What is a Charitable Remainder Trust (CRT)?

A CRT is a tax-exempt trust to which a donor may transfer assets and receive a charitable deduction and income for the term of the trust. The contributed assets are invested for the trust term. At the end of the trust term, the remaining assets of the trust, the “remainder”, are distributed to a qualified section 501(c)(3) charity. The term of a CRT may be for the lives of the named income beneficiaries or for a term of years, not to exceed 20 years. A CRT is tax-exempt unless it receives unrelated business taxable income during the year. CRTs have their own Internal Revenue Code section, section 664.

What are the various formats of CRTs?

There are several CRT formats distinguished by the payout format.

  • Charitable Remainder Annuity Trust (CRAT). A CRAT pays the income beneficiaries of the trust a fixed amount each year. This amount is not subject to change during the term of the trust, regardless of the investment performance of the trust. A CRAT may not receive additional contributions.
  • Charitable Remainder Unitrust (CRUT). A CRUT pays the income beneficiaries of the trust a fixed percentage of the trust’s value as redetermined annually. A CRUT may receive additional contributions. A CRUT also may be referred to as a standard payout charitable remainder unitrust (a SCRUT, S-CRUT, or STAN-CRUT).
  • Net Income Charitable Remainder Unitrust (NICRUT). A NICRUT pays the income beneficiaries of the trust the lesser of (i) a fixed percentage of the trust’s net fair market value of the trust assets as redetermined annually, and (ii) the trust’s net income.
  • Net Income with Make-up Charitable Remainder Unitrust (NIMCRUT). Like a NICRUT, a NIMCRUT pays the income beneficiaries of the trust the lesser of (i) a fixed percentage of the trust’s net fair market value of the trust assets as redetermined annually, and (ii) the trust’s net income. In addition, the trust accumulates any shortfall (i.e., amount by which the fixed percentage amount exceeds the net income) for distribution in future years when the trust’s net income exceeds the fixed percentage amount. The accumulated shortfall is known as the “make-up” amount.
  • Flip Charitable Remainder Unitrust (Flip-CRUT). A Flip-CRUT is a hybrid combination of a NIMCRUT (or NICRUT).and a CRUT. A Flip-CRUT begins its existence as a NIMCRUT and upon the happening of a pre-defined triggering event, the trust’s payout method changes to the fixed percentage payout of a CRUT.

Note: The “net income” and “make-up” provisions are only available to charitable remainder unitrusts. They are not available to charitable remainder annuity trusts.

What is a Charitable Remainder Annuity Trust?

A CRAT is a tax-exempt trust from which a fixed amount is paid to one or more persons, at least annually. This fixed amount may not be changed once the trust is funded. The fixed amount may not be less than five percent nor more than 50 percent of the value of the initial contribution to the CRAT. The term of a CRAT may be for the lives of the named income beneficiaries or for a term of years, not to exceed 20 years. Additional contributions to a CRAT are prohibited. At the expiration of the CRAT’s term, the remaining assets of the trust, the “remainder”, are distributed to a qualified section 501(c)(3) charity. Because a CRAT’s fixed amount may not be changed once the trust is funded, it is best suited for older income beneficiaries for whom the loss of purchasing power over time is not an issue.

What is a Charitable Remainder Unitrust (CRUT)?

A CRUT is a tax-exempt trust from which a fixed percentage of the net fair market value of the CRUT’s assets (redetermined annually) is paid to one or more persons, at least annually. In the event the income and realized gains from the trust are insufficient to pay the required distribution, a CRUT must distribute the principal of the trust. The product of the fixed percentage and the net fair market value of the CRUT’s assets is known as the “unitrust amount” or “fixed percentage amount.” The fixed percentage may not be less than five percent nor more than 50 percent. The fixed percentage may not be changed once the trust is funded.

The term of a CRUT may be for the lives of the named income beneficiaries or for a term of years, not to exceed 20 years. Additional contributions may be made to a CRUT if the trust’s governing document permits. At the expiration of the CRUT’s term, the remaining assets of the trust, the “remainder”, are distributed to a qualified section 501(c)(3) charity.

