I want to use some of my assets to make a charitable contribution to two of my favorite charities. However, the stock I will be using is a low basis, high value stock. It is currently worth $1,000,000 and has a tax basis of $10,000. I have poor liquidity, and would therefore need some income from this transaction. If I sell the stock outright, the capital gains tax would be about 35% for federal and state, which would be approximately $346,500. In addition, because of the low basis for this stock, I would face high income taxes that would diminish the contribution to the charity. How can I provide current (and even better future) income for my family and myself AND avoid capital gains tax and minimize my income tax.
Have you considered a Charitable Remainder Trust (CRT)? A CRT can accomplish your objectives. It can provide:
1. A charitable contribution; 2. An income tax deduction; and,3. Income for you and/or your intended beneficiaries.
A charitable remainder trust works especially well with highly appreciated assets since you avoid paying the large capital gains tax; yet get a tax deduction for the full amount of the high current value.
Charitable Remainder Trust Explained:
In most instances, the charitable remainder trust pays income to the grantor and/or their spouse for the remainder of their lives. Upon their death, the balance in the trust is donated to their designated charity. The provisions a CRT must meet are defined in the Internal Revenue Code. The IRS has trust document samples on its website that you can review to help determine if you meet the provisions. The CRT is often referred to as a charitable remainder trust annuity or charitable remainder annuity trust.
The annuity beneficiary (you, your spouse or other designated individuals) receive an annual payment (or annuity) for life or a term of years based upon the percentage you select. This is called the "payout rate". At the end of the trust term, the remainder of the assets go to the charity of your choice. You can even use a portion of the annuity payments or the tax savings from the charitable deduction to fund life insurance, the proceeds of which would be payable to family members upon your death. If done properly, the life insurance proceeds placed in an irrevocable trust are not included in your estate.
There are two types of CRT's. The first is the Charitable Remainder Annuity Trust (CRAT) which provides a fixed annuity amount to the beneficiary. The fixed amount is based on a percentage of the property's value when it is contributed to the trust. This will benefit the charity and disadvantage the income beneficiaries during inflationary times since any increase in the value of the property will not increase the payout of income.
The second type of CRT is the Charitable Remainder Unitrust (CRUT). If the amount of income provided is variable (depending on annual changes in the value of the property), then it is called a Charitable Remainder Unitrust.
With either a CRAT or a CRUT, the annual payout must be at least 5% of the annual value of the trust property.
In order to set up a trust, you must have a trust document. This establishes the trust as a separate taxable entity. The process is similar to setting up a corporation. Assets are transferred to a trustee. Under current IRS rules, an income tax return (Form 5227 and Form 1041-A) must be filed each year. All trusts (including CRTs) are required to adopt a calendar year. The grantor must file Form 8283 "Noncash Charitable Contributions" if the deduction for noncash gifts exceeds $500. Appraisals are required for any noncash contribution except publically traded securities when the contribution deduction exceeds $5,000. Form 709 "Gift Tax Return" is required to report a transfer into the trust when an individual other than the grantor or the grantors’ spouse is a recipient of the annuity or unitrust amount.
If the trust is established at death (or otherwise included in the grantor’s estate), the charitable interest and individual interest are reported on Form 706 "Estate Tax Return".
There are two types of CRTs:
Charitable Annuity Trust (CRAT) - This trust pays a fixed amount to one or more persons annually.
Charitable Remainder Unitrust (CRUT) – This trust pays a fluctuating amount to the beneficiary based on a fixed percentage (at least 5%) of the annual trust value.
The "T" Word
Because the trust is (in most cases) a tax-exempt entity, the sales of highly appreciated assets do not trigger income tax on the appreciation. Income tax is paid by the beneficiaries if they receive income distributions during the year.
The grantor does not pay tax on capital gains AND receives an immediate income tax charitable deduction for the present value of the charity’s remainder interest. The present value of the remainder interest is figured out based on tables the IRS provides (it depends on relevant factors including value of property when contributed; amount of income/annuity to be paid to grantor and life expectancy of grantor or other beneficiary.
If the assets are of a CRT are transferred into the trust during a grantor’s lifetime, then they are no longer considered part of the grantor’s estate for estate tax or creditor purposes (unless the grantor retains an interest in the trust).
Controlling the Charitable Remainder Trust
The contribution to a CRT is irrevocable. However, you may have some control over the investment of the assets in the trust. For instance, it is possible to switch from one charity to another – as long as the charity is qualified under the tax code.
Charitable Remainder Trust Calculator
If you would like to use a free calculator to explore the benefits and possibilities of a charitable remainder trust, you can find one at PhilanthroCacl. Quite nifty!
Charitable Remainder Trust Forms
You can find a link to free sample Charitable Remainder Trust forms at the bottom of the article at Free Estate Planning Forms.
There are two official publications put out by the Internal Revenue Service (IRS) that can help you determine the value of donated property and the ins and outs of making charitable contributions -- for tax purposes. You can find those pubs at Pub 526 and Pub 561.
If you are looking for something that's similar to the CRT except that it will pay your charity current income and allow you to leave your property to your heirs, you should read Charitable Lead Trust.
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