount by which the trust account income falls short of the fixed percentage is to be paid out in subsequent years to the extent the trust's accounting income exceeds the fixed percentage in such later years (i.e., a "make-up" provision). Also permitted are "flip" unitrusts, which start out with a "net income only" requirement, and then "flip" into a regular unitrust payout. (See Regs §1.664-3(a)(1)(i)(c)).

Other Mandatory Rules for CRTs

In order to qualify as a CRT, a trust must meet all of the requirements of Code Section 664 and the Regulations thereunder, as explained and illustrated in --
Rev. Rul. 72-395, as modified by
Rev. Rul. 80-123,
Rev. Rul. 82-128,
Rev. Rul. 82-165, and
Rev. Rul. 88-81.
These rulings contain certain mandatory provisions for the governing instrument of a qualifying CRT and illustrate certain optional provisions. As a result of the 1997 Taxpayer Relief Act these mandatory provisions include a limitation on new charitable distributions (Code Section 664(d)(1)(A) and (2)(A)) and a minimum charitable benefit. The failure to incorporate one of these mandatory provisions will cause disqualification of the trust.

Types of CRATs For Which Sample Forms Have Been Provided by Revenue Procedures

The IRS very recently provided updated and new sample forms for lifetime and testamentary CRATs:
Rev. Proc 2003-53 (2003-31 I.R.B. 230) inter vivos CRAT: one life
Rev. Proc 2003-54 (2003-31 I.R.B. 236) inter vivos CRAT: term of years
Rev. Proc 2003-55 (2003-31 I.R.B. 242) inter vivos CRAT: two lives, consecutive interests
Rev. Proc 2003-56 (2003-31 I.R.B. 249) inter vivos CRAT: two lives, concurrent and consecutive interests
Rev. Proc 2003-57 (2003-31 I.R.B. 257) testamentary CRAT: one life
Rev. Proc 2003-58 (2003-31 I.R.B. 262) testamentary CRAT: term of years
Rev. Proc 2003-59 (2003-31 I.R.B. 268) testamentary CRAT: two lives, consecutive interests
Rev. Proc 2003-60 (2003-31 I.R.B. 274) testamentary CRAT: two lives, concurrent and consecutive interests
The Revenue Procedures provide that a trust will satisfy the requirements of Code Section 664(d)(1) or (2) if the trust document: (1) creates a valid trust under local law (and for income tax purposes, see PLR 200203034); (2) makes reference to the applicable revenue procedure; and (3) is substantially similar to the sample instruments.
Unfortunately, the sample instruments do not include a number of common alternative provisions. For example, the sample instruments provide for the non-charitable beneficiary to receive only the specified unitrust or annuity trust amount on a guaranty basis for life; they do not include a provision by which the donor retains the right to revoke the interest of the non-charitable beneficiary; and they note all of the private foundation rules applicable to the trust, even though two of such rules are not generally applicable to CRTs.
The annotations to these forms in the Revenue Procedures should be reviewed carefully, as they are quite helpful.
"Practitioners should base all of their charitable remainder annuity trusts on these sample forms." (Howard Zaritsky)

Tax Consequences

The creation of a qualified CRT has significant tax consequences. The grantor of a lifetime CRT is entitled to an immediate income and gift tax charitable deduction for the present value of the remainder interest ultimately passing to charity. The creation of the income interest may, however, have gift tax consequences if the recipient is an individual other than the grantor. The creation of a testamentary CRT entitles the transferor's estate to an estate tax charitable deduction for the present value of the remainder interest.
A CRT is exempt from income so long as it has no unrelated business taxable income. It is not taxable on any capital gain in selling appreciated property transferred to it by the grantor. Neither the grantor trust rules of Code Sections 671-678 nor the throwback rules of Code Sections 665-668 are ever applicable to CRTs.
Pursuant to Code Section (664(a), the tax treatment of distributions for a CRT is determined pursuant to Section 664(b) and the regulations thereunder, which supercede all other provisions of Subchapter J.
If a taxpayer creates a trust that is not a qualified trust, not only will the taxpayer not get the benefit of the current income tax deduction, the trust will also not be tax exempt.

