Charitable Remainder Trusts "Have your cake and eat it too"

Years ago, it was possible to make a gift in trust to a charity, receive the benefit of an immediate, up-front income tax deduction and, at the same time, retain such immediate access to the property that, for all practical purposes, the donor still "owned" it.  In the most egregious situations, the donor manipulated the charitable trust so that, in the end, the property had been used up, and the charity received nothing, even though the donor received at the outset a substantial income tax deduction for his/her “gift” to the charity.  To curtail such abuses, the Congress enacted changes in 1969 such that it is now possible to make a "split-interest" gift to a charity only in three very narrowly-confined (and defined) circumstances:  A charitable remainder unitrust, a charitable remainder annuity trust, and a pooled-income fund.

The scenario is this:  A donor would like to make a gift to charity.  However, he doesn't want to lose the income stream that the property generates.  In other words, he would like to have the use of the property until he dies, at which time it would go to charity, but he wants the income tax charitable deduction now.  The usual vehicle for such a gift is a “split-interest” trust which provides  that all the income is to be paid to the donor during his lifetime and the principal is to be paid to the charity on the donor's death.  It is easy to see how the investment strategy for the trust could be struc­tured so that income payments would eat up the value of the trust, with the result that the trust would be worthless or nearly so by the time the donor died.
           

The IRS has issued specific and detailed rules providing for the regulation of such split-interest trusts.  There are two vehicles which a donor can set up and (to a certain extent)  control and still be allowed an immediate  charitable deduction:  The Charitable Remainder Unitrust (CRUT) and the Charitable Remainder Annuity Trust (CRAT).  The fundamental difference between the two is that the amount of unitrust income distributions is determined annually (a fixed percentage of the value of the trust annually) whereas an annuity trust pays a fixed amount which is determined at the outset.  Detailed regulations have been issued as to what the donor and the trustee must do to comply and qualify the gift as a charitable gift.  In either case, the minimum payout amount is 5% of the trust's value.  In the case of the unitrust, this amount is calculated annually.  If the income is greater than 5% of the asset value, that overage is added back into principal.  The IRS offers an option in situa­tions where the income is less than the required payout amount:  Either (1) the balance can be taken out of principal or (2) only the actual income can be paid out with an option for "catch up" in subsequent years.  In the case of an annuity trust, the annual percentage is figured at the time that the trust is created and that amount is payable annually.  Another major difference between the two forms is that a unitrust is permitted to accept additional gifts whereas an annuity trust cannot accept gifts in future years.
           

The third entity referred to above is a pooled income fund.  These are usually run by the charity itself as a vehicle for donors who do not want to set up a separate trust, either because they are not willing to accept the administrative costs of operating a trust or the size of the gift is not sufficient to warrant the expense of setting up a separate trust.
           

A charitable remainder trust is particularly attractive to donors who own highly appreciated assets, which, if sold, would generate large capital gains taxes.  If, for instance, a donor held stock which had appreciated dramatically or perhaps a small business which had increased dramatically in value, it would be possible to gift the stock to a charitable remainder trust, and then sell the stock, and reinvest the proceeds.  Since charitable remainder trusts are not subject to income tax, no capital gains tax would be paid, and thus the full value of the property would be available to generate an income stream.  The downside of this is that the property is forever lost to the donor's family.  This may or may not present an obstacle depending on the other assets owned by the donor, his family situation and his charitable interests.  One wealth replacement vehicle might be the creation of a separate irrevocable life insurance trust using a portion of the income stream from the charitable trust to pay the premiums on the life insurance policy.  Properly structured, both trusts will avoid federal estate taxes with the result that the insurance proceeds will pass to the next generation tax free.