12 minute readGiving Back to the Community:
Installment Four of Five
The Giving Back to the Community Series examines the benefits of charitable giving from the donor and their family's perspective and sheds light on three common strategies. The series will include five separate articles dealing with:
Installment One: What charitable giving can mean to you and your family
Installment Two: How A Private Family Foundation Works
Installment Three: What is a Donor-Advised Fund
Installment Four: The Use of a Charitable Remainder Trust
Installment Five: Compares the three methods for you to consider when deciding on how to give back to the community
Now, more than ever, we need all of us to expand our charitable giving, and Dunham hopes this series helps.
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A life is not important except in the impact it has on other lives.
In the summer of my 10th year, I read the biography of Jackie Robinson. The final page had the above quote and nothing more. I may have spent more time on that one page than the entire book.
The concept of positively impacting other lives intrigued me. I remember unfolding the idea of impacting lives, how many lives Jackie Robinson changed, and how that total was too great to count because it went beyond social changes. This impact changed people’s thinking, and his story inspired countless people, including me.
This powerful sentence became a guiding light for me for the rest of my life.
Today, the above quote is written across the Jackie Robinson Rotunda when you enter Citifield, where the New York Mets play.
This series examined two ways to impact other lives: a Private Family Foundation and a Donor-Advised Fund. We looked at how these programs can genuinely create an impact and should be viewed beyond eliminating income and capital gains tax. This article will explore what is known as a Charitable Remainder Trust. This trust can go by several names and formats, like a Charitable Remainder Annuity Trust (GRAT) and a Charitable Remainder UniTrust (CRUT), the two most popular.
What are the Similarities between the Three Charitable Programs?
In addition to the impact on your community these charitable programs bring, all three programs, a Private Family Foundation, a Donor-Advised Fund, and a Charitable Remainder Trust, have these other non-philanthropic traits:
1 – They can reduce your income tax liability
2 – They can eliminate capital gains tax of appreciated assets at the point of sale
3 – They can reduce or eliminate the potential estate tax
4 – They can provide tax-advantaged growth of the assets contributed to these charitable programs.
What Makes a Charitable Remainder Trust Different?
A Charitable Remainder Trust, created by Congress as part of the Tax Reform Act of 1969, is a program that can create benefits beyond income tax and capital gains tax advantages during your lifetime. These advantages include:*
1 – Creates a gift to a charity or a Donor-Advised Fund when you pass away.
2 – For highly appreciated assets donated to the trust, it will eliminate the capital gains tax at the point of sale.
3 - Since you did not pay the capital gains tax, the trust has the money that would have gone to the IRS, which may lead to more lifetime income.
4 - Also, because you are making a charitable gift when you pass away, you will receive a tax deduction you can use to reduce your tax bill in the year you funded your Charitable Remainder Trust.
*Please see important risks and disclosures at the end of this communication.
The Two Most Common Forms of Charitable Remainder Trusts
The two primary trust options that fall under the umbrella of Charitable Remainder Trusts are a Charitable Remainder Unitrust (CRUT) or a Charitable Remainder Annuity Trust (CRAT).
A Charitable Remainder Unitrust allows you to receive a fixed percentage of the trust assets annually, while a Charitable Remainder Annuity Trust distributes a fixed dollar amount annually.
The income distributed to you will generally remain stable with a Charitable Remainder Annuity Trust and fluctuate when using a Charitable Remainder Unitrust. A Charitable Remainder Unitrust's payment will change because it distributes a percentage of assets in the trust. Hence, as the assets in the trust fluctuate in value, so will the income. The income fluctuation in the Charitable Remainer Unitrust is contrasted with a Charitable Annuity Trust, where the income remains constant.
Also worth noting is that with a Charitable Annuity Trust, no additional contributions are allowed beyond the initial contribution. With a Charitable Remainder Unitrust, you can contribute more to the trust during your lifetime.
Your financial advisor can work with you to determine which of these two would be best for you.
