Charitable Remainder and Lead Trusts

Charitable remainder trusts and charitable lead trusts are split-interest trusts that divide benefits between charitable and non-charitable beneficiaries. These structures allow donors to support charitable causes while retaining income streams or passing wealth to family members, often with significant tax advantages.

Charitable Remainder Trusts (CRTs)

A charitable remainder trust provides income to the donor or other non-charitable beneficiaries for a specified period, after which the remaining trust assets pass to one or more charities.

Basic Structure:

1. Donor transfers appreciated assets to an irrevocable CRT
2. Trust sells assets without recognizing immediate capital gain
3. Trust pays income to donor (or other beneficiaries) for life or a term of up to 20 years
4. At termination, remaining assets pass to designated charity
5. Donor receives income tax deduction for present value of charitable remainder

Key Tax Benefits:

• Capital Gains Deferral: The CRT can sell appreciated assets without paying capital gains tax at the time of sale. Gains are recognized by beneficiaries as distributions are received, spread over many years.
• Income Tax Deduction: The donor receives a charitable deduction equal to the present value of the remainder interest passing to charity.
• Estate Tax Removal: Assets in the CRT are not included in the donor's estate.

CRAT vs. CRUT: Two Types of Charitable Remainder Trusts

Charitable Remainder Annuity Trust (CRAT):

• Pays a fixed dollar amount annually (at least 5% of initial contribution)
• Payment remains constant regardless of trust performance
• No additional contributions permitted after initial funding
• Better suited for donors wanting predictable income
• Risk: If trust assets decline, payments may deplete principal

Charitable Remainder Unitrust (CRUT):

• Pays a fixed percentage of trust value, revalued annually (at least 5%)
• Payment fluctuates with trust performance
• Additional contributions permitted
• Better suited for donors wanting inflation protection
• Variations include Net Income CRUT (NICRUT) and Net Income with Makeup CRUT (NIMCRUT)

Minimum Remainder Requirement:

For both types, the present value of the charitable remainder must be at least 10% of the initial contribution. This requirement limits the payout rate and term combination that can be selected.

Calculating the Income Tax Deduction

The charitable deduction equals the present value of the remainder interest, calculated using:

• The fair market value of contributed assets
• The payout rate selected
• The term of the trust (lives or years)
• The IRS Section 7520 rate (published monthly; December 2024: 5.2%)
• For lifetime trusts: the beneficiary's age(s) using IRS mortality tables

Higher payout rates and longer terms reduce the deduction. Younger beneficiaries reduce the deduction for lifetime trusts. Higher Section 7520 rates generally increase the deduction.

Charitable Lead Trusts (CLTs)

A charitable lead trust is the inverse of a CRT: charity receives income payments for a specified period, and the remaining assets pass to non-charitable beneficiaries (typically family members).

Basic Structure:

1. Donor transfers assets to CLT
2. Trust pays annual amounts to charity for a term of years
3. At termination, remaining assets pass to family members
4. Tax treatment depends on trust type (grantor vs. non-grantor)

Types of Charitable Lead Trusts:

Grantor CLT:

• Donor receives immediate income tax deduction for present value of charitable interest
• Donor is taxed on all trust income during the trust term
• Best suited for years with unusually high income
• Assets may still be included in estate if donor dies during term

Non-Grantor CLT:

• No income tax deduction for donor
• Trust is a separate taxpayer; deducts charitable payments against income
• Gift to remainder beneficiaries valued at present value of remainder (can be zero or negative)
• More commonly used for wealth transfer planning

CLAT vs. CLUT:

• Charitable Lead Annuity Trust (CLAT): Pays fixed amount to charity; appreciation above payment rate passes tax-free to remaindermen
• Charitable Lead Unitrust (CLUT): Pays percentage of annual value to charity; less transfer tax leverage

Worked Example: $2 Million Appreciated Stock into CRUT

Background:

Margaret Chen, age 68, owns stock worth $2,000,000 with a cost basis of $200,000. She wants to diversify, generate retirement income, and eventually benefit her alma mater. Selling the stock outright would trigger $1,800,000 of capital gains, resulting in approximately $360,000 of federal tax (20% rate) plus state taxes and the 3.8% net investment income tax.

