Arthritis Foundation
Texas Chapter
Planned Giving Seminar
May 20, 2010
PLANNING WITH CHARITABLE REMAINDER TRUSTS
R. Thomas Groves, Jr.
Jackson Walker L.L.P.
901 Main Street, Suite 6000
Dallas, Texas 75202
(214) 953-5813 (direct)
(214) 661-6635 (direct fax)
tgroves@jw.com
Overview of the CRT
• Provides a current beneficial interest to at
least one individual and a future remainder
interest to charity
• Provides a current deduction for income
and gift tax purposes or estate tax
purposes.
• Must meet the requirements set out in IRC
§644 and Treasury Regulations
Overview of the CRT
• Current Beneficiaries
– One or more “named persons”
– Individuals must be living when trust created unless
payments are to be paid for stated period of years
– Can be successive current beneficiaries
– Payments to trust for current beneficiary permitted
only if current beneficiary is incompetent
• Remainder Beneficiaries
– Qualifying charitable organization under applicable
income, gift, or estate tax charitable deduction
provision
– Caveat: May be different for different tax deduction
purposes
Overview of the CRT
• Term of Payments to Current Beneficiaries
– Begin with first year of the CRT
– Continue for the life or lives of the current
beneficiaries (including successive current
beneficiary) (not for life of another) or for
stated number of years, not to exceed 20
– Effect of 10% requirement on term
– Term may end early, on the occurrence of a
specified contingency – contingency not
considered in valuing remainder interest
Overview of the CRT
• Types of CRTs
– Charitable Remainder Annuity Trust (CRAT)
– Charitable Remainder Unitrust (CRUT)
– Primary difference is nature of payments to current
beneficiaries
• CRAT – Fixed dollar amount annually (constant payments
during term)
• CRUT – “Standard” or “Fixed Percentage CRUT:” amount
equal to fixed percentage of fmv of trust assets, valued
annually (variable payments during term)
– NICRUT
– NIMCRUT
– Flip CRUT
– One or the other but not both
Overview of the CRT
• Time for Payment of Annuity or Unitrust Payment
– Not less often than annually, at or before the close of the taxable
year of the CRT
– Payment can be made for any year after the close of that year
under certain circumstances
• NICRUT or NIMCRUT –may be made within a reasonable time after
close of taxable year
• CRATs and Standard or Fixed Percentage CRUTs
– Created pre 12/10/98 – may be made within a reasonable time after
close of taxable year if the fixed percentage or amount is 15% or less of
the fmv of trust assets
– Created 12/10/98 or later – may be made within a reasonable time after
close of taxable year if special requirements met.
• “Reasonable Time”
– Late Payment
Overview of the CRT
• CRT Investments
– Trustee cannot be restricted from investing
trust assets in a manner that could result in
the annual realization of a reasonable amount
of income or gain
– CRT may not hold S corporation stock without
disqualifying S corporation status
– Some investments may create violations of
applicable private foundation rules and
imposition of private foundation excise taxes
Overview of the CRT
• Federal Income Taxation
– CRT
• Income tax exempt
• But 100% tax on UBTI
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Income from trust-operated business
Borrowing funds to purchase investments
Holding mortgaged property
Investment in partnership having UBTI
Failure to timely make annuity or unitrust payment
Lien or trust real estate resulting from failure to pay taxes or
assessments
– Can have up to $1,000 classified as UBTI
• Tax year: calendar year
Overview of the CRT
• Federal Income Taxation
– Current Beneficiaries – (Individuals)
• Income taxation based on 4-tier system of deemed
ordering of distributions
– current ordinary income and prior years’ undistributed
unordinary income
– current capital gains and prior years’ undistributed capital
gains
– current “other income” and prior years’ undistributed
“other income” (typically tax exempt)
– corpus
– character in hands of current beneficiaries carries over
from CRT
Overview of the CRT
• Federal Income Taxation
– Current Beneficiaries – (Charities)
• If paid portion of annuity or unitrust payment:
same 4-tier system applies for purposes of
determining character of distributions
• If paid any amounts other than portion of annuity or
unitrust payment – 4-tier system applies in reverse
Overview of the CRT
• Must Meet Requirement of CRT and Function as
CRT from Date of Creation
– Date of Creation: Earliest time when neither grantor
nor any other person treated as owner of entire trust
under IRC grantor trust rules but in no event prior to
transfer of property to trust
– Grantor Trust Status
• grantor/grantor’s spouse not treated as owner solely because
of status as current beneficiary
• retained power to revoke
• Income applied in discharge of grantor’s legal obligations
– Inter Vivos CRT
– Testamentary CRT
Overview of the CRT
• Private Foundation Restrictions
– CRTs are treated as if they were private
foundations for purposes of certain of the
private foundation excise tax provisions of the
IRC
– The private foundation provisions do not apply
to annuity or unitrust payments made to
individual current beneficiaries
Overview of the CRT
• Private Foundation Restrictions
– Self-dealing
– Taxable expenditures
– Excess business holdings
