A charitable remainder trust (CRT) is an irrevocable trust that allow donors (called grantors) to give money or property to charities while also retaining an income stream. The grantor, or someone of their choosing, can receive an income for a term of up to 20 years or for the life of one or more noncharitable beneficiaries. At the end of the income term, at least one charity will receive the remaining assets in the trust.
CRTs can be created and funded during the grantor’s life as an inter-vivos trust or at death as a testamentary trust. Inter-vivos CRTs are predominantly used to provide income security to the grantor and the grantor’s spouse, while testamentary CRTs are typically used to provide a benefit to heirs and to reduce the grantor’s taxable estate. Provided that the CRT complies with all IRS requirements, the trust will be tax exempt, and the grantor is eligible for a charitable contribution deduction based on the present value of the remainder interest when the trust is funded.
Distributions from the trust to the income beneficiary are taxable using a four-tiered accounting system specific to CRTs. Though the trust is tax exempt, it tracks all taxable activity and builds up four buckets of income: ordinary income (e.g., dividends and interest), capital gains, tax-free income (e.g., municipal bond income), and return of principal. Distributions will first pull from ordinary income until that bucket is exhausted, then will pull from capital gains, and so on.
Types of CRTs
Charitable remainder annuity trust (CRAT). Annual distributions to income beneficiaries are represented as percentages between 5 percent and 50 percent of the initial net fair market value of the assets used to fund the trust. The payout is fixed, so if trust earnings are inadequate to meet the required amount, the remainder must be pulled from principal. Additional contributions to a CRAT are not permitted. Because of the guarantee of annual payouts, this trust is most attractive to older grantors.
Charitable remainder unitrust (CRUT). The annual payout is variable—a percentage amount between 5 percent and 50 percent of the current fair market of the assets in the trust, which is called the unitrust amount. Assets are revalued each year; if the principal increases, the payout increases. Younger grantors, who can risk reductions in payouts in return for the potential to shield against inflation, prefer a CRUT.
Net-income CRUT (NICRUT). This enables the trustee to distribute an annual payment that is the lesser of the unitrust value in that year or the net income earned by the trust in that year. Net income can be defined in the trust document or by state law.
Net-income makeup CRUT (NIMCRUT). This is a variation on the NICRUT. If the net income in a given year is less than the unitrust amount, this trust enables the difference to be made up in future years if income exceeds the unitrust amount.
Flip charitable remainder unitrust (Flip-CRUT). This trust is a NICRUT or NIMCRUT that “flips” to a standard CRUT upon a triggering event. Triggering events include the donor reaching a certain age, getting married or divorced, or becoming able to sell a previously illiquid asset. This is often used by donors who won’t need trust income until sometime in the future and want to maximize returns on trust assets.
Making the Right Decision
Even when you know the details, it can still be difficult to decide which type of CRT is the best fit for your specific situation. If you have any questions or would like to discuss your options in depth, I am here to help. Along with your attorney, we can sort out exactly which trust is right for you.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
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