Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts

Professor Russell JamesTexas Tech University

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts

1. Introduction

Professor Russell JamesTexas Tech University

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Donor CRT Charity

Initial Transfer

Anything Left at Death

5% of trust assets

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments during life

or lives

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments for 20 years

Donor CRT Charity

Initial Transfer

Anything Left at Death

$1,000 Per Year for Life

Donor CRT Charity

Initial Transfer

Anything Left at Death

5% of trust assets

Donor CRT Charity

Initial Transfer

Anything Left at Death

5% of trust assets

The donor creates the rules in a Charitable Remainder Trust, but once created it is irrevocable

Donor CRT Charity

Initial Transfer

Anything Left at Death

5% of trust assets

Donor CRT Charity

Initial Transfer

Anything Left at Death

5% of trust assets

Donor CRT Charity

Initial Transfer

Anything Left at Death

5% of trust assets

?

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

I would like to use $50,000

per year from my assets.

The rest, I want to go to my favorite

charity.

I want to control my

own investments and spend

about 5% of my assets each year.

After death I want it all to go to charity.

I want to retire today, but my pension

doesn’t start paying for 9 more years. I want to give assets to charity, but I still

need $65,000 per year for 9 years.

However, the

biggestreason for donors to use Charitable Remainder Trusts is…

Tax Benefits

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts

1. Introduction

Professor Russell JamesTexas Tech University

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts

2. Tax Benefits

Professor Russell JamesTexas Tech University

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

With a charitable gift in a will, there is no income tax deduction

There are no capital gains taxes when a donor makes a transfer to a CRT

A CRT is itself a nonprofit entity and pays no capital gains tax when it sells

appreciated property

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

A client holds low-basis appreciated assets that

generate little income (e.g., developable land or small

business growth stock). How can she convert to

diversified income-generating investments?

Option 1: Sell it. Pay the capital gains tax. Invest the remaining amount.

$1,000,000 zero basis asset $238,000 tax (23.8% federal)

$762,000 left to invest

Option 1: Even worse in many states

$1,000,000 zero basis asset $339,350 tax (33.935% Calif. + Fed.)

$660,650 left to invest

Option 1: Or with certain assets

$1,000,000 zero-basis art$408,706 tax (40.87% Calif. + Fed.)

$591,294 left to invest

Option 1: Or certain holding periods

$1,000,000 zero-basis short-term capital gain

$509,280 tax (50.928% Cal. + Fed.)

$490,720 left to invest

Note that gifts of short-term capital

gain are deductible only at basis

Option 2: Transfer to a CRT

$1,000,000 zero-basis asset_____$0 tax (CRT pays no tax)

$1,000,000 left to invest

You can produce more income

with $1,000,000

Than with $762,000 or $660,650 or $591,294 or

$490,720

CRT Advantages

• Immediate income tax deduction

• No capital gains tax on transfer to CRT

• No capital gains tax when CRT sells

• Lifetime income

CRT Concern?

• Remainder goes to charity not to family

How can we address this limitation?

Inheritance replacement by purchasing ILIT life insurance with tax deduction or

part of payments

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts

2. Tax Benefits

Professor Russell JamesTexas Tech University

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts3. Calculating Deductions

Tax rules for CRTs

Charitable deduction

is the value of

what you give less the value of what you get

back (CRT payments)

$100,000 Cash─ Value of CRT payments

Charitable Deduction

Donor gives

$100,000

CRT pays age 55 donor

$4,000 per year for life

$4,000

Payment

$100,000Cash

Tax deduction is amount gifted less value of

annuity/unitrust payments

What is the value of CRT payments?

Find the §7520 rate http://www.irs.gov/Businesses/Small-Businesses-&-Self-

Employed/Section-7520-Interest-Rates

Multiply payment by annuity factor in IRS Pub. 1457

http://www.irs.gov/Retirement-Plans/Actuarial-Tables

Value of CRAT payments

Find the §7520 rate http://www.irs.gov/Businesses/Small-Businesses-&-Self-

Employed/Section-7520-Interest-Rates

Choose current or one of last

two month’s rate

$4,000/year CRAT age 55

donor on 1/31/15

Section 7520 Interest Rates

Valuation Month

120% of Applicable Federal Midterm Rate

Section 7520 Interest Rate

Revenue Ruling

November 2014 2.28 2.2 Rev. Rul.