CRATs - Definition and Qualification

To qualify as CRAT a trust must meet the following requirements:
• The trust must pay a sum certain to at least one noncharitable beneficiary; in the case of an individual beneficiary, the individual must be living at the time the trust is created.
• The sum certain that is paid cannot be less than 5% nor more than 50% of the initial net fair market value of the property placed in the trust.
• The sum certain must be payable, at least annually, either for a term of years (but not more than 20 years) or for the life or lives of the noncharitable beneficiary or beneficiaries.
• The trust may pay no other amounts to or for the use of any person other than a qualified charitable organization.
• When payment of the sum certain terminates, the remainder interest either must be transferred to or for the use of a qualified charitable organization or must be retained by the trust for such use.
• The value of the charitable remainder interest at inception must be at least 10%.
• The annuity may not be so great that there is a more than 5% chance that the corpus will be exhausted before the charity receives its interest (Rev. Rul. 77-374, based on Treas. Reg. §20.2055-2(b), Code §§2037 and 2042).
While the requirements may seem simple, substantial problems are often encountered in meeting them. In most cases the problems are attributable to the failure of the trust's governing instrument to comply with the strict requirements of the law and regulations. The IRS' insistence on strict compliance with these requirements indicates that a taxpayer's good faith intention to comply with the rules cannot overcome technical deficiencies in the structure of a transaction.

Mandatory Provisions of CRATs (Rev. Ruling 72-395)

• Creation of annuity amount for a period of years or life.
• Creation of remainder interest in charity.
• Selection of alternate charitable beneficiary if remaindermen do not qualify under Section 170(c) at time of distribution.
• Computation of annuity amount in short and final tax years.
• Prohibition of additional contributions. (Note: CRUTs may receive additional contributions.)
• Prohibitions governing private foundations.
• Deferral of annuity amount during a period of administration or settlement (originally optional but subsequently made mandatory by Revenue Ruling 80-123).

Optional Provisions of CRATs

• Dollar amount annuity may be stated as a fraction or a percentage.
• Annuity amount may be allocated to class of noncharitable beneficiaries in discretion of trustee.
• Reduction of annuity amount if part of corpus is paid to charity on death of first recipient.
• Distributions to charity in kind.
• Termination of annuity amount on payment date next preceding death of recipient.
• Retention of testamentary power to revoke noncharitable interest.
• Investment restrictions on trustee prohibited.
• Distribution from trust used to administer an estate may be made to a CRT.

CRUTs -- Definition and Qualification

To qualify as a CRUT, a trust must meet the following requirements:
• The unitrust must pay a fixed percentage, not less than 5% nor more than 50%, of the net fair market value of its assets, valued annually, to one or more beneficiaries, at least one of which is not a charitable organization; in the case of an individual beneficiary, the individual must be living at the time the unitrust is created.
• The payment of the fixed percentage amount must be made at least annually; to determine the amount of such payment, the unitrust assets must be valued annually.
• The payment of the fixed percentage amount must be made either for a term of years (but not more than 20 years) or, in the case of individual beneficiaries, for the life or lives of those individuals.
• The unitrust may pay no other amount to or for the use of any person other than a qualified charitable organization.
• When payments of the fixed percentage amounts terminate, the remainder of the unitrust either must be transferred to or for the use of a qualified charitable organization or must be retained by the unitrust for such use.
• The charitable remainder calculated at the trust's inception cannot be less than 10% of the contributed asset's value. If additional contributions are transferred to a CRUT, the 10% -remainder rule must be followed. If the additional contributions fail under this requirement, then two trusts are created; the existing CRUT and a trust that fails to qualify as a CRUT.

