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Unlock Tax Benefits and More While Giving Back with a CRT

Would you like to support your favorite charitable organizations while maintaining an income stream for yourself and saving taxes? A charitable remainder trust (CRT) might be right for you. It can be a particularly powerful tool if you hold highly appreciated assets that you’d like to sell, but you’re worried about the tax cost.

How It Works

A CRT is an irrevocable, tax-exempt trust. You contribute assets to the CRT, and it provides income to you for a set number of years (up to 20) or for life. After that, the remaining assets are distributed to one or more qualified charities you’ve chosen.

CRTs come in two main forms:

1. Charitable Remainder Annuity Trusts (CRATs). A CRAT pays a fixed dollar amount each year. It’s simple and predictable. But you can’t add assets to the trust once it’s funded, and your distributions won’t increase if the assets held by the CRAT grow.
2. Charitable Remainder Unitrusts (CRUTs). A CRUT pays a fixed percentage of the trust’s value, recalculated annually. So payments may vary, increasing if the trust assets grow but decreasing if they lose value. Also, additional contributions are allowed.

With both CRT types, the assets you contribute are removed from your estate, and you can claim an income tax deduction based on the present value of what the charity is projected to eventually receive. The IRS has strict formulas to calculate the deduction, and the value of the charitable remainder must equal at least 10% of the initial contribution.

Tax Advantages

CRTs offer various potential tax benefits:

Capital gains tax reduction and deferral. Contributing highly appreciated assets (such as stock or real estate) to a CRT can be particularly beneficial. Because the CRT is tax-exempt, it can sell the assets without incurring any capital gains tax at the time of the sale. When you receive payments from the CRT, you might owe some capital gains tax. But only a portion of each payment will be attributable to capital gains; some may be considered tax-free return of principal. And because the payments are spread over time, much of the tax liability will be deferred. This also may help you reduce or avoid exposure to the top 20% long-term capital gains tax rate or the 3.8% net investment income tax.

Charitable deduction. As noted earlier, when you create the trust, you can claim an income tax deduction based on the present value of the remainder interest designated for charity. However, the benefits of itemizing deductions vs. claiming the standard deduction must be considered. This deduction is also subject to annual adjusted gross income limits. But if it’s not fully used in the first year, the remainder may be carried forward for up to five years.

Estate tax savings. Assets transferred to a CRT are no longer part of your estate. So they won’t be subject to estate tax regardless of the size of your available estate tax exemption.

The combined tax savings from using a CRT can be significant. (See “Case Study: Diversifying Concentrated Stock Holdings” below.)

Naming Other Beneficiaries or Funding at Death

You don’t have to name yourself as the CRT’s income beneficiary. For example, you may wish to provide income to an adult child or other loved one. If you choose a beneficiary who’s younger than you and the term is for life, the tax deduction will be lower. This is because the IRS formula will assume that the charity will receive less due to the longer potential payout period. Additional gift tax or generation-skipping transfer tax considerations may also apply, depending on the beneficiary.

Alternatively, you can establish a CRT through your will, known as a testamentary CRT. In this case, the trust is funded at your death, and the income beneficiary could be your spouse or another heir. Testamentary CRTs can be especially helpful in planning for heirs who need an income stream while ensuring that the remainder benefits a charitable organization. Your estate might qualify for charitable deductions, but there also could be estate tax implications related to the payments going to the beneficiary.

Professional Advice Required

CRTs offer significant benefits, but they aren’t DIY arrangements. Additional rules apply beyond what’s been discussed here, including limitations on how the trust is funded, required minimum payout rates and restrictions on charitable beneficiaries. Poor structuring or administration can jeopardize the trust’s tax-exempt status and your tax deduction.

For these reasons, it’s essential to consult with your tax and legal advisors before moving forward. They can help determine if a CRT is the right fit for your financial goals, charitable intent and family circumstances. And, if you decide to move forward with a CRT, they can also help ensure the trust is properly drafted and administered in compliance with IRS rules.

Case Study: Diversifying Concentrated Stock Holdings Michael owns $2 million of a single publicly traded stock with a cost basis of only $250,000. Selling it outright would result in a $1.75 million capital gain — and approximately $416,500 in capital gains taxes (assuming a 23.8% rate). Looking to diversify without taking such a large tax hit, Michael contributes $1.2 million of that stock to a CRT. The CRT sells the stock without triggering capital gains tax, preserving the full proceeds for reinvestment in a more diverse portfolio. Michael receives an annual income stream from the trust and spreads any capital gains tax over many years. This helps him to stay under the thresholds for the 20% long-term capital gains tax rate and the 3.8% net investment income tax in some years. He also claims a charitable deduction in the year he sets up the trust, based on the projected amount going to charity at the end of the term. While this is a simplified example, it illustrates how CRTs can provide tax and other financial benefits while supporting a philanthropic legacy.