Focus on Giving:
Using A Charitable Remainder Trust to
Make A Gift to the International OCD Foundation
by Kathleen Bornhorst, Esq.
Pepe & Hazard, Hartford, CT
Charitable Remainder Trusts are trusts that provide fixed or variable payments to individuals for a period of years or for their lives. When the specified period ends, the property remaining in the trust is paid to a charity. A charitable deduction at the creation of the trust is allowed, based on the current value of the charity’s right to receive the property at the end of the trust term. Thus, Charitable Remainder Trusts can be ideal vehicles to provide tax benefits to the donor, create an income stream for the donor or in a special needs trust for a child and ultimately benefit a charity such as the Internationa OCD Foundation (IOCDF).
Charitable Remainder Trusts allow the taxpayer to convert highly appreciated assets without erosion by capital gains tax. Because a charitable remainder trust is tax exempt, the taxpayer will have the full value of the asset working for her to produce income. For example, taxpayer transfers $500,000 of IBM stock with a basis of $100,000 to a charitable remainder trust. The Trustee sells the IBM shares and pays no capital gains tax. The full $500,000 (as opposed to $420,000 if the taxpayer had sold the shares and paid the tax) is invested and grows on a tax free basis until distributions are made to the taxpayer or her beneficiary. In addition, the taxpayer will have a current charitable deduction of $150,000± depending upon the terms of the trust.
Charitable Remainder Trusts are of two types: the Charitable Remainder Annuity Trust and the Charitable Remainder Unitrust. Gifts to Charitable Remainder Trusts may be made during a taxpayer’s lifetime or at her death.
Charitable Remainder Annuity Trusts
The taxpayer places property (cash, stock, land, etc.) into the trust and receives each year an annual payment equal to a fixed percentage of the value of the donated property. The annuity payment remains the same during the term of the trust, regardless of whether the trust property increases or decreases in value. No further donations may be made to an annuity trust.
For example: On January 1, 2011, husband and wife place $500,000 in a charitable remainder trust which provides that 5% of the initial value of the trust (i.e., $25,000) will be paid to the taxpayers annually during their lifetime. Following their deaths, the property will be distributed to a qualified charitable organization. The taxpayers will receive $25,000 each year. If when both husband and wife die in 2017, the trust has grown to $535,000, that amount will be paid to the charitable organization selected by the taxpayers. Because the taxpayers have an income stream, they will have a $249,075 charitable deduction in 2011 even though the charity will receive nothing until their deaths.
Charitable Remainder Unitrusts
The taxpayer places property (cash, stock, land, etc.) into the charitable remainder trust and receives an annual payment equal to a fixed percentage of the value of the donated property, as revalued each year. The amount the taxpayer receives thus changes, depending on the performance of the trust. Property may be added to a unitrust.
For example: On January 1, 2011, husband and wife place $500,000 in a charitable remainder trust, which provides that 5% of the annual value of the trust will be paid to them in annual installments during their lifetimes.
Following their deaths, the property will be distributed to a qualified charitable organization. The taxpayers receive $25,000 in 2011. If, on January 1, 2012, trust assets are worth $503,891, the taxpayers will receive a total of $25,191 during 2012. After that, payments will increase or decrease depending on the value of the trust. If after the death of husband and wife in 2017 the trust has grown to $519,760, that amount will be paid to the charitable organization.
Advantages of One Form over the Other
With a Charitable Remainder Annuity Trust, the taxpayer is guaranteed a fixed amount each year. There is no need for annual valuation of assets. (This is not an important consideration when assets are easy to value).
With a Charitable Remainder Unitrust, if the trust grows in value, the taxpayer benefits from the growth and her annual payment is better able to keep up with inflation. In contrast to a Charitable Remainder Annuity Trust, the taxpayer can add property to a unitrust. If she wishes to spread out her contributions to the trust (e.g., $50,000 this year, $50,000 next year, etc.), her use of a unitrust would require no new instrument. A unitrust has more planning flexibility. For example, it can provide that if (a) trust income is less than (b) the unitrust amount, the trust can defer the difference between the two amounts until income becomes available. (This is an important consideration, when the asset donated by the taxpayer may be difficult to sell or produces a low rate of return.) An annuity trust cannot have such a provision.
Computing the Charitable Deduction
The IRS provides detailed charts for computing the charitable deduction. If your trust provides that you will receive distributions for the rest of your life, your deduction will be based on IRS life expectancy tables. In addition to the length of the trust term, the IRS takes into account, current interest rates (the “applicable federal rate”), the timing and frequency of your payout (monthly, quarterly, etc.), and the type of trust that you establish (annuity or unitrust).
All deductions are subject to the percentage limitations (typically, 50% of adjusted gross income for cash donations and 30% for gifts of appreciated stock and real estate); alternative minimum tax rules (for deduction taken on the built-in appreciation of donated property); and the carryover rules (if you can’t use the full deduction in the first year, you will have the next five years to use it).
Taxation of Distributions
Distributions from a charitable remainder trust are usually taxable to the taxpayer. The trust computes its income for the year, like an ordinary trust. The distribution to the trust beneficiary will be classified as follows:
1. As taxable “ordinary” (interest and dividend) income; and to the extent the distribution exceeds the trust’s ordinary income
2. As taxable “short-term capital gain” income; and to the extent that the distribution exceeds the trust’s combined ordinary and short-term capital gain income
3. As taxable “long-term capital gain” income; and to the extent that the distribution exceeds the trust’s combined ordinary and capital gain income
4. As nontaxable (e.g., tax-free municipal bond interest) income; and to the extent that the distribution still exceeds the combination of all these items, the balance will be attributable to
5. Trust principal. If substantially appreciated securities are contributed to the trust and the trust sells the securities, the taxpayer will incur tax on his distribution. If cash is contributed and the trustee (of a unitrust) invests in tax-free municipal bonds, the taxpayer will receive tax-free income.
Special Needs Charitable Remainder Trusts
A charitable remainder trust can be an ideal vehicle for a Special Needs Trust. For example, mother, age 70, can place $500,000 into a Charitable Remainder Trust retaining a 5% annuity for her life and following her death, for her son, currently age 43. Following son’s death, any remaining assets will be paid to a charity such as the IOCDF. Mother will receive $25,000 annually until her death. Thereafter, $25,000 annually will be held in a Special Needs Trust for son [for more on Special Needs Trusts click here]. Following son’s death, any remaining assets will be distributed to charity. Mother will receive an income tax charitable deduction of $122,000 in 2011.
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