Why CRTs Remain a Preferred Tax Planning Toolby
CRTs come in two basic molds: the charitable remainder unitrust(CRUT) and the charitable remainder annuity trust (CRAT). The CRUT is permitted to receive additional contributions, so the trust can get added use over a long period. The CRAT is funded only at inception.
For tax planners with investment-minded individual clients, there's a lot of reasons why CRATS and CRUTs remain planning tools of choice.
To begin with, as the names suggest, the CRAT pays a fixed amount to the non-charitable donation beneficiaries while the CRUT’s annual distributions turn on the changing valuation of the trust assets. The grantor/donor gets paid first, hence the name confirming the charity or charities receive the remainder.
The transfer to a trust meeting the tax rules yields an up-front, partial deduction (For a recent overview of donations, see “Present Law and Background Relating to the Federal Tax Treatment of Charitable Contributions,” Staff of the Joint Committee on Taxation, 3/11/22, p. 1-49).
The income tax deduction depends on the measure of the remainder interest and arises upon funding. The actuarial measure of the remainder interest is affected by such factors as the payout rate, the IRS interest rate, and presumed lifespan, if the payout is over a life or lives. The actuarial value of the charitable interest can be as low as ten percent going into the trust (Sec. 664(d)(1)(D) re annuity type trust and Sec. 664(d)(2)(D) re unitrust type trust).
It is common for such trusts to pay the grantor and spouse for their lives, but tax planning may also focus on such circumstances as paying a child income over college years or meeting an elderly family member’s need. It is common to describe payouts as “income,” but technically, they are annuity or unitrust amounts.
It is possible to include an income limitation with a unitrust. Such trusts typically have a “make-up” provision, which can have the effect of making the non-charitable beneficiary whole while deferring taxable income.
The Unique CRT World
Charitable remainder trusts have their own Code provision, one which has a history of relative stability (Sec. 664). CRTs are generally tax-exempt under this provision without having to apply for exemption. They have exempt status, which can facilitate achieving a diversified portfolio. CRTs can be subject to unrelated business income tax, a contingency that is ignored in the actuarial calculations.
The non-charitable beneficiary(ies) of the CRT can be those creating the trust, or others, typically the grantor’s children. Terms of up to twenty years are also permissible. Payments for life with minimum terms are permissible.
It is not uncommon to fund such trusts with listed securities whose value is readily determinable. The securities would be transferred with the benefit of yielding the donor an income tax charitable deduction equal to the actuarial value of the remainder interest.
Low basis, high value assets are typically those chosen for funding the trust. Post-transfer sales of the appreciated securities used to fund the trust don’t trigger taxable income within the trust, due to its exempt status. The earnings-base is enhanced because of the trust’s exempt status.
The trust needs to pay at least 5 percent, but cannot pay more than 50 percent each year. The rules characterizing distributions from CRTs presume distributions are the most taxable. Dividends and interest would be distributed prior to long-term capital gains, but it is quite possible that the effect will be preservation of the long-term capital gain character as to portions of the distributions, along with deferral.
It isn’t very common, but it is possible to name charities as receiving some portion of the payouts. It is possible to irrevocably name one or more charities to receive the remainder interest, which is at an indeterminate future date if the non-charitable beneficiaries receive payouts over lifetimes. It is possible and common to defer the choices of charity until a later date.
The charity or charities need to be qualified when they later receive distributions in termination of the trust. The charity(ies) are commonly public ones, but it is also possible for the CRT to benefit a private foundation.
There are myriad detailed rules but there are also simplifying factors – notably the long history of such trusts, model IRS agreements and their relatively stable tax rules.
The CRT annually files an IRS return, Form 5227 (At IRS.gov, see the form and its instructions as an introduction to the topic). This individually designed trust approach comes with some administration costs.
Self-dealing rules are a factor, but also easily avoided. It wouldn’t be possible, for example, to plan on funding a CRT and loan the funds back to the grantor or family.
Transfer Tax Savings
The CRT gets the assets remaining in the trust out of the category of incurring transfer tax. The retention of the income interest (annuity or unitrust amount) will typically bring the assets back into the estate but such assets pass to charity.
So, the estate tax on CRT assets is usually zero despite the retained annuity or unitrust amount (See also Prop. Regs. 20.2010-1(c’)(3) announced 4/26/22, Sec. 2001(b), “IRS proposes to amend estate and gift tax basic exclusion regs,” Bonner, Journal of Accountancy, 4/26/22; see also “What’s New – Estate and Gift Tax,” IRS.gov, and “Estate and Gift Tax,” IRS.gov).
The Biden Tax Proposals
The Biden administrations latest “green book” announcement of tax proposals is March, 2022’s “General Explanation of the Administration’s Fiscal Year 2023 Revenue Proposals.” Among the proposals, we note particularly the following. (For more detailed discussion, see “President Biden’s Fiscal Year 2023 Revenue Proposals, Proposals Relating to Business, International, Individual, Real Estate, and Digital Assets Taxation, S&C Memo, Sullivan & Cromwell LLP, 3/31/22.)
Income tax rates are higher, such that the charitable income tax deduction may be more valuable. Transfer tax rates are higher, so the estate tax charitable deduction may be more valuable.
Basis shifting among related partners in a partnership context are addressed. Transfers to or from trusts or partnerships could be income recognition events in some circumstances.
The tax rate on long-term capital gains for taxpayers with income over $1 million would be taxed at ordinary income rates. “Moreover, under the proposal, the donor or deceased owner of an appreciated asset would realize capital gains at the time of the gift or death.” (Sullivan & Cromwell, ibid, p. 3.)
Special, tax-maximizing rules would apply in a $100 million wealth situation, which could reach realized and unrealized income. Like-kind exchanges would become unavailable as to realized gains in excess of $500,000, or $1 million on joint returns.
If this general perspective of legislative direction prevails, the move is toward tax maximization in new ways – trading like-kind realty may become taxable; taxable income can arise without any semblance of realization. We’d hope the legislators give thought to guidance re various charitable planning vehicles, including CRTS, within the context of these potential changes.
We would anticipate that the CRT’s tax advantages may play an even more important planning role in such a higher tax environment.
CRTs may well play an increasingly important role in tax planning for our clients, with or without major legislative changes. The CRT often fits the needs of the donor or donor’s family while also having significant income and transfer tax advantages.
Mike Pusey, CPA served as National Tax Director at Rojas & Associates. He has a BBA and Master of Science in Accounting from Texas Tech where he graduated with honors. He planned to be an accounting professor and worked a year on the Ph. D. at the University of Arizona before beginning his career at KPMG Peat Marwick, where he worked in...