CRUT Structure:

Margaret establishes a Charitable Remainder Unitrust with the following terms:

• Initial contribution: $2,000,000 of appreciated stock
• Payout rate: 5% of trust value, annually
• Income beneficiary: Margaret, for her lifetime
• Remainder beneficiary: State University Foundation

Step 1: Contribution and Sale

Margaret transfers the stock to the CRUT. The trust sells the stock for $2,000,000. Because the CRT is tax-exempt, no capital gains tax is due at the time of sale. The full $2,000,000 is available for reinvestment.

Step 2: Calculate Charitable Deduction

Using IRS tables with the following assumptions:

• Section 7520 rate: 5.2% (December 2024)
• Margaret's age: 68
• Payout rate: 5%

The remainder factor for a 68-year-old with a 5% payout at 5.2% Section 7520 rate is approximately 0.4412.

Charitable deduction = $2,000,000 × 0.4412 = $882,400

Margaret can deduct $882,400 against her income taxes, subject to AGI limitations (generally 30% of AGI for gifts of appreciated property to public charities). Unused deductions carry forward for five years.

Step 3: Annual Income Payments

Year 1: Trust value is $2,000,000. Margaret receives 5% = $100,000.

Assuming 7% annual trust growth and 5% annual distribution:

If Margaret lives to age 88 (20 years), she would receive cumulative distributions of approximately $2,358,000, and the trust would be worth approximately $2,732,000 for charity.

Step 4: Taxation of Distributions

CRT distributions are taxed under a four-tier system:

1. Ordinary income (to extent of trust's ordinary income)
2. Capital gains (to extent of trust's accumulated capital gains)
3. Other income (tax-exempt income, etc.)
4. Return of principal (tax-free)

Margaret's $1,800,000 of built-in capital gain is recognized as she receives distributions. In Year 1, her $100,000 distribution might be characterized as:

• Long-term capital gain: $100,000 (until the $1,800,000 is exhausted)
• Tax at 20%: $20,000 (plus 3.8% NIIT if applicable)

Summary of Benefits:

Compared to selling stock and investing after-tax proceeds, Margaret has significantly more capital working for her and a substantial tax deduction, while ultimately benefiting her chosen charity.

Comparing CRTs and CLTs

Practical Considerations

Minimum Funding: Most trustees require minimum contributions of $100,000-$500,000 due to administrative costs.

Irrevocability: Once funded, CRTs and CLTs cannot be revoked or modified (with limited exceptions).

Charitable Beneficiary Changes: Most trusts allow changing the charitable beneficiary, but the new beneficiary must be a qualified charity.

Private Foundation as Remainder Beneficiary: Using a private foundation as CRT remainder beneficiary reduces the income tax deduction (30% AGI limit vs. 60% for public charities).

Professional Administration: Most donors use institutional trustees or trust companies to manage these complex structures.

Pre-Implementation Checklist

• Identify appreciated assets suitable for contribution
• Calculate built-in capital gains and potential tax liability if sold outright
• Determine income needs and appropriate payout rate (5%-50% for CRTs)
• Select trust type: CRT vs. CLT, annuity vs. unitrust
• Calculate charitable deduction using current Section 7520 rate
• Verify remainder interest meets 10% minimum (for CRTs)
• Identify qualified charitable beneficiaries
• Consider naming donor-advised fund or private foundation as remainder beneficiary
• Select qualified trustee (individual, corporate, or institutional)
• Draft trust document with qualified attorney
• Obtain appraisal for non-publicly traded assets
• File Form 5227 (CRT annual return) and applicable state filings
• Coordinate with overall estate plan and other charitable giving
• Review AGI limitations on charitable deduction
• Plan for carryforward of unused deduction (5-year limit)