How Does a Charitable Remainder Trust Work?
A Charitable Remainder Trust is a powerful solution for eliminating capital gains tax at the point of sale of highly appreciated assets, like real estate or stock, and in the process, converting them into lifetime income. As you establish the trust, you are also planning the impact you want to make on the community by naming a charity or donor-advised fund that will receive what remains in the trust when you pass away.
What Types of Assets can you Place Within a Charitable Remainder Trust?
You typically fund Charitable Remainder Trusts with highly appreciated assets like publicly traded securities, bonds, cyber currencies, real estate, C-Corp stock, and more. You can simply use cash as well when funding the trust. It is important to note that certain types of closely-held stock, such as S-Corp stock, do not qualify.
Unfolding a Hypothetical Example of a Charitable Remainder Trust
For this hypothetical illustration, we will look at the Charitable Remainder Unitrust, although the steps we will examine are primarily the same for Charitable Remainder Annuity Trusts.
Let us assume that Mary is selling a stock with substantial gains. Remember, this strategy is not just for stocks but most other assets.
As Mary contemplates this stock sale, her CPA tells her she will pay a relatively large capital gain tax.
Let's assume that Mary lives in a state with a 5% state tax, and the result of the gain is that it will put her in the highest tax bracket. That would mean that the tax she pays would be:
• 20% in federal capital gains tax
• 5% state tax, and
• 3.8% net investment income tax
That is 28.5% of the gain to the IRS.
Instead, let's assume Mary's CPA and financial advisor recommend she uses a Charitable Remainder UniTrust.
Step One:
Mary's attorney drafts the trust,
Step Two
Mary will donate the stock to the newly formed Charitable Remainder Unitrust her attorney drafted, and her trustee will sell the stock inside the trust.
Step Three
Because a Charitable Remainder UniTrust is a tax-exempt entity, she avoided the federal gains tax at the point of sale!
Step Four
Mary is the trust's income beneficiary and will now receive lifetime income from the trust.
Step Five
Since Mary is making a gift when she passes away, she will receive a tax deduction on a portion of the stock gifted to the trust, reducing the income tax she pays that year.
Step Six
Based on an IRS actuarial formula, she only needs to leave 10% of the asset she sold in the trust for the charity, meaning she can choose to receive up to 90% of the value of the stock distributed to her in her lifetime. It is also important to note that the other IRS regulation is that the Charitable Remainder Trust must distribute a minimum of 5% of its assets each year.
Step Seven
When Mary created the Charitable Remainder UniTrust, she named a charity or Donor-Advised Fund as the remainder beneficiary. The remainder beneficiary means that what remains in the trust will be donated to the charity or the Donor-Advised Fund when she passes away. Hence the name Charitable Remainder Trust.
Step Eight
Mary's income from the trust will have special tax treatment and be a combination of ordinary income, capital gains, or tax-free, depending on various factors her tax advisor can explain.
Conclusion
A Charitable Remainder Trust can potentially provide you with benefits during your lifetime and an opportunity to impact others once you pass away. In conclusion, a Charitable Remainder Trust may provide:
1. An opportunity to convert an appreciated asset into lifetime income.
2. Reduce your current income taxes with a charitable income tax deduction
3. Can eliminate the capital gain tax at the point of sale of the asset.
4. The elimination of the capital gain tax can allow you to receive more income over your lifetime than if you had sold the asset outside the trust.
5. You support your community's well-being by giving a gift to a charity or Donor-Advised Fund when you pass away.
In addition, you may also:
6. Reduce your estate taxes.
7. Gain asset protection from creditors or predators for the gifted asset.
Understanding the Other Factors
Other important considerations of this strategy include
1. The asset sold passing to a charity when you pass away leaves none of that asset for family members, although life insurance might mitigate this.
2. There are fees associated with this strategy, among which include legal and trustee fees.
3. The trust is not guaranteed and can fluctuate in value.
4. Federal and State laws and regulations are complex and subject to change, which can materially impact your results.
Please read the disclosure following this article explaining these and other facets of this strategy you should be aware of.