– Jeopardy investments
Overview of the CRT
• Funding CRTs
– “Best” property: cash or passive investment
assets
– Property with problems
• Mortgaged property
• Interests in businesses
Specific Considerations for
CRATs
• Annuity payment
– At least 5% but not more than 50% of initial net asset value
– Protects charitable remainder beneficiaries from inflation
• Valuation of charitable remainder interest/charitable
deduction
– value of contribution less present value of annuity payments
– Must be at least 10% of net fair market value of contributed
property
• No additional contributions
• No amounts payable to noncharity other than annuity
payments
• 5% probability of consumption of principal test
Specific Considerations for
CRATs
• Advantages/Disadvantages
– Deferred charitable giving for donor desiring
consistent income stream
– Generally a more attractive vehicle for tax
deduction purposes when the assumed rates
of return for purposes of computing the
present value of the annuity payments are
high
– Generally produces a larger tax deduction
than a comparable CRUT
Specific Considerations for
CRATs
• Advantages/Disadvantages
– Can be used to provide stream of payments to
persons other than donor, but present value of
annuity payments to third person is gift for gift tax
purposes or part of taxable estate for estate tax
purposes
– Can’t invade principal for current beneficiary except to
the extent necessary to fund annuity payments
– No additional contributions can be made to a CRAT
– Recordkeeping/administration issues for CRAT are
less onerous than for a CRUT
Specific Considerations for
CRUTs
• Unitrust payment
– At least 5% but not more than 50% of net asset value
each year
– Protects current beneficiaries from inflation
• Variations on standard or fixed percentage
CRUT
– NICRUT
• unitrust payment is lesser of current income or fixed
percentage
• Protects interests of charitable remainder beneficiaries since
principal is not invaded to fund unitrust payment
• Useful when trust funded with illiquid assets with yield less
than projected fixed percentage payments
Specific Considerations for
CRUTs
• Variations on standard or fixed percentage
CRUT
– NIMCRUT
• NICRUT with additional feature: if current income in any year
exceeds amount needed to fund fixed percentage unitrust
payment, excess current income used to fund prior years’
“deficiencies”
• Useful when trust funded assets with an anticipated yield, for
at least some part of the term of the trust, less than
anticipated income from trust assets, but at some point (e.g.,
on a sale of initial assets), yield may exceed the anticipated
fixed percentage unitrust payment
Specific Considerations for
CRUTs
• Variations on standard or fixed percentage
CRUT
– Flip CRUT
• Begins as a NICRUT or NIMCRUT but later “flips” to a fixed
percentage CRUT
• Flip “Triggers:” Must be on a specific date or by a single
event the occurrence of which is not discretionary with or
within the control of the trustee or any other person
– Sale of unmarketable assets (real estate, closely held stock,
unregistered securities with no registration exemption
permitting public sale), marriage, divorce, death, or birth of a
child
• Flip must be effective at the beginning of the taxable year
following year in which the flip trigger occurs
• If a Flip NIMCRUT, any “makeup” amount is forfeited on the
occurrence of the flip trigger
Specific Considerations for
CRUTs
• Allocation of Capital Gain to Income
– In the context of a NICRUT, NIMCRUT, or Flip CRUT (while in the
NICRUT or NIMCRUT stage), determination of what is “income” is
important
– Capital Gain
• Gain on the sale of assets contributed to the trust must be allocated to
principal, at least to the extent of pre-contribution gain
• Gain on the sale of assets acquired by purchase by the trust must be
allocated to principal, at least to the extent of the trust’s purchase price
• Other capital gain may be allocated to income pursuant to the terms of the
governing instrument, if not prohibited by state law
– Trustee’s discretionary power to allocated capital gain to income may be granted
to trustee under the governing instrument but only to the extent state law permits
the trustee to make adjustments between income and principal to treat
beneficiaries impartially
– If capital gain is allocated to income, the annual valuation of the trust assets must
be adjusted for the amount of any deficiencies from the fixed percentage unitrust
payments in prior years
Specific Considerations for
CRUTs
• Allocation of Capital Gain to Income
– Capital Gain
• Other capital gain may be allocated to income pursuant to
the terms of the governing instrument, if not prohibited by
state law
– Trustee’s discretionary power to allocated capital gain to
income may be granted to trustee under the governing
instrument but only to the extent state law permits the trustee to
make adjustments between income and principal to treat
beneficiaries impartially
– If capital gain is allocated to income, the annual valuation of the
trust assets must be adjusted for the amount of any
deficiencies from the fixed percentage unitrust payments in
prior years
Specific Considerations for
CRUTs
• Valuation of Charitable Interest (and Charitable
Deduction) in CRUTs
– Net income limitation on distributions in NICRUT,
NIMCRUT, and Flip CRUT disregarded.
