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Navigating the maze of Internal Revenue Code regulations and
Treasury Regulations in order to ensure that the Charitable
Remainder Trust is qualified and valid under such regulations
is complicated and time consuming. While the IRS provides
sample language, the samples do not contain other provisions
that are commonly incorporated into trust agreements in California,
such as standard trustee powers, spendthrift clauses, perpetuities
savings clauses, and definitional provisions. A misinterpretation
of the complex rules will result in a loss of the income,
gift, and estate tax charitable deduction.
Tamara L. Harper incorporates these California
trust provisions into the trust agreement to the extent they
are not inconsistent with IRS mandated requirements. You should
engage competent and experienced counsel to prepare a charitable
remainder trust.
A Charitable Remainder Trust provides for a specified distribution, 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.
An annuity trust requires that distribution be a sum
certain which is not less than 5 or more than 50 percent
of the initial net fair market value of the trust assets.
A unitrust requires that the specified distribution
be a fixed percentage which is not less than 5 or
more than 50 percent of the net fair market value of the trust
assets determined annually.
The value of the remainder interest in a charitable trust, whether an annuity trust or unitrust, must be a least 10 percent of the initial fair market value of all property placed in the trust. To qualify as a charitable remainder trust, a trust must be either a charitable remainder annuity trust in every respect or a charitable remainder unitrust in every respect. A hybrid that incorporates features of both types will not qualify for the charitable deduction.
CHARITABLE REMAINDER ANNUITY TRUST
By using a charitable remainder annuity trust (“CRAT”), a donor can transfer property to a trust, provide an annuity for a term of years or for the life or lives of an individual or individuals, and deduct as a charitable contribution the present value of the remainder interest that will eventually pass to a qualified charitable organization. The CRAT must pay a sum certain, which is not less than 5 or more than 50 percent of the initial net fair market value of the property placed into trust, to at least one non-charitable beneficiary. This sum must be paid at least annually either for a term of years not to exceed 20 years, or for the life of the non-charitable beneficiary. Unique to the charitable remainder annuity trust is the inability to provide for a fixed percentage payout that is to be increased upon the happening of some event.
The CRAT must be funded all at once and cannot allow any additional contributions to the trust after the initial contribution. There is an exception to this rule for testamentary charitable remainder annuity trusts e.g. passing by reason of death.
CHARITABLE REMAINDER UNITRUST
The charitable remainder unitrust (“CRUT”) is an important deferred giving tool. The use of a unitrust allows a donor to provide a variable annuity payable for a term of years or for the life or lives of an individual or individuals, and to obtain a deduction for the present value of the remainder interest that ultimately will pass to a qualified charitable organization.
A CRUT must pay a fixed percentage, which is not less than 5 or more than 50 percent, of the net fair market value of its assets to one or more beneficiaries, at least one of which is not a charitable organization described in I.R.C. §170(c). Payment must be made at least annually and the unitrust assets must be valued at least annually. Valuation may be required to be completed by an independent auditor and current qualified appraisal.
Additional contributions to a CRUT are permitted only if the trust instrument provides for them and provides for both valuation of the property at the time of contribution and determination of the prorated unitrust amount based on the values.
A CAUTIONARY NOTE REGARDING MORTGAGED PROPERTIES
Mortgaged property may cause unrelated business income to the
trust under the Internal Revenue Code, realization of gain
to the donor, and penalties for self dealing. The transfer
of mortgaged property, when the donor is liable for the debt
and when the charitable remainder trust may make payments
on the debt, will cause the trust to fail to qualify due to
treatment as a grantor trust.
A significant advantage may be gained by transferring appreciated
property to a charitable remainder trust. After the property
has been transferred to the trust, the trustee can sell the
property and reinvest the proceeds without the trust or the
grantor incurring an immediate income tax on the resulting
gain. The grantor will then be taxed on the gain only to the
extent authorized distributions made from the trust to the
grantor are treated as gain.
WHO CAN BE THE GRANTOR OR TRUSTEE?
The grantor can be any individual, trust, estate, partnership, association, company or corporation. Any money or other property can be transferred to a charitable remainder trust. However, with tangible personal property, there is no income tax deduction if the grantor or related parties are named as income beneficiaries.
The trustee can be any person, including
the donor, who often prefers to retain the power to administer
the trust assets. However, in a trust in which the donor has
the power to affect the income distributions, the donor will
be considered the owner of the trust and thus, included with
the donor’s own assets for tax purposes. When the trust
includes hard to value property such as closely held stock
and real estate, an independent trustee is needed.
WHAT ABOUT THE BENEFICIARIES?