2014-28December

2014 2.06 2.0 Rev. Rul. 2014-31

January 2015 2.10 2.2 Rev. Rul.

2015-1

Nov 2.2%Dec 2.0%Jan 2.2%

Value of annuity

Section 7520 Interest Rates

Valuation Month

120% of Applicable Federal Midterm Rate

Section 7520 Interest Rate

Revenue Ruling

November 2014 2.28 2.2 Rev. Rul.

2014-28December

2014 2.06 2.0 Rev. Rul. 2014-31

January 2015 2.10 2.2 Rev. Rul.

2015-1

Find the §7520 rate

2.2%http://www.irs.gov/Businesses/Small-Businesses-&-Self-

Employed/Section-7520-Interest-Rates

$4,000/year age 55 donor on 1/31/15

For the lowest annuity

valuation [highest

charitable deduction]

select

Jan. 2.2%

Table S - Based on Life Table 2000CMInterest at 2.2 Percent

Age Annuity Life Estate Remainder Age Annuity Life Estate Remainder0 36.1979 0.79635 0.20365 55 18.6808 0.41098 0.589021 36.2496 0.79749 0.20251 56 18.2157 0.40074 0.599262 36.0655 0.79344 0.20656 57 17.7494 0.39049 0.609513 35.8711 0.78916 0.21084 58 17.2826 0.38022 0.619784 35.6693 0.78473 0.21527 59 16.8149 0.36993 0.63007

Find the §7520 rate

2.2%www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Section-

7520-Interest-Rates

Multiply annual payment by annuity factor in IRS Pub. 1457

$4,000 X 18.6808www.irs.gov/Retirement-Plans/Actuarial-Tables

$4,000/year age 55 donor on 1/31/15

Find the §7520 rate

2.2%www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Section-

7520-Interest-Rates

Multiply annual payment by annuity factor in IRS Pub. 1457

$4,000 X 18.6808www.irs.gov/Retirement-Plans/Actuarial-Tables

Value of annuity

$74,723

If annuity pays more

than annually, add adjustment factor from

Table K

$4,000/year age 55 donor on 1/31/15

$100,000Cash

Donor gives

$100,000

CRAT pays age 55 donor

$4,000 per year for life

$4,000

Annuity

$100,000 Cash─ $74,723 Annuity

$27,277 Deduction

$100,000Cash

Donor gives

$100,000

CRUT pays age 55

donor 5% per year for life

5% of CRUT

Payment

CRUT calculation process

Section 1 Table U(1) - Based on Life Table 2000CM

Adjusted Payout Rate

Age 4.2% 4.4% 4.6% 4.8% 5.0% 5.2% 5.4% 5.6% 5.8% 6.0%

55 .37183 .35635 .34166 .32773 .31450 .30194 .29001 .27868 .26791 .25768

56 .38390 .36841 .35370 .33971 .32642 .31378 .30175 .29032 .27943 .26907

57 .39618 .38069 .36596 .35194 .33859 .32588 .31377 .30224 .29125 .28077

5% per year age 55 donor on 1/31/15 with

annual payments on

1/31

Multiply transfer by remainder interest factor in IRS Pub. 1458

$100,000 X .31450www.irs.gov/Retirement-Plans/Actuarial-Tables

Charitable deduction

$31,450

CRUT deduction calculation

If payments other than annual given immediately after annual valuation, calculate adjusted payout rate (APR) as payout rate X table F (www.irs.gov/Retirement-Plans/Actuarial-Tables)

reduction using appropriate §7520 rate. If factor for adjusted payout rate (APR) is not on unitrust table, use:

Factor above APR –[(factor below APR –factor above APR) X ((APR-rate below APR)/.002 )]

CRUT calculation for differing payments

Donor CRT Charity

Anything Left at Death

Payments During Life

Initial Transfer

Rule: 10% of present value minimum to

charity

Reality: Share of CRT assets

to charity, <2%

Split interests trusts, filing year 2011, IRS Statistics of Income

The IRS tax deduction is actuarially too large because CRT donors live longer

Annuity purchasers live longer (i.e., sick

people don’t buy lifetime annuities)

Wealthy people live longer (CRT donors are very wealthy)

Charitable bequest donors live longer

See: James, R.N., (2013) American Charitable bequest demographics.