Mandatory Provisions of CRUTs (Rev. Rul. 72-395)

• Creation of unitrust amount for a period of years or life.
• Creation of remainder interest in charity.
• Selection of alternate charitable beneficiary if remaindermen do not qualify under Section 170(c) at time of distribution.
• Adjustment for incorrect valuations.
• Computation of unitrust amount in short and final tax years.
• Additional contributions.
• Prohibitions governing private foundations.
• Deferral of unitrust amount during a period of administration or settlement (originally optional but subsequently made mandatory by Revenue Ruling 80-123.

Optional Provisions of CRUTs

• Unitrust amount expressed as the lesser of income or a fixed percentage.
• Unitrust amount may be allocated to class of noncharitable beneficiaries in discretion of trustee.
• Reduction of unitrust amount if part of corpus is paid to charity on death of first recipient.
• Distributions to charity in kind.
• Termination of unitrust amount on payment date next preceding death of recipient.
• Retention of testamentary power to revoke noncharitable interest.
• Investment restrictions on trustee prohibited.
• Distribution from trust used to administer an estate to a CRT.

Types of CRUTs For Which Sample Forms Have Been Provided by Revenue Procedures

Rev. Proc. 89-20
• Inter vivos CRUT: one life.
Rev. Proc. 90-30
• Inter vivos CRUT: two lives, consecutive interests.
• Inter vivos CRUT: two lives, concurrent and consecutive interests.
• Testamentary CRUT: one life.
• Testamentary CRUT: two lives, consecutive interests.
• Testamentary CRUT: two lives, concurrent and consecutive interests.
Rev. Proc. 90-31
• Provides sample forms for declarations of trust for the six types of CRUTs listed above with specific application solely to net-income-with-makeup unitrusts (NIMCRUTs); see below.
New forms for CRUTs are expected to be published shortly.
Sample CRAT Calculations at Various Ages, Various Interest Rates
A. Assume 5% CRAT for life of donor at various ages, various interests rates, gift of $1 million:

  Scenario #1 Scenario #2
Age Interest Rate
May 2004
Quarterly
Payout
Charitable
Deduction
Interest Rate
2% Higher
Quarterly
Payout
Charitable
Deduction
45 3.8% $12,500 None* 5.8% $12,500 $293,056  
55 3.8% $12,500 None* 5.8% $12,500 $382,856  
65 3.8% $12,500 $405,727 5.8% $12,500 $495,747  
75 3.8% $12,500 $577,906 5.8% $12,500 $625,947  

* Because probability of survival to exhaustion of trust principal exceeds 5%, and value of
charitable remainder is less than 10% of the initial contribution.

** Because probability of survival to exhaustion of trust principal exceeds 5%.

B. Assume 5% CRAT for joint lives of donor and spouse at various ages, various interest rates, gift of $1 million:

Scenario #1 - May 2004 Rates (3.8%)

Husband's
Age
Wife's Age Charitable
Deduction
75 75 $453,258
45 45 None*
75 45 None*
65 55 $169,026

* Because probability of survival to exhaustion of trust principal exceeds 5%,
and value of charitable remainder is less than 10% of the initial contribution.

Scenario #2 - Interest Rates 2% Higher (5.8%)

Husband's
Age
Wife's Age Charitable
Deduction
75 75 $523,807
45 45 $223,328
75 45 $282,023
65 55 $329,830

Sample CRUT Calculations, At Varying Ages, At Varius Interest Rates

A. Assume 5% CRUT for life of donor at various ages, various interest rates, gift of $1 million:

  Scenario #1 Scenario #2
Age Interest Rate
May 2004
Income Tax
Deduction
Interest Rate
2% Higher
Income Tax
Deduction
45 3.8% $227,420 5.8% $229,520
55 3.8% $332,920 5.8% $335,220
65 3.8% $461,460 5.8% $463,730
75 3.8% $605,450 5.8% $607,430

B. Assume 5% CRUT for joint lives of donor and spouse at various ages, various
interest rates, gift of $1 million:

Scenario #1 - May 2004 Rates (3.8%)