Charitable remainder trust income must be paid to one
or more persons, at least one of which is not a charitable
organization, for a term of years not exceeding 20 years or
the life of the individual. Upon termination of
the required payments to the income beneficiaries of a charitable
remainder annuity trust or unitrust, the remainder interest
in the trust must be transferred to, or for the use of, a
qualified charitable organization as described in I.R.C. §170(c).
Donors should be cautioned that some of these organizations
do not qualify for the 50 percent income tax charitable deduction,
the gift tax charitable deduction, or the estate tax charitable
deduction. Thus, it is my opinion that in order to assure
the higher income tax percentage limitation when the donor
intends the remainder to be received by public charity, that
the trust further require that the organization selected as
an alternate remainderman also qualify under I.R.C. §170(b)(1)(A).
If any provision is included with the charitable remainder
trust that allows the donor to dictate the trust’s investment
policy, no charitable deduction for income, gift, or estate
tax purposes will be allowed.
If any provision is included within the trust that allows
the power to alter the amounts paid to beneficiaries of a
trust could cause the individual to be the owner of a trust
or part of a trust, even though the individual is not directly
a beneficiary, and consequently the trust will not
qualify as a charitable remainder annuity trust or charitable
remainder unitrust.
TAX TREATMENT
Charitable remainder annuity trusts and charitable remainder
unitrusts are distinct entities under the law. These trust
are not “exempt organizations,” however, they
are generally exempt from income tax, except when they have
unrelated business taxable income as defined in I.R.C. §512.
These trusts may accumulate income tax free, any realized
income or gain in excess of the amount required to satisfy
their obligations to non-charitable income beneficiaries.
The income tax consequences of a deferred gift are
determined by a variety of factors, including, the type of
trust selected, the length of the non-charitable beneficiary’s
interest, the age and number of the non-charitable beneficiaries,
the amount of the annuity percentage rate, and the applicable
federal interest rate. The tax consequences should be discussed
with your tax professional, CPA and attorney. A charitable
contribution is available for the present value of the remainder
interest that will pass to a qualified charitable organization.
If you would like further information about calculating the
present value of the remainder interest, please contact Tamara
L. Harper for an initial office consultation.
The gift tax consequences are determined by a number
of factors, such as whether the non-charitable interest is
for a fixed term or created for the life or lives of an individual
or individuals, whether the donor or spouse or other individual
is the beneficiary, and whether there is a power to revoke
the income interest. Generally, when there is a transfer of
property to a charitable remainder trust in which an income
interest is retained for the donor for a period of years,
there are no gift tax consequences, and the gift of the remainder
interest qualifies for the gift tax charitable deduction.
I.R.C. § 2522(c)(2)(A). When the income interest in a
charitable remainder trust is created for successive lives,
the gift tax consequences may differ. If you would like further
information unique to your situation, please contact Tamara
L. Harper for an initial office consultation.
The estate tax consequences are dependent upon whether
the arrangement is for a fixed term or for the life or lives
of an individual or individuals, or whether the beneficiary
is the donor, donor’s spouse, or another person. For
fixed term arrangements, the estate tax consequences will
depend on whether the donor retained a testamentary power
to revoke the beneficiary’s interest and whether the
interest expired before the donor’s death.
Generally, the annuity and unitrust amounts paid by the charitable
remainder trusts to the non-charitable beneficiaries are taxable
to the recipients. The beneficiaries are required to treat
the individual distributions in accordance with a four-tier
order of distribution pursuant to I.R.C. §664(b). This
is a complicated area and is beyond the scope of this article.
In conclusion, the charitable remainder annuity trust is advantageous
for a donor who wants the income beneficiary to received a
fixed amount during the term of the trust, because the amount
of the required annual distribution can be fixed, at not less
than 5 or more than 50 percent of the fair market value of
the assets on the date of transfer to the trust. The income
beneficiary, however, will have no protection against inflation
and no additional contributions are allowed. If you wish to
make a series of contributions, you should consider a charitable
remainder unitrust.
The unitrust is the preferred tool to hedge against inflation,
since the annual distribution to the unitrust beneficiary
is determined annually by the value of the trust’s assets.
The uncertainty of the amount of the annual payment to the
beneficiary in a volatile market, however, is a disadvantage
in addition to the added administrative cost of the annual
valuation of the trust’s assets as discussed above.
The ability to make additional contributions after the initial
transfer may outweigh this burden, however, and the same trust
can be funded with several transfers of property.
As always, I appreciate your referrals and your business and
look forward to working with you and showing you ways to protect
and maximize your wealth and assets.
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