What is a Net-Income Charitable Remainder Unitrust (NICRUT)?

A NICRUT is a tax-exempt trust to which the trust’s income beneficiaries are paid the lesser of (i) a fixed percentage of the trust’s net fair market value of the trust assets as redetermined annually, and (ii) the trust’s net income. The product of the fixed percentage and the net fair market value of the NICRUT’s assets is known as the “unitrust amount” or “fixed percentage amount.” The fixed percentage may not be less than 5 percent nor more than 50 percent. The fixed percentage may not be changed once the trust is funded.

The term of a NICRUT may be for the lives of the named income beneficiaries or for a term of years, not to exceed 20 years. Additional contributions may be made to a NICRUT if the trust’s governing document permits. At the expiration of the NICRUT’s term, the remaining assets of the trust, the “remainder”, are distributed to a qualified section 501(c)(3) charity. A NICRUT is often used when the trust is initially funded with an illiquid asset that is not readily converted to cash.

What is a Net-Income with Make-up Charitable Remainder Unitrust (NIMCRUT)?

A NIMCRUT is a tax-exempt trust to which the trust’s income beneficiaries are paid the lesser of (i) a fixed percentage of the trust’s net fair market value of the trust assets as redetermined annually, and (ii) the trust’s net income. In addition, the trust accumulates any shortfall (i.e., amount by which the fixed percentage amount exceeds the net income) for distribution in future years when the trust’s net income exceeds the fixed percentage amount. The accumulated shortfall is known as the “make-up” amount. The product of the fixed percentage and the net fair market value of the NIMCRUT’s assets is known as the “unitrust amount” or “fixed percentage amount.” The fixed percentage may not be less than 5 percent nor more than 50 percent. The fixed percentage may not be changed once the trust is funded.

The term of a NIMCRUT may be for the lives of the named income beneficiaries or for a term of years, not to exceed 20 years. Additional contributions may be made to a NIMCRUT if the trust’s governing document permits. At the expiration of the NIMCRUT’s term, the remaining assets of the trust, the “remainder”, are distributed to a qualified section 501(c)(3) charity. A NIMCRUT is often used when the trust is initially funded with an illiquid asset that is not readily converted to cash.

What is a Flip Charitable Remainder Unitrust (Flip-CRUT)?

A Flip-CRUT is a hybrid combination of a Net Income with Make-up Charitable Remainder Unitrust (NIMCRUT) (or a Net Income Charitable Remainder Unitrust (NICRUT)) and a CRUT. See the questions “What is a Net Income with Make-up Charitable Remainder Unitrust?”, “What is a Net Income Charitable Remainder Unitrust?”, and “What is a Charitable Remainder Unitrust?” for a description of these CRT formats. A Flip-CRUT begins its existence as a NIMCRUT or NICRUT and converts (or “flips”) to a CRUT upon the happening of a triggering event. The payout structure changes on January 1 of the year following the year in which the triggering event occurs.

By regulation there are seven permissible triggering events:

  1. The sale of an unmarketable asset;
  2. A date certain;
  3. A birth;
  4. A death;
  5. A marriage;
  6. A divorce; or
  7. An event outside the control of any person.

The triggering event must be stated in the trust’s governing document and may not be altered once the trust is funded.

The term of a Flip-CRUT may be for the lives of the named income beneficiaries or for a term of years, not to exceed 20 years. Additional contributions may be made to a Flip-CRUT if the trust’s governing document permits. At the expiration of the Flip-CRUT’s term, the remaining assets of the trust, the “remainder”, are distributed to a qualified section 501(c)(3) charity. A Flip-CRUT is often used when the trust is initially funded with an illiquid asset that is not readily converted to cash.

Is an income tax deduction allowed for a contribution to a Charitable Remainder Trust (CRT)?

Yes, an income tax deduction is allowed for a contribution to a CRT. However, the allowed deduction is discounted to reflect the fact that the charitable recipient will not receive its share of the trust for many years in the future. This discounted value is referred to as the “present value of the remainder interest.”