STEP 1: Using §7520 rate, at what age will the CRAT exhaust? Using a financial calculator solve for n (number of time periods) after entering present value (initial CRAT assets), rate (§7520 rate), payments, and setting future value to 0. The underlying formula is

STEP 2. Is there >5% chance the donor will live that long? (lx@age-of-exhaustion / lx@current-age, using Table 2000CM at www.irs.gov/Retirement-Plans/Actuarial-Tables )

CRAT disqualified if >5% chance of exhaustion due to annuitant longevity

So what happens if it doesn’t qualify as a CRT?

Retained interest gifts are not otherwise deductible. Trust isn’t charitable and pays taxes on any gain or income.

No tax benefits

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts3. Calculating Deductions

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts4. Income Calculation

Professor Russell JamesTexas Tech University

How are distributions from a CRT

taxed?

When the trust makes a payment, it opens the

spigot.

Ordinary income is paid first, then capital gain and

so forth.

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

Donor gives $100,000 of stock ($10,000 basis) to CRT. The CRT sells the stock, buys corporate bonds generating $3,000 of income and municipal bonds generating $2,000 of tax exempt income.

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

Donor gives $100,000 of stock ($10,000 basis) to CRT. The CRT sells the stock, buys corporate bonds generating $3,000 of income and municipal bonds generating $2,000 of tax exempt income.

$10,000

$2,000

$90,000

$3,000

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

What is the tax treatment of a $2,000 distribution?

$10,000

$2,000

$90,000

$3,000

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

What is the tax treatment of a $2,000 distribution?

Recipient pays taxes on:

$2,000 of ordinary income

$10,000

$2,000

$90,000

$3,000

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

What is the tax treatment of a $5,000 distribution?

$10,000

$2,000

$90,000

$3,000

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

What is the tax treatment of a $5,000 distribution?

Recipient pays taxes on:

$3,000 of ordinary income$2,000 of capital gain

$10,000

$2,000

$90,000

$3,000

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

What is the tax treatment of a $10,000 distribution?

$10,000

$2,000

$90,000

$3,000

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

What is the tax treatment of a $10,000 distribution?

Recipient pays taxes on:

$3,000 of ordinary income$7,000 of capital gain

$10,000

$2,000

$90,000

$3,000

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

If CRT ordinary income earnings are always higher than distributions, no capital gain tax will ever be paid.

Return of PrincipalExempt IncomeCapital

GainOrdinary Income

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts4. Income Calculation

Professor Russell JamesTexas Tech University

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts5. Special Trust Types

Professor Russell JamesTexas Tech University

Other charitable remainder

trust combinations

Donor CRT Charity

Initial Transfer

Anything Left at Death

Lesser of trust income or 5% of trust assets

When would you want this limitation?

Suppose you want the trust to hold a

non-income producing asset

A normal payout requirement could

force a sale

land, art, non-dividend or closely-held stock

Donor CRT Charity

Initial Transfer

Anything Left at Death

Lesser of trust income or 5% of trust assets

Past payments are made up

whenever net income is sufficient

NIMCRUTs may be problematic when later returns are consistently less than payout rates.

There isn’t enough income to make normal payouts or make-up past deficiencies.