Husband's
Age
Wife's Age Charitable
Deduction
75 75

$495,130

45 45 $

145,150

75 45 $

215,410

65 55 $

273,880

Scenario #2 - Interest Rates 2% Higher (5.8%)

Husband's
Age
Wife's Age Charitable
Deduction
75 75

$497,510

45 45 $

147,080

75 45 $

217,540

65 55 $

276,270

Examples of Uses of CRATs/Why Donors Choose CRATs Over CRUTs

A. CRATs, as opposed to CRUTs, favor the charitable remainderman over
the income beneficiary, because the benefit of appreciation of the principal goes to the remainderman, because the value of the fixed and unchanging lifetime annuity, fixed as a percentage of the value of the initial gift at the time of gift, erodes over time due to inflation.
B. On the other hand, the risk of investment performance falls on the
charitable remainderman, because the income stream of the income beneficiary is fixed, guaranteed if you will, whereas the trust principal will erode or even exhaust to provide the required income distributions to the income beneficiary.
C. The higher the percentage payout, the more benefit there is to the
income beneficiary, the more risk to the charitable remainderman.
D. The lower the AFR interest rate on the date of creation, the lower the
remainder interest passing to charity. If interest rates are extremely low, as they are today, it may be impossible to create a CRAT for a relatively young noncharitable beneficiary without violating the 5% exhaustion test and the requirement that the value of the remainder interest be at least 10% of the value of the initial contribution.
E. The higher the AFR interest rate on the date of creation, the higher the
value of the remainder interest passing to charity.
F. The greater the inflation or economic growth (expected) over the term of
the CRAT the greater (expected) return to the remainderman.
G. The greater the macroeconomic shrinkage/recession (expected) over the
term of the CRAT, the greater (expected) security of the income beneficiary, whose income stream is fixed and protected.
H. A testamentary CRAT might be used to guarantee a larger charitable
estate tax deduction while assuring the annuitant a fixed income stream for life.
I. A CRAT with a higher percentage interest (above market rate of return)
payout, e.g., 6%-7%, will favor the annuitant, because the initial principal is likely to erode over time, and possibly even disappear.

Examples of Uses of CRUTs/Why Donors Choose CRUTs Over CRATs

CRUTs are much more common than CRATs because --
A. Donors who are lifetime annuitants want to protect themselves
from the effects of inflation, so they arrange for the management of the CRUT to produce appreciating principal and hope for increasing payouts each passing year.
B. Donors creating testamentary CRTs normally want to protect their
family members who are lifetime annuitants from the effects of inflation, so they arrange for the management of the CRUT to produce appreciating principal and hope for increasing payments to their loved ones who are annuitants each passing year.
C. A CRUT may also be seen to more effectively protect the
charitable remainderman, in that the risk of depreciation in the principal is shared with the annuitant, and the benefit of appreciation in the principal is shared with the annuitant. All things being equal, the remainderman would like to see the principal grow over the term of the annuitant's interest.
D. The lower the AFR interest rate at the date of creation, the lower
the value of the remainder interest passing to charity, but the effect is quite small.
E. The higher the AFR interest rate at the date of creation, the higher
the value of the remainder interest passing to charity, but the effect is quite small.
F. The greater the inflation or economic growth (expected) over the
term of the CRUT, the greater the return to the income beneficiary.
G. The greater the macroeconomic shrinkage/recession (expected)
over the term of the CRUT, the greater the threat of shrinkage to the income stream of the income beneficiary.
H. A testamentary CRUT might be used if the income beneficiary is
expected to be relatively young (middle-aged or younger) to protect the income beneficiary from the effects of inflation over what may be a lengthy lifetime annuity period.
Of course, a CRUT with a higher percentage interest (above market rate
of return) payout, e.g., 6%-7%, will favor the annuitant, because the initial principal is likely to erode over time, and possibly even disappear.

