Charitable Remainder Annuity Trust

Some planned giving programs will accept gifts of real property through a retained life estate or a charitable remainder trust. Determining which split-interest gift is the right option depends on the needs and interests of the donor and the charity. The two options are described below followed by some questions to help guide you through conversations with your donors about gifts of real property.

When a donor funds a charitable remainder trust (CRT), the assets are irrevocably transferred to the trust. The trust makes distributions to one or more non-charitable beneficiaries, usually including the donor, for life and/or a term of years (not to exceed 20 years), after which the remainder passes to charity. The donor receives a charitable deduction at the time of the gift to the CRT, which is the present value of the remainder interest expected to pass to charity. The remainder interest is calculated based on the life expectancy of the beneficiaries, the term of years, or a combination of the two. For CRTs funded after July 28, 1997, the remainder value must be at least 10% of the initial gift value.

A CRT is irrevocable, however, the trust can be terminated early, with the remainder passing then to charity if all the parties (trustee, beneficiary, and charity) agree.

The persistently low IRS discount rates over the past five years has had a chilling effect on charitable remainder annuity trusts (CRATs). One reason is that these low rates have made 1-life CRATs unavailable for beneficiaries younger than their early 70s. Beneficiaries of 2-life CRATs must be even older. The roadblock has been the 5% probability of exhaustion test.

Why Size Matters

A primary objective in establishing and operating any CRT is to ensure the CRT will have enough money to make the required payments to its life income beneficiary(ies) each year throughout the trust term.  Even with a low payout rate, in any given year trust income may fall short of the amount that needs to be paid.  Unless the CRT is a charitable remainder unitrust (CRUT) with a net-income limitation, the CRT will have to make up the difference by drawing on principal.

Generation skipping transfer tax is a federal transfer tax that is assessed on an individual who transfers assets to a "skip person" during life or by will. This tax is assessed in addition to gift or estate tax. Its purpose is to prevent donors from avoiding transfer taxation in one generation by giving assets directly to the next generation.

The four tiers of income are IRS tax reporting rules that dictate the order in which a charitable remainder trust must distribute the four types of income when fulfilling payments to its income beneficiaries.

The 5% probability test is a test described in Revenue Ruling 77-374 that requires all charitable remainder annuity trusts (CRAT) that will make payments for one or more lifetimes to have less than a 5% chance of corpus exhaustion. The test is conducted using the same facts used to compute the provisional charitable deduction for the gift.

The remainderman is the recipient of a trust's proceeds when the trust terminates.

In the context of planned giving, remainderman usually refers to the charity that will receive the final distribution from a charitable remainder trust or pooled income fund. Technically speaking, gift annuity and retained life estate gifts do not have a remainderman because the charity takes possession of the gift assets immediately.

A charity's remainder interest in a planned gift equals the present value of the promise to distribute the remaining principal of the planned gift when it terminates.

In the case of life income gifts, such as a gift annuity or a charitable remainder unitrust, the charity owns the remainder interest in the gift.  In the case of a lead trust, individuals named by the donor own the remainder interest in the gift.

The remainder factor is the fraction of the funding amount of a planned gift that is considered a charitable contribution, expressed as a decimal. The remainder factor multiplied by the funding amount equals the value of the charitable contribution.

For example, if the remainder factor for a charitable remainder unitrust is .24561 and the unitrust is funded with $100,000, the value of the charitable contribution is .24561 x $100,000 or $24,561.