Charitable Remainder Trusts

A Charitable Remainder Trust is an irrevocable trust that distributes an income stream to one or more non-charitable beneficiaries for life or a term of up to 20 years, with the remaining principal transferring to a qualified charity at the end of the term. For most donors who simply want a deduction and to give appreciated stock, a donor-advised fund (section “Use Donor Advised Funds (DAF)”) is far simpler and cheaper; a CRT earns its administrative complexity only when you also need the lifetime income stream or want to defer a large embedded capital gain.

Under IRC §664, CRTs must meet the following rules:

• The annual payout must be at least 5% and no more than 50% of the trust’s value.
• The present value of the charitable remainder interest must be at least 10% of the initial fair market value of the assets contributed.

There are two primary types of CRTs:

Charitable Remainder Annuity Trust (CRATs)

Pays a fixed dollar amount annually based on the initial funding value. Payouts do not adjust for inflation, and no additional contributions can be made after funding. Refer to Rev. Proc. 2003-53 through 2003-60 for IRS-approved sample governing documents.

Charitable Remainder Unitrust (CRUTs)

Pays a variable amount recalculated annually based on a fixed percentage of the trust’s current valuation. Additional contributions are permitted. Refer to Rev. Proc. 2005-52 through 2005-59 for IRS-approved sample documents.

Upfront Charitable Deduction A CRT delivers three benefits at once, and the deduction is the one people forget. When you fund the trust, you claim a partial charitable income tax deduction equal to the present value of the charitable remainder interest—the contributed value minus the present value of the income stream you keep, computed under IRC §7520 actuarial tables (Treas. Reg. §1.664-2(c) for a CRAT, §1.664-4 for a CRUT). The deduction is capped by the usual IRC §170, “Charitable, etc., contributions and gifts” adjusted-gross-income limits: 30% of AGI for appreciated long-term assets, 60% for cash, with a five-year carryover for the excess. Two refinements matter. First, the remainder must clear the 10% present-value floor, so a young beneficiary or a high payout rate can shrink—or disqualify—the deduction. Second, under IRC §170(e) a contribution of ordinary-income property (inventory, short-term holdings) is deductible only at basis, not fair market value. The combination that pays is a high marginal bracket meeting genuine charitable intent: you take the deduction now, the appreciated asset sells inside the tax-exempt trust without triggering capital-gains tax, and the income stream funds your retirement.

Taxation of CRT Distributions CRTs are tax-exempt entities; they pay no tax on capital gains when assets are sold within the trust. Payouts to beneficiaries are taxed under a “four-tier” distribution system on Schedule K-1 (Form 1041):

1.

Ordinary Income: Taxed first, to the extent the trust has current or accumulated ordinary income.

2.

Capital Gains: Taxed second, to the extent the trust has current or accumulated capital gains.

3.

Tax-Exempt Income: Taxed third, such as municipal bond interest.

4.

Return of Corpus (Principal): Tax-free distributions of the original principal.

Tax Filings and Compliance CRTs must file Form 5227 (Split-Interest Trust Information Return) annually to report transactions, income, and beneficiary distributions. Non-charitable beneficiaries must report Schedule K-1 allocations on Form 1040.

Prohibited Transactions CRTs must comply with strict IRS rules. Prohibited actions include:

• Self-Dealing: The grantor or family members cannot borrow from the trust, lease property from it, or buy/sell assets directly to the trust (see IRS Pub. 578).
• Personal Use: Trust funds cannot pay for personal expenses of the grantor or beneficiaries.
• Incorrect Basis Reporting: Assets contributed must carry over the donor’s original cost basis.