Man Holding Christmas Money


Gregory S. DuPont Dec. 21, 2018

Are you considering a transaction that will generate a significant tax liability such as capital gains? Do you need income now or in the future? Do you have charitable goals and interests to support? If you answered yes to these questions, you may find the following information useful. By using a financial planning tool called the charitable remainder trust (CRT), you can eliminate capital gains taxes, receive a charitable tax deduction, receive a stream of income for life, and benefit the charity of your choice.

The CRT starts with a contribution of assets (stocks, bonds, mutual funds, restricted securities, exchange traded funds, real estate, art, or other tangible property) into an irrevocable trust. The trustee agrees to pay you an income each year for either your life or a term of years. If you select a term of years, as opposed to life payments, the maximum term is 20 years. The minimum payout you must receive is 5%, while the maximum is 50%. When the trust’s term of years ends, the remaining interest that passes to charity must be at least 10% of the original assets in the trust.

Let’s take a closer look at some of the advantages a CRT can provide to see how it might benefit your particular situation. Assume that Mr. and Mrs. Baker decided to fund a CRT with $250,000 of stock they purchased 20 years ago for $25,000. Because the CRT is tax exempt, the trustee can sell the Bakers’ stock tax free and reinvest the full $250,000 in income-producing assets. If the Bakers decided to receive monthly payments for 15 years and set the CRT’s payout rate at 9% (assuming the payout rate satisfies requirements under the Taxpayer Relief Act of 1997), the Bakers would receive an annual income of $22,500. They would also be able to take a charitable deduction on their personal income tax return (based on the amount of time the charity must wait to receive payment, the percentage rate of funds payable to income beneficiaries, and the current rate of return as determined by the applicable Federal rate). The charitable deduction may be limited by the type of property donated, the kind of organization receiving the gift, the nature of the donor, and the trust’s income payout rate. If the Bakers’ deduction is limited on their current year’s tax return, Internal Revenue Service (IRS) rules allow them to carry forward any excess for five years.

In addition to a sizable income tax deduction and an enhanced income, the Bakers will realize three additional benefits. First, since the $250,000 is no longer in their estate, they have effectively reduced their potential estate tax burden. Second, since there is no tax on the transfer, they have avoided the potential capital gains tax they would have faced had the stock been sold first. Finally, they have provided a significant gift to the charity of their choice.

With higher income tax brackets on the books, charitable income tax deductions are worth correspondingly more to taxpayers who find themselves in high tax brackets. Moreover, since donations of appreciated property are no longer preference items for the alternative minimum tax (AMT), donating such property may now be much more advantageous. (Under prior law, the AMT could, in many cases, have significantly trimmed the income tax deduction for donations of appreciated property.)

Additional Opportunity

When the Bakers first took the CRT into consideration, they may have felt some apprehension about transferring property out of their estate for the ultimate benefit of a charity, rather than for their children. What could the Bakers have done to ensure their children would receive something similar (or, perhaps, even greater) in value to the transferred property?

Using the savings from their charitable deduction (and possibly a portion of their monthly income stream), the Bakers could make gifts to an irrevocable life insurance trust (ILIT), which, in turn, would purchase a life insurance policy on the lives of both Mr. and Mrs. Baker. After they die, the proceeds of the life insurance policy would be passed to the trust beneficiaries (their children), free of estate and income taxes. Keep in mind that, if the Bakers never transferred any assets to the CRT and instead left them for their children, the transferred assets would be subject to estate and gift taxation. This underscores the wealth preserving potential that life insurance offers the Bakers and their children.

Philanthropy—It’s Up to You

While most people may be resigned to the inevitability of taxation, many may be unaware that they have a choice with respect to estate taxes. Since a certain amount of your money is likely to give back to society one way or another, the choice is in what form your contribution to society will be. When viewed from the perspective of channeling your funds through the government or directly to the charity of your choice with a CRT, charitable giving takes on new meaning.