The Power of the Charitable Remainder Trust

The Power of the Charitable Remainder Trust

The Charitable Remainder Trust or CRT is a very powerful tool to save taxes and protect assets. In fact, there are a number of benefits available to the average taxpayer. The CRT can be an important option for anyone selling an asset with a big gain!

What is a Charitable Remainder Trust?

A CRT is an irrevocable trust that makes sense when you have a highly appreciated asset and facing some serious taxes. You could actually use a CRT for ANY of the following:

  • Rental property
  • Raw land
  • Cryptocurrency
  • Stock
  • Small Business
  • Venture Capital Business Interest
  • Precious Metals
  • Artwork or any collectible
  • Oil, Gas, Mineral or Water interest
  • The list goes on and on…

The strategy (described more fully below) is essentially that of transferring ‘the asset’ into a CRT that sells the asset ‘tax-free’ and you get to invest the proceeds with the cash flow coming to you for the rest of your life…you also get a tax-deduction to boot!

What Taxes am I trying to avoid with a CRT?

The root of the problem is that when you sell any of these assets above with a big gain (held short-term or long-term), the taxes could be brutal. If you’re lucky you will get Long-Term Capital Gains rates, but then you could be dealing with State Tax, ACA Net-Investment Income Tax (ObamaCare), and heaven forbid Ordinary Income Tax Rates!! Specifically, here are the taxes to be aware of:

  • Long-Term Capital Gains (15-20%)
  • State Taxes (3-13%)
  • Net Investment Income Tax (2.8%)
  • Ordinary Income (Short-Term Capital Gains) (10-37%)

…and just to add to this stress, here in early 2021, the Biden Administration wants to increase the Ordinary Tax Rates, and if you have a big gain you would get pushed out of the Capital Gains Table and back over to the highest rate in the Ordinary Tax Bracket (39%).

Example

Let’s say you are married, living in California with an annual combined income of $150,000. After the standard deduction ($25,100) you would have a taxable income of approximately $125,000. This would put you in the marginal bracket of 22%. But if you had a unique one-time event of $1.5M of income from the sale of any of the assets listed above, you would have a 20% cap gain rate, 12.3% State Tax rate, and 3.8% ACA tax rate, for a total of 36.1% of tax on the bulk of the income. Not to mention how much may get taxed under the Biden Tax Plan (which we have yet to see the details).

Because of this example above, and a significant tax bill, taxpayers may opt for the CRT and pay zero tax – Fed, State, or ACA!!

I discuss this strategy in detail in Chapter 14 of my book The Tax and Legal Playbook and work with clients on a regular basis implementing this powerful tax tool. In fact, students in my presentations tend to be blown away by how amazing the CRT can be.

What are the main benefits of a Charitable Remainder Trust?

A number of advantages may flow from a well-crafted CRT. However, keep in mind that there is almost an infinite number of variations depending on the type of asset, the gain, the age of the taxpayer, whether they are married or single, their typical tax bracket, and how much of a tax deduction on cash flow they want at the end of the process. There is A LOT of variables to consider.

Nonetheless, most agree that there are (6) six major benefits with the CRT as follows:

  1. Pay no tax whatsoever on the sale of the asset. Thereby creating a larger ‘pool’ of money the trustee can invest within the CRT.
  2. Receive a current income tax deduction for the charitable contribution of the value of the asset to the trust. The deduction is permitted when the trust is created even though the charity has yet to sell the asset donated to the CRT.
  3. The CRT creates an asset-protected plan for the proceeds from the sale that are generally untouchable by creditors of the donor (assuming the CRT is entered into before any ’cause of action’ or judgments and avoiding a fraudulent transfer claim).
  4. The trustee of the CRT will pay out a stream of income to the donor/taxpayer for life, based on the value of the CRT. This annuity or percentage will vary dramatically based on the age of the taxpayer, the value of the CRT, and the amount of the tax deduction.
  5. The trust will be eligible for the estate tax charitable deduction if it passes to one or more qualified charities at your death, or even excluded from the value of your estate entirely.
  6. Finally, through the leveraging effect of life insurance, it is possible to pass on assets of greater value to your family ‘tax-free’, rather than those contributed to the CRT. This is accomplished by purchasing life insurance with some of the cash flow from the CRT for a period of time (typically accomplished through a separate Irrevocable Life Insurance Trust). In this way, your heirs are not deprived of property they had expected to inherit.

What Are the Basic Steps Involved in Creating a Charitable Remainder Trust?

Keep in mind that there can be a lot of variations on this basic plan, and charities are more than willing to get creative to meet a donor/property seller’s needs.  However, below are the basic steps with a standard CRT plan.

1. Create the trust, designate the charity, and define the terms of the trust. For example, what amount of income from the trust will be paid to the donor, and when and how it will be disbursed.

2. Donate/transfer property to the trust. This needs to take place before the property is put under contract; other IRS rules apply as to the timing of the trust and the transfer and sale of the property.

3. The trustee sells the property to a third party tax-free. All proceeds from the sale of the property donated to the trust go into a trust account controlled by the trustee.

4. The donor takes a tax deduction over the next five years. The deduction will be based on the property value, typically determined by the sale to the third party or an appraisal.

5. The trust pays income or an annuity to the donor for life. Again, the terms of the trust will direct the trustee as to how to invest the trust assets, and when and how to distribute funds.

6. The donor may fund life insurance. The income paid to the donor can then fund a separate irrevocable life insurance trust on the life of the donor and/or their spouse. This is the final piece of the equation, as you can see in Figure 14.2  below (a diagram from my book The Tax and Legal Playbook in Chapter 14).

 

Charitable Remainder Trust Diagram

7. The charity gets the remaining money in the trust in 20 years or upon the donor’s death, whichever is longer. This is typically the incentive for the charity to pay for preparing and implementing the entire charitable trust strategy.

8. The family gets life insurance tax-free upon the donor’s death. As I mentioned in No. 6, this is the life insurance policy that will be paid tax-free to the beneficiaries upon the donor’s passing and, in effect, replace the value of the assets that were donated to the charity.

Many taxpayers are surprised to learn that this strategy is allowed by the IRS and has been for many years. There are so many reasons why the parties involved benefit, and why the IRS effectively loses. The reason the government allows it is because of its beneficial impact on charities and thus society as a whole.

Bottom line, if you have highly appreciated property, meet with your tax advisor or lawyer to consider this powerful tool as an option.

* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.

Mark J. Kohler is a CPA, Attorney, co-host of the PodCasts “The Main Street Business Podcast” and “The Directed IRA Podcast”, and the author of “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”, as well as several other well-known books. He is also the CFO of Directed IRA Trust Company, and a senior partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP, and the accounting firm K&E CPAs, LLP. 

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