“Flip CRUT”: A NICRUT/NIMCRUT that converts to a CRUT at a trigger event

NICRUT/NIMCRUT

Standard CRUT

Trigger Event

Common trigger events are sale of hard-to-value property or reaching

retirement age

2015 2016 2017 2018 2019 … Death

Initial Transfer

Anything Remainingat Death

2014

Trig

ger E

vent

Inco

me

up

to

5

%

Inco

me

up

to

5

%

Inco

me

up

to

5

%

5%

5%

2015 2016 2017 2018 2019 … Death

Initial Transfer

Anything Remainingat Death

2014

Trig

ger E

vent

$0

.00

Ex: Trigger is sale of $1,000,000 of non-income producing land funding CRT

$0

.00

$0

.00

$5

0,0

00

$5

1,0

00

CRT “spigot” trustsTrustees flip income off and on at will by investment choice• Commercial deferred annuities*

• Limited partnership interests

• Non-dividend paying growth stocks

• Delay realizing gains (post-transfer capital gain can count as income)

*Limits on this activity currently “under review” by IRS

Conrad Teitell suggests triggering a FLIP-CRUT using a small, but hard-to-market, asset such as one share of closely-held stock

Then trustee sells whenever the flip is desired

Flip when sold

A donor can give part of an undivided interest (e.g., 75% as tenants in common) to a CRT.

Subsequent sale generates capital gain for the retained share, but the contribution generates a tax deduction.

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts5. Special Trust Types

Professor Russell JamesTexas Tech University

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts6. Solutions & Problems

Professor Russell JamesTexas Tech University

Charitable Remainder Trust

Flexible & Expensive

• CRTs are individually created according to the specific desires of each client

Charitable Gift Annuity

Simple & Cheap

• CGAs from a charity are usually identical except for the dollar amount

The flexibility of CRTs

• Unlimited number of public charity or private foundation beneficiaries (income limitations pass through)

• Open choice on payout years and amounts

• Unlimited number of income beneficiaries

• Special restrictions on income beneficiaries allowed (where violation gives income to alternate beneficiary)– Spendthrift trusts

– Match earned income to prevent “trust fund” kids

– Require random drug tests

“Notwithstanding any provision of this Will to the contrary, my grandchildren DAVID PANZIRER and WALTER PANZIRER shall not be entitled to any distributions from any trust established for such beneficiary's benefit under this Will unless such beneficiary visits the grave of my late son JAY PANZIRER, at least once each calendar year, preferably on the anniversary of my said son's death (March 31, 1982) (except that this provision shall not apply during any period that the beneficiary is unable to comply therewith by reason of physical or mental disability as determined by my Trustees in their sole and absolute discretion).”

Leona Helmsley’s Charitable Remainder Unitrust created

in her will includes

What kind of property can a CRT hold?

Subchapter S corporation rules do not allow CRT shareholders

100% excise tax on Unrelated Business Taxable Income (UBTI), where CRT is

running a business (e.g., owning as a sole proprietor or partner) instead of being a

passive investor

Not UBTIDividends, interest, annuities, royalties, rents from real estate, and capital gains, so long as none of them involve debt-financing

UBTINet income from running a hotel, parking lot, convenience store, coin operated laundry

orDebt financed net income

Ex: CRT receives a $1,000,000 home ($100,000 basis). Trustee makes improvements using a $100,000 mortgage (acquisition indebtedness) and sells for $1,200,000.

Result?

Ex: CRT receives a $1,000,000 home ($100,000 basis). Trustee makes improvements using a $100,000 mortgage (acquisition indebtedness) and sells for $1,200,000.

Due to debt financing

$1,000,000 capital gain is UBTI, taxed at 100%, and lost.

Self-Dealing

CRT can’t sell, lease, loan, or allow use of assets by CRT creator, contributor, trustee, or their ancestors, descendents, or spouses

If all parties agree can a

CRT be broken and

distributed?

If all parties agree can a

CRT be broken and

distributed?

IRS has allowed termination & distribution of present value of all interests

PLR 200208039

Donor plans to create CRT with remainder value sufficient to build a building, but charity needs building now. Solutions?

Donor plans to create CRT with remainder value sufficient to build a building, but charity needs building now. Solutions?

CRT may segregate and pledge funds as collateral for a loan taken out by the charity. (Charity can pay off loan with remainder at death.)

PLR 8807082

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts6. Solutions & Problems

Professor Russell JamesTexas Tech University

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Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts

Professor Russell JamesTexas Tech University