Is a gift tax deduction allowed for a contribution to a Charitable Remainder Trust (CRT)?

Yes, a gift tax deduction is allowed for a contribution to a CRT. However, the allowed deduction is discounted to reflect the fact that the charitable recipient will not receive its share of the trust for many years in the future. This discounted value is referred to as the “present value of the remainder interest.”

Is an estate tax deduction allowed for a testamentary contribution to a Charitable Remainder Trust (CRT)?

Yes, an estate tax deduction is allowed for a testamentary contribution to a CRT. However, the allowed deduction is discounted to reflect the fact that the charitable recipient will not receive its share of the trust for many years in the future. This discounted value is referred to as the “present value of the remainder interest.

How is the tax deduction for a Charitable Remainder Trust (CRT) computed?

Whether computing an income tax deduction, a gift tax deduction, or an estate tax deduction, a number of factors are used to compute the amount of the deduction. Specifically (i) the type of CRT, (ii) the ages of the trust’s income beneficiaries or term of years, (iii) the trust’s payout rate, (iv) the frequency of payments to the income beneficiaries, and (v) a discount rate published monthly by the Internal Revenue Service. The monthly discount rate published by the Internal Revenue Service is commonly known as the Applicable Federal Rate (AFR).

Are there any limits to the use of the income tax deduction?

Yes. The tax code limits the use of an income tax deduction to a percentage of the donor’s adjusted gross income (AGI). Unused deduction amounts may be carried forward for an additional five years.

Important: The rules regarding the use of the income tax charitable deduction are complex. It is strongly recommended that you discuss the use of the income deduction with your tax advisor.

What benefits does a donor receive for creating a CRT?

A donor that creates a CRT receives a number of benefits including:

  • The avoidance of capital gains on the contribution of appreciated assets;
  • A current income tax deduction;
  • Increased cash flow (in current years or future years);
  • The opportunity to benefit the charity or charities of the donor’s choice;
  • The ability to diversify a concentrated asset position and reduce investment risk;
  • The reduction of the donor’s taxable estate; and
  • An exit strategy from certain types of business endeavors such as owning and managing rental properties.

Who is an ideal client for a CRT?

A CRT is ideal for clients that want or need:

  • A current income tax charitable deduction;
  • To avoidance of capital gains tax on the sale of an appreciated asset;
  • The tax-advantaged diversification of a concentrated portfolio; and
  • Immediate cash flow.

Is a CRT required to file an annual return with the IRS or State Governments?

Yes, a CRT must file the following forms:

IRS Form 5227, Split-Interest Trust Information Return
Filed with the Internal Revenue Service.  This form is due by April 15 and may be extended to July 15 and October 15.

IRS Form Schedule K-1, Beneficiary’s Share of Income, Deductions, Credits, etc.
Mailed each year to the trust’s income beneficiaries.  It must be mailed by the due date of Form 5227.

IRS Form 8282, Donee Information Return
This form is required to be filed if the CRT sells an unmarketable asset within three years of the contribution date and the donor files Form 8283, Non-cash Charitable Contributions with his or her individual income tax return.

IRS Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code
This form is required to be filed if the CRT must pay the excise tax on unrelated business taxable income or engages in a prohibited act of self-dealing.

State Trust Income Tax Forms
Some states require that a CRT file an income tax return with the state taxing authority, even though the trust is exempt from tax.  In addition, two states, New Jersey and Pennsylvania, do not recognize a CRT as a tax-exempt trust. However, not all states require that a CRT file a state trust income tax return.

State Charitable Registration Forms
Some states require that a CRT register its existence with the state Attorney General and file an annual report with the state Attorney General.

What are the annual valuation rules for a CRT?

The annual valuation date on which a CRT’s net assets are valued should be defined in the trust’s governing document. The most common date on which the net fair market value of a CRT’s assets is determined in the first business day of the calendar year. However, the trust’s governing document may specify that the net assets are to be valued on any date during the taxable year, or by taking the average of valuations made on more than one date during the taxable year of the trust. Whatever method is selected, the same valuation date(s) and methods must be used consistently each year.

