Estate Planner Mar-Apr 1998
Choose the Charitable Remainder Unitrust Option To Meet Your Needs
Charitable remainder unitrusts (CRUTs) can provide an income stream to an individual, a contribution to a charity and an income tax deduction for the donor. Certain limitations, however, make traditional CRUTs less attractive in some situations. Two other types of CRUTs — the net income with make-up CRUT (NIMCRUT) and the Flip CRUT — can be useful alternatives. The type of assets you are contributing and your charitable goals will help you determine which type of CRUT is right for you.
How CRUTs Work
You (the donor) contribute assets to a trust and take a current income tax deduction equal to the present value of the gift that will eventually be distributed to charity. The CRUT pays the noncharity beneficiary (the annuitant, who can be you or someone else) a percentage of the trust assets, valued each year either for the annuitant’s life or for a term of years (not more than 20). At the end of the trust term, the remaining assets go to the charity (or charities) you have named as the beneficiary.
For example, Beth creates a CRUT and funds it with $1 million. The CRUT terms require the trust to pay Beth 7% of the value of the trust assets each year for 20 years. Beth will receive a distribution of $70,000 in the first year. If the trust assets grow to $1.1 million in the second year, Beth will receive $77,000. At the end of the trust term, Beth’s favorite charity will receive the balance of the trust assets.
Use a CRUT To Defer Taxes on Appreciated Assets
CRUTs can be ideal vehicles to defer tax liabilities on appreciated assets. Why? Because the trustee of a CRUT can sell the appreciated assets transferred to the trust without incurring capital gains tax, though the annuitant is responsible for income tax on the payment he or she receives each year.
For example, if Beth sells $1 million of stock, for which she had paid $100,000, she will pay $180,000 in tax, leaving her $820,000. To receive the $70,000 annual income stream she needs, she will have to earn a 9% return. If instead she funds a CRUT with the stock, and the CRUT sells it, the full $1 million will be available to invest because the CRUT will pay no immediate capital gains tax.
CRUTs don’ t work as well when funded with assets that produce no income, such as real estate. If the assets held by a CRUT do not produce enough income to meet the annual payment obligation, the trustee will be forced to use the trust corpus to transfer a portion of the assets back to the annuitant as a part of the payment. This will reduce the trust’s ability to produce income in the future and leave less for the charity at the end of the trust term.
Use a NIMCRUT To Hold Currently Unproductive Assets
If you are interested in funding a CRUT with assets that are currently unproductive but are likely to be productive at some point over the trust term, consider using a NIMCRUT instead. Under the NIMCRUT, the annuitant receives the lesser of either the net income earned by the trust during the year or a fixed-percentage amount. A make-up account is established for years when the trust pays less than the percentage amount, and any shortfall is made up in years the trust earns more income than the percentage amount.
Using our previous example, if the NIMCRUT earns $60,000 in the first year, Beth will receive a payment in that year of $60,000, because this is less than the 7% required amount. If the trust earns $90,000 in the following year, and assuming the value of the trust is still $1 million, Beth will receive a payment of $80,000 — the $70,000 percentage amount, plus an additional $10,000 to make up for the prior year’s $10,000 shortfall.
By using a NIMCRUT, the trustee avoids having to distribute a portion of the trust corpus to an annuitant as part of the annual payment in years in which the trust does not produce enough income. Thus, a NIMCRUT preserves trust corpus while still, over time, paying the annuitant the percentage he or she is entitled to under the trust.
But the trustee may face another dilemma if the unproductive asset is sold. Generally, the terms of a NIMCRUT agreement forbid the trustee to pay the fixed-percentage amount from capital gains or trust principal. Therefore, the trustee may feel pressured to invest for current yield, and produce additional income to make up prior shortfalls to the annuitant, rather than to invest for total return, which may better serve the long-term interest of the charitable beneficiary.
Use a Flip CRUT To Benefit Annuity and Charity More Equally
If you want to benefit the annuitant and the charitable beneficiary more equally, consider a Flip CRUT, a technique approved in last year’s tax legislation. The Flip CRUT begins as a NIMCRUT and can be funded with an unproductive asset. This allows the trustee to make smaller or no payments to the annuitant in years the trust is earning little or no income.
Once the asset is sold, the trust flips to a traditional CRUT, which then pays the annuitant the fixed-percentage amount, allowing the trustee to invest for total return.
For instance, using our prior example, if Beth funds a Flip CRUT with an unproductive asset valued at $1 million, the trust will earn no income and Beth will receive no annual payments. When the trust assets are sold and invested in income-producing assets, Beth will begin to receive fixed percentage payments of 7% of the trust assets as valued each year but will receive no make-up for payments not received in prior years.
To qualify as a Flip CRUT, though, at least 90% of the fair market value of the trust assets must be unmarketable at the time of trust funding, and the trust’ s governing instrument must provide that it will be a NIMCRUT until the unmarketable assets are sold. At that point, it will flip to a standard CRUT and the annuitant will forfeit any make-up payments.
Which Vehicle Is Right for You?
CRUTs, NIMCRUTs and Flip CRUTs can all be effective estate planning techniques if you want to make a charitable donation while retaining an income stream that can continue for the benefit of your spouse or children. If you have questions about these trust options, please contact us. We would like to help you determine which is appropriate for your situation.
Flip CRUT as a Retirement Planning Tool
If you have no current need for income, you can fund a Flip CRUT with an unproductive asset, retaining an income interest and receiving a current income tax deduction. You can time the sale of the asset to coincide with your retirement, when you will need additional income. The trust will flip on the sale of the assets and begin paying you income during your retirement years.