Two Trusts That Can Help

By : Wasserman, Phillip Sarasota, FL

How would y ou like to lower your capital gains and estate taxes at the same time? Y es, it can be done

through a charitable remainder trust (CRT) or a private annuity trust (PAT). Setting up either of these

trusts will allow y ou to reduce your estate taxes. But hardly any one knows that depending upon which you

choose, y ou will also be able to defer paying capital gains taxes on highly appreciated assets — such as real

estate and stocks — or avoid paying them altogether. With the CRT, y ou make an irrevocable gift of assets

(such as appreciated securities, real estate, or cash) to a trust. For the remainder of y our life, y ou (or a

party y ou designate) receive the investment income from the assets held within the trust. Upon your

death, the principal value of the assets is transferred to y our designated beneficiary, which must be a

recognized non-profit organization.

People ty pically shy away from the CRT because while the donors receive income for life, the “donated”

asset gets left behind to charity, which disinherits heirs. To solve this problem, many people who do set up

a CRT “sweep” some of the income off the income stream and use it to pay for a life insurance policy that

replaces the amount of the donated asset tax-free upon their death. There are a number of benefits to

setting up a CRT, but the three major reasons pertain to reduced taxation. First, you won’t pay any capital

gains tax on the appreciated assets in the trust, making CRTs ideal for assets with a low cost basis but high

appreciated value, such as real estate. Second of all, contributions to a CRT are considered charitable

contributions, so they qualify for an income tax deduction (and any deduction not taken in the y ear of

contribution can be carried forward for the next five years). And third, the value of the assets held in a

CRT trust is considered “outside of y our estate” by the Internal Revenue Service (IRS), meaning

it’s excluded from the calculation of y our estate taxes. This could reduce y our estate tax rate by as much as

46 cents of every dollar, given current estate tax rates.

To summarize the workings of a CRT, when including life insurance as part of the plan, the donor: 1 .)

avoids capital gains tax when donating the asset and selling it; 2.) gets income for life from the CRT,

which has its own tax breaks given the donation of the asset itself; 3.) removes the asset from the estate,

which would lower the estate tax, if there is any ; and lastly, 4.) replaces the donated asset tax-free to heirs

through the life insurance policy.

It’s really not a bad deal, and it is something that certainly should at least be considered by those who are

planning to sell highly appreciated assets and have lots of taxes awaiting them.A PA T is another type of

trust that’s similar to a CRT. With a PAT, y ou transfer the desired assets into the trust, the assets are then

sold, and the proceeds are used to purchase an annuity. As with a CRT, the assets held in a PAT are

excluded when calculating y our estate taxes. But part of each pay ment you receive from the PAT will

contain a portion of the capital gains which were due on sale. So while a CRT eliminates the capital gains

tax, the PAT spreads them out over the rest of y our life.

This latter point may make the PAT less desirable than the CRT. Y et some people consider the PAT a

better option because over time, the investor and the investor’s family receive all proceeds from the sale of

the asset. Thus, if y ou create a PAT, upon y our death the asset will be removed from your estate and y our

heirs will receive whatever portion of the asset remains, free of estate taxes, gift taxes, generation-

skipping taxes, and transfer taxes. However, y our heirs will have to pay any remaining capital gains tax

due.

How much income can you receive from a CRT or PAT? That depends. With a CRT, for example, y our

income will be based on the amount of income y our assets generate while inside the CRT, as well as the

“pay out percentage,” or the size of the pay ments y ou choose to receive. The IRS requires CRTs to

distribute a minimum of 5 % of the net fair market value of its assets annually. If y ou don’t need income

from the CRT in one y ear, y ou can defer it through a “makeup provision,” but the CRT's net distributions

must eventually equal 5%. This means that y ou don’t have to start taking income right away. In some

cases, if y ou defer taking the income, you can potentially take more income out later than if y ou would

have taken the distributions in the first place. One caveat here: The higher the payout percentage, the

lower y our charitable income tax deduction will be, so y ou’ll want to talk to an advisor about striking the

right balance

between the two.

I would strongly urge anyone considering a CRT or PAT to speak with a qualified estate planning attorney.

Although the concepts as presented here are somewhat simple, the complexity of the taxation, along with

one’s estate and income requirements, all need to be well factored into the decision making process. This

is not run of the mill ty pe planning, and it definitely takes an experienced individual to assist you.

That said, don’t be shy . A CRT or a PAT can be an excellent choice in helping y ou reduce taxes, create

lifetime income and of most importance to some — leav ing a legacy behind.