– Determine “adjusted payout rate” from IRS tables
– Determine valuation factor from IRS tables
– Multiply valuation factor by net fair market value of
contributed property
– IRS will provide value where valuation cannot be
made based on published tables
– Must be worth at least 10% of net fair market value of
contributed property
Specific Considerations for
CRUTs
• Additional Contributions to CRUT are Permitted
– Governing document must contain special provisions
regarding determination of unitrust payments in the
event of additional contributions
– If special provisions not included, document must
prohibit additional contributions
• No amounts payable to noncharity other than
unitrust payments
• Potential application of IRC sec. 2702 to
NICRUTs, NIMCRUTs, and Flip CRUTs
Specific Considerations for
CRUTs
• Advantages/Disadvantages
– Deferred charitable giving for donor desiring steady
income stream, wants to benefit from increases in
value of CRUT assets and is comfortable with the risk
of decreases in value
– Generally a more attractive vehicle for tax deduction
purposes when the assumed rates of return for
purposes of computing the present value of the
charitable interest are high
– Can be used to provide stream of payments to
persons other than donor, but present value of
unitrust payments to third person is gift for gift tax
purposes or part of taxable estate for estate tax
purposes
Specific Considerations for
CRUTs
• Advantages/Disadvantages
– Generally produces a smaller tax deduction than a
comparable CRAT
– Can’t invade principal for current beneficiary except to
the extent necessary to fund unitrust payments in a
fixed percentage unitrust payement
– Additional contributions can be made to a CRUT
– Recordkeeping/administration issues for CRUT are
more onerous than for a CRAT
Drafting the CRT
• Governing Document Must Meet Requirements
of IRC sec. 664 and Regulations
• IRS Published Sample CRAT and CRUT
Documents
– Annotations and alternative provisions included
– Reliance on sample forms
• IRS will automatically recognize a CRT as qualified if
– Trust operated consistently with terms of governing instrument
– Trust valid under state law
– Governing instrument is “substantially similar” to the applicable
IRS published sample form
Applications for CRTs in Wealth
Planning
• Basic: Donor who wants to make eventual transfer to
charity but needs or wants to keep (or wants to give
another person) an income stream
• Sales of appreciated property - generally
– Avoid assignment of income
– Avoid obligation of trustee to invest proceeds from sale in
specific manner
– Use of NICRUT, NIMCRUT, or Flip CRUT where delay in sale
anticipated
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Investment diversification
Enhancing annual return on assets
Income for retirement
CRT in connection with life insurance planning
Applications for CRTs in Wealth
Planning
• Some Controversial Applications
– Depreciable property and CRTs
– Donor with Capital Loss Carryforward
Planning Points and Traps to
Avoid
• Trustee/Trust Administration Issues
– Avoid grantor trust status
– CRUT with difficult-to-value assets
• Independent trustee with valuation responsibility
• Qualified appraisal requirements
– Fiduciary Duties
– Self dealing issues
Planning Points and Traps to
Avoid
• CRTs and Business Interest Redemption
Planning
– Private foundation rules, esp. self dealing
– Transfer of closely held stock to CRT – 30%
of contribution base limit unless value of stock
reduced by 100% of appreciation
– CRT trustee cannot be under any legal
obligation to surrender the shares in a
redemption at time of contribution
Planning Points and Traps to
Avoid
• Gift Tax Planning Issues
– Creation of inter vivos CRT has gift tax
consequences if an individual other than
grantor has interest in annuity or unitrust
payments
– Value of gift
– Gift tax annual exclusion: present interest
requirement
– Gift tax marital deduction
– IRC sec. 2511 and completed gifts
Planning Points and Traps to
Avoid
• Estate Tax Planning Issues
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Can a qualified testamentary CRT be created in 2010?
Potential inclusion in donor’s estate
Estate tax marital deduction
QTIP Trust as alternative to CRT for spouse (estate and gift purposes)
• Advantages
– QTIP: all income to spouse; CRT: only fixed amount or amount by fixed
percentage
– QTIP: principal can be invaded for spouse for stated purposes; CRT: principal
can be invaded only to the extent necessary to fund annuity or unitrust payment
• Disadvantages
– No income tax charitable deduction for charity’s remainder interest in inter vivos
QTIP
– QTIP must pay all income to spouse, even if not needed; CRT income in excess
of required annuity or unitrust payment is not distributed and is not subject to
income tax to the CRT
– QTIP: no requirement that principal be invaded for spouse; CRT: if CRAT or fixed
percentage CRUT, principal will be invaded if income not sufficient to fund annuity
or unitrust payment
Planning Points and Traps to
Avoid
• Changed Circumstances: “Fixes”
– Division of CRT incident to divorce
– Subsequent gift to charitable remainder beneficiary of
donor’s retained annuity or unitrust interest
– Transfer of annuity or unitrust interest in exchange for
charitable gift annuity to increase income stream
– Early termination of CRT term and distribution from
CRT to current beneficiary of actuarial value of
annuity or unitrust interest
– Sale of annuity or unitrust interest to third person