Net Income CRUTs

• In years when the net income of the unitrust is less than the fixed percentage of the net fair market value of the unitrust's assets, the unitrust may pay the lesser amount, without recovery and distribution of the shortfall in subsequent years. This is sometimes referred to as a net-income unitrust. Care must be taken when utilizing such trusts and investing in stocks. The dividend payout may be very low relative to the unitrust percentage. It is important to consider the definition "of income" as trust accounting income for this purpose. See below.

NIMCRUTs

• In years when the net income of the unitrust is less than the fixed percentage of the net fair market value of the unitrust's assets, the unitrust may pay the lesser amount, but recover and distribute the shortfall if, in subsequent years, the net income of the unitrust exceeds the fixed percentage of the net fair market value of the unitrust's assets. This is sometimes referred to as a net income with makeup charitable remainder unitrust (NIMCRUT).
Even if the "makeup" difference is not paid to the noncharitable beneficiary, no further charitable deduction is available. Thus, it would appear logical for the makeup feature to be used, and if the recipient does not desire to retain the funds, the recipient can contribute them directly and obtain a deduction. This feature has special appeal when the net income exceeds taxable income because of definitional differences, or when the taxable income has significant elements of capital-gain or tax-free income that is deemed distributed.

What Is Income?

If the unitrust has an income limitation feature or is a NIMCRUT, the definition of trust accounting income (principal and income) becomes critical because it affects the payout from the trust. Trust accounting income is determined by reference to the trust document, but if the document is silent, income is determined according to state trust law. Finally, if no other guidance is given, income is computed according to the trustee's discretion. Generally, trust accounting income includes the following: interest, dividends, rents and royalties, less all expenses related to the production of such income. Note that trust accounting income does not include capital gains and losses. Gains and losses, stock dividends and related expenses are usually allocated to principal.
In regulations issued in December 1998, IRS adopted a rule that prohibits pre-contribution appreciation from being allocated to trust accounting income. Thus, while post-contribution appreciation on contributed assets may be allocated to trust accounting income if the trust instrument and state law permit, IRS will not allow appreciation that arose while the grantor held the asset to be included in the trust accounting income of the trust.

EXAMPLE:
A NIMCRUT is funded with $1,000,000 in value of listed stock whose basis is $200,000. In determining trust accounting income, the $800,000 "built-in" gain at the date of contribution must be allocated to principal and cannot be distributed as part of the net-income-makeup feature.

Income Deferral

NIMCRUTs have been used effectively to defer income into future years, so the annuity serves, in effect, as a retirement plan. The basic concept is that by controlling the definition of trust accounting income, the trust may have little or no trust accounting income in early years and thus make little or no payments to the noncharitable beneficiary due to the income limitation. Then in later years, the investment strategy is altered, producing significant trust accounting income, so that the percentage amounts relating to early years and the current year are distributed to the noncharitable beneficiary under the makeup feature. This defers the payment of income tax and is particularly advantageous if the noncharitable beneficiary will be in a lower tax bracket in future years (such as retirement years).
The IRS has had reservations about the use of NIMCRUTs to achieve deferral of income to the noncharitable beneficiary. Among the issues that have been raised in this regard are qualification of the trust, indirect self-dealing and whether the trust "constructively receives" fiduciary income before it is actually received by the trustee. Currently, IRS is studying the question of whether an income-limitation CRUT is a qualified CRT "when a grantor, a trustee, a beneficiary, or a person related or subordinate to a grantor, a trustee, or a beneficiary can control the timing of the trust's receipt of trust income from a partnership or a deferred annuity contract to take advantage of the difference between trust income under Sec. 643(b) and income for federal income tax purposes for the benefit of the unitrust recipient." While it studies the question, IRS will not issue rulings on the matter. One important point to keep in mind is that if the donor dies unexpectedly before the CRUT investments produce trust accounting income, the strategy is thwarted and the charitable remainderman benefits.

