Fedele and Murray, P.C.

17 Walpole Street, Norwood, MA 02062-3318 - (781) 551-5900

Charitable Remainder Trusts

If you have a low-yield asset (e.g., unproductive land or low-income stock) and if it would be good to sell if you were able to do so without significant taxes, a "charitable remainder trust" ("CRT") would be a good idea from a planning standpoint. If you set up a trust designed in such a way that some charity is guaranteed to receive the assets at the death of the survivor of you, you will be able to

With such a CRT you actually can have a better income for yourself because a non-income producing asset can be converted into an income producing asset but without the government taking a big bite out of the asset when it is sold. Any capital gain is tax free unless and until you withdraw "income" from the trust and such income is greater than the actual income earned by the trust. For example, if you established a trust that will pay you eight percent of the trust’s value each year and if the trust earned six percent in a particular year, the excess two percent being distributed to you would represent capital gain. That result will occur only if the distributed amount is greater than the actual income and only to the extent there remains untaxed capital gain in the trust. If the trust were designed to pay only the actual income earned, you would never be taxed on any capital gain.

The CRT is probably the only vehicle that actually makes it profitable to give to a charity; thus, even people without a charitable motive will use them to increase the family’s wealth. If one is charitably motivated to begin with, the best of all worlds can result (except for the government taxing authorities).

If you created such a trust and used part of the extra income you earn by paying insurance premiums on a new life insurance policy with a face amount equal to the value of the asset that you give to charity, your children will actually inherit more. The reason is that the insurance will replace the CRT asset, but the insurance can easily be arranged to avoid all estate taxation (such as by using an irrevocable insurance trust). Because the insurance bears no estate taxes it effectively is worth over twice as much to your children as would a taxable asset of the same value.

For example, suppose you took a parcel of vacant land that annually costs you $1,000 of taxes and other carrying expenses after all deductions are allowed. Suppose it is worth $200,000 and that you bought it originally for $50,000. If you sold it, there would be a tax of about $35,000 between federal and state taxing authorities. That would leave you with $165,000 of proceeds to invest which, at 7%, would generate an income of $11,585 per year. At your death someday, assuming you would be in roughly a 50% estate tax bracket, there will be an estate tax of about $83,000—assuming you had sold it and paid a capital gains tax while alive. If you had not sold it during lifetime, the estate tax on that land would be slightly over $100,000.

Suppose instead that you contribute the land to a trust which provides for a 7% income payment to you each year, with the assets in the trust passing to a charity after you have died. Such a trust would give you a current income tax deduction of $39,000, saving you about $15,500 on your first year’s taxes—assuming a 39% bracket. The trust could sell the land and pay no taxes; that would leave the full $200,000 for investment which would provide you with $14,000 each year. That puts you $15,000 ahead, considering you would no longer have any carrying costs.

Suppose further that you took $5,000 of the added income you would be receiving and paid premiums on an insurance policy. That might buy about $250,000 of insurance. If you then arrange to have that policy owned by an irrevocable trust, the result will be a net inheritance to your children of the entire $250,000. Compare that to the land passing to them; that would leave them a net of less than $100,000. Thus, even if you assume that the land would have grown in value, the insurance arrangement is better unless the land would have appreciated to more than $500,000 prior to your death. That does not even consider the $15,500 deduction nor the added income you would have had during your lifetime. If you add to the foregoing the fact that you would still have an additional income of $9,000 plus the relief of $1,000 in annual expenses, you can make a case that it is foolish not to enter such a plan—assuming you have the type of asset described or something similar such as low basis, low earning, IBM stock.

If you created such a plan, you are able to be your own trustee, and you would be able at all times to change the identity of the charities named in the instrument. If the trust assets increased in value through a good stock market and smart investing, your income would increase proportionately. The 7% specified income (or other amount you specify) would be a function of the annual value of the trust.

Return to Charitable Giving