Many potential clients have become increasingly interested in charitable giving since the tax reforms enacted by Congress in 2001 and 2002. Specifically, the temporary repeal of the federal Estate Tax and the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), have many nontraditional clients—those under 50, and middle class—looking at charitable giving.
Charitable remainder trusts (CRTs) are the most common approach to charitable giving, after direct gifts to religious entities, goodwill, and so forth. Choosing the right gifting strategy can be critical to your client’s well-being and peace of mind.
CRATs and CRUTs
There are several advantages and disadvantages to the two major types of charitable trusts: charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs). Whether or not these types of trusts are right for your client depends largely on his age, income and goals.
Why would you recommend a CRAT or CRUT?
- Both are tax-exempt, so there are no taxes, even
on retained income. The beneficiary is taxed on the income distributed
based upon its character in the trust.
- There can be a significant current-year (and possibly
future) tax deduction.
- Highly appreciated assets can be contributed to
the trust (and then sold within the trust) to generate a tax deduction
and avoid capital gains taxes. With a CRUT, income can be deferred,
higher return investments can be used in the earlier years.
- The trust’s assets are outside your client’s
estate, so there should be no estate taxes (unless the laws change again
in 2010), but it does use up the client’s unified credit (since
a charity is a nonspousal beneficiary) and could create a gift-tax issue.
- Your client, as trustee, normally can direct the
investments in the trust in marketable assets.
- Your client can usually change the charitable beneficiary
of the trust.
- You may recommend a CRAT specifically if your client
wants a guaranteed income each year, or if your client is middle-aged
or younger. CRUTs may limit your client’s access to funds to a 20-year
- With a CRUT your client can defer income from the
trust in the early years.
- CRUTs are appropriate if your client is past middle-age—otherwise
CRUTs may limit your client’s access to funds to a 20-year term.
- A CRUT pays benefits based on a preselected percent of assets (always talk to tax and legal advisors). As the value of the assets fluctuate, so does the payment amount. Deferred payments can be taken at a later date.
Why would you not recommend a CRAT?
- A fixed income is not very appealing to younger
- If the rate of return on the trust assets falls
below the figure chosen as the annual distribution amount, the trust’s
value could fall and eventually reach zero.
- Once payments start, they cannot be stopped.
- The trust is irrevocable.
Why would you not recommend a CRUT?
- A fluctuating income is not very appealing to older
- The 20-year term that many younger clients may face
is not appealing and may leave them with no assets to live on.
- Once payments start, they cannot be stopped, but
they can be deferred and left in the trust.
- The trust is irrevocable.
Most clients chose to fund these trusts by transferring assets to the trust and then selling the assets to get the greatest possible tax advantages. Not all assets can be placed in the trust. Always consult with legal and tax experts before having your client transfer assets or make purchases in the trust. With CRATs, the money is then invested fairly conservatively to ensure the required annual distribution can be made while preserving most, if not all, of the capital. However, with CRUTs the money is invested fairly aggressively in the early (income deferral) years to generate the greatest possible capital.
With both trusts, there are limits to the percent of the original assets that can be chosen as the distribution amount. Your client can choose to receive the annual amount in a lump sum, quarterly or monthly, etc. Once payments begin, they cannot stop for the remainder of the beneficiary’s lifetime or the specified number of years. With CRUTs it may be possible to defer the payments.
More about CRTs
Your client can direct how the charity may or may not allocate the funds in the CRT. This is very important to many people. While the client is living, assuming he is the trustee, he can direct the marketable investments in the CRT. If the trust is a CRUT, your client can defer payments for some time and vary the annual amounts (up to the preset percent of current assets plus deferred amounts) paid out. These trusts are irrevocable; about the only way to terminate one is for it to run out of money.
As with any planning, charitable giving can be flexible. According to tax-planning attorney Jeff Scroggin, “Many clients avoid making sizable charitable gifts because they are concerned about the irrevocable nature of a charitable gift. But, the gift does not have to be totally unchangeable. Flexibility is critical in this area. For example, the donor to a CRT can retain the right to change the charity that will receive the trust fund at the beneficiary’s death. Clients can contribute to donor-advised funds or supporting organizations and retain for themselves or other family members the right to decide future dispositions from the fund. Clients giving directly to charities should consider giving to endowment funds to provide for a long-term benefit.”
Janet Arrowood is the managing director of The Write Source. She can be reached at TheWriteSource@earthlink.net.