The Flip Alternative

Three forms of CRUTs are discussed above: (a) a standard form (straight CRUT) that provides the beneficiary with a payout equal to the stated percentage applied to the net fair market value determined annually; (b) a trust that provides payout equal to the stated percentage so multiplied, or the annual income whichever is less; and (c) a NIMCRUT that currently pays out income if that is less than the established pay-out, but the deficiency is made up in subsequent years.
The IRS issued final regulations in 1998 sanctioning the "flip unitrust" which begins as an income limitation CRUT or NIMCRUT but then drops the income limitation feature upon the occurrence of a qualifying "triggering event." The regulations apply to unitrusts created on or after December 10, 1998.
When "flipping" to a straight unitrust, the fixed percentage cannot change. The income limitation disappears on the first day of the following year, that is, January 1st of the year after the triggering event. This avoids cut-off accounting within the year of the triggering event. The makeup feature also disappears upon the conversion of the trust to one without an income limitation, so that if fiduciary income is not sufficient during the period of the income limitation (the period before the "flip" to a straight unitrust), the noncharitable beneficiary suffers permanent economic loss. While the charitable beneficiary thereby benefits, note that no income tax deduction is available for this forfeited makeup amount.
The triggering event is a "specific date or single event whose occurrence is not discretionary with, or within the control of, the trustees or any other persons." Permissible triggering events are marriage, divorce, birth or death, and the sale of "unmarketable assets," defined as assets other than cash, cash equivalents or assets that can be readily sold.
Thus, the "flip unitrust" is commonly used when a trust has unmarketable assets that produce little or no income. The CRUT cannot satisfy the annual distribution requirement until it converts the unmarketable assets into liquid assets that can be used to pay the fixed percentage amount.

Advantages

Flip unitrusts are designed primarily for a taxpayer who wants to create a straight percentage CRUT, but is funding it with an appreciated asset. A straight CRUT requires an annual payment, which would have to be paid "in kind" and would result in income to the beneficiary (with no cash to pay the tax). A flip CRUT starts out as a NIMCRUT and avoids having to make a distribution while there is no income. When the property is sold, it converts to a straight CRUT.

Permissible Uses

• Unitrust is funded with donor's former personal residence. The trust could provide that the income limitation be dropped as of the first day of the year following the sale of such former residence.
• Unitrust is funded with cash and an unregistered security for which there is no available exemption permitting public sale under SEC rules. The trust could define the triggering event as the earlier of the date when the stock is sold or at the time the restrictions on its public sale lapse or are otherwise lifted.
• Unitrust drops the income limitation as of the first day of the year after the income beneficiary attains the age of 18. This is permissible and might contemplate the beneficiary's need for income during college years.
• Unitrust drops the income limitation as of the first day of the year after either the donor marries, is divorced, has a child, or after the beneficiary's father dies.

Impermissable Uses

• Unitrust is funded with cash and publicly traded securities that are not subject to SEC restrictions. The unitrust may not define the sale of the publicly traded securities as a triggering event because the sale of such securities is in the discretion of the trustee.
• Unitrust drops the income limitation as of the first day of the year after the beneficiary's financial advisor determines that he or she should receive income from the trust without regard to an income limitation or in the year following the beneficiary's request to the trustee that payments be made without regard to the income limitation. These are not permissible because the decisions are within the trustee's or another person's control.

Examples: How the Use of CRTs May Facilitate Tax and Financial Planning and Estate Planning

• On the sale of business
to avoid immediate capital gains tax on a portion of the stock to be sold, so that the pre-tax sales price may be invested to produce an annuity
• On the sale of appreciated publicly traded securities
• On the sale of appreciated real estate
• To diversify a highly concentrated appreciated position in stock or real estate
• To generate greater retirement income
• To avoid estate tax at death and to obtain an income tax deduction and remove assets from the taxable estate during life, replacing the otherwise taxable assets given away with non-income and non-estate taxable life insurance held in an irrevocable life insurance trust

