Maximizing the Flexibility of a Charitable Remainder Trust—Without Creating Unintended Results
In many ways, a charitable remainder trust (CRT) is rigid—the trust document must meet the requirements of IRC §664 (income tax), §2522 (gift tax), or §2055 (estate tax) if the donor’s gift is to qualify for a charitable deduction. The current IRS model documents for charitable remainder annuity trusts (Rev. Procs. 2003-53 through 2003-60) and charitable remainder unitrusts (Rev. Procs. 2005-52 through 2005-59), incorporate and highlight many—but not all—of the possible options. In this charitable planning in practice we’ll review planning options that provide flexibility in CRT planning and the impact of those choices.
The CRT can allow the trustee to sprinkle the annuity or unitrust income among a group of beneficiaries. If any person, or a non-adverse party, or both without the approval of an adverse party, has the power to alter the amount paid to an individual income beneficiary, the CRT is not qualified. However, a discretionary allocation of income is permitted when the trustee making the allocation is neither the grantor nor a group of trustees “no more than half of whom are related or subordinate parties who are subservient to the wishes of the grantor.” (See IRC §674(c)). CRTs that sprinkle the income amount should use an independent trustee, or appoint a special trustee to make the discretionary allocation. In cases where the grantor retains the right to replace the trustee, the document should include language that the replacement trustee may not be the grantor or a related or subservient party within the requirements above.
The CRT may provide for charitable and non-charitable beneficiaries of the annual trust income. Some donors who create charitable remainder trusts want to create a current beneficiary for charitable as well as non-charitable beneficiaries. This is permissible so long as there is at least one non-charitable beneficiary of the income stream. There is no additional charitable income tax deduction at creation of the trust for including a charitable beneficiary of a portion of the income. See the IRS model documents for the language.
The CRT may pay the income stream of a “financially disabled” beneficiary to a trust for the individual. While this is not addressed specifically in the model documents, the IRS provides direction in Rev. Rul. 2002-20; 2002-17 IRB 794. Also see IRC §6511(h)(2)(A).
The donor may retain the power to replace the charitable remainder beneficiary or beneficiaries. The donor’s retention of the power to replace the CRT’s charitable beneficiary or to name multiple charitable beneficiaries will not disqualify the trust. However, the extent to which the donor’s gift is deductible for income tax purposes will depend upon whether the charitable beneficiaries are restricted to public charities set out in IRC §170(b)(1)(A) (which makes the income tax deduction subject to the 30/50% AGI limits) or the broader IRC §§170(c), 2055(a), and 2522(a) charities which include private foundations and will make the income tax deduction subject to the lower 30/20% limits. When a donor retains the power to replace the charitable remainder beneficiary the gift is not complete for gift tax purposes. (Rev. Rul. 76-8; 1976-1 C.B. 179) See the IRS sample documents for language.
The CRT document may provide for early termination of an income distribution subject to a “qualified contingency.” IRC §664(f) allows the trustee to terminate the income interest subject to a “qualified contingency” such as the income beneficiary’s remarriage. The early termination does not increase the income tax charitable deduction for the donor. See the IRS model documents for language.
A CRT may be terminated prior to the term set out in the document, subject to state law and IRS approval. Numerous letter rulings permit the early termination of all or a portion of a charitable remainder trust upon the actuarial determination of the life income and remainder interests and the appropriate disposition or merger of those interests. (The most recent such approval is set out in Letter Ruling 200808018, November 7, 2007.) If the income beneficiary chooses to take the present value of the life income interest, the transaction is treated as a sale and the proceeds as capital gain or loss. (IRC §1001) If the income beneficiary chooses to donate the present value of the life income interest to the charity, he receives a charitable income tax and gift tax deduction for the value of that interest. Once the income and remainder interests in the trust merge, the trust is terminated to the charitable beneficiary.
The donor can defer the gift tax consequences of a gift by retaining the right to revoke the income interest. Creating a charitable remainder trust for one’s self has no gift tax consequences; however, creating a charitable remainder trust for another creates a taxable gift. In instances in which the donor names himself/herself and spouse as the income beneficiaries, the marital deduction would not normally apply since the interest is not for the spouse alone. However, the gift tax consequences can be deferred by retaining the right to revoke the interest.
The key to drafting the most effective documents is to fully explore the donor’s charitable and personal goals in creating the CRT and to incorporate the flexibility required to best meet those goals.
Charitable Mid-Term Federal Rates
The charitable mid-term federal rates under IRC § 7520 for gifts made in May 2008 are set out below. These rates are used to determine the present value of an annuity, an interest for a life or term of years, or a remainder or reversionary interest. Call Marilyn B. Schaffer, CAP, Director of Planned Giving, at 847.384.3424 or e-mail marilyn.schaffer@advocatehealth.com if you need current rates for your calculations.
March 2008 3.6%
April 2008 3.4%
May 2008 3.2%