Basic Setup of a Charitable Remainder Unitrust
A charitable remainder unitrust (“CRUT”) is an estate planning tool using an irrevocable trustcreated under state law in accordance with Internal Revenue Code (“IRC”) §664(d)(2) to distribute income to a named non-charitable beneficiary or several beneficiaries annually or more frequently during the grantor’s life. The grantor or members of the grantor’s family are usually the initial beneficiaries. The remainder after the grantor dies devolves to a charitable cause.
The CRUT provides for the distribution of a fixed percentage of the trust assets’ fair market value (“FMV”) to beneficiaries each year. The distribution percentage, under W.S. §2-3-908, can be no less than 3% and no more than 5% of FMV per year. The IRC provides that the unitrust amount can be no less than 5% nor more than 50% of FMV per year. IRC 664(d)(1)(A).
The CRUT may only have beneficiaries who are living at the time of the trust’s creation. The term of the trust may be for the grantor’s or the beneficiary’s lifetime or a fixed term not exceeding 20 years. Distributions may only be made to the annuity recipient or the qualified charity beneficiary.
FMV is determined at the beginning of each year and determines the annuity amount for the year following. IRC §664(d)(2)(A). Thus, the annuity amount may vary year to year, but the percentage remains the same.
At least 10% of the statistical fair market value of each trust contribution must be a part of the estimated remainder interest. IRC §664(d)(1)(D).
Once the annuity period is over, the remainder of CRUT principal is distributed to charity. IRC §664(d)(1)(C).
CRUTs are generally funded with asset such as artwork, a house, stocks, bonds, or other property. Additional assets can be added to the trust over time. The Internal Revenue Code (“IRC”) requires that the charity receive at least 10% of the asset’s contribution value.
Example Charitable Remainder Unitrust
Lisa, an alum from USC, receives $500,000 in stock on her mother’s death. She wants to contribute this to USC on her death, but would need to receive income from trust during the remainder of her life. She establishes a CRUT following these steps:
- Lisa transfers the cash to the CRUT.
- The CRUT pays a percentage of the principal’s value each year to Lisa.
- When Lisa dies, the CRUT terminates and transfers the remainder to USC.
Types of Charitable Remainder Unitrusts
The amount of income that the initial beneficiary or beneficiaries receive depends on which type of CRUT is set up. The income varies each year and is usually taxable. The duration of the income payments may be for your life or up to 20 years.
A standard unitrust provides an income based on a fixed percentage that is determined at the time you set up the trust. The percentage must be 5% or more, which is then multiplied by FMV.
Net Income Unitrust
A net income unitrust provides annual payments that can follow the process of a standard unitrust or it can provide net income of the trust, whichever is lower. This type of trust is usually preferred by donors who may be younger or otherwise want to wait until later to get larger payments.
Treas. Reg. §1.664-3 authorizes the payment of the lesser of:
- The annuity percentage discussed in the preceding paragraph; or
- The CRUT’s net income for the year, a “Net Income CRUT or NICRUT.”
Further Treas. Reg. 1.664-3(a)(1)(i)(b)(2) allows the CRUT to make up an amount if trust income is lower than a selected percentage.
A flip unitrust begins as a net income unitrust, but it only pays beneficiaries based on actual earnings of the trust. This type of trust is usually set up when an asset that is not liquid like real estate or artwork is used to fund the trust. The trust states that at some specified date in the future the asset will be sold and will then operate as a standard unitrust. This type of trust may be preferred for a donor who wants it to fund retirement.
A donor is entitled to a charitable deduction equal to the present value of the remainder interest in a CRUT. Treas. Regs. §1.664-4(e)(3) and (4). The method of determining the charitable deduction is complicated, and set out in Treas. Regs. § 1.664-4(e)(3) and (4). Various factors are considered, including the adjusted payout rate, the value of the remainder interest, the age of the measuring life (the annuitant), the term of the CRUT, the date of trust creation, and federal interest rates.
The donor will not have a taxable gift if he or she is the beneficiary of the CRUT; however, it will have gift tax consequences if any individual other than the grantor and/or his or her spouse is the designated beneficiary.
The donor’s tax and probate estates will not include the the CRUT at his or her death.
CRUT distributions are taxed to the beneficiaries receiving them on a "Worst-In, First-Out"(WIFO) method in the following order: ordinary income, capital gain, other income, and trust corpus.
Capital Gains Tax and CRUTs
One of the reasons for establishing a CRUT is the favorable tax treatment. The CRUT does not have to pay capital gains tax when it sells a trust asset.
If Lisa’s stock value increases by $100,000 to a new value of $600,000 and she decides to sell it, she would be subject to capital gains taxes. If she is in the 24% federal income tax bracket, the long-term capital gains tax would be approximately 15%, meaning or a tax of $7,500. By transferring the stock to a CRUT with a 5% annual income stream, Lisa would receive $30,000 in the first year and would also receive an income tax deduction. She avoids paying the capital gains tax. When Lisa passes away, USC would receive the trust corpus.
- immediate income tax deduction for a portion of the contribution;
- no upfront capital gains tax on appreciated assets donated;
- steady income stream for life or many years;
- federal and possible state income tax charitable deduction; and
- knowledge of your philanthropic contribution to a charity of your choice.