Specimen provisions: To aid drafters of charitable remainder trust agreements, the Internal Revenue Service has issued specimen provisions in such agreements. Many of these can be found in the August 2003 Internal Revenue Procedure 2003-54 which contained eight new charitable remainder annuity trust specimen documents (Rev. Proc. 2003-53 through Rev. Proc. 2003-60). In 2005, the IRS released eight new charitable remainder unitrust specimen documents (Rev. Proc. 2005-52 through Rev. Proc. 2005-59).
The document suite in Gift Planner’s Work Station™ utilizes the critical specimen language as well as many features not included in the IRS specimen language.
Charitable remainder trust for a term of years: An annuity trust or unitrust may be set up for a specified number of years (not to exceed 20). See IRC section 664(d). It is possible to establish a trust for one or more lives or up to 20 years, whichever is a longer or shorter period. It is not possible to provide for a trust to last for the life of one or more individuals plus 20 years.
Unitrusts: A charitable remainder unitrust pays out an amount generally equal to a fixed percentage—at least 5% and not more than 50%, as selected by the donor—of the value of trust assets for that particular year. As directed by the trust agreement, the trust assets are commonly valued on the first business day of each taxable year. A unitrust may also be designed to pay out whichever is less—its net income for the year or the specified fixed percentage amount. This is commonly called a “net income” unitrust.
With a net income unitrust, the trust agreement may provide that for years in which trust net income exceeds the specified unitrust amount, the excess income may be used to “make up” for past years in which trust net income was less than the specified unitrust amount. This type of unitrust is known as a “net income unitrust with a make-up (or catch-up) provision.” See IRC section 664(d)(2).
A net income unitrust (with or without a make-up provision) is ordinarily used when the charitable remainder trust is to be funded with unimproved real estate or another type of asset that produces relatively little or no income.
Another use for the net income unitrust with make-up provision is retirement planning. The trust assets are invested voluntarily by the trustee in low-yield, high-growth assets during working years. At retirement, the gains are taken tax-free within the trust, and the trustee then invests the proceeds in higher-yield assets in funding retirement needs. Check for current regulations regarding this type of trust.
Flip unitrusts: Final IRS regulations issued in December 1998 allow for the creation of so-called “flip unitrusts”—trusts designed to start as net income or net income with make-up unitrusts, which “flip” to become straight-payout unitrusts following some “triggering event.”
The triggering event generally must be an event outside the trustee’s control or any other person. Permissible triggering events include marriage, divorce, birth, or death. The sale of an unmarketable asset is also a permissible triggering event. Impermissible triggering events include the sale of a marketable asset or a request from the donor or any other person or entity that the trust flip. The flip occurs as of the first day of the taxable year following the year in which the triggering event occurs. See Reg. section 1.664-3(a)(1)(i)(f).
Tax considerations: When a qualified charitable remainder trust is created, a current tax deduction is allowed for the value of the charitable remainder interest (except in certain situations involving funding the trust with tangible personal property). The method of computing the deduction is described in Reg. section 1.664-4. See IRC section 170(a)(3).
The Taxpayer Relief Act of 1997 added the requirement that the initial present value (as determined under IRS guidelines) of the charitable remainder interest be no less than 10% of the value of the assets contributed to fund the trust. The IRS had previously determined that no deduction would be allowed if it determined that the terms of a trust would lead to a 5% or greater probability that the trust assets would be exhausted before the trust’s termination. The so-called “5% probability test” is laid out in Rev. Ruling 77-374.
If an individual establishes a charitable remainder trust for their life only, the trust assets will be included in their gross estate under IRC section 2036. However, the amount included will “wash out” as an estate tax charitable deduction under IRC section 2055. A surviving spouse’s interest in a qualified charitable remainder trust qualifies for the estate tax marital deduction. See IRC section 2056(b)(8). Note that the marital deduction is lost if there is any non-charitable beneficiary of the trust other than the donor and the donor’s spouse.
Assets sold by a charitable remainder trust are exempt from the capital gains tax, as the trust is a tax-exempt entity (except for any unrelated business taxable income for the year). This can be advantageous for donors who wish to fund such a trust with highly appreciated, low-yielding assets. The trust will retain the entire net proceeds of the sale of such assets, which can then be reinvested in higher-yielding investments.
There is a four-tier system of attributing ordinary income, capital gain, tax-free income, and corpus to the trust payout. See IRC section 664(b).
This provision may be very favorable in instances where appreciated assets have been used to fund the trust, as distributions deemed to be trust corpus will be reported by the donor as capital gains income until all capital gain realized by the trust has been “paid out.” This is especially attractive to donors who pay tax on capital gains at significantly lower rates than the tax on other income.
Under the four-tier system, it can be possible to report dividend income from a charitable remainder trust at lower tax rates than would be payable on other ordinary income. In addition, income earned by a charitable remainder trust from tax-exempt bonds can be received free of tax by a trust beneficiary.
Recipients of income from a qualified charitable remainder trust should seek guidance from the trust fiduciary and their tax advisor when reporting income from this source.
Mortgaged property: In Letter Ruling 9015049 (January 16, 1990), the IRS ruled privately that a trust cannot be a qualified charitable remainder trust if any trust income (which includes realized capital gain) is used to pay a mortgage debt on which the donor is personally liable. There are, however, ways to use property subject to such a mortgage to establish a charitable remainder trust. The most obvious way is for the donor to pay off the mortgage before transferring the property to the trust.
Rev. Proc. 2005-54 Charitable Remainder Unitrust, two lives, consecutive interests
Rev. Proc. 2005-55: Charitable Remainder Unitrust, concurrent and consecutive interests