What factors should I consider when determining which format of CRT to use?

The choice of CRT format depends upon a thorough analysis of a number of factors, including:

  • The type of assets funding the trust
  • The tax rate applicable to the appreciation in the assets funding the trust (e.g., ordinary income rates or
  • capital gain rates)
  • The age and investment temperament of the income recipient(s)
  • The recipient’s income needs
  • The donor’s goals regarding the size of the ultimate charitable gift
  • A realistic assumed rate of return on the trust’s assets
  • The liquidity (or illiquidity) of the funding asset

Important: A key consideration in the choice of trust format, is the liquidity of the funding asset. Failure to make a required distribution may result in a prohibited act of self-dealing, the realization of unrelated business income, and/or the disqualification of the trust. For example, funding a CRAT or CRUT with an illiquid asset may create challenges if the illiquid asset doesn’t sell prior to the end of the year in which the trust was funded. This is because the CRAT or CRUT will lack the cash necessary to make its required distribution.

What are some common measuring terms for a CRT?

Some common forms of measuring terms for a CRT are:

  • Life only – The trust makes payments to one or more named individuals as long as one individual is alive.
  • Term of years– The trust makes payments to one or more persons for a period not to exceed 20 years.
  • The longer of life and concurrent term of years – The trust makes payments for a guaranteed term (not to exceed 20 years) that is concurrent with the life span of one or more individuals. For example, the trust could pay income to an individual for the life of that individual or for a period of 14 years, whichever is longer. If the individual dies within the first 14 years, income will be distributed to the individual’s estate or named individuals for the balance of the original 14 year period.
  • The Shorter of Life and Concurrent Term of Years – The trust makes payments for the shorter of a term of years (not to exceed 20 years) or the life span of the measuring life. For example, the trust could pay income to an individual for a period of 20 years however, if the individual dies during that 20-year period, all payments stop and the remainder interest then passes to the charitable beneficiary.
  • Lives Followed by the Shorter of Lives or a Term of Years – The trust makes payments to an initial group of named recipients for the balance of their lives. At their deaths, the trust continues to make income payments to a new group of recipients whose income term is measured by the shorter of their lives or a term of years not to exceed 20.  If the second class of recipients dies before the expiration of the term of years (in this example 20), the trust terminates.

Planning Caution: It is important that every life recipient is specifically identified when the CRT document is created.

How can you achieve "income deferral" within a Flip Charitable Remainder Unitrust (Flip-CRUT) or a Net Income with Makeup Charitable Remainder Unitrust (NIMCRUT)?

The Flip-CRUT during its initial phase and the net income charitable remainder unitrust, with or without a make-up provision, are particularly suitable for income deferral because distributions from these types of trust are limited to the net income as determined under state trust law principles.  This net income is known as “trust accounting income” (TAI) or “fiduciary accounting income” (FAI).  Income deferral is achieved in a Flip-CRUT or NIMCRUT by careful drafting to support an investment plan that minimizes the realization of TAI. In later years when distributions are desired, the investment portfolio is repositioned to invest in assets which do produce TAI.

One common means of achieving income deferral is the use of commercial deferred annuities to control the timing and amount of TAI.  Our consultants are available for questions surrounding the special rules that should be considered when investing in commercial deferred annuities.

It is not possible to achieve income deferral with either a CRAT or a CRUT because these trust formats are required to make distributions, at least annually, to the income beneficiaries.

What are the typical responsibilities of a Trustee?

A trustee’s typical responsibilities include:

  • valuing trust assets
  • selling contributed assets when prudent
  • computing the annual unitrust amount
  • receiving and disbursing income
  • accounting under the unique CRT four-tier system
  • filing fiduciary tax and information returns
  • maintaining the trust’s tax-exempt status
  • holding and managing trust assets, and
  • communicating with and reporting to a CRT’s income beneficiaries