Charitable remainder trust

A charitable remainder trust is an irrevocable trust that splits the beneficial interest into an income stream for the donor or other beneficiaries and a remainder interest for charity. The donor transfers assets (often appreciated securities or real estate) into the trust, which then sells the assets without immediate capital gains tax because the trust is tax-exempt. The trust pays the non-charitable beneficiary a fixed percentage of the initial fair market value (in a CRAT) or a percentage of the annually revalued trust assets (in a CRUT). At the end of the term—either the death of the income beneficiary or a specified period not exceeding 20 years—the remaining trust assets are distributed to one or more qualified public charities or private foundations.¹

The donor receives a charitable income tax deduction in the year of the transfer, equal to the present value of the remainder interest, calculated using IRS tables and the applicable federal rate. To qualify, the trust must meet several statutory tests: the payout rate must be at least 5% and not more than 50% of the initial fair market value (for CRATs) or of the annual value (for CRUTs); the actuarial value of the remainder must be at least 10% of the initial fair market value; and the trust must be a valid trust under state law. The trust itself is exempt from income tax, but distributions to beneficiaries are taxed under a four-tier ordering rule that characterizes income as ordinary income, capital gain, tax-exempt income, or corpus.²

Beyond the standard CRAT and CRUT, several specialized CRUT variants exist: the net income with makeup CRUT (NIMCRUT) pays only net income, with deficits made up in later years; the flip CRUT converts from a net-income to a standard unitrust upon a triggering event, such as the sale of unmarketable assets; and the charitable remainder unitrust with a qualified contingency allows a reduced payout if a specified event occurs. CRTs are often used to defer capital gains on the sale of a closely held business or real estate, to provide retirement income, or to fund a charitable legacy. They are also used in conjunction with charitable lead trusts to achieve both income and estate tax objectives.³

One lesser-known aspect is that a CRT can be funded with a life insurance policy, though the donor must transfer the policy and name the trust as owner and beneficiary. Another is that the IRS requires the trust to be a "qualified" trust, meaning it must be a trust under state law and not a trust that is part of a retirement plan. The 10% remainder test was added by the Tax Reform Act of 1969 to prevent abuse, and it can be particularly challenging for younger donors because the remainder value is lower when the income interest is longer. Additionally, CRTs are often used in "charitable remainder trust sales" where the donor sells appreciated property to the trust in exchange for an annuity, a technique that requires careful structuring to avoid gift tax. Finally, the trust must file an annual tax return (Form 5227) and provide beneficiaries with Schedule K-1, even though the trust itself pays no income tax.⁴

CRAT

Charitable remainder annuity trust; pays a fixed dollar amount annually.

CRUT

Charitable remainder unitrust; pays a fixed percentage of the trust's annually revalued assets.

NIMCRUT

Net income with makeup unitrust; pays only net income, with deficits made up in later years.

Remainder interest

The portion of the trust assets that eventually goes to charity.

Qualified charity

A public charity or private foundation that meets IRS requirements for receiving deductible contributions.