If a person's life can be measured by the impact, it makes on other lives, consult with a qualified estate planning attorney, CPA, and financial advisor to confirm that a Charitable Remainder Trust can provide you with the lifetime benefits that suit you and your family and the ultimate benefit it can leave as an impact on your community.
Disclosures:
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax, or investment advice, an investment recommendation, or a substitute for legal or tax counsel. Any investment products, services, and examples named herein are hypothetical and for illustrative purposes only and should not be considered an offer to buy or sell or an investment recommendation for any specific security, strategy, or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Federal and state laws and regulations are complex and subject to change, which can materially impact your results. Charitable deductions at the federal level are available only if you itemize deductions. Rules and regulations regarding tax deductions for charitable giving vary at the state level, and laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of the information provided. Dunham Associates & Investment Counsel, Inc. ("Dunham") cannot guarantee that such information is accurate, complete, or timely; and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
All examples are hypothetical and for illustrative purposes only. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. The solution for an investor depends on their and their family’s unique circumstances and objectives.
Charitable deductions at the federal level are available only if you itemize deductions. Rules and regulations regarding tax deductions for charitable giving vary at the state level, and laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy or completeness of the information provided. Dunham Trust Company cannot guarantee that such information is accurate, complete or timely; and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Although the trust itself is a tax-exempt entity, the trust income distributed to beneficiaries is taxable, according to terms dictated by the U.S. Internal Revenue Code and accompanying U.S. Treasury regulations.
Because the annuity payments from CRATS are fixed and must immediately begin after the creation of the trust, the underlying assets within the structure must be kept highly liquid.
Dunham Trust Company does not guarantee the completion of the installment note as investments will be subject to market conditions.
Dunham does not provide legal or tax advice. Federal and state laws and regulations are complex and subject to change, which can materially impact your results. Dunham cannot guarantee that such information is accurate, complete or timely; and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. All financial decisions and investments involve risk, including possible loss of principal.
Investors should carefully consider a fund’s investment goals, risks, sales charges and expenses before investing. The prospectus contains this and other information. Please read the prospectus carefully before investing or sending money.
A donor advised fund is a separately identified account that is maintained and operated by a section 501( c)(3) organization, and is not a registered investment company.
Contributions to a Donor-Advised Fund are irrevocable contributions. Individuals considering a contribution to a Donor-Advised Fund should consult their legal and tax advisors regarding deductions, based on their personal considerations.
Administrative services fees and other fees may apply. There may be additional fees charged by the Financial Advisor that is separate from the administrative and impact investment fees.
The tax information provided is general and educational in nature, and should not be construed as legal or tax advice. Dunham does not provide legal or tax advice. Content provided relates to taxation at the federal level only. Charitable deductions at the federal level are available only if you itemize deductions. Rules and regulations regarding tax deductions for charitable giving vary at the state level, and laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy or completeness of the information provided. Always consult an attorney or tax professional regarding your specific legal or tax situation.
We encourage you to seek from qualified professionals regarding all, personal finance issues.
The trust is subject to the published fee schedule at the time the trust is established.
There are two types of CRTs, Charitable Remainder Annuity Trusts (CRATS) and Charitable Remainder Unitrusts (CRUTs). Both CRATs and CRUTs require that the payments be made to designated individuals for their lifetimes or a fixed term not exceeding 20 years.
Because the annuity payments from CRATS are fixed and must immediately begin after the creation of the trust, the underlying assets within the structure must be kept highly liquid.
Income tax consequences for the donor can be complex, depending on the individual situation. All or some of the income from the trust may be taxed at ordinary income rates, but part may be taxed at lower capital gains tax rates or may even be tax-free for some years.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA / SIPC. Advisory services and securities are offered through Dunham & Associates Investment Counsel, Inc. Trust services offered through Dunham Trust Company, an affiliated Nevada Trust Company.