Tax Compliance/Reporting for CRTs

• Tax I.D. numbers must be obtained for CRTs
• All CRTs must be maintained on a calendar year basis
• Tax returns are filed on Form 5227, Split-Interest Trust Information Return
• This return is due on the 15th day of the 4th month following the close of the trust's year, i.e., by April 15.
• CRTs must also file Form 1041-A each year unless all net income is distributed currently to the beneficiaries.
• CRTs must provide Form 1041-k-1 to the recipients of CRT income reporting the income and deductions reflected on Form 5227

Taxation of the Recipient of the Annuity or Unitrust Amount

The tax character of distributions in the hands of the recipient are set forth in Code Section 664(b) and the regulations thereunder under complex so-called "tier" rules.
These intricate rules determine what respective portions of distributions are ordinary income, capital gain, tax-free income and corpus.
The instructions for current Form 5227 explain how to deal with the complex new (2003) income tax rules for dividends and capital gains.

Miscellaneous Rules

• Transfer of S Stock to CRT terminates S Election (Rev. Rul 92-48, PLR 8922014).
• Inexact drafting and planning have resulted in numerous requests for IRS approval of trust reformation to attain qualification. Sometimes this is possible.
• It is possible for the donor to retain, or give another, the power to add or substitute charitable remaindermen without jeopardizing the qualification of a trust as a CRT.
• While generally mandatory CRAT distributions for a year must be made by December 31, under some circumstances mandatory CRUT distributions for a year may be made by the filing deadline (as extended) for the CRT's tax return.
• CRTs must file annual tax returns on Form 5227.
• Record keeping duties are less onerous on CRATs than CRUTs.
• CRUTs may receive additional future contributions; CRATs may not.
• Because of NIMCRUTs and FLIPs, CRUTs have much more flexibility in payout options for non-charitable beneficiaries.
• With the 2003 reduction in individual income tax rates in general and capital gains rate specifically, the advantages of gifts to CRTs was reduced. If and when income tax and capital gains rates rise, gifts to CRTs will become more advantageous.
• Is the donation so close in time to the sale (of stock or real estate) that the doctrines of assignment of income and step-transaction apply to cause income on donated stock to be taxable to the donor?
The test, which is very favorable to taxpayers making last minute gifts, is found in Palmer v. C.I.R., 62 T.C. 684, (1974), acq. Rev. Rul. 78-197. But see, as a caution, Rauenhorst v. C.I.R., 119 T.C. 157 (2002).
• Many large charities have very capable inside and outside counsel and will draft CRTs for donors for their lawyer's "review" at no charge, and they may well send the computer disk so you can customize the document. Or they will review your draft for your peace of mind.
• Many large charities will serve as Trustee of a CRT and they may have, such as Harvard does, uniquely attractive investment vehicles available where the charity serves as Trustee, and they will not charge to serve as Trustee.
• There are corporations, such as Renaissance Inc. (www.reninc.com) and Crown Financial Group (www.crownfinancialgroup.com) whose business is to handle tax compliance and administration for CRTs. They support lawyers, financial planners, accountants, clients and trustees working with CRTs. They will normally provide CRTs or review your drafts free of charge. Some of these entities may serve as Trustee and/or manage the funds.
• Banks and nonbank trust companies will serve as Trustee of CRTs and manage their funds and handle the tax compliance and administration.
• According to the IRS, at the end of 2000 there were some 100,000 CRTs holding more than $75 billion.

Bibliography

Tax Economics of Charitable Giving 2003/2004, Toce, Jr., Adbin, Pace and Vorsatz, of Wealth and Tax Advisory Services, Inc. [a successor to Arthur Andersen's Tax Practice, or part of Hong Kong Shanghai Bank], published by Warren, Gorham & Lamont of RIA.
Charitable Remainder Trusts and Pocket Income Funds, Rosepink, Brier and Krauer, Tax Management Portfolio #865, published by the Bureau of National Affairs, Inc. (updated through January 2004).
Intuitive Estate Planner, (Software for Charitable Remainder Calculations), produced by West Group.

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